Blackstone Inc (BX) 2014 Q3 法說會逐字稿

Good day ladies and gentlemen and welcome to the Blackstone third-quarter 2014 investor call.

My name is Lisa and I will be your operator for today.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Miss Joan Solotar, Senior Managing Director, Head of External Relations and Strategy.

Please proceed, ma'am.

Thanks, Lisa.

Good morning everyone.

Welcome to Blackstone's third-quarter 2014 conference call.

I'm joined today by Steve Schwarzman, Chairman and CEO; Tony James, President and Chief Operating Officer; Laurence Tosi, CFO; and Weston Tucker, Head of IR.

Earlier this morning we issued our press release and slide presentation illustrating our results, which are available on the website.

We expect to file the 10-Q in the next few weeks.

So I'd like to remind you that the call may include forward-looking statements, which are uncertain and outside of the firm's control, and actual results may differ materially.

For a discussion of some of the risks, please see the risk factor section of our 10-K.

We don't undertake any duty to update forward-looking statements.

We will refer to non-GAAP measures on the call and you can find the reconciliations in our press release.

I'd also like to remind you that nothing on this call constitutes an offer to sell or solicitation of an offer to purchase an interest in any of our funds.

The audiocast is copyrighted and can't be duplicated, reproduced, or rebroadcast without consent.

So, quick recap of our results.

We reported record third-quarter economic net income, or ENI, of $0.66; that's up from $0.56 in last year's third quarter and it was driven by both higher performance and management fees.

Distributable earnings of $672 million or $0.53 per common unit were also a third-quarter record and more than double last year's third quarter.

Of that amount, we'll be paying a distribution of $0.44 per unit to shareholders of record as of October 27.

And with that, I will turn it over to Steve Schwarzman.

Good morning and thank you for joining our call.

Or maybe not such a good morning depending upon what you own in the markets today.

Blackstone, however, has had a terrific quarter, which was a record third quarter for ENI, cash earnings, and assets under management.

In fact, in every major area, investment performance, capital raising, investment activity levels, and realization, the firm is producing record or near record results.

Our investment performance continues to significantly outperform the public market.

Over the past 12 months we've created $35 billion in total appreciation across our funds; a staggering number.

Even in the third quarter, most of our funds delivered returns that were multiples of their comparable market indices.

Our real estate funds were up 6% for the quarter, and 28% for the past year.

Our private equity funds were up 4% overall for the quarter, 28% for the prior year.

Our credit drawdown funds, as Tony indicated earlier, were up between 8% and 15% gross for the quarter.

The stock market barely went up at 30% to 34% for the year, altogether, this is really stunning performance.

This performance, along with strong demand for alternative products continues to drive significant capital inflows to the firm against the positive secular backdrop of limited partner investors allocating more to alternatives, which I think we've told you in prior calls, was going to happen.

Also, reducing the number of managers they do business with, we also indicated we thought would happen.

Blackstone is, I believe, the best positioned firm to capture and grow market share and that's occurring.

We're doing that in all of our businesses.

As our global investing platforms have become more diversified, we continually have new funds in the market, and our capital inflows are no longer the step function they were years ago when we were a lot smaller firm.

Blackstone has raised $13 billion just in the current quarter.

And $55 billion over the past year, which is by far, a record.

In the past two years, we've raised $100 billion.

That's greater than the total size of many of our closest competitors.

It's a real testament to the performance of our products and our relationships, and depth of relationship with our limited partners.

We have $42 billion in dry powder capital to invest, and with leading global platforms in each of our investment businesses, we're able to find many interesting opportunities to deploy this capital.

We invested or committed a record amount in the third quarter of $10 billion, bringing us to nearly $30 billion over the past year as a result of our unique position.

Over 30% of the $30 billion was in Europe, primarily in real estate, as we are taking advantage of the current distress there.

GSO completed the largest investment in its history, for example, a $1 billion acquisition financing package that they were uniquely positioned to execute.

Our private equity invested in several very carefully selected and conservatively structured deals.

Our new European real estate fund, as Tony mentioned, is now two-thirds invested or committed after only one year.

We were waiting for the European real estate sales to break open, and it did and we were ready.

And we've executed.

Because of our rapid deployment, we've agreed with our investors to expand the size of what was already the largest fund of its kind ever raised in Europe, by additional EUR1.5 billion.

That will bring the total fund to EUR6.6 billion, or approximately $8.8 billion dollars, bringing us well to continue to take advantage of the distressed opportunities in Europe.

This is really quite remarkable.

It exemplifies how quickly Blackstone can raise and deploy large-scale capital to take advantage of a vintage or market opportunity minimizing any J curve.

Private equity we very selectively pursued transactions usually with low double-digit unleveraged target returns and enhance those returns further with prudent levels of leverage.

We've been doing this for about 28 years and it early works out extremely well for our investors.

In fact, despite having an active weekly calendar deal sheet, the vast majority of our corporate private equity capital deployed was actually only in 10 to 15 transactions a year.

It's a very small number of actual transactions when you look at it on the global basis, which is why we can be so careful in terms of setting up things we think are very sensible for our investors with minimum downside and a lot of upside.

Our behavior remains contrary to what you may hear about capital-chasing deals and sacrificing returns, or taking additional risk in order to move capital.

Since the end of the third quarter, obviously, public markets have clearly deteriorated significantly, with a sharp increase in volatility that you can see on your screens and see on television.

The S&P and global indices are both down 6%.

Credit indices have also declined with widening spreads and frankly a lot less liquidity than people expected.

Hedge funds are being forced to unwise positions and sometimes are doing them voluntarily, and capital markets generally have seen decreased liquidity, as I mentioned.

I'd like to make two important points on this development.

First, we are uniquely positioned to take advantage of the market volatility across all of our businesses.

We've seen the public markets correct many times before.

And as always, we'll present the potential for abnormal deal flow with favorable risk-adjusted returns.

With one of the largest pools of dry powder capital, we can and will move quickly to respond to market dislocations.

These types of investment environments end up becoming some of our best vintages.

Our job is to look at the markets and the world objectively, not emotionally.

Second, as it relates to Blackstone's current investments and our performance going forward, public markets alone do not dictate realizations for us.

We also rely on strategic sales, strategic buyers, and other private sale opportunities, which would include the liquidation, for example, of our office portfolio in real estate.

We closed the sale, $2 billion of our Boston office portfolio in the third quarter, and have approximately $12 billion of office assets remaining in liquidation.

In addition, our growing base and expanding diversity of monies under management drives greater ongoing fee-related earnings, which are part of our distributions to shareholders.

In other words, we are not hostages of the stock market.

We have a lot of mechanisms for realizing investments.

We are never forced sellers, unlike almost all other market operators.

Given the long-term and locked-up nature of our funds, with no redemptions, we do not sell at inopportune times, as I have seen people do repeatedly in times of market uncertainty.

In fact, our portfolio of Companies are in great shape, best shape they've been in in many, many years, and continue to see strong operating results.

So if we have to wait from time to time for a realization, it's not a bad option.

A market readjustment might delay certain public market dispositions in the near term, but things have a habit of changing.

But if the timing is impacted, we would expect our Companies to continue to grow very nicely while we wait, compounding our return for our investors where they end up being very pleased when we sell these investments.

The public markets tend to overshoot and undershoot what's going on in the economy, and the investment sentiment, now, we all know, is very negative.

What we see, however, is that the US is growing nicely, particularly in our real estate area where we're seeing sustained positive fundamentals across every sector of our portfolio.

In our private equity Companies, revenue and EBITDA trends remain quite strong, up 7% and 10%, respectively year over year, well ahead of the average company.

The US market is currently trading somewhere around 15 times earnings, although that seems to move around a lot every day, which doesn't seem unreasonable.

Very low interest rates and declining oil prices should be good for growth in most countries of the world.

We feel very good about our current portfolio, and particularly good about our ability to invest when other people have fear.

On the advisory side, we also have tremendous momentum.

Our M&A backlog is more than double what it was this time last year.

That's double.

Our restructuring group was just recognized by Thomson Reuters as the number-one distressed advisory business in the world, and Park Hill is the clear number-one in the placement business in the world, and is projecting a record year this year.

As we announced last week, we'll be spinning these businesses into an independent publicly traded firm at some point next year.

We are very excited about the opportunity for that.

There couldn't be a better time other than the market uncertainty to launch this new Company, given the significant market opportunity that exists for a top-notch, independent, and diversified advisory practice.

With such a talented team untethered from our larger asset-management business which creates conflict, and under Paul Taubman's leadership, one of the top bankers and advisors in the world, I believe we are creating something that will be truly special.

Feedback from our clients and potential clients has been extraordinarily favorable.

Our shareholders should benefit as stand-alone advisory businesses generally trade at significantly higher multiples in the public markets than Blackstone does.

A better earnings trajectory coupled with a better multiple should equal a compelling value for our shareholders.

In summary, I couldn't be more pleased with our third-quarter performance.

I'm excited about the firm.

We are wonderfully positioned and I expect a lot of good things to be happening over the forthcoming years.

With that, I will ask Laurence Tosi to take over with a review of our financial results and then we'll be taking questions, and there are a lot of them for us, because I think the current market environment gets people curious as to what's going on, generally, and what we're seeing.

Thank you, Steven.

Thank you everyone for joining the call.

The one takeaway we want to leave investors with today, is that while market movements are, by their very nature, temporary, the momentum of Blackstone's performance is not.

In the third quarter, the S&P saw volatility and a peaked trough value differential of 5.3%, similar to the volatility seen in the fourth quarter to date.

It still ended up largely flat on low growth and earnings for the index companies.

Against this rather lackluster backdrop, Blackstone has produced record third-quarter and year-to-date earnings while posting above market fund performance in almost all of our investing businesses.

The key to Blackstone lies not in short-term public market fluctuations, but in longer-term trends like the availability of credit, the mispricing of liquidity, bank downsizing, regional capital constraints, supply and demand imbalances, strategic opportunities, lack of new construction, asset price devaluation, and operating underperformance.

These are operating and risk drivers that make up Blackstone's expertise, not public market metrics.

The 30% returns across private equity real estate and credit funds over the last 12 months reflects strong underlying portfolio Company and asset performance, as Steve outlined.

These are some of the best fundamentals and operating performances we have seen across these assets classes.

Similarly, BAAM outperforms most in difficult markets, while also maintaining one third of the volatility of the S&P, which is why that business is seeing both record inflows of $12 billion over the last 12 months, while outpacing the broader market in returns year to date.

More than anyone, our fund investors understand and appreciate the long-cycle benefits of investing with Blackstone.

Over the last year, we had record organic inflows of $55 billion, but perhaps most interesting, is that 65% of that amount, or almost $36 billion of the inflows came from new funds, new businesses, and new strategies we didn't launch until a few years ago, as we continued to innovate best-in-class product, ideas, and extensions across Blackstone.

We also had $18 billion of inflows over the last year in evergreen funds that are always in the market, giving us continuing access to new capital.

Some of those funds are specifically created for high net worth individuals where we have raised a record $10 billion over the last 12 months, representing a new and growing market for us where there is a broad demand for Blackstone's unmatched product quality, depth, brand, and performance.

Over the last several years, almost all of Blackstone's drawdown funds have hit their caps.

This strength is continuing for alternatives in general, and Blackstone in particular.

We are currently fundraising our second energy fund, which is well on its way towards our $4.5 billion cap.

We're also raising our second tactical opportunities strategy, which we think could exceed the $5 billion we raised for the first fund.

Our new core plus real estate platform is nearing $2 billion in commitments.

We are launching new strategies in our secondaries business, which just closed on $4.4 billion for its newest fund, nearly doubling the last pre-Blackstone fund, in part, by accessing channels uniquely developed by Blackstone.

We're also adding EUR1.5 billion to our fourth European real estate fund, which is double the size of its predecessor fund.

These fundraisers will drive growth for Blackstone, and that is before we even begin to launch our flagship seventh global private equity fund this year and our eighth global real estate fund early next year.

All of this comes at a time when we are returning record levels of capital to our investors at attractive returns.

Record AUM and consistent fund performance on a growing base of assets accelerates earnings and distributions even in volatile or flat public markets.

This is exactly what we've already been seeing so far this year.

Our record year-to-date ENI easily outpaced record fund performance, boasting a 47% increase to $2.9 billion.

Realization activity was also robust, and continued unabated in a flat but sometimes volatile market, driving distributable earnings up 85% to $1.9 billion, another record.

In both cases, the performance was broad-based and that, for investors, is a unique balance only Blackstone can deliver.

Further note, that while marks can impact ENI temporarily, distributable earnings is a longer-cycle reflection of both sustained inflows and the value created in our funds, where we focus on decade-long returns and never on just quarters or even single years.

First, we are at record levels of locked-in fee revenues and profits, up 22% on record inflows, a consistent source of cash earnings, regardless of market conditions.

Secondly, our realizations are also of greater scale and more diverse across a wider set of growing businesses than ever before.

Some details.

The momentum of realizations has been building over the last several quarters with the second and third quarters of this year marking our best realized performance fees ever.

Distributable earnings year to date reflect over 150 different transactions.

Only 50% of those transactions involve public markets.

The remainder was generated by private sales, operating earnings, and refinancings.

None of that activity is dependent on public market or occurs at a spot price.

Our forward outlook for realizations has a similar public and private split.

Blackstone's financial profile has also been strengthening at a rate greater than the broader markets.

At the end of the quarter, Blackstone had a record $8.72 a unit on our balance sheet, up 34% in just one year.

Our liquidity profile has also improved as we ended the quarter with record cash and treasury investments of $2.56.

We currently have $4.3 billion or $3.78 per unit in net accrued performance fees, and another $931 million or $0.81 per unit of investment gains on the balance sheet.

Together, this represents $4.59 a unit of future cash earnings, and 64% of that amount is in assets that are public, liquidating, or paid annually.

Our record results for the quarter, the year, and the last 12 months reflect sustained fund returns, strengthening of our market position, and earnings momentum that will certainly outlast current market volatility.

For whatever reason, what drives Blackstone and what drives Blackstone stock price appears to date, to be two entirely different and somewhat unrelated dynamics.

We do know that Blackstone's performance is driven by long-term, value creation in our funds, which in turn drives the growth of our asset base and our earnings performance.

Today, those dynamics are unchanged and have never been stronger.

With that, we will open about up to questions.

(Operator Instructions)

Craig Siegenthaler with Credit Suisse.

First, on BCP VII, I'm just wondering did any of the recent market weakness have any driver in terms of the timing?

Starting to raise that fund here in the fourth quarter, just given improving assets, class valuations broadly, here?

No.

This is Steve.

I'd say, absolutely not, for that.

We are kind of a strong investment rate and when it's time to raise funds, typically, as you know, we get around 75% invested.

You go out to market, we are approaching that.

So there's nothing other than normal course in that.

One of the interesting things, the trend that's going on as opposed to several years ago, is that larger sized funds are becoming much more popular, if you will, than they had been.

So that's a good sign for that fund raising.

That's an across-the-board type of phenomenon, not just involving Blackstone.

Larger funds and alternatives, also, alternatives in general are growing as part of LP's portfolios.

Thank you.

Bill Katz with Citi.

Just two unrelated questions.

The first question I have, you mentioned in your opening remarks that the flexibility to exit and selectivity on private equity deals and still applying some good, underlying rates of return, both levered and unlevered.

I guess the question that is affecting the group and your stock to some degree, is how are you thinking about funding availability given the fact that credit spreads have backed up a little bit, and some banks have been highlighting the riskiness in the levered loan markets.

How do you think about financing growth from here?

My own sense, and Tony can give his view, is things cycle a bit, in terms of the availability of credit.

We haven't been seeing that this is a problem, and we may have a somewhat idiosyncratic portfolio or the types of transactions we are doing.

In our model, private equity, availability of capital is the most important criteria.

The cost of money goes up and down a little bit, doesn't affect return too much, surprisingly.

So at the moment, we haven't really experienced what you're describing.

I will add two things.

First of all, as I said, many times before, but I just want to remind the audience, here -- hot credit markets tend to be difficult markets for us to earn high returns on new investments.

So we don't -- if the credit market has cooled off in private equity, we would welcome this.

Secondly, we have been shying away from maximizing leverage in private equity for some time, just feeling there was too much credit available, was leveraging the company's too heavily.

I think Steve mentioned, we look at -- the real driver of our investing is unlevered returns and they have to get to the levels.

Then we use credit markets to enhance that and magnify it.

But they've gone overboard.

So a lot of what we've been doing, specifically in investing in private equity have been growth investments.

I mentioned on the press call, energy investments where we're actually going out and finding hydrocarbons or building generation facilities and so on and so fourth, which are not particularly credit market dependent and not, also, equity market or anything else dependent.

We're not worried, I guess.

One other thing.

Blackstone, taken this group is in most years, the largest generator of fees to the financial community in the world.

So if there's credit to allocate, we tend to be well-positioned to get that credit.

Also from memory, I don't know that throughout our whole complements of real estate, and private equity, and other types of investing, that we've ever lost money for any bank in the firm's history.

This type of positioning, in terms of protecting the banking system, when we borrow money, as well as being historically one of the top fee payers of the world, really positions us very well.

When Tony said he's not concerned about -- in effect, the difficulty of borrowing money, that when times are tough, borrowing, generally, prices go down.

Then there's a cycle where credit improves.

If you can buy things when those prices go down, you always get wonderful vintage returns.

It's just logical.

We don't look at any of this as a problem.

In a way, it's a competitive advantage for the firm.

Thank you for that perspective.

My second question, unrelated.

You mentioned in your press release you're having some good success in European retail funds.

Could you talk a little bit about how you see that opportunity over the next several years?

I'm thinking maybe if you could answer it in the prism of either product opportunity or incremental distribution relationships?

Okay.

I think you are referring to the comment in the BAAM portion where we talk about the use of funds we released in Europe?

Correct.

It's two things at play.

The first is BAAM has been hard at work for several years at different ways that they can create customized or tailored versions of their products and risk exposures for the retail audience.

The launch of our first ever usage fund in Europe is an extension of that.

So on a macro basis we're talking about addressing retail with retail tailored products within BAAM, and more recently, putting out the usage structure.

There are other funds at Blackstone in other businesses that are more liquid, that will benefit from a usage-type structure that we can then offer to that European retail base.

And that's some of the beauty of having the technology or the learning, if you will, fund by fund, we can pass that onto the other funds as we offer them.

So it's another way of accessing that market.

The usage structures are very popular and dominate the high net worth channels in Europe, and the ability of BAAM, frankly, over a couple of years to tailor to that audience is really great growth opportunity.

Okay.

Thank you.

Michael Kim with Sandler O'Neill.

My question has to do with the outsized growth that you talked about coming from newer strategies that you've brought to market over the last few years.

Just wondering how you're thinking about product development broadly speaking, these days, going forward.

Then, related to that, as these newer strategies continued to season, what's the dynamic between letting incremental revenues fall to the bottom-line versus continuing to reinvest in the business as that cycle plays through?

Just in terms of developing new products, we actually have a very good procedure here.

We have once a year strategic planning sessions for each of our four major business groups.

At that meeting, each group brings in two to three new ideas, ways that we can serve investors better, generate high returns for them, which tends to be, in effect, packaged as a new product.

Then we debate among the Management committee members and the group, as to which one has the best upside for our investors, and how executable that is.

And depending upon the ease of introduction, we either do one of them in a year, assuming there's something really good to do, or if there's really something terrific in two of them, we will do two of them as long as we have the human capital to execute.

It's a wonderful way to run a business, because it gives younger people in developing talent, the opportunity, with supervision, to run these new businesses.

So we have a steady stream of these now.

10 years ago, some of us had to invent these things, very few remember it's a system.

In terms of the second part of your question, we don't flaunt for financial resources to prosecute our growth strategies at the firm.

In other words, if there's something terrific to do, we will do it, because as you know, markets are somewhat fragile.

There is a moment for different strategies.

Our job is to hit that moment where we can generate really outsized returns for our clients and our investors.

So we don't hesitate to spend whatever it takes to stand up any new product if it's really terrific.

So it's a simple way we do things.

Michael, let me just say, in general, we've never had more new products than we have now.

The new products we have have never had more opportunity to be huge.

So more runway ahead of them.

We are not talking about starting something that's niche and that is what it is.

We are talking about things which could be huge, even in the scheme of Blackstone.

I think we've got the richest, biggest, longest term, strongest new product set we've ever had.

Yes, there is a lag.

We lose money for the first few years in a new product, typically.

That investment is flowed through the P&L.

So the future is to come.

Great.

That's helpful.

Thanks for taking my question.

Glenn Schorr with ISI.

Two quickies.

One is, fourth quarter historically has been a very good performance fee quarter for you all, and performance over the last 12 months has been excellent, as you pointed out.

How much does the volatility that we've seen in October dent what should have been really good expectations for performance fees?

Any color around how we should think about that for the fourth quarter would be great.

Glenn, it's LT.

A couple of things.

You are correct.

Typically the fourth quarter for us, let's just talk about locked-in fee growth and deal activity tends to be busy, as there is some seasonality to our business.

We tend to be about 28% to 30% of a full year's fee-related activities during the fourth quarter and that's been true for several years.

But I don't think these short-term market fluctuations will dent that.

With respect to performance fees and the performance quarter to date, we saw some volatility in the third quarter, turned out to be a great quarter.

We'll just have to wait and see.

No problem.

Another unanswerable one, curious on how you think about the potential of the buyback in the context of great growth, great performance.

You've been vocal enough that you think the stock is cheap, so do I. Yet, you've got to manage the fact that the float is small.

The reason I ask, is the share count each quarter has been up a little bit year on year, nothing material.

Just pops to mind.

It pops to our mind too.

We actually think the liquidity of the stock is pretty good by comparison to the rest of the industry, but we haven't made any decisions.

I think our liquidity equals pretty close to the liquidity of the whole rest of the industry.

So in that sense, it's pretty close to that.

So we think we have good liquidity, and I think on our of valuations, it wouldn't surprise you, but I often turn out to be right on these things.

It's sort of really, like, what are we thinking, frankly.

I think Glenn, you raised a good point.

The free float now is about $15 billion or so.

That's continued to move up and over time, we would expect the whole sector's free float will move up into more mature territory.

So I think it's just following the path of other financial services subsectors; when they were born and became more mature like you saw with the whole brokerage industry.

But as Steve mentioned, relative to the rest of the group, I think if you look at our average daily trading volume, it equals more than pretty much everyone else combined.

So there seems to be good liquidity.

All right.

Thanks very much.

Patrick Davitt with Autonomous.

Wanted to focus a little bit on energy exposure and oil, in particular, and how you think -- how we should think about $80 oil or even lower flowing through private marks, or if you think that's much of an issue.

Secondarily, does the collapse in the oil price change your view on that niche as kind of a major growth engine for your business?

Okay.

I don't think we think the lower oil price will have a very big impact on our marks.

There is some companies we still own that are dependent on oil, most particular Cosmos; it trades publicly on the stock market.

So you'll know what that's doing to the marks, you can see what happens to the stock price.

With respect to a lot of our private oil-oriented assets, most of them have been sold, frankly.

Lately, we've been mostly buying gas, figuring that gas was nearer or low ebb and oil was pretty high.

That view has been pretty accurate.

And then in general, lower energy costs and lower feedstock cost for a lot of our companies, actually is helpful for margins.

So how all that plays through on balance, I'm not even sure it's negative at all.

But I must say I'm not sure.

And dislocation in the energy business, we think this is a temporary dislocation of oil price.

We think that our long-term view of oil price really hasn't changed.

Our long-term view of energy prices was below most of the price levels in the last two years.

It's probably a bit above today's spot price.

But we review that periodically.

Our investments that we've been made in energy will be quite successful if oil prices even stay at this level.

Great, that's helpful.

Thanks.

Robert Lee with KBW.

Could you update us on so many fundraisers, I sometimes lose track.

Where do things stand with BREP, I guess it would be BREP VIII, so what you're thinking about that.

Also curious on BCP VII and maybe also the next BREP fund, are you seeing any change or change in the typical LP demands, particularly maybe around the demands for coinvest?

Is it backing off at all?

Is it getting more pressure for coinvest opportunities as part of the commitment?

Just some color on that would be helpful.

Okay.

BREP VIII will be -- Steven will chime in in a minute -- BREP VIII looks like it will be early next year sometime, most likely.

BCP, probably late this year, most likely.

Yes, there's a lot more interest on the part of LPs for coinvest.

What I would say is that almost every fund -- I'm not aware of any fund that's trying to be -- not criticized by my General Counsel -- but every fund that we've offered over the last several years has like been significantly oversubscribed.

So when you asked the question of what do we think is going to happen to BREP VIII or where we typically in real estate have been the signature sort of investor, where people like to put money -- that's been the empirical reality, giving us huge multiples of what other people have raised.

We don't know anything in the environment that's going to change that.

We can't guarantee that, but that's what we would expect to have happen.

In private equity, as we are going to market, we've had a very successful fund VI so far, and we have a lot of activity and we'll see how that goes.

There is more of a demand for coinvestments.

But it's interesting that we are being regularly approached for very large capital allocations by some of the largest investors in the world, way beyond what we've ever experienced.

And sort of as part of a package, they'd like to see in some cases, more coinvestment.

What we find is just fascinating, is that when we offer coinvestment to people who ask for it, they don't often take it.

I don't quite understand that.

But they are trying to balance their own portfolios and they've got their own reasons for not wanting to do something at any given point in time, given the demands on their overall payments to beneficiaries, or whatever.

So in a way, we think this is something that makes sense from their perspective.

It certainly makes sense from ours.

And these discussions -- net net, the evolving world appears to be a very good one for a firm like ourselves.

So it's not an issue that's unexpected.

And in many cases, in the olden days, like four years ago, when we needed more money for an individual transaction because of size, we would call another firm, a competitor of ours, and team up and make investment.

It works really nicely to have our own limited partners put up that money.

It makes them happy.

Gives us more control of the deal, less shared control, because typically we are in charge of that investment.

So it's an interesting phenomenon, but it works very well for us.

Maybe one other quick question for LT, just a modeling question.

It looks like the taxes have jumped up a bit in the quarter.

Anything specific driving that?

Sure, Rob.

There's really two factors at play.

The more material factor -- so what you are referring to is our tax rate typically runs around 2.5% to 3%, it jumped up to about 9% this quarter.

So that 6 percentage point difference, a large part of that is related to the fact that a very good, in fact, record realization quarter in GSO -- those realizations are on the mezz funds and the rescue funds, which are typically ordinary income funds, and so there's a higher tax rate associated with them.

That's number one.

And number two, the pre-IPO funds in real estate, which would BREP IV and BREP V, also had strong realizations and those too actually run through an ordinary income vehicle.

So I would say it's a short-term spike in large regard related to those two phenomena related to the realizations in those funds.

The second and to a lesser extent impact on it is that much of the equity that we grant, invest in the first half of the year, which lowers the tax rate as that gets deducted for tax reasons.

Rob, with respect to modeling, I think I'd continue to keep it to what it has been historically and I would view this as a one-time event.

Great, thanks for taking my questions.

Devin Ryan with JMP Securities.

I just want to follow-up on the strong realizations in real estate, just to make sure I understand.

So BREP IV and BREP V, I know you guys had mentioned earlier in the year that we'd be seeing a pickup in realization activity.

So just trying to get some additional perspective there around how strong, now we've had two really good quarters and realizations.

Just get a sense of some perspective of is this kind of a sustainable type of trend?

I know it will be lumpy.

But are we now at a more elevated potential level moving forward here for at least the foreseeable future?

With regards to BREP, we think what you've seen a sustainable and could even grow from here.

Okay.

Great, good to hear.

And then secondly, with respect to $13 billion of gross flows, is there any way to break down how much came in from existing LP relationships and maybe how much of those flows are being generated from new relationships that you guys have made?

It's LT.

About 80% of those flows are coming from existing LPs.

I did highlight in my speech that there's some new pockets of LPs as well that are contributing materially.

And one of the exciting aspects of this is that we're also putting now a wider range of funds in front of the same LPs, so the cross-selling continues to gain momentum.

And all those, the new pockets, the cross-selling, we all view as sustainable trends.

Great.

Appreciate the color, guys.

Mike Carrier with Bank of America.

Steve, you mentioned upfront, some of the color around the portfolio Companies and how they are performing.

Just curious if you can give some perspective on maybe the European part of the business?

It could be in real estate or private equity.

But what are the trends there maybe in some of the sectors?

And if the growth outlook does take a step down, how is that relative to what your expectations were in making some of these investments?

And then for the portfolio Companies, what are their options to try to hit those returns?

Meaning, driving stronger revenues?

Looking at expenses again?

Just what are the variables that they will reconsider if the growth is slowing?

I'd say in the European area, our biggest exposure is in real estate.

We have a very conservative view towards Europe.

[I guess you would] another word choice, [other half to that], which is unoptimistic.

When we buy something, and again we are buying very large amounts of different types of assets, simply because there's an imbalance with way more sellers than buyers, which puts pressure on price.

So we can create investments at very good yield and then leverage them and get very satisfactory returns with no growth in individual markets, simply because of the illiquidity out there.

We also, when we buy something, we try not to be asset buyers of anything.

We usually have some improvement plan of what can be done, even if a market is flat.

If an asset has not been maximized, our job, as John Gray would say, very nicely, it's by it, fix it, sell it.

Our overall economic model is that we are not optimistic about economic growth in Europe.

So we're consequently not disappointed when that growth is not there.

It's all part of that plan.

In terms of purchases of US assets and what we were talking about and Tony mentioned in his remarks earlier, our investments in fund VI have performed very well, very well.

And we're not supposed to be selling securities on these calls, so I guess I won't tell you how well it's doing.

It's like really good.

So we've been, if you will, surprised on the upside.

That was not the case, in effect, four years ago after the financial crisis.

It was slow coming out of the chute.

Both real estate in the US and private equity in the US, is doing better than our expectation.

So that's all good.

That's sort of how we see the two geographic areas that I think you asked about.

Yes, that's helpful.

LT, real quick, just given the volatility in the markets right now, with BCP V, how much of a buffer do we have if it got back to close to the hurdle?

And then on the transaction fees in the quarter, was pretty high.

Just wanted to get any color on the outlook there?

Sure.

For BCP V at the end of the quarter, it was about halfway through the catch-up, and you need, if you were to reverse the carry that we've accrued year to date, you'd need about a 10% decline in equity value to reverse it.

Just to give you an idea of magnitude.

It's been accumulating over some time.

With respect to transaction fees, the uptick in the quarter had to do with an interesting transaction really in real estate that you will see on the line by line related to what is effectively a disposition fee that they got on the syndication of a deal, so it wasn't just their own sale, which was quite material and that caused the uptick.

Other than that, it was relatively flat quarter over quarter for the transaction fees for the quarter, as a whole.

Okay.

Thanks a lot.

Marc Irizarry with Goldman Sachs.

Steve, I just trying to figure out the impact that denominator effects have maybe had on the allocations to the firm across asset classes.

If markets are more volatile and outlooks changed around rates and global growth, and public markets trade lower.

Do you think going forward that that could play a role in the percentage that investors might allocate to alternatives?

Thanks.

That's a good question, Marc.

Obviously, if these funds shrink down 75%, and they have no money of any type and the world is completely desperate, yes, that will have an impact on everybody who's in the business, even Goldman Sachs, a great firm.

In a normal operating environment, since we are actually selling out everything that we've offered, we have a built-in buffer in terms of that shrinkage.

There's also something very material going on, and that's the fact that not only are about half of large institutional investors increasing their exposure to alternatives, they are really shrinking the number of people, the number of firms they give money to.

So what's happening with that phenomenon, it's quite wide spread, it's hurting capital to the high-performing firms -- sort of like ourselves who can also handle significant amounts of money.

So if you have roughly half of the investor base increasing in our class, let's just say that markets are down 5% to 10%.

Given the fact that they'll be a significant shrinkage of money managers that will be allocated to, and the fact that we constantly at least over the last X number of years have been limited by investors as to how much money we can take, not what they'll give us.

Every fund has limited us.

We've blown over the caps.

So we have a lot of safety, if you will, built into that.

If markets give way to the point that there is a catastrophe, than what happens is, people just freeze.

But I don't think that's part of this cycle; the US economy is doing quite nicely.

I think we've got like an overreaction going on, because it's health concerns, foreign policy concerns, all this stuff come together that's just scaring people.

In a way, you can't blame them, there's a sense that we're sort of out of control and that's being reflected in the markets.

But that's not -- I don't think -- sustainable.

Let me make a couple of comments.

First of all, from five or six years ago, public markets are up 70% or something.

It's huge.

It's up way more than these people have been able to allocate to alternatives.

Secondly, they're net becoming disinvested in alternatives.

For several years they've been getting back way more capital than they're actually able to put out, which is causing them to run faster and faster to try to get invested.

Thirdly, some of the markets like treasuries are actually appreciating in here.

Let's not forget that.

And a few days in the public market, when year to date, maybe it's off the peak 5% to 6% in the last few weeks, but boy, it's still a pretty high level by most standards.

And then finally, where the big new flow is coming are not so much some of these traditional pension funds with asset allocation and denominators; a lot of that money is coming from sovereign wealth funds from foreign investors and whatnot, where they are wildly underinvested in alternatives where they are just beginning to move money into that.

So there are a lot of trends here that overwhelm a few work weeks in the stock market.

Right.

And we are perceived by non-US investors as a US-based firm, even though we operate globally, we are US-based.

Right now, the US is the number one developed market economy that non-US people, as a rule, want to be invested in.

They're very open about that.

So our positioning is quite good.

Okay.

Great.

Thanks.

Brian Bedell with Deutsche Bank.

To follow on the line of fundraising maybe in a different way.

I think Steve and Tony, you mentioned the pace of deployment or the opportunity for deployment could potentially improve with the dislocation in the markets.

Two questions on that.

Maybe first, how quickly do you think that could improve, given what we are seeing in the markets?

And if you could comment on the US versus non-US.

Then does that give you capacity, as you mentioned Steve, you are oversubscribed in a lot of funds, typically.

Does that do you feel gives you capacity to basically raise or to basically narrow that gap between oversubscription and what you actually raise?

Let me comment on the deployment.

First of all, I think we're all getting a bit really focused on -- overly focused on a few days in the public stock market.

Our business isn't really a public markets business and so things don't move that quickly.

It's a long-term business, as Steve said, we buy assets.

The value doesn't come so much from the purchase price or the exit multiple, it's the value we create in the assets, which decouples the investment performance from economies and markets.

The fundamental picture, frankly, notwithstanding a few bad days in the market, hasn't changed very much.

In terms of the deployment level, recognize too, that the deployment levels are already extremely high.

So do I think that they'll go a lot higher from what they've been?

No, I don't.

Do I think that we'll be able to have maybe some juicier opportunities and some things that are a little easier to find?

We've been working hard to find what we've been finding.

And be able to sustain our deployment, I do think that.

So I'm not sure I can quite -- and I'd say both -- that's the same for the US as well as the non-US.

I don't think the picture is that different.

Things are already pretty troubled in Europe and there is some credit issues in Asia.

So I don't think -- that hasn't really changed, here, obviously.

And then in the US, in terms of particularly real estate, rents are still going up.

Occupancies are still going up with a stronger economy.

There's still an ability -- when you have a stabilized building of high-quality real estate, there's plenty of ability to finance it.

I think we will continue to be able to sell assets, and I think the amount of distress in the US is still going to be low, because we are still lagging the amount of building we should have had for the last six or seven years.

So I don't know that that changes much on the real estate side.

On the private equity side as I said, we've been focused more on how we haven't been doing a lot of public and privates anyway.

I think we've got a ways to go, frankly, before those get to be very attractive.

Not a big change, from my perspective.

Supplementing one of the areas that Tony didn't touch on, we will see a pickup in the GSO area.

They've been waiting patiently for something bad to happen, because they've got tons of money and credit spreads were so tight that there wasn't enough juice in this to really play.

But what's happening now, as a result of lack of liquidity in certain types of markets and fear, is that outflows from junk and things of that type, is that you are going to have some marvelous opportunities.

That is actionable in the short term.

And they'll be certain types of extensions of credit to longer-term borrowers if public markets are reduced or closed for certain types of lower-rated, long-term debt.

Boy, that's like a feast for the GSO group.

That's like a perfect storm for their type of business.

We were talking yesterday to one of the Senior people there.

Tony and I are were meeting with the group and they said, geez, there are some individual situations, the bonds went down 6 points yesterday, just like screaming by.

Those are opportunities because we are very liquid.

We can take advantage of things like that.

Fear -- what do they say -- one man's -- Shakespeare -- one man's tragedy is another one's comedy.

So I think we'll be able to deploy significant resources there in response.

In terms of what Tony was talking about, you don't have those instant changes in the M&A markets to buy companies or buy real estate.

Sometimes it really helps you get a deal done when you're in the midst of something and you have a blowout and somebody is a little reluctant and you're willing to close and close to where you were and they say, oh my goodness, I've had enough.

You get an occasional accident like that.

But it doesn't change the whole flow of things.

But to the extent that as a buyer, we've closed virtually every transaction we've ever announced in 29 years.

It makes us a much better buyer in an uncertain world because the seller knows we will find a way to get that deal done.

Somebody else might not.

So that's good for us from a competitive perspective.

Great.

That's really helpful.

Maybe, just one quick follow-up.

I know you guys had talked about the realization mix between strategic sales and strategic buyers and private sales versus the ideal market.

So just maybe if the IPO market does shutdown for any reason, if the market gets worse, do you see that shift changing much more towards the M&A side from an exit perspective?

Or do you think you might end up just being more patient and waiting for that to rebound?

First of all, the M&A side closes down periodically.

It's not an odd outcome, when it's going on and it's rolling and people tend to think it happens all the time, it will always happen.

So we've lived through a lot.

We switch our realizations, whether they are certain recaps, whether they are individual sales, we do what -- it's sort of like a restaurant -- what's the special of the day here?

You can order what they are serving, but you can't order what's not on the menu.

So if, for some reason, they stock out of IPOs for sale, then we just move what we are doing.

Where we keep compounding these companies, which as we said in the prepared remarks, is going really well.

Then we pop out periodically and we make it work then.

And you see much larger realizations at that time.

But this isn't a world that shuts down.

Let me make a couple of comments.

First of all, when your EBITDA of a company is growing at 10%, as we are on a weighted average basis and you are leveraged, so in other words -- a lot of capital structure is debt, not equity.

The accretion to equity just by waiting is very substantial.

So we are paid to wait.

Our LPs are paid to wait.

We make more money by waiting because the carries grow in value.

So understand that waiting is not at all a bad thing for us, and realize the public likes and prefers $0.01 than $0.02 tomorrow.

But we get richer by waiting.

And our investors will get richer by waiting.

Secondly, IPOs are not exit events.

IPOs are the most volatile part of the equity market.

But we have something like 40% of our private equity portfolio is already public.

We can sell those shares at values that are consistent with our marks and our carries and all that.

We can sell those shares any time we want.

We can do block trades, we can do secondary -- it's not -- that's not the end of the [whip].

The IPOs are in the whip, but the irony of that is we don't sell in the IPOs generally speaking.

We have an have an awful lot of real estate -- public securities in our real estate business, as well.

There's tens of billions of dollars across the firm.

That is still eminently executable into the public markets, if we want to.

But then I come back to my first point.

The value accretion is so high that we kind of like making more money.

That's what we get paid to do for our LPs and for our public investors as well.

But fundamentally, to your question, of course, if equity markets shut down completely and if equity markets get hammered, then the percentage of our liquidations from equity markets will go down.

As Steve said, we've had years when it's been all strategic or recaps or other things or tertiary buyouts and whatnot.

No equity.

And that's fine.

We are not a one trick pony here.

Great.

That's super helpful.

Thanks so much.

Final question from Bulent Ozcan with Royal Bank of Canada.

I've got a question regarding the credit business.

Can you credit business participate or provide financing to your own basically LPOs and your private equity portfolio companies?

Or are there certain restrictions that would prohibit you from basically providing financing?

Our credit business -- the credit business is not one business, it's multiple businesses, and it varies somewhat by business, but in general, our credit business can provide financing to our private equity company as long as at least half of the credit is provided by third parties on the same terms.

Okay.

So liquidation shouldn't be an issue if there is no liquidity in the market, because you'd be able to finance your own deals, so to speak, if you can find --

Our credit guys would only do that if that's the best available return for the risk at a moment in time.

I don't want you to overstate that actually.

(laughter) Okay, understood.

My second question would be, on performance in the credit business.

Seems like the hedge fund strategies have not so strong quarter.

But you've seen strong quarter out of the mezzanine fund and the rescue landing funds.

Could you just give some perspective on what was driving the performance?

And I'm comparing 3Q to 2Q.

Okay.

I actually think that the hedge funds have performed very well, frankly.

Remember this -- and I think with the backups and the volatility in the market lately, the performance is going to particularly shine.

The hedge funds tend to underperform when there's very low volatility in big bull markets.

It's very hard for a fund that's managing risk down and hedging to keep up with the indices.

So our investors couldn't be happier with the hedge fund performance.

And they're even happier now with that investment than they were before the recent market volatility and backup.

As regards to the performing of the credit funds, they've had a confluence of a few factors.

First of all, the faults have been near zero, so they've made great selections of the credits.

Secondly, when they make those things, they tend to get equity kickers and things like that, which have appreciated a lot.

Thirdly, as credit markets rallied, two things happen.

Number one, obviously, the interest rate that you put on in a higher interest rate environment, there is capital appreciation, because it's a debt instrument.

But then two, a lot of issuers will sometimes refinance you and pay you out and pay you a call premium and some things like that, which accrues to the benefit of investors, obviously.

And then finally, just operating performance in the underlying Companies has been really good.

And again, as I was mentioning before, with response to the last question, when you have a leveraged capital structure and your operating performance of the underlying Company is good, the equity appreciates a lot, the equity kickers appreciate a lot, and the lowest tranche of the capital stack in terms of the credit instruments pick up credit quality very fast and therefore appreciate quickly.

Maybe, just as a final question, since I'm the last one on the call.

I was just wondering about your credit business and you are contemplating spinning off your investor business, given that the valuation could increase significantly as a stand-alone Company.

Could we see this with other business segments such as credit, seems like the market has climbed so high and multiple in the credit businesses versus private equity and (multiple speakers).

I know the question and the answer is no, absolutely not.

I hope that's clear.

Absolutely not.

There's a lot of synergies with this business.

We do a lot -- there's a lot of magic that makes this firm go.

It's a core part of the business and you certainly won't see that spun off.

Thanks very much.

Great, thanks everybody and we look forward to following up with Q&A after the call.

Ladies and gentlemen, that concludes today's conference.

Thank you for your participation.

You may now disconnect.

Have a great day.