Ares reporting at earnings, highlighting another record quarter of fundraising with over $36 billion of inflows. The CEO Mike Arougheti writing, 'Our clients continue to reward us due to our strong and consistent fund performance across our strategies.' Mike joins us now in the studio for more. Mike, good morning. Good to see you.
Good morning. Good morning.
I wanted to start with a quote of yours from earlier this year when things were pretty difficult with the software issue, and you said something really important. You said the following: If you're going to underwrite a narrative of AI disruption, you also then have to say, well, what does that mean for the productivity and margin improvement for the rest of your book? I think that's a good place to start. Where are you seeing value being created right now?
I'm glad I said that. So, if you look at the way that Ares is playing the AI transformation, it's: what are we doing within the data center and digital infrastructure space, what are we doing within our portfolio companies and what's that productivity uplift, and then what are we doing within Ares proper to either improve our investment outcomes or profitability. So if you start with Ares first, we're obviously deploying AI across the entire enterprise. We're seeing significant efficiency. We had a 100 basis point margin increase in the quarter year-over-year and we've guided the street to expect 0 to 150 basis points per annum. A fair amount of that is technology efficiency that's getting created, re-underwriting processes, re-underwriting systems, and we are seeing uplift that is also translating into increased productivity and margin expansion within the portfolios. So, if you were to look across our private equity portfolios, our private credit portfolios, cash flow growth is still plus or minus 10%. If you look at corporate earnings, I think you're going to see that that's generally the theme. And then within the investment space, we are doing our best to stay diversified in the way that we're attacking the digital infrastructure opportunity. Big investors in data center development, but I think our approach has tended to be a little bit more targeted. We're doing 150 to 300 megawatt deals, hyperscaler-adjacent, in large tier one markets like Tokyo, London, Sao Paulo, pre-leased, 12 to 15 year terms with escalators. So we have probably shied away from some of the secondary and tertiary markets and stayed away from some of the frontier model type of opportunities. Two, we're a very large lender in the infrastructure debt space, and you're seeing that rolling through our earnings as well in terms of the fundraising and deployment momentum there. So, we are one of the largest institutional lenders to other developers and that's been a bright spot. Three, we have a large asset-based finance business and we're squaring off with a lot of the banks on SRTs and portfolio purchases where we're helping them free up liquidity on their balance sheet to continue to deploy into the opportunity. And then four, we have a very large infrastructure equity business where we're investing all around the digital ecosystem, transmission, fiber, battery storage, etc. So, we're kind of attacking it from all angles. But our view has been we want to be global, we want to be diversified, and we want to have the full capital structure so that we can move around where we see best relative value.
The second word I want to dig into, diversified. And I'm open to the reality check. I'm just going to say it feels like a lot of people are in the same trade. They're in asset-backed infrastructure debt on the credit side and they're taking direct equity investments into say software and models. How do you avoid all the crowding that we're starting to see in other places in digital specifically within your firm?
Yeah, I think the key, and this goes, if you look at our earnings this quarter and you put the numbers up on the screen, what screams out to me is just the broad base nature of the business and the diversification. And so the way that we think about private markets is we want to be up and down the capital structure, debt to equity, so that we can move around and find relative value in response to rates or the economic environment. We want to be horizontally diversified across all the different private market asset classes, secondaries, private equity, real estate, infra. And you'll see investor appetite and our own view of relative value shift. And then within the funds, we want to be highly, highly diversified. So if you look at our credit funds as an example, you may see 900 to 1,000 line items. So we're not going to have any single exposure really drive the long-term performance. And I think that's key. There is a risk in any investment business that you're over-diversified. And I could argue maybe a thousand loans in one fund is over-diversified, but it's served us well over the 30 years that we've been doing it.
Earlier this year, everyone was saying there's going to be a complete collapse, that the private credit space is going to go down in flames because of the retail investors etc. And your compatriots and yourself are coming out and saying whoa, not at all. We're seeing actually performance hang in there and people are still interested. Where are we in that in terms of interest from investors in private credit? How much the pendulum has shifted to the infrastructure and some of the other plays instead?
Yeah, look, we've been pioneers in private credit and people have been saying it's a bad place to be for 30 years and it's grown pretty consistently and compounded at a very attractive rate of return. So, anytime there's a narrative that's that loud, you've got to at least ask yourself, you know, what is it that they're looking at? We don't see it. If you look at our direct lending business, which is kind of where I think people are focused, our non-accruals across the direct lending business right now are inside of 2%. That is well below the historical averages. Our cash flow growth is plus or minus 10% as I said and that's been consistent. We are seeing healthy interest coverage, very low loans to value. So the fundamental performance is exactly what was underwritten. A lot of the noise, you know, I don't really know where it's coming from. It could be coming from a competitive set of capital that doesn't like to see the flows. It could be software related, but there's nothing that we see in the portfolios that would indicate that credit's weakening. And the interesting thing to your question, and you see it this quarter in earnings, the institutional demand for private credit is probably accelerating right now because they're seeing spreads widening and they're seeing capital leave the market and feel like there's an opportunity to come in and take share. So, our last two credit funds, both in asset-based finance and opportunistic credit, hit their hard caps and we had demand well in excess for the hard caps and we raised those funds quicker than any prior vintage.
