Ares Management Corporation (ARES) Q2 2018 Earnings Report, Transcript and Summary

Welcome to Ares Management, L.P. Second Quarter 2018 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded on Thursday, August 2, 2018. I will now turn the call over to Carl Drake, Head of Public Investor Relations for Ares Management.

Good afternoon and thank you for joining us today for our second quarter 2018 conference call. I'm joined today by Michael Arougheti, our Chief Executive Officer; Michael McFerran, our Chief Operating Officer and Chief Financial Officer. In addition, Bennett Rosenthal, Co-Head of our Private Equity Group; Kipp deVeer, Head of our Credit Group; and Blair Jacobson, Co-Head of European Direct Lending, will also be available for questions. Before we begin, I want to remind you that comments made during the course of this conference call and webcast contain forward-looking statements and are subject to risks and uncertainties. Our actual results could differ materially from those expressed in such forward-looking statements for any reason, including those listed in our SEC filings. We assume no obligation to update any such forward-looking statements. Please also note that past performance is not a guarantee of future results. Moreover, please note that performance of and investment in our funds is discrete from performance of and investment in Ares Management, L.P. During this conference call, we will refer to certain non-GAAP financial measures such as economic net income, fee-related earnings, performance-related earnings and realized income. 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. These measures may not be comparable to like-titled measures used by other companies. In addition, please note that our management fees include ARCC Part I fees. Please refer to our second quarter earnings presentation we filed this morning for definitions and reconciliations of the measures to the most directly comparable GAAP measures. This presentation is also available under the Investor Resources section of our website at www.aresmgmt.com and can be used as a reference for today's call. Please note, we plan to file our quarterly report on Form 10-Q early next week. I would like to remind you that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase an interest in any security of Ares or any other person, including any interest in any fund. This morning, we announced that we've declared our third quarter common dividend of $0.28 per share, which we paid on September 28, 2018, to holders of record on September 14. This represents a 5.3% annualized yield based on our closing price on August 1. We also declared our quarterly preferred dividend of $0.4375 for Series A preferred share, which is payable on September 30, 2018, to holders of record on September 15. Now I'll turn the call over to Michael Arougheti, who will start with some financial and business highlights.

Great, thanks, Carl. Good afternoon, everyone. Hope everybody is enjoying the summer. Our second quarter results demonstrate continued momentum in our core management fee business and a significant acceleration in the growth for AUM. For the second quarter, we posted record core fee-related earnings of $62 million, up 16% year-over-year, marking our fifth consecutive quarterly increase. In addition, driven by over $12 billion in second quarter fundraising, our AUM also reached a record $121 billion, up 17% year-over-year. For the first half of 2018, our new commitments of approximately $19 billion have exceeded all of last year's funds raised, and we are on pace for our best year yet. We currently expect to end 2018 with more than $125 billion in AUM. Our second quarter realized income was also significantly higher as we monetized a portion of recent gains and added to our strong underlying core fee-related earnings. Since our realized income was in excess of our stable dividend, we plan to reinvest our retained earnings to fuel future growth, consistent with our new dividend and capital management policy. In the quarter, several important events and actions that we took further solidified our leadership in global direct lending and private credit. As I'm sure our investors can appreciate, these should have meaningful impact on our growth and earnings in the years to come. As you may have seen from our recent press release in July, we closed our fourth European direct lending fund, ACE IV, at its hard cap of EUR 6.5 billion in less than six months from its launch. With anticipated leverage on the fund, total capital available will be approximately EUR 10 billion. We believe ACE IV is the largest European direct lending fund raised to date, and it will become Ares' second-largest fund. Our fundraising success reflects our European market leadership and our team's successful track record over the past decade with more than EUR 12 billion in commitments across over 150 transactions closed. ACE IV brought in over 125 investors, 59 of whom were new to Ares. And overall, existing Ares investors committed 70% of total commitments with 30% coming from those new investors. Of the ACE investors that re-upped, the average upsize of their commitment was over 50%. The roster was comprised of investors from all over the world, including Europe, Asia, North America and the Middle East, and included not only pension insurance and sovereign wealth, funds but also a growing number of endowments, private banking clients and family offices. Our European teams grow in scale, and breadth of coverage translates into active yet highly selective deployment into that growing market. And over the last 12 months, we've closed more than EUR 4 billion in new financing transactions, and we're already off to a strong start with ACE IV having invested approximately EUR 750 million, thus far, in the third quarter. Another noteworthy development relates to our BDC, Ares Capital Corporation, or ARCC, which recently announced its plans to take advantage of the operational flexibility on leverage permitted in the 2018 Small Business Credit Availability Act. Essentially, this legislation permits BDCs to decrease their asset coverage requirements from 200% to 150%, or said differently; increase their debt to equity from 1:1 to 2:1 under certain circumstances. ARCC has announced that it intends to gradually increase its leverage from its current debt-to-equity target up to 0.9 times to 1.25 times beginning in late June of next year once the new requirement becomes effective. Assuming 1.25 times leverage using its stockholders' equity as of June 30, 2018, ARCC would have uninvested available capacity of close to $5 billion. With this additional capacity, we can patiently grow ARCC's AUM and earnings over time, which translates into higher earnings for Ares Management as well. ARCC is in an even stronger competitive position today as one of two BDCs that elected the lower asset coverage requirement and also retained an investment-grade rating from both S&P and Fitch. And lastly, as Kipp discussed on yesterday's ARCC earnings call, ARCC is demonstrating strong earnings momentum as the company benefits from LIBOR increases and portfolio rotation and asset monetizations related to the acquired ACAS portfolio. And based on that strong recent performance and a positive outlook, ARCC also announced a quarterly dividend increase yesterday. Third, after the end of the second quarter, we held our first closing and a new U.S. senior direct lending strategy. Although we've been in the middle-market senior lending business for over 14 years with a long and compelling track record, this is our first commingled fund raised focused principally in U.S. senior direct lending. And it highlights our ability to leverage our capabilities into new solutions and new products for both our borrowers and our clients. In our first closing, we raised $1.4 billion in LP commitments, and we expect to have a final closing in excess of $3.5 billion by year-end, including additional LP equity commitments and anticipated leverage. Like our first junior capital fund that we closed last year, Ares Private Credit Solutions at $3.4 billion, this expanded strategy is just another example of our ability to diversify and to capitalize on our leading global direct lending and private credit franchise. Our recent fundraising momentum is not surprising given the significant investor demand for alternative credit and our long-standing market leadership and successful track records in both the U.S. and European illiquid credit markets. Investors are gravitating toward defensive asset classes with high current yields, low volatility and had benefit from rising interest rates. In recent years, we've been investing significantly in the continued growth of several capabilities where we believe we can offer attractive new investment solutions with these similar characteristics. These strategies are across our three investment groups and include asset-backed and structured credit, commercial real estate lending and special opportunities in distressed. We believe that these areas all provide powerful future growth opportunities for us and can offer our investors premium, less correlated returns through our firm's deep self-origination capabilities and global reach. Our continued fundraising momentum also illustrates the valuable partnerships that we've developed with our existing LPs and the continued growth of our global LP base. During the second quarter, about 60% of our capital raised directly from institutional investors came from existing Ares clients. This highlights an important continuing trend in the industry where LPs are consolidating funds with broader and more diverse asset managers. We continue to see growth opportunities in all major investor categories, particularly with global pension funds and insurance companies. Our total number of direct investors has now increased to over 840, a threefold increase from five years ago. On the investing side, we had an active quarter, deploying $4.3 billion in our drawdown funds, mostly in European and U.S. direct lending strategies, followed by selective deployment in our flexible corporate private equity, structured credit and special-situation strategies. Notwithstanding the current environment, we're continuing to successfully leverage our global self-origination capabilities and multiple platform advantages, including incumbency, our broad relationship network and our industry and market knowledge to find attractive, risk-adjusted return across all of our businesses. We believe that the increase in our scale and the broadening of our product has solidified our competitive advantages in origination, deployment, research and information. And with that, I'll now hand the call over to Mike McFerran.

Thanks, Mike. I'll start with a review of our quarterly results, followed by an update on some key areas of focus for us. The strength of our fundraising has supported our AUM growth, which is up 17% year-over-year, to $121.4 billion. We've raised just over $12 billion during the second quarter, which was highlighted by $6.5 billion raised in the ACE IV first closing. Note that you'll see the remaining amount of approximately $1.2 billion on our third quarter results, which brought the total fund size to approximately $7.6 billion of equity commitments. We also added to existing funds and raised new SMAs in both the U.S. and Europe, totaling over $2 billion, including a new $1 billion separately managed account in U.S. direct lending during the second quarter, and the pipeline continues to be promising. In structured credit, we raised more than $900 million, mostly in our private asset-backed strategies but also in new secured income strategy focused on the insurance market. Our liquid credit team remains very active in the CLO market. Pricing and closing are 48 CLO, which totaled over $500 million. And we just priced another CLO in Europe last week, representing our fourth CLO price year-to-date. Across our two other investment groups, we experienced additional inflows of more than $650 million, including more than $300 million in new capital and two real estate private equity funds and $350 million in our power and energy infrastructure strategy within our Private Equity Group. Since we have remained selective in our deployment, while our capital raising has accelerated, our year-over-year Fee Paying AUM growth rate of 9% has not yet caught up to our AUM growth. For the second quarter, management fees and fee-related earnings increased 9% and 16% from the second quarter of 2017, respectively, or up 10% and 22% for the first half of the year compared to the first half of 2017. Our second quarter realized income totaled a near record $108.1 million, which translated into after-tax realized income per common share of $0.40 or a 40% increase compared to the second quarter of last year. For the first six months, our realized income totaled $180.1 million. And our after-tax realized income per common share was $0.67, up 60% from the same period a year ago. As Carl stated earlier, we declared a quarterly dividend of $0.28 per common share for our third quarter, consistent with our second quarter's level. As a reminder, along with our election for corporate tax status, we moved to a level qualifying the quarterly dividend that would be reassessed annually based on the expected trajectory of our after-tax fee-related earnings. Our core fee-related earnings continues to grow against the stable dividend, while our realized income may allow us to retain earnings when we have meaningful realizations like we have this past quarter. Let me now spend a few minutes on our assets under management and available capital. A big driver of our future earnings is the embedded growth from capital raised but not yet deployed. We ended the second quarter with a record amount of dry powder and shadow AUM, setting us up for significant growth. Our available capital totaled $33.3 billion, up 34% from prior year. And our AUM not yet earning fees, or shadow AUM, increased 85% from prior year to $24 billion. Of this $24 billion, approximately $19.9 billion is available for future deployment with corresponding management fees totaling $218.4 million or approximately 28% over the last 12 months management fees. Approximately 90% of the management fees tied to AUM available for deployment relate to our direct lending and structured credit strategies in our credit group. The continued deployment of capital from these strategies will bring these fees online in the quarters and years ahead and we believe will continue to serve as a key growth driver for both top line revenue and fee-related earnings. With this growth in future management fees, we also expect to be able to gain efficiencies on our margins through operating leverage. Please note that these numbers do not include increased management fees and Part 1 fees we expect to earn in the future from, one, the increase in Ares Capital's targeted debt-to-equity ratio beginning in the second half of 2019; and two, the expiration of the $10 million per quarter fee waiver at the end of the third quarter of 2019. Incentive eligible AUM also reached a record high in the second quarter of more than $73 billion, up 23% year-over-year. Of that amount, nearly $30 billion is not yet invested and available for future deployment, which we believe represents the potential for significant future performance fees over the longer term. Incentive generating AUM of $24.5 billion is at record levels, up 11% year-over-year, driven by additional funds above our hurdles and our credit funds. Looking forward, we believe the growth in our shadow AUM and incentive eligible AUM metrics provide valuable insight into our embedded earnings growth potential. Importantly, our growth is not coming at the expense of stability due to the strong mix of management fees, which continue to represent more than 80% of our total fees. Our management fees are derived from locked-up, long-dated capital as 81% of our second quarter management fees were earned from funds that had a remaining life of more than three years, and approximately 90% of our management fees were generated from permanent capital or closed-end funds. Before I hand the call back to Mike, I'd like to provide an update on our corporate structure. As you know, we elected to be taxed as a corporation beginning March 1 of this year, but we do not undergo a complete legal conversion. When we announced the change in tax status, we indicated that we would continue to evaluate our structure. At this time, we intend to move forward with the process of converting our legal structure to a state law corporation. We plan to structure the company in a manner that we hope will meet the eligibility requirements for inclusion in certain stock indices to further enhance the accessibility and ownership of our shares. However, we are still working through the details, and there's no assurance that we will be included in any of the stock indices. We expect to complete the conversion by the end of this year. Mike will now close with his thoughts on historical and future growth.

Great, thanks, Mike. Before opening the call up to questions, I would like to take a minute to share some concluding thoughts on where we've been and where we're heading. Obviously, our business is trending very nicely, and we believe our growth outlook is promising. We're enjoying double-digit growth in most of our key financial metrics, and the seeds for future growth are already planted in our current operating model, shadow and incentive eligible AUM, as Mike just talked about, and our current robust fundraising pipeline. But with all of that, our greatest assets still remain our culture and our team. Ours is a culture of high performance and collaboration and innovation, which has led our expansion into new channels of distribution, new geographies, new asset classes and even to the proposed evolution of our corporate structure. This culture is nurtured by a deep and experienced leadership team of over 100 partners and is evident in the unique origination and investment skills that our investment teams possess across the globe. This team has delivered strong results over the last 20 years across asset classes, across markets, through cycles. And our consistent performance has earned us the trust of our investors over a long period of time, which has enabled us to invest in our business for the long term and to evolve our core competencies into adjacent markets and products. Perfect example of this, a little over 10 years ago, we made the decision to leverage our U.S. experience to launch a European direct lending business with no assets, no revenue but a lot of conviction around the long-term market opportunity. And now having just closed our fourth European direct lending fund, which we expect will total nearly $12 billion with anticipated leverage, we're proud and happy to say that we now have yet another business with its own market leadership position and still more room to grow. We now have similar conviction in our ability to expand our private credit expertise into new growth areas such as senior direct lending, private asset-backed investments, real estate debt and special opportunities, just to name a few. In addition to our credit group which is benefiting from our leadership position in direct lending and private credit, our leading private equity and real estate franchises also present meaningful opportunities for continued growth. And over the next few years, we expect to grow our private equity AUM organically with our existing strategies and through potential step-out strategies. And our real estate group, which operates in our largest and most fragmented addressable market, should have robust and actionable organic and inorganic growth opportunities over the coming years. So needless to say, we're excited about where we've been but even more excited about where we're taking this company. And as always, we appreciate your time and support, and we'll now open up the line for questions.

[Operator Instructions] Our first question comes from Gerald O'Hara from Jefferies. Please go ahead with your question.

Great, thanks. Maybe, one, just kind of on the conversion or I guess continued conversion. Could you perhaps elaborate a little bit on the process and maybe how involved it is? Are there any potential hurdles or shareholder approvals that might delay or I suppose even accelerate that process?

We're not aware of anything that would potentially be hurdles that would delay it. We've guided towards year-end is our intent. Frankly, it's a lot of administrative work. And the time period we spent since we announced the tax conversion has really been spent on inventory and considerations around us and also less involved with doing it. But I think, again, it's mostly administrative, a lot of documentation, potentially updating filings with the SEC, but nothing that we see as being overly complex or burdensome, just stuff that takes time.

Okay. That's helpful. And I appreciate your comments for future management fee growth. But perhaps as it relates to FRE and the margin, which we've witnessed grinding up over the past several years, but perhaps you can give us a sense of how that trajectory might look going forward, balanced against your comments for obviously investment in the firm for future growth? Thank you.

Sure. So yes, our margins today at 30% has been the last few quarters. When you look at the over $200 million of management fees tied to our shadow AUM that's already raised, we've talked about the potential of ARCC's incremental management fees and the future changes in leverage that are not included in our $200-plus million number. That's a lot of capital where we have people in the seats today and we have the infrastructure to support without any meaningful direct costs to support it and that are incremental to what we spend today. As always, we do continue to invest in the business. But needless to say, I think, as you see, all - management fees come align over the next couple of years, we do expect continued margin expansion. I don't know if that's 32% a year from now or 33% or 34%, but we're pretty confident we will continue to go past 30%, and as you say, grind upwards over the next few years.

Great, thanks for taking my questions.

Our next question comes from Michael Carrier from Bank of America Merrill Lynch. Please go ahead with your question.

Hey, good afternoon. It's Mike Needham in for Mike Carrier. So the first question we have is on ARCC. Can you talk about the outlook for management fees and Part 1 fees for that business? The portfolio continues to evolve, and it looks like the current leverage is pretty conservative versus where it could ultimately go.

Sure. Kipp is here as well, so he can chime in. But what I'm most pleased to see in the recent ARCC results is the consistent ability to have the dividend exceed core earnings at a point in the company's evolution history where we're running at a fairly low leverage level relative to historical levels. I think that's given that management team a lot of operating flexibility to navigate the cycle. I think the ARCC folks put out a wonderful presentation, outlining their strategy to re-lever over time. I think the takeaway there is, one, not really changing the asset strategy at all from what the company is doing today. Obviously, the track record there has been exceptional. And I think they're going to continue to do what they've always done, albeit with modestly higher leverage. So when you think about the math of it, it's fairly straightforward, although it will take some time. And so far, the leverage won't go into effect until the end of June of next year, and I think the ARCC team has communicated a gradual re-leveraging of the business. But if you just took the midpoint of the targeted leverage range that we've articulated of 0.9 to 1.25, that's about 1.08 times. And you applied basically the same portfolio metrics that would generate roughly $100 million in incremental management fee and Part 1 incentive fee revenue in excess of where it is today. Importantly, as Mike McFerran just mentioned, that is not in our shadow AUM number and not in the management fees that could be generated from shadow AUM. So if you added that $100 million, it would go from about $218 million to about $318 million. The secondary catalyst, which we referenced in the prepared remarks, is after the third quarter of 2019, the $10 million per quarter or $40 million per annum fee waiver currently in place rolls off. So as we re-leverage, you could see that $100 million increase into the $140 million, $150 million range post waiver roll-off.

Okay, great. Thanks for walking through that. And the other one we have is just reinvesting to drive future growth in your comments on your realized income in the quarter. Can you, I guess, talk about your future growth initiatives and where you might be able to use excess capital as you generate it, particularly if you could touch on the insurance industry? I think you managed a fair amount of capital for that industry already, but I'm wondering if you're seeing any opportunities for things that might be for sale like managing closed blocks or runoff businesses that companies may not want for capital reasons.

Sure. So there's a lot there, so we'll unpack each one. When you think about the excess capital, as we've articulated before, we'll use it for organic and inorganic growth and we'll use it for general corporate finance purposes. So as an example, you probably saw we announced a share repurchase plan for our preferreds. As we've talked about on prior calls, we are likely to pursue a share count neutral strategy over time, and so there's an opportunity for some excess retained earnings for share buybacks. So when you then go to the organic and inorganic growth, as folks know, acquisitions have been a part of our growth history where we've been able to acquire teams and capabilities in markets or asset classes where we see an opportunity to accelerate growth and profitability, and I think that will continue. Needless to say, we're in an elevated valuation environment. And so while we continue to actively look at acquisition opportunities, candidly we're not finding that many that check all of our boxes, but we're still at it. On the organic side, I highlighted in our prepared remarks a couple of areas where we've been investing significantly in new product development, distribution and people. Some of those areas are real estate lending business, which is on a fantastic glide path now. Our special opportunities business, which we talked about last quarter, where we've added about 18 people in the last 18 months as we continue to ramp that business behind, really, really good performance. Our alternative credit businesses with large in and around private asset-backed, asset-based lending structured credit are all big growth areas that we think could be meaningfully larger for us given our track record in and around the illiquid credit markets. Insurance, you're absolutely right, is already a big business for us. We and our peers are all attacking that industry opportunity in different ways. I think people know, depending on how you look at it, that's anywhere from a $15 trillion to $27 trillion market opportunity. And we're getting more than our fair share when you look at the growth in insurance assets that we manage. While we have thoughts on closed blocks in the past, the bulk of our growth in insurance assets is coming through SMAs and strategic partnerships in and around core parts of our business. We are keenly aware of the opportunity to continue to grow that business through acquisition, whether it's ongoing life cost or closed blocks. And obviously, that's one place that we can turn our attention to in terms of the use of capital.

Okay, thank you.

Our next question comes from Ken Worthington from JPMorgan. Please go ahead with your question.

Hi, good afternoon. Just on the competitive landscape for direct lending. From the outsider's perspective, we're seeing new entrants continue to build there as well, and you've got greater leverage potential on the existing funds. So you're clearly successfully raising assets. Maybe talk a little bit about the investment environment in direct lending, both in the U.S. and Europe, if they're different. How frothy really is it? Are you seeing the impact of increased competition on the investing side? And maybe how are you managing that risk?

Ken, this is Kipp deVeer. Some of the comments that we made on our call for Ares Capital yesterday addressed this. We had a lot of questions about it. I think your observations are right. There's certainly interest in the asset class broadly, both with Ares and with others. I think the interest is I think it made sense to us relative to the risk reward, generally speaking, in middle-market loans versus other things that you can do with your capital or what you're talking, mostly senior secured loans, floating rate, first lien, all of that, good downside protection. And where we invest, we tend to choose defensive industries and tend to stay away from places where we think we're creating potential credit issues and defaults for investors. But it's absolutely late in the cycle. It's absolutely more competitive. And all we can continue to do is, frankly, assert our leadership position in that market. We've been doing this a long time. We've got one of the largest teams in the space. We've got very flexible capital. We have a multi-hundred named portfolio to play off where we're backing a lot of our best companies with continued kind of ongoing financings which keeps us away from new deals that we think certainly there's new problems being created by others. I think a takeaway for you should be and for others will be, in our opinion, a likely wider dispersion of results, i.e. the strong players in the market I think will continue to do well. And I think that some of the weaker player's maybe with less pedigreed or established platforms and less experience operating through a cycle may do not so well. And so we're still finding enough to do. We're still very positive on the business, but I think your observations, generally, are good.

Yes. Maybe just to chime in on the European side -

Ken, Blair is here today, too, so we're going to answer your question on Europe, too. But I think it's largely going to get -

Awesome, no, thank you. No. That's great.

Yes, sure. In terms of Europe, I think what we're finding is that the market structure is frankly many years behind where the U.S. market is. In other words, the transition of that market from a bank-led market to an institutional investor and fund-led market is still in its development stage. And as a result of that, we found just excellent deployments and risk-adjusted return on opportunities over time. In terms of the competitive landscape itself, with respect to other funds and institutional investors, it's actually been relatively stable over time. We talked a lot on this call about ACE IV. But I recall when we talked with investors about ACE II and ACE III, the competitive set that we benchmark ourselves to was largely quite similar. So it's actually been fairly stable as have our risk-adjusted returns over time.

Thank you. And then just on ACE IV, when do fees turn on? When does that fund get activated?

I think we mentioned in our prepared remarks, we started investing capital this quarter. We get paid on invested, so -

We actually sent the first capital call earlier this week, so it started.

Within this current quarter, our first management fees hit the box.

Okay, awesome. Thank you.

Our next question comes from Kenneth Lee from RBC Capital Markets. Please go ahead with your question.

Hi, thanks for taking my question, wondering if you could comment on the environment for deploying capital within the private equity space. And what's your near term outlook for potential realizations?

This is Bennett Rosenthal. So in terms of capital deployment, we had a very active 2017 and beginning 2018. I'd say, today, the pipeline is a little bit lighter than we've seen in the past year, primarily driven by high valuations, big multiples, very competitive environment. We are active, having the - Scott and his team on the special opportunities side integrated into private equity is generating some more opportunities on the private equity side that we are working on in terms of rescue capital and distressed debt for control opportunities. And we also continue to be very active on the energy side. So I'd say a little - very cautious on the deployment side because of the competitive environment. Obviously, that translates into opportunities for realizations. While we've been pretty aggressive about realizing in this market and I don't see a whole lot in the short term on the realizations side, but we are exploring realizations in the portfolio and opportunities over the next 6 months to a year.

Ken, just a quick overlay and maybe talk about PE and what we're seeing in private debt because we're one of the larger financiers of private equity, and I think we are seeing exactly what Bennett is articulating, which is if you don't have operational expertise, unique distressed for control angle, a broad, flexible mandate, I think it's very, very hard to compete in the regular way private equity business right now. If you look at where companies are getting bought relative to where they're getting leverage on the cost of capital, the unlevered yield to the equity on buyouts is pretty low right now relative to our historical standards. At a point in time where we're late in the economic cycle, rates are going up. And so it's hard to see in an environment where you have multiple expansion, uninterrupted cash flow growth and cost of capital coming down. So when you look at the math of the buyout, what it really tells you in a rising rate environment, people are able to generate returns in debt similar to what I think you can generate in private equity at half of the exposure to a company. So part of the way I'm experiencing the growth in private credit is a little bit of a rotation from kind of the core buyout up the capital structure to try to capture returns as rates are going up.

The good news is in terms of realizations, the portfolio is performing very well on an operating basis. While we've had one or two things that we're - of particular issues we're focused on, on an overall basis, the portfolio is up from an EBITDA perspective well into the double digits, so we're very excited about the underlying portfolio and what that could mean for realizations and the ability to support the multiples that we're hoping to get on the realization front.

Great, thanks. And just one quick follow-up on gaining traction with insurance clients, I think you mentioned this briefly in your prepared remarks as well. But is there any need to use either new types of products or any kind of adjustment in distribution strategy that would be acquired to gain any further traction with insurance clients? Or is just sort of the capability already there at this point?

Yes that's a good question. We have a fully developed capability resonant in our insurance solutions group, and that's everything from product development and structuring expertise around regulatory capital requirements for insurance companies, both here in the U.S. and in Europe. So as we continue to see that asset class grow, we're obviously putting more human capital behind it, hiring more distribution folks to cover those accounts, more structuring folks to work on unique structures. But in terms of the technology, if you will, and the capability, I think we have everything that we need right now.

Great, thanks.

Our next question comes from Chris Harris from Wells Fargo. Please go ahead with your question.

Thanks. Hey, guys. So it was obviously a very good quarter for fundraising. That's clearly lumpy, can vary a lot quarter-to-quarter. You guys mentioned a lot in your prepared remarks, so it sounds like there's still good momentum. Is it kind of possible to size what you guys know about today for us, so we can kind of gauge where things might be headed the next couple of quarters?

Sure. We said on the call, we expected AUM for the year to finish north of $125 billion. With ACE IV done, we have other funds in the market, including real estate, so we're still raising for two private equity funds. We talked about another private funding credit. We've priced the fourth CLO this quarter for $500 million, so that momentum continues and we do have pretty good visibility. I don't know. Again, we don't want to give a precise number. We feel very comfortable with the $125 billion comment. I think we'll shoot past that, whether or not that means we end the year of $129 billion or higher, we'll see. But the fundraiser momentum remains very, very strong for us.

I think two qualitative points, Chris, not to - not put a number out there. Just - that's a little tougher. But that type of fundraising momentum we have I would expect to see continue in the coming years for a couple of reasons. One, in each of our businesses, we're now well into the evolution of what I would call our flagship families of funds. So ACE IV, as we just talked about, $12.5 billion fund, which is 2.5 times the size of the prior fund. We're raising our ninth U.S. private equity real estate fund. We're on our fifth U.S. corporate opportunities fund, so on and so forth. So when you get to that level of maturity, not only have good visibility into the fundraising, but with good performance, which we have, you see continued support from your existing investors at larger commitment levels. So as we talked about in the ACE experience that we just had, meaningful commitments from existing investors who also happen to increase their commitments on average by 50%. So that's one dynamic in the background. And then the second dynamic is as we're raising new funds, we're bringing new investors onto the platform. They're committing less, but they are growing with us. And so you have a wave of new LPs coming onto the platform that will then get onto that trend line of increasing their commitments. And interestingly, what we've seen as we've invested in investor relations and business development capability here and continue to deliver excellent performance, we're seeing a much broader cross-platform investment from our LPs. And when you look at our institutional LPs now, 40% of the folks who invest with us now invest in more than one strategy. And so we're able to now introduce folks to the Ares way of investing in private equity, for example. And five years later, they're going to be meaningful investors in some other part of our platform. So we're growing existing funds. We're introducing new first-time funds like the senior direct lending fund or private credit solutions that had meaningful sizes and then we're cross-selling investors across the platform on the backs of good track record and a good client experience. So I'd expect this kind of momentum to continue. And maybe just ending with the obvious, as we've talked about before, the global demand for alternatives continues to grow for all the reasons we've talked about around what the investment outcomes are and some of the challenges people are having with more traditional asset classes in both equities and fixed income. So I think the industry tailwinds and the second we move to alternatives, we think, is going to continue to drive some pretty serious growth.

Thank you.

Our next question comes from Robert Lee from KBW. Please go ahead with your question.

Great, good morning, Mike's. First question is going back to the C corp, the full conversion. I'm just curious when KKR announced theirs. They talked about having some - at least temporary tax benefits from step-up basis that could lower kind of tax rates and things like that. So from where you sit today, should we expect anything - is there any of that potential in your conversion?

Our structure is different than KKR's. I can't speak to them. We already made the tax conversion. So the corporate change, I don't anticipate having any further tax implications for us. So short answer, Robert, is I don't think there will be basis adjustments, anything. Again, they're structured, and I think the way they do their conversion was a little different.

Okay and may be just a follow-up to Mike, your comments about inorganic growth. I think you - and you referenced it, I think, specifically within the real estate business. So I mean, clearly, it's something you guys have done in the past to various beliefs. But I'm just curious about your take on the current environment? I mean, you've seen a lot of activity of minority stakes being sold to different managers to so-called permitting capital vehicle and whatnot. So is it your sense on the inorganic front, and I'm sure you look at a lot of stuff, that there are some things you'd like to partner up with but some of the pricing is just kind of wacky and out of sync? Or is the stuff that you're interested in really that's going to be just completely different than what's transacting out there?

It's a little of all of that, Rob. So it's interesting you mentioned some of these minority stake sales. On the one hand, I think it highlights and articulates the value opportunity that people see in alternatives. On the other hand, I'm a little bit perplexed by the valuations being put on these companies in the private market relative to the valuation framework that exists for the public alt managers. So there's a little bit of a disconnect there and because of that disconnect, as you've just highlighted, it makes it challenging for us to be aggressive on the acquisition front relative to some of that minority capital. I think that will work itself out over time, but that is definitely a dynamic that we're experiencing right now. But away from that, again, valuation is a big challenge for us because given our platform strength, access to capital, ability to attract and retain talent, when we buy, we're always measuring the buy decision against the build decision and whether or not we can actually grow a business in a growing market organically by bringing on teams and putting resources behind them. So when we get into an environment where valuations are tough and there's a little bit more competitive capital out there, I think you'll start to see us, which we've been doing, being much more aggressive in organic business build behind some of the strategies that we find attractive.

Great and then maybe just one follow-up, I mean, you've clearly have talked about the - a fundraising environment that's, let's call it, almost nirvana, in a sense, for you and maybe many of your peers. Just kind of curious on where you sit, what kind of do you think really could disrupt that? I mean, obviously poor performance on a manager basis. But is there anything you're - you think that, hey, this could really kind of derail this trend? And then maybe is it - corollary to that, are there strategies you're looking in or raising where maybe it's a little bit more of a slog or tougher to kind of get the LPs interested?

No. There's very few product categories in and around the alternative universe that are - I would say are a slog and again because of what people are trying to sell for. So if you're a pension fund or an insurance company with some actuarial pad requirement and you've been in an environment with persistently low interest rates and some fears around global equity volatility, you're going start naturally gravitating towards alts. So the wave of capital is coming from folks chasing their actuarial benchmarks, rotating out traditional assets. It's new investors coming online, i.e. retail and high net worth. It's new geographies coming online, i.e. Latin America, Japan, China. And so it's hard to see that even with core performance that capital flows are going to reverse anytime soon. There had been some fear, particularly around the alternative credit space, that with rising rates, you may see a slowdown in appetite for the asset class. You can see from our fundraising results and others, it's actually been the opposite, which I think speaks just to the durability of the relevant value opportunity in private credit against traditional fixed income. So our rates have gone up and total return in the asset class has gone up, but it's actually become significantly more attractive rather than less. So I think we've kind of crossed over that inflection point where people had some fear that you'd see the flows reverse with rates going up, but I don't see it.

Great, thanks for taking my questions.

Thanks, Rob. Operator Our next question comes from Alex Blostein from Goldman Sachs. Please go ahead with your question.

Hi, good afternoon. This is Daniel Jacoby filling in for Alex. Just a quick question around the legal conversion to a C corp, can you remind us of the current breakdown of voting rights, if this could change with the legal change that you guys are making, and then ultimately, how this all ties to potential index inclusion?

Sure. So currently, there are no voting rights held by the public shares outstanding. All voting rights sit with the private units. As part of the conversion, we do intend to put voting rights with the common shares, which we do think is - lends itself to be - frankly increase the probability of index inclusion for us. The specifics of how we planned the structure or different share classes post that conversion later this year and how the rights will be carved up, we'll talk about later in the year as we finalize. But short answer is there will be some voting rights with the common.

Got it, that's helpful. And then just shifting gears to the - on the fundraising side. Obviously, fundraising, overall, has been absolutely fantastic, but just maybe drilling down a little bit more into the PE side of things. Can you guys walk us through the drivers of FRE growth on the PE side in the near term? And I heard you've spoken about step-out strategies. Can you maybe provide a little bit more color there?

Sure. So right now, our private equity business has the core family is what we call ACOF funds, Ares Corporate Opportunities Funds. We raised our fifth fund about two years ago at $7.9 billion. And as Bennett said, deployment has been quite good there, so we'll be marching towards the next fund over the next year or two. Alongside that flagship ACOF family, we have a number of other strategies, special opportunities, which Bennett referred to traditionally with a special sits business largely focused on the liquid end of the distressed market. We've been making meaningful investments in team and capability there over the last 18 months. We've had tremendous performance in the last 18 months. Since inception of that new strategy, we've generated a 15.6% rate of return. And so with that performance momentum, you should expect to see us raising a fairly sizable amount of capital behind that strategy. And then lastly, as Bennett mentioned, energy has been a place where we have enjoyed really good deployment and really good investment performance. And given the level of activity and the qualitative track record there, we've been scaling up some step-out strategies in and around our energy business away from that ACOF business. So I think the nice thing is the combination of energy and special ops will grow as effectively a bridge to our sixth flagship fund, which would be a meaningful step-up in FRE.

Got it, that's helpful. Thank you.

And we have time for one final question. This comes from Michael Cyprys from Morgan Stanley. Please go ahead with your question.

Hey, good morning. Thanks for taking the question. Just curious on the legal entity structure change, why the two-step move first with the check the box and now a legal entity change? And what sort of feedback did you receive from the indices on the check the box? Is that just deemed ineligible because of the partnership legal entity structure?

So when we made the announcement, Mike, we were evaluating the corporate structure, the legal corporate structure change. We knew and have had great conviction around the tax change, so we didn't want to delay the tax change to make a decision on the corporate structure while it was in process. Plus we knew the time lines are effective, too, were very different. The tax change was something we were able to affect immediately. And the corporate structure change, because of the administrative requirements around it, was just going to take more time. So when we think about why we did this two-step, the first step was actionable immediately and conviction was clear. The second step required more in planning, but we're pleased that we're - we've made the determination around this. And on the index side of this, well, we can't speak for how the indexes respond. We're aware of the various index roles, and we look at them. And so as we think about this, we're obviously sensitive to voting rights and such. As it relates to certain indices, we think this again will make us increase the likelihood we're eligible. We can't assure that because only the indexes will determine who's included and who's not.

And just lastly on the legal entity change, what sort of implications are there for the insiders that today own the partnership units and then also the public shareholders, I mean, from a legal entity change, as it relates to either tax implications, earnings allocations, governance and so forth?

So on an economics - from an economic perspective, there was zero implications. This is literally a legal change in structure. Since we already made the tax change, no impacts on taxes or basis differentials or anything else there from what we've already done. Again, on governance, the common shareholders today have effectively no voting rights. And our intent is as we make this legal state law conversion, we will have new - add and replace existing share classes with new share classes that will contain voting rights for our common.

Great, thanks very much.

And ladies and gentlemen, at this time, I'm showing no additional questions. I'd like to turn the conference call back over to management for any closing remarks.

We have none, only to thank you again for your time today. And hope everybody enjoys a restful end to the summer, and we look forward to speaking again next quarter. Thanks a lot.