Jarrod Phillips Discusses Ares’ Financials | Ares Investor Day 2024

Good morning. It's great to be here. It's great to see all of you here in person. Hello to all of you on the live stream. Sorry you couldn't be here in person with us, but we're excited to have you. And it's my pleasure to talk to you a little bit about our financial results, where we've been, to where we're going.

And ultimately, I do want to just stop and reflect on the last five years. So we're talking about our five-year plan here. So what do the last five years look like? You can see in our last 12 months, we've hit records across all of our major metrics, and we've been up more than 25% CAGR for all of our major metrics. This is a great launching point. We've done it consistently with a business model that we believe has us well positioned for future growth and is going to continue to drive growth forward.

I'm going to spend a little bit of time today talking about each of these items. First, I'm going to talk a little bit about our management fee-centric business that drives high-quality fee income that makes us more stable and predictable within our growth. I'll talk about the long-dated, long-duration capital that enables that. I'll spend a minute on our balance sheet-light model, which we believe enhances the cash flow to our investors and enhances the cash flows available to invest in new management fee growth areas. I'll talk a little bit about how our growth has come with an expansion of scale and an expansion of our margins. And lastly, I'll spend some time on our European waterfalls.

To start with our management fees, this is our slide of many colors with our numerous platforms that we've put together lovingly, and we're very, very proud of. So you can see up here how diversified that we've been over the last five years. We've grown our core businesses. At the same time, we've added new businesses, and we've seen growth in management fees across the platform. This is core to how we view our growth going forward: to continue to grow what we do well, as Tony said earlier, but find new areas to grow in an outsized manner.

And it's important to understand how we grow our management fees in different market environments. When you take a look at what we've put up here, we tried to summarize as we were thinking about the questions we get from all of you: what are the different market environments? We get questions about when default rates are high, how have we grown? And you can see up here that we've grown when default rates are high. When M&A volumes are low, we've grown. As we've seen for the last year, M&A volumes were relatively depressed. And in fact, if I took this graph back a little further, back to the turn of the century, 1999, 2000, you'd see a dollar value of M&A transactions that was reasonably similar to what we had last year. When you adjust that for inflation, it's almost 60% higher in terms of dollar value. So we know that M&A works in cycles. The ability to grow when that cycle is slower, like it has been for the last year, and be prepared for when that cycle kicks back up is very important.

And then a question we often get is, well, what about interest rates? When interest rates were low, we got the question of, well, are people just coming here in search for yield? Now that interest rates are high, we get asked, well, how's it going to change when things are low? You can see here that we've been able to grow our management fees throughout interest rates being low and interest rates being high. One of the reasons for us to be able to grow in all of these different scenarios is that long-dated, long-duration capital. That means that when investors commit their dollars to us, we can continue to hold that without fear that they can call it back. We can invest it when it's the best time to be investing. We can generate alpha for them by investing in the right companies at the right times, and we don't have to be on defense protecting the portfolio. That's what has enabled us to grow.

And you add to that that the majority of our growth comes from the speed of our deployment and our deployment in our portfolio, unlike equity-based strategies that are really just committed and rely very much on the next fund to grow. As we raise, we prepare to deploy. So that shows that we're also not as correlated to a fundraising cycle. When fundraising cycles have been low or when they've been high, we've continued to grow. That's because of the nature of the AUM that we manage. So we're very focused on deployment and how much we can deploy within a given period and what the markets are for that deployment.

Just like that first slide that I shared, you can see here that the deployment that we can have off of our platform has diversified significantly over the last five years. And in there, you see that coiling for growth that Mike talked about. You see that we understand that those M&A markets, they go in cycles. They come and go. We need to be prepared for higher deployment environments. So we build behind that. We build based on our dry powder, and we build based on the markets that we operate on.

So I wanted to come up with a way to help you understand how we can view what our deployment could be within a given year and what are some correlations that we've seen in the past. In our earnings presentations, you'll often hear me talking about our AUM not yet earning fees, available for future deployment. That amount, if you take that amount at the end of any given year, so if you take it at the end of 12/31/23, we had $63 billion, a record for that amount. That would equate to a little over $612 million of management fees. But then you see what's our drawdown deployment been like in the years after that. And you can see from up here that there's a pretty high correlation. Our drawdown deployment has run from 85% to well over 100% of what our AUM not yet paying fees were in the prior year. So that would tell you we have a tremendous capacity for deployment going into this year. And as we continue to fundraise, we continue to look to build that capacity so that we can deploy in all types of markets.

That diversity in management fees also is carried over into our other fee income. And when you take a look at our fee income, that's really because of some of the new businesses that we've added and some of the things that we've enhanced. For instance, we have a registered broker-dealer that can now participate in capital markets transactions. So you've seen us grow our diversification and the ability to generate other types of fees in addition to just our management fees. When you take that fee income plus your management fees, you have very strong fee-related earnings that supports your recurring revenue through various periods. So if you look here, you can see that fee-related earnings has maintained a high percentage of our recurring revenue year-over-year. And again, looking at a market where there's not as much realization activity, you can see that fee-related earnings has continued to propel our recurring revenue to growth year-over-year despite that.

Now, we would expect in a more normalized environment that fee-related earnings is going to run about 80% of our total recurring revenue. And one of the important things about recurring revenue is these represent earnings that actually are distributable. They're not earnings that have to go back into a capital machine or have to go back in to support our balance sheet. And that's one of the precepts of our balance sheet-light model: is creating free cash that enables us to grow our management fee business.

If you see here, our balance sheet investments represent half a percent of our AUM. That stands in a pretty large contrast to our peers, whose average is about 8.5% of their AUM. We're not actively investing in our funds. We invest in them strategically when it allows us to grow our management fees. That also means that we can put together a better ROE because our ROE is not dependent on the compounding of investments on our balance sheet, but on the funds that we manage. And having that limited balance sheet exposure makes us less exposed to changes in interest rates. Changes in interest rates won't affect spread earnings that we have. They will be much more minimal compared to what they would be if we had a more balance sheet-intensive approach.

Now, taking a step from our balance sheet-light model into our margins, you'll see here that along with that growth that I highlighted in the first slides, we've continued to expand our margins. So in that 25 to 35% growth timeframe, you've seen that we've expanded our margins from slightly below 30 to slightly above 41%. We believe that we'll continue to expand our margins with growth. But very important to us, we won't sacrifice growth in order to expand our margins. And you can see here just a little bit of the scale that we've driven. As you see our AUM per professional, our management fees per investment professional, that's allowed us to grow our scale over time.

Now, when I say that we're going to prioritize growth and we're going to look at that first, I want to show a couple examples of how we've done that in the past, and then I'll show a couple examples of what we're doing right now. But our opportunistic credit business and our alt credit business, they both, if you had looked at them five years ago, they were compressing our margins. And in fact, if you add them together, they were little zero to negative fee-related earnings. But we believed and had a lot of conviction in the growth of those strategies. And you can see today they are highly accretive to our margin. They have helped us grow our fee-related earnings significantly, and they are some of our best performing overall investment classes. This is what we look for when we're investing. If we had sacrificed these businesses for the expansion of margin, then we would be a lot less successful in the long run. So our goal again is to look for those areas where we can grow and invest in them wisely.

If you take a look at this next slide here, it highlights for you three areas that we're focused on now. And if you take these three areas: our real estate multifamily vertical integration, our European real estate debt, and our credit secondaries business. If you look at what their economics were to the firm in 2023, they were a drag on fee-related earnings and they compressed our margins. And if you look at what we believe will build over the next five years in these businesses, as we see acceleration across all of them, we believe that they'll be accretive to fee-related earnings and they're going to add 115 basis points to our margin. So again, focusing on how can we build businesses with high-quality fees, long-term growth, and doing that even though it may compress margins in the short term.

This shows you some of the businesses that are more mature on the platform and the margins that we can use to support some of that growth over the long run. It also gives you an idea of where we believe we can get to with a lot of our businesses that are low margin right now and growing. But I know everyone's interested in where do I think we can go with margins in the long run, and that's what's highlighted here. When I think about our margins, if I just said today, we'll tamp down growth activities and all we'll do is focus on that AUM not yet deploying fees that I talked about earlier, that would add $620 million of management fees. That would then, added to what we already have, would put us at a margin well over 50%. So I think we can get to that margin over 50%. We're marching there. I would expect every year you'll see margin expansion, very likely somewhere between 0 and 150 basis points. But it's going to depend on our deployment.

As I highlighted earlier, the faster we deploy, the faster management fees grow. The faster management fees grow, the faster you generally see our margin expand. So it's going to depend on that deployment environment and what other opportunities may be present in the market at that time that we may look to invest in. But overall, we have a lot of runway with margin, and we're very excited about the potential that we have there. When it comes time for it, there will be significant tailwinds in using margin for additional growth.

Now, it wouldn't be a presentation of mine if I didn't talk a little bit about the European-style waterfall. For those of you who are just joining us, the European-style waterfall represents performance fee income that you receive once an investor's original investment has been returned and their preferred return has been reached. So it's generally late in the life of the fund. What is unique about our European-style waterfalls is it predominantly comes from our credit business. Over 77% of our incentive-eligible AUM that's European waterfall is coming from credit funds. Now, why that's a little different than people may be used to is your American-style waterfall is the more traditional equity style where when an asset appreciates and I sell it, I harvest. But that was very much reliant on a mark-to-market that was there and actually being able to harvest at that mark-to-market. In a credit fund, you have a loan that you've made at or near par. You know a maturity date of that loan, so there's not a guess as to when it may be sold. You know what the outer bound is. Then that loan is going to mature at par, and it's going to have a stated interest rate or stated yield that's associated with it. So you're able with much more conviction to predict the amount of performance fee that you're going to generate from this because it isn't dependent on as many variables. The primary variable you have really is the duration of the asset, because most of these assets don't actually go to that final maturity. They go somewhere earlier than that.

Now, where are we right now? You can see the slope of where we're at right now. We're at the very beginning stages. So what we're harvesting today is this far side, this $27 billion and $31 billion of incentive-eligible AUM. That's what's just entering the harvest stage. You can see that this has grown 36% over the last five years up to $134 billion of incentive-eligible AUM that will earn these European-style waterfalls. But right now, we're just seeing the performance come through on a much smaller amount, on that $27 billion and $31 billion. And how's that ultimately going to come through? Well, that's going to come through over the next 10 or so years in the following manner. As we see that first batch come in, that's what we're seeing. That's going to be paid towards the end of this year into '25 and 2026. Now, as I mentioned, duration is the one variable. So we ultimately are able to calculate what we expect to get. And what we use is: what are the dollars in the ground? What's the forward curve look like for those dollars? What's my expected then incentive fee that I'll earn? And for those dollars that are not yet invested, what's the ultimate target return for those? And that's what leads you to the $3.6 billion that you see up there. And that is $3.6 billion of net. So that's the bottom line amount that will be coming to Ares Management. You can see because we're at the early stages, the strength of that $134 billion as it's there and earning, that's going to drive a significant amount of cash flows into that 2028 to 2030 period. So it's something that we're excited about and we're looking forward to.

Now, what are we going to do with that cash is another question I get every time I talk about this. Well, it's going to provide flexibility first and foremost, and it's going to depend on the year that it comes in and what opportunities present themselves in that year. But ultimately, we're going to follow the same thing that we do now with our free cash. We're going to look to seed new growth strategies. In other words, look for areas where we can generate more management fee. We'll look to fund creative acquisitions, as Mike discussed. We'll look to enhance our dividend distributions. And if the timing's right, we'll look for share repurchases or debt paydowns. So it is flexibility. I think that's very valuable, and it's something that we're very, very excited about.

Now, we'll take a look at what our forecast looks like over the next five years. So our AUM, as Mike highlighted, of over $750 billion. It's key to see that this is growing at 50% faster than the projected industry rates. And as Mike also mentioned, the goal is to grow quality AUM. We want AUM that is going to be high fee and is going to allow us to continue to grow with margin. We would much rather raise $50 billion at a 100 basis point management fee than $100 billion at 30 basis points. We're looking to grow with quality and use that quality to then build on our fee-related earnings and recurring revenue. And you can see from this that quality AUM will enable us to more than double our recurring revenue and our fee-related earnings. And here you can see the strength of the European waterfalls coming in with the outsize growth of our recurring revenue over fee-related earnings. And lastly, how does that impact our dividend? Because of the conviction of the cash flows that we have coming in, we're targeting an over 20% growth of our dividend for the next five years. So continuing to return with the dividend.

So what have we gone over here? We're well positioned with our model to continue the growth trajectory that we've been on. We're going to continue to invest in growth opportunities. We're going to generate over $3.6 billion of European waterfall performance fees. We're expected to grow faster than the industry average in our AUM. And importantly, we're going to more than double our fee-related earnings and recurring revenue and have a 20% plus CAGR on our dividends. With that, I'm going to turn it over to my friends and partners, Ryan, Tony, and Ed, to talk a little bit about business development. Thanks, everyone. Have a great rest of your day.