Ares Management Corporation (ARES) Q1 2014 Earnings Report, Transcript and Summary

Welcome to Ares Management, L.P.'s First Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded on Tuesday, June 10, 2014. I will now turn the call over to Carl Drake, Head of Public Investor Relations for Ares.

Good afternoon, and thank you for joining us today for our first 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, our senior partners, Bennett Rosenthal and Greg Margolies, are also 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 annual SEC filings. Ares Management, L.P. assumes no obligation to update any such forward-looking statements. Please also note that past performance or market information is not a guarantee of future results. 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 as 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 from this morning and Form 10-Q, which will be filed later today, for definitions and reconciliations of these measures to the most directly comparable GAAP measures. I will now turn the call over to Mr. Tony Ressler, Ares' Chairman and Chief Executive Officer.

Thanks, Carl. As Carl just mentioned, this is really our first opportunity to speak with all of you since our IPO. We're eagerly looking forward to our next growth phase as a public company, and we certainly appreciate the early support from our investors. We believe that we have built Ares into a leading global diversified asset manager with attractive characteristics of both traditional and alternative asset managers. We have a meaningful concentration of stable and growing management fee income, mostly on long-term capital, and a platform poised for growth in new assets as we capitalize on the growing global demand for alternative assets across our platform. In general, in a world of low interest rates and equity market volatility, retail and institutional investors are seeking higher returns without taking on a commensurate amount of risk. We are very fortunate that our investment platform is comprised of 4 leading businesses that do just that, whether in Tradable Credit, Direct Lending, Private Equity and Real Estate, all 4 businesses under very strong business leaders with long-term investment track records. Our culture is highly collaborative with integrated business units, each complementing the other by providing deal flow, valuable market intelligence, access to important relationships and due diligence expertise. We believe that going public was a logical next step in the evolution of our franchise. Although our growth and investment track records speak for themselves, we believe that the greater brand awareness obtained as a public manager may open doors for us with new investors in new geographies. We also believe that having equity capital available as additional acquisition currency may provide new strategic opportunities and partnerships, which will eventually improve our distribution channels, fund products and earnings. We expect to have greater access to capital for growth, and we can enhance our already strong ownership culture by providing deeper employee incentives across our firm. Before I turn the call over to our President, Mike Arougheti, please note that our interests are indeed very aligned with our new unit holders. Following the IPO, Ares employees still own in excess of 70% of the company. Also in the coming years, we intend to make investment decisions with the same care and discipline that we have in the past. We firmly believe that asset growth follows strong performance. And if we continue in this regard as we expect to, we will reward all of our stakeholders. Now let me turn the call over to Mike Arougheti for additional thoughts. Thank you.

Great. Thanks, Tony, and good afternoon, everyone. Maybe to help put the market opportunity in context, there are a number of industry trends that are particularly favorable for us and should drive our growth into the future. There is a growing thirst for yields and higher noncorrelated returns from investors of all types. Pension funds are facing funding gaps. Insurance companies are experiencing low single digit returns while trying to reduce volatility. Sovereign wealth funds are searching for higher noncorrelated risk-adjusted returns, and many individual investors are requiring higher current yields and income. At the same time, the global banking system is facing higher capital requirements and required deleveraging as a result of increased bank regulation and continuing challenging global economic conditions. This is leading to increased opportunities for nonbank capital providers like us to take advantage of the void that is created as these banks vacate certain markets. And we believe strongly that our Direct Lending and Real Estate debt platforms, as well as certain strategies within our Tradable Credit Group, are particularly well positioned to take advantage of these trends as we focus on directly originating these assets, providing more flexibility while receiving attractive relative risk-adjusted returns. Investors are increasingly making choices to invest with asset managers with global diversified investment platforms and scaled infrastructure. We have been making significant investments to scale our back office and to further expand our platform. We continue to diversify into attractive new areas, including global real estate equity, and subsectors within direct lending like energy and our recently announced expansion into the commercial finance sector. We have also substantially added to our noninvestment personnel, particularly in marketing and business development, information technology and legal and compliance, all to help us scale our business and support a much larger asset base. As Tony highlighted, the power of our platform is rooted in our philosophy of sharing our best ideas, expertise and resources across our businesses in a unique culture of collaboration. We leverage the broader Ares platform for deal flow, relationships and due diligence, and we use our flexibility and our multi-asset class capabilities in tandem to source and make attractive investments across different market environments and parts of the cycle. For example, in our Private Equity Group, we've invested successfully in both traditional buy-outs and growth capital in robust economic conditions and in distress for controlled investments in less robust environments. Within Direct Lending and Tradable Credit, when market terms on new investments are less favorable, we are increasingly selective with a more intense focus on quality and the more senior portions of the capital structure. So we change our investment mix based upon our fundamental view of relative value for a given security weighted against our macroeconomic and individual market outlooks. We also focus on differentiated sourcing using direct origination platforms, which we believe provide more proprietary investment opportunities. As Tony mentioned, we do believe that our business model is unique. Given the relative size of our private invest -- equity investment platform, we are not a performance-fee driven or private equity-centric business. We still have performance-related earnings fluctuations, but we hope to prove that we are more stable than more PE-centric business models given our higher mix of management fees and our fee revenue and the relatively higher percentage of our performance fees based upon yield-oriented investment strategies. Our balance sheet has already benefited from our status as a public company. In connection with our IPO, we increased our revolving credit facility provided by 17 banks from $735 million to over $1 billion, and we extended the term out to April of 2019 with a current interest rate of LIBOR plus 175 basis points. This greater access to longer and attractively priced capital is a strategic advantage providing financial flexibility and representing additional earnings power for us. Our strategy is to continue to execute on the same growth avenues that we have in the past. We expect to continue to grow our AUM organically by adding new investors, ancillary products, geographies and distribution channels. In terms of geography, we are particularly excited about our expansion in European corporate and real estate credit. And from a distribution standpoint, we see meaningful opportunity for expansion in the insurance sector, where insurers are seeking higher returning alternatives to traditional fixed income without significant volatility; and in the retail channel, where individual investors are demanding higher current income for retirement. So we are expanding our products and our distribution channels to address these demands. We are also focused on cross-selling new fund offerings to our existing growing investor base. For example, we have identified over 500 of our direct institutional investors who currently have investments in a single Ares fund -- that invest in other asset classes we provide. We also continue to explore new strategic partnerships and acquisitions of investment teams and ancillary investment platforms when we believe that they can be highly complementary to our core competencies. And so, finally, before I turn a call over to our CFO, Dan Nguyen, just let me take a minute to highlight a few themes regarding our first quarter results. In the last 12 months, our assets under management grew year-over-year by about 27%, modestly above our 5-year compound annual growth rate and AUM of 23%. This was primarily driven by about $17 billion in new commitments. And importantly, our dry powder increased meaningfully from $15.3 billion as of March 31, 2013, to $18.2 billion as of March 31, 2014. And as Dan will discuss, we do expect to earn a significant amount of new management fees as we invest this capital. Our investment returns have remained strong over the past year. Our credit portfolios continue to perform well against the relevant benchmarks in what has been a healthy and benign credit environment. And we believe that we remain well positioned should interest rates start to rise due to the fact that 80% to 90% of our credit assets are in floating rate securities. We believe the underlying companies and real property assets within our private equity and real estate funds are also well positioned for a slow, growing global economy. From a revenue perspective, our management fees, which include our Part I incentive fees from ARCC, increased about 29% year-over-year, with all groups contributing to higher fee income. Our management fees now represent 86% of our total fee revenue. Net performance fees were lower year-over-year as we faced a tough comparison in our Tradable Credit Group as market credit asset appreciation was much greater in last year's first quarter. And from an earnings perspective, you will see that our economic net income was lower by a similar amount due to the lower performance fees in Tradable Credit and also due to the significant investments that we've made in our firm to expand our platform over the last 12 months. We've added approximately 160 professionals to expand in areas such as real estate equity and European Direct Lending, as well as noninvestment professionals in business development, information technology, legal, compliance and tax. These short-term costs, which have reduced current period profitability, are investments that should pay off in future periods as we grow. And with that, I'll now ask Dan to walk us through our first quarter results in a little bit more detail. Dan?

Thanks, Mike. Although we were not a public company during the first quarter, we provided some pro forma information in our earning release as if we had completed our IPO on January 1 of 2014, in order to make our historical results more useful to our new public investors and analysts. First, starting with our assets under management. Our AUM for the first quarter 2014 increased to $77 billion, up from $74 billion as of December 31, 2013, and $60.7 billion as of March 31, 2013. Over the last 12 months, the largest driver of our AUM growth was new capital raised of $17 billion coming from 3 groups, namely: Tradable Credit with $10.4 billion; Direct Lending with $4.8 billion; and Real Estate with $1.7 billion. We also experienced continued strong investment performance, with $4.1 billion of appreciation over the last 12 months. Note that our net growth was strong, despite about $6 billion in distribution to fund investors as we continued to benefit from our long-term capital under management. Fee earning assets under management increased 20% over the last 12 months to $57.2 billion as of March 31, 2014. The slower growth compared to AUM represents the amount of new assets under management that are either not yet earned fees or not eligible to earn fees. For an example, leverage in particular funds might enhance return on our capital but not earn fees. As Mike previously noted, we have approximately $18.2 billion of dry powder to invest as of quarter end. Of that amount, $9.8 billion is included in AUM and eligible for fees, but it's not yet earning such fees. If we would invest this capital at the contractual management fee rate currently in place with respect to such capital, we would expect to earn additional management fees' revenue of approximately $85 million on an annual basis with the potential to generate incentive fee as well. We believe this represents important potential future growth in fee income. Our economic net income for the first quarter of $77.4 million was down from $93.9 million for the same period of last year but consistent with our expectations. On a pro forma basis, economic net income after tax was $72.5 million or $0.34 per unit. As Mike stated, we have continued to make substantial investment in expanding our platform to new front and back office personnel in new investment area, which has also led to investment in new office locations and technology and infrastructure. These thought [ph] have had a short-term negative impact as quarter fee-related earnings of $31 million were lower by about $4 million compared to March 31, 2013, due to these higher compensation and G&A costs. However, we expect the new personnel and investment to have a positive longer-term impact on new assets growth and those earnings. In addition, E&I was impacted by an unfavorable decline in unrealized performance fees and lower net investment income in our Tradable Credit Group, which caused a variance of about $27 million versus comparable period a year ago. As you might recall, during the first quarter of 2013, many credit assets appreciated well in excess of par, and that degree of appreciation proved to be difficult to repeat for the first quarter of this year. However, performance-related earnings were about $14.7 million, higher across our other 3 groups for the first quarter of 2014 compared to the same period last year. First quarter of 2014 pretax distributable earnings were $54.5 million, primarily driven by our fee-related earnings of $31 million and net realized performance-related earnings which were about $28.1 million. The net realized component of our pro forma-related earnings, which was a little lower than our historical average experience, were driven by realization in private equity and tradable credit funds, as well as a large current income component from balance sheet investment in our Tradable Credit Group. As previously disclosed, it is our intention to distribute approximately 80% to 90% of quarterly pretax distributable earnings to all unitholders. In April of this year, we distributed about 85% of pretax distributable earnings or $46 million to our pre-IPO owners. On a pro forma basis, assuming completion of the IPO and the related reorganization, distributable earnings allocable to the common units, which represented about 38% ownership in our company, would have been $0.22 per share after netting out applicable income taxes. Our balance sheet is one of our great sources of strength. As of March 31, we have about $37 million in cash, $520 million in investment and debt outstanding of $172.1 million. As Mike stated, we now have over $1 billion of revolver capacity at a very attractive rate of LIBOR plus 1.75%. Our net accrued incentive fees remained in line with the prior quarter at $187 million, attributable largely to our Tradable Credit and Private Equity Groups. Now I would turn it back to Mike for some additional thoughts on recent fund raising activity and closing remarks.

Great. Thanks, Dan. So in the first quarter, we continued our fundraising momentum primarily within our Tradable Credit Group, accounting for about $4.3 billion of our total $4.8 billion in new commitments. This success was primarily driven by a large European-leveraged loan fund that we are raising to take advantage of dislocation in the European loan markets as banks retrench, leaving attractive opportunities for us. We also raised new long-only loan in high yield capital in the U.S. and in our public vehicles within U.S. direct lending and real estate debt. In terms of current activities, we are working towards near-term additional closings in our real estate equity funds in the U.S. and Europe. In addition to these real estate funds, we are also focusing current fundraising efforts in credit opportunities, special situations, U.S. and European credit, and U.S. and European Direct Lending. Within Direct Lending specifically, we plan to raise additional funds to grow our new platform in commercial finance, which we expanded last week through our previously announced acquisition of Keltic Financial. We believe that asset-based lending is an attractive and growing market that represents a significant opportunity and is highly complementary to our existing direct lending franchise in the U.S. So in closing, we're very much looking forward to our next growth phase as a public company. We believe that we are in a great spot to capture our share of the market growth ahead. We hope to provide a stable and growing profit and dividend stream for our public investors and believe that we have built the foundation for more profitable growth with the investments that we have made in our firm over the past year. Again, thank you, all, for your time and support, and thanks to our over 700 dedicated employees around the globe for all of their continued hard work and effort. And with that, operator, will you please open the line up for Q&A?

[Operator Instructions] Our first question comes from Eric Wasserstrom at SunTrust.

Two questions please and just to follow up on those closing comments. With respect to Keltic, could you maybe touch on what other product holes you might have identified or that you'd seek to fill? And then more broadly in the direct lending segment, could you also just touch on if there's been any change in your view about the opportunity in Europe in terms of either its magnitude or the timing of capital deployment?

And just to clarify, with regard to Europe, you're talking about direct lending in Europe?

Correct.

Okay. Let me just take one step back to frame the whole direct lending conversation to put the Keltic acquisition as well as the European business and its growth in context. I think many of you know us through ARCC and have seen us scale a very large global direct lending business. And as we have learned over the years, we think that there are a number of key success factors that you have to have in order to really drive outperformance through a cycle in direct lending, namely: very well established local origination networks; a flexible product set, giving you the ability to move up and down the capital structure in response to a client's needs or changes in the market; balance sheet scale so that you can provide a full balance sheet solution to a borrower; and I think ever increasingly important is the ability to really be a lead and active investor throughout a company's life cycle. And as we've looked at the direct lending business, we've applied those same core themes to each of our businesses, whether they're in cash flow lending in the U.S. or Europe or in our newly growing commercial finance business. The other macro trends that are driving the opportunity in direct lending -- and I mentioned this in the prepared remarks with regard to our tradable credit business as well -- is a lot of the regulatory headwinds that are facing the banking sector, both in the U.S. and Europe. And those regulatory headwinds, whether you're talking about Basel III, the OCC leverage lending guidelines, Dodd-Frank and Volcker, are manifesting themselves in different primary market behavior and secondary market behavior both here in the U.S. and in Europe, and it's playing out a little bit differently. So to think about Keltic specifically, in the U.S., the U.S. direct lending market debanked many, many years ago through a series of consolidation phases and changing bank behavior. What we are seeing, we're seeing this in both our cash flow and commercial finance businesses, is now post the dislocation with increased regulatory scrutiny and more challenging regulatory capital requirements, there are new opportunities that are becoming available to Ares in the core cash flow business as well as commercial finance. The Keltic acquisition is a perfect example of that. Keltic is a business that is very well entrenched with a 20-year track record in small ticket and specialty asset-based lending. We have observed that, for the most part, below investment grade corporate credit is becoming increasingly difficult for the banks to own economically, and we see a very large opportunity to build out ABL businesses but really, any asset-oriented strategy. So other opportunities away from Keltic as we see them are health care-related and other specialty ABL, rediscount lending and lender finance strategies, where we can actually be a lender to other specialty finance companies up the balance sheet to drive very attractive risk-adjusted returns. We're seeing opportunities in the nontraditional structured asset businesses, and we are now beginning to see big white space open up in areas such as transportation assets, where the banks used to be much more aggressive and are no longer aggressive. So predominantly in the U.S., the market opportunity is a primary market opportunity, and we're attacking it both in the cash flow business and the commercial finance business. In Europe, it's a little bit of a different story because the market is much less evolved in terms of its institutionalization and debanking. That said, just to put our history there in perspective, we went into Europe in the direct lending space beginning in 2007. We think that we have real first mover advantage in our European business. Today, we have over 70 investment professionals on the ground in the pan-European origination footprint. We're overseeing in excess of EUR 10 billion of capital, which we think puts us really at the leading edge of some of the debanking trends that we're seeing in Europe. We're very pleased with the way that the deployment and the opportunity is developing in Europe. Many of our peers will talk about the opportunity to buy secondary assets in the European market from banks in the form of NPLs or certain noncore assets. And while that has been an opportunity, I would say that we've been a little disappointed with the pace of those asset sales. And so whether you're talking about our direct lending business, which is positioned to buy assets from banks, or our tradable credit businesses which are similarly looking to buy assets from banks, while we're active there, the pace of that opportunity has probably been slower to develop than we would've liked. On the flip side, the primary market opportunity, i.e. the market opportunity in self-originated direct lending, has probably exceeded our expectations and so we've built a business model that is very balanced that if we're not seeing the opportunity in the secondary market, hopefully we'll see it in the primary market. So on balance, I think Europe is developing well within -- in line with our expectations. We've amassed a significant amount of scale. We have a significant amount of dry powder in both our direct lending and tradable credit business to go after the debanking trend.

And just a follow-up on that and then I'll hop off. What is the complexion or mix of the primary market opportunity in Europe that you're seeing right now?

Yes, so dependent again. It depends on the business. As you think about Ares' business as a whole, if we're doing our jobs well, each of our businesses should be supporting the other with deal flow and diligence and capital. The nice thing about the European opportunity is the regulatory headwinds facing the banking system are providing meaningful opportunities for direct lending and tradable credit. It's also providing opportunities in our real estate business. As an example, the commercial real estate lending opportunity in Europe is something that we're very excited about, and we're putting a lot of resources and capital behind. So the complexion, it -- really, it's all of our businesses are benefiting. Our private equity business, similarly, is benefiting. Having the ability to invest out of our fund into rescue capital and balance sheet restructuring situations in Europe is something that we think will become available. So if you look at the deployment, it's pretty balanced across each of our businesses right now.

Our next question comes from Patrick Davitt, Autonomous.

I want to talk a little bit about the expense revenue disconnect into your later earnings [ph] and to what extent you can help us think about the timeline for revenues catching up with the amount of investment you made. Is it really just about that dry powder getting put to work and the fees turning on from that? Or is there a lot of kind of other stuff in there that really isn't flowing through the revenue line as well?

Yes. I think it's -- the timing will be fairly quick, 12 to 24 months. And I think as we go sequentially quarter-over-quarter, you'll start to see the absorption come through. Obviously, we've made meaningful investments in our asset gathering capabilities, which should translate into fee-earning AUM for us in the very near future. And as you highlighted, you can see the sequential growth in our dry powder. As Dan mentioned, $85 billion (sic) [million] of pent-up FRE on capital that we've already raised and resourced that isn't running through the P&L yet, so I think the absorption will be quite significant and fairly rapid.

And it's fair to assume that, that $85 million doesn't really come with any expense, right? Incremental...

Yes. Obviously, it will come with moderate expenses you deploy, but there's going to be a very high level of absorption and dropping down to the bottom line.

The next question comes from Robert Lee at KBW.

I was wondering if you can maybe -- going back to -- you have a lot oars in the water from a fund raising perspective, but if you can maybe help us size some of the initiatives such as -- be it the 2 real estate funds and some of it in the European direct lending. Maybe just kind of update us on not just where you've maybe got commitments so far but what kind of the ultimate targets may be on some of the more significant initiatives.

Sure. So this is Tony Ressler speaking. I guess we have -- as we talked about, I think as Dan mentioned, and Mike for that matter, both Euro and U.S. loans, which are each in the billion-each type range but the more specific numbers, in real estate, we have a U.S. value-add fund in the market somewhere in the $700 million to $800 million range. We have a euro opportunistic real estate fund in the market somewhere in the $1 billion-ish range. We have some European and U.S. -- European direct lending discussions in the $0.5 billion to $1 billion range. I think those are the -- I'm sorry, we also have a special situations fund from tradable credit also in the $1 billion-plus range. So I think those will be the more material items out there.

Okay. And maybe just curious on -- in your sense of the market environment, and this focuses mainly on tradable credit, I guess. I mean, one of the things you kind of hear around is that just given the -- whether it's the tightening of spreads or rally in kind of credit markets and just overall demand that maybe it's somewhat less attractive than it had been. But can you kind of help us reconcile strong fundraising and your ability, though, to kind of put a lot of this capital to work at an acceptable return or rate?

Sure, sure, sure. Maybe -- again, we always have the discussions on how a vast number of investors are looking to earn 6%, 7%, 8% returns in a 3% or 4% world in their traditional high-grade portfolios. Greg Margolies, who runs our Tradable Credit Group, is actually here, so he might want to touch on that. But we are seeing exactly what you would imagine. People do have tight spreads and are looking for more yield, and many of our products and tradable credit offer just that. But Greg, you want to add to that a little bit?

Sure. Thanks, Tony. You're absolutely right. We're seeing 2 significant trends that are driving funds for us. And one is, as Tony said, there is a global low interest rate environment. People are always continuing to search for yield, and that's driving flows both into leveraged loans and into high-yield bonds. And secondly, the biggest trend within that is more and more clients are asking us to dynamically allocate their capital for them, i.e. not going to a single product but rather into multiple products across the noninvestment grade lending and securities business so that we can help them navigate either credit cycles or interest rate cycles. So that's been a big driver of our funds for us as well.

I'll just make one final comment, too. When you talk about difficulty deploying -- I think the nice thing about all of our businesses is we operate in very, very large addressable markets, and we built a platform and fund structures that allow us to be quite selective in what portion of that addressable market we want to invest in, and to Greg's point, really give us the opportunity to move around within that addressable universe. So unlike some other asset management category even in the market like our tradeable credit businesses, where you're fighting spread compression, the addressable market is so significant relative to the capital base that you can still drive outperformance through good asset selectivity and good fund structures.

Our next question comes from Chris Harris at Wells Fargo.

So I had a question about the competitive environment today. Mike, you mentioned that banks are either scaling back or capital constrained, and I guess that's kind of not a new theme. But I guess what I'm just wondering over the last, say, year or 2, the markets that you guys are in, are you seeing nontraditional lenders picking up the slack at all from banks? So in other words, even though the banks are getting out or scaling back, others are maybe kind of getting a little bit more competitive with you? And how does that kind of impact how you guys are approaching originating assets going forward?

Yes. So there are 2 trends. One is squarely flows. So obviously, hitting on what Tony mentioned and what Greg mentioned, in the interest rate environment we're in, in the economic environment we're in, where we're actually seeing good underlying fundamental credit performance, people are allocating dollars to our asset classes. That, in and of itself, isn't a bad thing. It's spurring transaction activity, and I believe that the scale players like Ares are taking a disproportionate share of the market. The other trend we are seeing along that consolidation theme is we're seeing money flowing to the larger platform. So some marginal competition is coming into the market, but we're seeing a disproportionate amount of the capital flow to the incumbent market participants who, in my historical experience, tend to be much more rational competitors. So when you're in a market environment like, this, similar to the way that we behaved across the platform in 2006 and 2007, you have to be more selective. You probably have to be a little bit more defensively positioned. You probably have to be a little bit more liquid. But the competition has not gotten to the level where we're still not attracted to and excited by the return opportunity.

Okay, great. And then just a follow-up on the direct lending business, specifically the BDC. I know there's this opportunity out there for you guys to potentially increase your leverage, but the CBOE has negatively scored that piece of legislation. Wondering if you guys can comment at all about the prospects of that legislation following that negative scoring.

Sure, I'll do my best. We're -- it's always difficult to probability weight anything happening in Washington. Having watched with great interest that piece of legislation now for a couple of years, I think it speaks volumes to the amount of support it has -- the fact that it is still around and moving through the House with very strong bipartisan support. My understanding of where the bill is now is that the CBOE has scored it, and now the joint tax is looking at that scoring and potentially reevaluating it. I think we talked about this on the ARCC earnings call as well. The scoring that came out at CBOE, in and of itself, does not mean that the bill's chances are impossible. But I think people know the way things work with any new legislation is to the extent that there is a negative revenue scoring, it has to be attached to a piece of legislation with a positive revenue scoring. Typically, that would mean that you would have to delay until you identified the right vehicle to move the bill through. I look at that bill and, as we always say around here, it's very difficult to see who is opposed to it. It doesn't cost the government any money. There's no taxpayer subsidy. It creates jobs and it gets capital flowing to small- and medium-sized companies in this country. And so as a result, it does have a significant amount of bipartisan support at very senior levels. And typically, when you see that, I think things have a good chance of happening. So we're still cautiously optimistic even with the scoring, but candidly have no way to quantify it or probability-adjust it just because that's not what we do for a living.

The next question comes from Ken Worthington at JPMorgan.

Maybe to follow up on Robert's question. I wanted to start maybe a little higher -- more high level. Can you share just your opinion on the credit markets today? We keep hearing it characterized as frothy, but you mentioned in your prepared remarks that you're still finding opportunities, particularly tradable credit versus lending. And then just how do you see the rest of the year developing? You mentioned you have a lot of dry powder. You think it'll be absorbed quickly. So just the high-level comments would be helpful.

Yes. Ken, it's Mike. Maybe I'll just -- I'll frame it at a high-level and then maybe Greg can give some specific commentary around the credit markets. What may not be altogether obvious to everybody but it is core to how we think about raising and investing money at Ares is, to Greg's point earlier, about dynamic allocation. The majority of the fund structures that we're raising give us the ability to allocate across securities, whether it's senior secured, bonds, distressed, par lending. In our direct lending funds, we have the ability to do senior secured loans floating rate or long duration fixed rate mezzanine. So core to how we think about managing the portfolios through a cycle is having the flexibility to allocate to where we see the best risk-adjusted return and frankly, having the discipline to accept a lower return if it's the best risk-adjusted return even in an environment where people are stretching for yield. And I think you would see that across each of our strategies where we're being quite nimble looking for opportunities to exploit market inefficiencies or complexity to drive real outperformance and then in the more benchmark products is really using the asset selectivity and the dynamic allocation capability to drive outperformance. And I think that's key because we have demonstrated over our 15-year history the ability to grow and grow profitably in any market environment. And maybe Greg wants to give a couple of comments on just what we're seeing in the markets.

Sure. Thanks, Mike. What we're seeing in the market is really 2 significant trends. One is the underlying fundamental performance of the credits that we are looking at and specifically, that we invest in, are actually quite positive. But from a top line growth -- which is albeit benign but still growing. And the company's continued ability to take cost out of the system and therefore, margin expansion in the companies that we're investing in. So we are seeing positive, albeit benign growth in our portfolio of companies across both the U.S. and Europe. But we are seeing some more aggressiveness come into the marketplace in terms of structures or leverage both at the company level or at fund levels. So our view is that we've got a window in front of us for a bit of time where we will continue to see very strong or high-quality growth in the franchise companies that we invest in, and -- but we're setting ourselves up for what we think will be a credit cycle in the out years. And the critical part of that, is what Mike mentioned, is that increasingly our funds, whether they be traditional loan and high-yield funds all the way through to our alternatives, are increasingly structured because our LPs are asking us to do that, to be able to flex where we invest and how we invest, whether it be getting more conservative and moving up the capital structure or moving it to more defensive industries or more defensive capital structures or in our credit opportunity funds being able to short the market in areas that we think have gotten too frothy and lastly, in our specialty situations business, which is clearly an area of focus for us, taking advantage of what's happening with finally seeing the banks selling assets over in Europe, which we're seeing at the highest quality in terms of asset quality and diversity in Europe than we've seen in the last 5 years, as well as setting ourselves up for a potential credit cycle in the U.S. So we see today, again, fundamental growth and pretty good fundamental growth in the companies we invest in, but our structure and our approach to the markets allows us to be flexible to take advantage of that market cycle when it comes.

Okay. Have you gotten defensive yet in the U.S., or is it still too soon to take that step?

The answer is a combination. The answer is -- for the most part, we are getting more selective, not necessarily more defensive. And what I mean by that is we're turning down more credits today in the new issue market than we've turned down over the last 4 or 5 years. So we've gotten substantially more selective. We haven't necessarily moved up in terms of out of high-yield bonds and into leveraged loans in the last month or 2, which is a good thing because as treasuries have rallied, it's benefited our portfolios. And secondly, we still believe there's some very high-quality single B issues received [ph] . It's not a need to rush into BBs. But the difference is we're getting very, very selective on individual credits, and I think that's the beginning of making sure that you're buying the right credits.

Okay, great. And then just maybe one for Dan on share count. The approximately 214 million shares, is that a good level for 2Q, or is there other shares likely to find their way into the total share count near term?

Yes, Ken. I think that's a good level. The breakdown, that as you noted from the previous filing, we have about 211.5 million shares. That's a combination of common units as well as the operating group units. And in addition to that, we have about 2 million shares that we use in the treasury method to account for the restricted stock units. So the 213.6 is what the unit count outstanding on a pro forma basis for Q1, and that will be the consistent level for Q2 as well.

Our next question comes from Chris Harris at Wells Fargo.

A quick follow-up on the numbers, guys. What should we expect in Q2 for dividends? Are public shareholders going to be getting a dividend in Q2? And is it going to be based on the full quarter's results, or is it going to based on a partial quarter? So any kind of guidance you can give there would be helpful.

Yes. Our expectation is consistent with our historical policies. As we mentioned, we'll be distributing 80% to 90% of our DE to the shareholders, and our expectation is that in Q2, people should expect a full quarter of dividend.

At this time, there are no further questions. I would like to turn the conference back over to management for any closing remarks.

Great. No real closing remarks other than to thank everybody for their time and early support in our beginning of a new phase as a public company, and we look forward to speaking with everybody again next quarter.

Ladies and gentlemen, this concludes the conference call for today. If you missed any part of today's call, an archive replay of this conference call will be available approximately 1 hour after the end of this call through June 23, 2014, to domestic callers by dialing (877) 344-7529 and to international callers by dialing 1 (412) 317-0088. For all replays, please reference conference #10047012. An archived replay will also be available on the webcast link located on the homepage of the Investor Resources section of our website. That does conclude today's conference. You may now disconnect.