Ares Management Corporation (ARES) Q4 2018 Earnings Report, Transcript and Summary

Hello everyone and welcome to Ares Management Corporation Fourth Quarter and Year Ended December 31, 2018 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded on Thursday, February 14, 2019. And I would now turn to turn the call over to Carl Drake, Head of Public Investor Relations for Ares Management. Please go ahead.

Thank you, William. Good afternoon and thank you for joining us today for our fourth quarter 2018 conference call. I'm joined today by Michael Arougheti, our Chief Executive Officer, and Michael McFerran, our Chief Operating Officer and Chief Financial Officer. In addition, we’ll have other executives available for the Q&A session including, David Kaplan, Co-Head of our Private Equity Group, and Mitch Goldstein, Co-Head of our Credit Group. 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 investment in Ares Management Corporation. During this conference call, we will refer to certain non-GAAP financial measures such as fee-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 third quarter earnings presentation that 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 that we plan to file our Form 10-K later this month. 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 we declared our first quarter common dividend of $0.32 per share, represents an increase of 14% over our prior year’s quarterly dividend. The dividend will be paid on March 29, 2019 to holders of record on March 15. This dividend level represents a 5.9% annualized yield based on yesterday's closing price. We also declared our quarterly preferred dividend of $0.4375 for Series A preferred share, which is payable on March 31, 2019, to holders of record on March 15. Now, I'll turn the call over to Michael Arougheti, who will start with some quarterly and full year financial business highlights.

Great. Thank you, Carl. Good afternoon, everyone, and happy Valentine’s Day. Our fourth quarter’s results concluded a record year for Ares. We grew our fee-related earnings and realized income in excess of 17%, and increased our AUM over 20% driven by a record year of fund raising. As Carl mentioned, we’ve increased our regular quarterly dividend by 14% to $0.32 per share which annualized represents a $1.28 per share based on our positive outlook for continued growth in our core fee related earnings. Mike McFerran will provide more color on that when he walks through the financial results a little bit later. Before I get into the specifics and review of the 2018 key highlights, I would like to start with just a few comments on the recent market volatility and the implications for our business. As you all know the fourth quarter saw significant equity market volatility, which bled into parts of the credit markets. In our view, the technical selling pressure was disconnected from otherwise healthy corporate fundamentals. While we're seeing some modest deceleration of earnings growth, credit performance in general remains stable. Default rates remain low, and below historical average levels. And I remind everybody that often times a slow growth choppy environment can be very good for our investing. It extends the duration of credit portfolios without compromising already strong debt service levels and can provide more lender friendly pricing in terms. On the PE side, it may reduce competition for assets, and if we were to see a more significant dislocation, this could also create separation between stronger and weaker credit managers and meaningful consolidation opportunities. Also on the PE side, it also enhances rescue financing and distress for control opportunities. So while the markets have recovered most of their December losses, the Q4 environment was a great reminder to everyone that markets can be fragile and that many geopolitical and global macro risks still remain. Our strong inflows and performance against the volatile Q4 backdrop is evidence of the stability and strength of our business model. We invest with a flexible, relative value approach, and since we have locked up capital, we have a long timeframe for value creation and are never forced sellers. Our clients trust us to invest aggressively during periods of dislocation and to exit investments as appropriate during more constructive times. So unlike many traditional asset managers that experienced severe outflows in Q4, we saw near record inflows to our firm illustrating this dynamic, and that leaves us well-positioned for opportunities that future volatility may bring. In Q4, we had gross inflows of $10.4 billion and new capital bringing the full year to a record of over $36 million. All of this fundraising was organic, and does not include assets acquired or any material amounts raised through partnerships or joint ventures. Our growing client base continues to reward our consistent performance even in volatile markets by giving us more capital. And over the past several years, we've been fortunate to experience strong fundraising in each of our business lines from ever larger subsequent vintages and well-established commingled fund families like ACE and ACOF and our real estate private equity funds. Through launching new commingled funds, as we demonstrated with PCS, SDL, energy ops and real estate debt, by growing our managed account business across our credit strategies, by securing certain strategic partnerships such as the insurance company JV we talked about on last quarter's call and strategic mandates with large institutional investors and importantly the ongoing efforts outside of our institutional fundraising channel in places like ARCC and our growing CLO franchise. This fundraising momentum also demonstrates the valuable partnerships that we continue to build with our LP’s, the expanding reach of our marketing infrastructure and our ability to offer a growing array of innovative and attractive investment strategies across the platform. Over the past several years, we've added significant resources across our marketing, strategy product development, and IR teams and extended our coverage across the globe. Today, we have approximately 95 professionals across these groups compared to 64 just three years ago. And we're really starting to see the benefits of these investments. Over the past 12 months, we added 139 new direct fund investors to the platform, and 57% of all money raised came from investors outside of North America, illustrating our increasingly global footprint. We believe that we're just scratching the surface, growing in all major investor categories particularly with global pension funds, insurance companies, sovereign wealth funds, and private banks. Our total number of direct investors has now increased to over 900, up more than 15% over the past year, and fivefold since 2011. And our existing investors continue to re-up with us in new funds or across the platform at an impressive rate. During 2018, 131 existing LP’s who invested directly with us, invested 2.7 times more capital than our new investors. This reinforces the industry trend of LP’s placing more of their capital with fewer managers, and we believe that it demonstrates their growing desire to invest more with Ares. So maybe now turning to more specifics on the fourth quarter and full year results. We had first closings in two first time co-mingled funds, over 750 million in our energy opportunities private equity strategy, and 600 million in our real estate debt core plus strategy. We also held multiple final fund closings, including our first time senior direct lending fund or SDL at 3 billion of equity, which we expect will grow to over 5 billion AUM with leverage, and in our 9th U.S. real estate value add fund, with over $1 billion of capital commitments. In our market leading European direct lending business, we added over $2 billion in new capital, across new and existing strategic accounts, and we added over $1.4 billion to ACE IV’s total capital, bringing total equity and debt in that strategy and fund to over $9 billion. As we've discussed on prior calls, another exciting growth area for us is in our asset backed and structured credit strategies. We've renamed this strategy alternative credit to better reflect the breadth of the strategies that we offer across a wide spectrum of non-traditional corporate, consumer and real estate credit assets. We believe that our alternative credit strategy has an addressable market of over $3 trillion in assets across the globe. As discussed over the past year, we've added and we'll continue to add significant talent to our team and have enhanced our capabilities across a wide range of assets. And during Q4 alone, we added $1.4 billion in new alternative credit funds, bringing full year fundraising to $2.6 billion of gross commitments. These record levels of fundraising drove AUM growth of 23% for full year 2018 positioning us to meaningfully grow fee-related earnings and realized income in the years ahead. And our fundraising momentum is continuing, as we expect another above average year in 2019 with several larger flagship funds either launching this year and into 2020. I think most importantly, we continue to perform well for our fund investors. Our direct lending strategies generated exceptional relative returns in both the US and Europe as evidenced by a ARCC’s strong earnings results, and stable credit reported earlier this week including a 12% net return for 2018. In Europe, our third European direct lending fund, ACE III had gross returns in excess of 16% for 2018. Our real estate funds had yet another strong year, with our major U.S. and European private equity funds generating gross returns between 16% and 20% for 2018. And from a private equity standpoint, while still down for Q4, our corporate private equity fund composite outperformed the public equity markets for the quarter down 5.7% versus the S&P 500, which was down 13.5%. I remind everybody that our three year gross appreciation for our corporate PE composite remains in the high teens, and our longer term aggregate gross IRR since inception remained well over 20%. From an investing and deployment standpoint, we had an active year, as we scaled our teams and broadened our investing reach across various market segments and strategies. Total drawdown deployment was over 17 billion in 2018, up from nearly 13 billion in 2017 with growth across all three investment groups. Given the market environment, the key theme for us in 2018 was quality. We continue to focus on franchise businesses, with top management teams where we could add value over time and protect our downside risk. In direct lending, we largely stayed senior secured and defensively positioned industries with a strong emphasis on backing incumbent borrowers and larger more durable companies. About 90% of our 2018 transactions are direct lending included financial covenants, and more than half of those new commitments were to incumbent borrowers. In that business, we closed only 4% of the transactions we reviewed with significant overweighting, to non-cyclical and recession resistant industries. In PE, given the challenging environment for regular way private equity, we invested our flexible capital selectively in high quality platform companies with compelling growth dynamics, and an attractive energy investments, where we were seeing interesting relative value. And lastly, in real estate, we took advantage of favorable demand demographics and local supply demand trends to invest across multi-family and industrial and logistics properties in strong growth markets. And finally, before I turn it over to Mike, I think as everyone knows in 2018, we made an important change to our corporate structure as we converted to a C-Corp for tax purposes in March and for legal governance purposes in November. These changes were designed to increase the liquidity in, and broaden the universe of potential buyers of our stock. And while still early, we've already seen the benefits of these actions. Between March and year end, our public float increased from approximately 10% to about 30%. Our average daily trading volumes increased more than fourfold, and our institutional ownership has tripled. In addition, we were also included in several well-known stock indices for the first time, which facilitated nearly 6 million shares purchased by index funds late last year. We would also expect to be added to at least another large index later this year. And while our stock price was not immune to the year end market pressures, we do believe that as a C-Corp, we're now better positioned to capture value for our stockholders over the long term. And with that, I'll turn the call over to Mike McFerran, who will walk through the Q4 results in detail and describe our expected growth.

Thanks Mike. I'll start with the review of our fourth quarter and full year results, and conclude with a discussion on our dividends and capital management activities. As Mike stated, Ares is benefiting from the strongest fundraising year in its history, as existing investors provide us additional capital to manage and as new investors are attracted to our leading strategies and expanding platform. We had gross inflows of more than $36 billion for the year, which drove acceleration in our AUM growth to 23% year-over-year. This growth sets us up very nicely for AUM conversion of fee related earnings, as we invest our capital not yet earning fees. Our AUM reached $130.7 billion on the heels of another strong quarter of fundraising. Our fee paying AUM increased 13% percent year-over-year driven by deployment as a meaningful amount of our AUM converts to fee paying AUM once it is invested. Management fees and fee related earnings both increased 16% from the fourth quarter of 2017 or up 12% and 18% respectively for the full year compared with the same period in 2017. Looking forward, our corporate objective is to continue to grow our AUM and fee related earnings annually in the low-to-high teens consistent with our historical rates. Our fourth quarter realized income of $123.9 million up 66% was a record, which helped drive full year realized income to $395.4 up 21% compared to 2017 levels. In addition to the growth in our underlying fee related earnings, the strength in the fourth quarter realized income included $15.1 million from succeeding and earning the capital gains fee this year at ARCC also known as Part 2 fees along with several real estate private equity fund monetizations. Our fourth quarter after tax realized income per common share of $0.41 increased 78% year-over-year and on a full year basis, was $1.42 per share, a 31% increase over 2017 levels. Our steady, stable growth in our fee related earnings continues to account for about two thirds of our realized income, and provides a solid and growing foundation for realized income growth. Our realized net performance income and realized net investment income collectively have averaged about $117 million annually over the past five years, and we believe the aggregate amount will continue to attract higher over time, as our underlying incentive generating AUM increases. Our business provides visibility on future management fee growth through the embedded management fees we expect to generate from capital already raised, but not yet deployed, also known as our shadow AUM. We entered the fourth quarter with record amounts of dry powder and shadow AUM and shadow AUM is more diverse, and more global at any point in our history. Our available capital totaled $38.1 billion, up 52% from prior year, and our shadow AUM increased 94% from prior year to $28.2 billion. Of those $28.2 billion, approximately $24.8 billion is available for future deployment with corresponding, annual management fees totaling $245.5 million or approximately 29% of our last twelve months management fees. Based on the underlying strategies, we would expect deployment horizons ranging from 18 to 36 months. Please note that the $245.5 million in incremental management fees does not include the impact of any potential ARCC Part 1 fees we expect to earn in the future. Any additional management fees, we would expect to earn if ARCC is above its 0.75 times debt-to-equity ratio, or the expiration of the $10 million per quarter ARCC Part 1 fee waiver at the end of the third quarter of 2019. Assuming ARCC’s leverage reaches the midpoint of this previously announced new target debt to equity range, beginning in the second quarter of 2019, we estimate that our future management and Part 1 fees from ARCC could provide an additional $50 million of incremental fees on an annualized basis above the amount included in the $245.5 million I already referenced. Therefore, while there can be no assurance that $245.5 million to $50 million of incremental fees and the $40 million in Annual and Part 1 fee waivers totals approximately $336 million of potential future annual management fees or 40% of our last twelve months management fees. Incentive eligible AUM also reached a record high in the fourth quarter of $78.4 billion, up 26.1% year-over-year. Of that amount, $31.6 billion is not yet invested and available for future deployment, which is up more than 83% of our fourth quarter incentive generating total which implies material potential upsides to our realized performance income in future years. Our incentive generating AUM of $38 billion which is comprised of 73% in credit strategies and 18% in private equity strategies, increased 67% year-over-year. Of the amount of incentive eligible AUM that is currently invested, over 81% is generating performance fees. As Mike stated, based on the market volatility, we witnessed in the fourth quarter, it's good to remind everyone about the nature of our revenues in AUM. Our management fees continue to represent more than 80% of our total fees and are derived from locked up, long dated capital, including permanent vehicles. Approximately 98% of our fourth quarter management fees were generated from permanent capital or funds with closed end structures. We derive only about 5% of our management fees from liquid to credit funds, based on market values. Since many of you asked about our CLO exposure in December, we thought we could provide you some updated statistics. As a reminder, a CLO is simply a type of highly diversified institutional loan fund that holds primarily senior secured, syndicated bank loans, managed by asset managers like Ares or many of our peers. We derive about 7% of our management fees from CLOs and we only have approximately $75 million of recourse exposure and CLO tranches on our balance sheet. CLOs have been tested throughout the past two decades, due to multiple credit cycles, and the result has been cumulative loss rates near zero. Our experience of CLO investing in down credit cycles has also been strong. For example, our 2004 to 2007 CLO vintages, which we managed as a great financial crisis, generated a weighted average annual distribution with the equity of 19.7%. Finally, turning to our dividend, we declared a new quarterly dividend of $0.32 per common share for our first quarter, which represents an increase of 14% over our dividend levels in 2018. As a reminder, in early 2018, we move to a level qualifying quarterly dividend as we said that we would reassess the dividend annually at the beginning of each year. Our new dividend is pegged to the expected trajectory of our after tax fee related earnings. We expect to retain the access realized income above our dividends to either reinvest or a management fee business, for potential stock repurchases, or for any cash required in acquisitions or other strategic ventures. On the topic of share repurchases, this morning we announced a new $150 million stock repurchase program. The primary objective of this program is to have the flexibility to use our free cash flow to manage our share count from the vesting of employee equity awards. Mike will now close with his thoughts on our future outlook.

Great. Thanks Mike. Reflecting on 2018 and looking ahead to 2019, I couldn't be more excited, and I don't think that we've ever been better positioned. We operate a balance sheet light business model, with modest net debt relative to our core earnings and our business is growing at a double digit pace. We expect this growth to continue as we invest in new products, people and operating infrastructure to support our expansion. As Mike talked about, we believe our future is bright as the levers of future growth already exist in our shadow and incentive eligible AUM and current fund raising pipeline. Our clients continue to give us a greater share of their capital, and with our expanding product suite, we just had our best fundraising year in our history. With new growth initiatives and adjacent strategies launched in every business group, we’re poised to continue our growth and expansion in the years ahead. We have world class investment capital raising and business ops teams, and a cycle tested investment approach. And this shines through in our excellent investment performance. We're starting the year with over $38 billion of dry powder to invest, which puts us in a great position, as evidenced by our strong growth in management fees, and AUM during the financial crisis, volatile markets have always been good to Ares and provide us the chance to really showcase the power of our platform. In past cycles, we've been able to differentiate our investment performance, make accretive, strategic acquisitions and grow faster than our peers. And I'm confident that the next dislocation whenever it comes will also provide strong opportunities for Ares, our fund investors and our shareholders. So in closing, I want to thank the entire Ares team for all the hard work and effort in delivering incredible results in 2018, and to our shareholders, as always, we appreciate your time and support for our company. And operator, we'd like to now open up the line for questions.

[Operator Instructions] And our first question for today will be KenWorthington with JPMorgan. Please go ahead.

Hi, good afternoon, and thank you for taking my questions. And so, first one, 2018 was obviously a tremendous year for capital raising. You gave some high level comments in the prepared remarks. I was hoping you could share more the outlook for capital raising in 2019 maybe by the asset class. So kind of thoughts on credit, thoughts on private equity and real estate. And you mentioned in the prepared remarks, the flagships and flagship funds in pipeline for 2019. Maybe just help us understand how big the prior vintages were in terms of AUM?

Sure. Ken, it's Mike. I'll try to answer that somewhat [Indiscernible]. I think look 2018 was an incredible year, but I'd highlight, if you go back our historical average over the last couple of years, it's been about $17 billion. And so, while the $36 billion stands out, these numbers have been increasing sequentially. And to your point as we talked about in the prepared remarks, we've gotten into a rhythm now where the growth is coming not only from sequentially larger flagship funds, but it's coming from our ability to launch new strategies alongside those flagship fund families, open up new geographies, open up new distribution channels like private banks and non-traded retail developing strategic partnerships. So, our whole approach to fundraising as we talked about has gotten more global more systematic and we're now able given the track record of investment performance here able to launch new strategies more quickly and get them scaled. We won't give you a projection into 2019. But as I mentioned, I think, our 2019 gross fundraising should be at or above the historical averages. And again, that's going to come from a combination of flagship funds and new strategies. On the private equity side, we are in the market with a special opportunities fund that is a first time fund in a strategy that we've been executing on since the inception of the firm. Our expectation is that can be a multibillion dollar product in 2019 and a significant growth area going forward. As I mentioned, we have launched an energy opportunity strategy, again, as a quote-unquote first-time fund but sitting alongside our core energy capabilities within private equity. And as we sit here today, our ACOF V fund is in and around 40% deployed. And so, within the next maybe even more within the next 12 to 18 months, I think those teams will begin to think about what ACOF VI could look like. With regard to credit, the fundraising tends to be much more broad based. We're obviously coming off of a significant fundraising year in credit. I think the story in credit for 2019 will be much more about continued deployment than large flagship fundraises, but you should expect to see us growing in each of our credit categories with an emphasis on the alternative credit strategies I referenced in the prepared remarks. And then in real estate, as I mentioned, we are in the market with our fifth European flagship fund. The prior fund size there was about EUR1 billion. We would expect this fund to exceed that. And we will likely be back in the market based on the exceptional performance we've had in our US opportunistic equity strategies and that prior fund was about $800 million..

And our next question today will be Robert Lee with KBW. Please go ahead.

Hi yes. This is actually Pell Bermingham on for Robert Lee. I just kind of wanted to get a sense of the FRE margin, which has remained relatively flat over the past few quarters. I was wondering if you guys had any guidance on when we can expect an acceleration in that FRE margin?

We are – yes, we said we've targeted 30% this year is what we've delivered. We find 30% staff is sustainable. On the call we highlighted the amount of management fees, tied to capital has been raised, but will be recognized as we invest that capital. So I think over the coming years, as management fees grow, the deployment of capital is raised and where a lot of the expense is tied to the raising that management in that capital are already embedded in our numbers. You'll see progressive expansion. I think the important thing is I wouldn't necessarily view this as a quarter-to-quarter exercise, but view it over a longer time horizon. I think we've mentioned on past calls, that we think in the years ahead, we would expect our margin to expand past 30% into the low and then eventually in the mid 30s. I think one other comment which echoes some things we've talked about on prior calls, Ares is a growth company. We've been delivering growth between 15% and 20% for 15 years. And while we are focused on driving economies of scale as we grow, folks should appreciate that there are a number of meaningful investments in the P&L that allow us to continue to sustain that type of growth into the future. And I think, we committed on past calls and I think over the course of this year, we'll try to give folks better transparency into what those investments look like, and the impact on the margin. But we really want people to understand if you want to grow at 15% to 20% for 15 years you have to reinvest in growth and people and infrastructure, which is what we continue to do. So when you see our margins going up 500 basis points over the last three and a half years, that's inclusive of all of the growth investments that we've made.

Great. Thank you for taking my question.

And our next question today will be Gerry O'Hara with Jefferies. Please go ahead.

Thanks and good morning. Maybe a question on the backlog and pipeline metrics that were provided in the supplemental slide, appreciate the additional disclosure. But perhaps you can maybe help us think a little bit about how we should model this kind of going forward in terms of realizations or flow through into realized income and perhaps kind of mark-to-market swings that that these metrics might be might be susceptible to. Thank you.

Why don't we -- if the -- make sure we understand the question, Jerry. If the question is how should you be thinking about monetizations in realized and unrealized. Maybe, we'll let Mike walk through the unrealized component. A good place to look historically is we've averaged about $120 million annually since our IPO, below the FRE line if you will in incentive income and an investment income. As Mike mentioned in the prepared remarks, the pool of incentive eligible AUM continues to scale quite aggressively as we raise more capital. So those historical averages, while big numbers should scale with the AUM base. But it's probably worthwhile dissecting the unrealized just to get a sense for how that plays with the realized income is.

Yeah, and I think Mike hit on it probably thinking about the realized as the incentive eligible AUM grows, that notional amount expands, you expect over the longer term realized income would have the opportunity to expand with it. The unrealized piece, just stepping back for a second. If you recall, we led the industry away from viewing E&I as a key metric. During the course of this year, I think all of our peers have now dropped E&I. And the reason we did that, was we felt unrealized gains and losses was an appropriate reflection of value creation and portfolios. And that's most parents when you remember we said this in our prepared remarks, that we manage these assets neither permanent, or long dated closed end fund vehicles, where we control the timing of exits. So when prices go up or prices go down, doesn't mean we would manage, we would actually monetize at those prices. So I think, looking at the unrealized to us was a distraction for the public. I think our industry has agreed and followed suit. When you look at that going specific to unrealized, you have to remember that when you think about unrealized gains or losses, that number it reflects the actual change that happened during the period. So if your assets went up a dollar one quarter, and the next quarter you monetize those that gain and book a realized gain of a dollar, in that same quarter you’ll show an unrealized loss of a dollar, all else being equal. So I think that's when you think about the unrealized function. You have to remember it's not necessary asset, declines or gains, it’s also netted against the activity of realizations. Did that answer your question.

It does. That’s helpful color. I appreciate it.

And the other thing we talked about too is, if you look at where we are in fund life, we have talked on prior calls and in our private equity franchise ACOF III and ACOF IV are seasoned and you've been seeing us monetize as appropriate there. You saw a meaningful pickup in monetization activity within some of our older vintage real estate funds, which drove some of the exceptional performance in Q4, so we are in a healthy harvesting cycle across the platform. And I think, you'll continue to see us focused on that throughout 2019.

And our next questioner will be Michael Carrier with Bank of America Merrill Lynch. Please go ahead.

Hi. Thank you. This is Mike Needham in for Mike Carrier. Just two quick items. First, on the fee rate, it was higher again in the fourth quarter. Is there anything particular driving that higher? And the second item on ACOF V, can you just touch on how that funds doing pretty significant fund hoping we could get an update. Thank you.

So, I'll start with the fee rate, and David Kaplan can give you an update on ACOF V. On the fee rate, it has ticked up in most -- that's really a function of you think about the capital raising it's mostly around real estate, private equity and illiquid credit strategies that have fee rates higher than some of what we call the lower fee rates assigned to our liquid credit business, which was more probably in the historical 50 bp range, and most of the capital we raised today is north of a point. So, as we're deploying that capital and raising it, you're actually seeing our average fee rate tick up a little bit. David, you want to give some color on ACOF V?

Sure. So just to remind folks, it's a $7.85 billion fund. It is a February 2017 vintage, which is when the fee clock started working or was turned on. Mike mentioned that we're 40% plus invested committed. We're actually very very happy with that pace of deployment in what is a tightly priced private equity environment. The composition of the portfolio is a is a very good mix, reflective of our flexible capital approach, inclusive of more distressed rescue opportunities as well as straight plain vanilla buyouts of more growth oriented companies. So we feel very good about where the fund sits today.

Thank you.

And our next questioner will be Alex Blostein with Goldman Sachs. Please go ahead.

Hey thanks guys for taking the question. I was hoping to dig into a couple of fundraising trends that you've highlighted in particular in U.S. direct lending and European direct lending side of things. If you kind of look at the year-to-date numbers are very strong, and those are the areas obviously that it sounds like you might continue to see some growth. So, I was wondering if you could spend a minute on where the momentum is coming from still and maybe talk a little bit about kind of the nature of that capital. So, duration and sort of lockups it does not have a similar kind of longer duration characteristics as we know the rest of your credit business has?

So as we've talked about before, the demand for private credit strategy is broadly defined whether it's corporate direct lending, privately originated asset backed, privately originated commercial real estate, the investor appetite is coming for a couple reasons. It was initially spurred because of a low interest rate environment and frustration with the yields, and coupled with volatile global equity markets, which forced folks to rethink how they would generate excess return. What we've seen over the last 10 years is, while that may have catalyzed the growth, the growth is now being sustained because of phenomenal relative value and relative performance within the private credit asset classes. So when people find their way to private credit and they're allocating away from private equity or traditional fixed income they're basically looking to de risk, try to move up the capital structure, position into floating rate loans, as the hedge against rising interest rate environment and candidly shortened duration because weighted average most private credit asset classes are going to have an average life somewhere between two and four years. Once folks have now tried the product and seen how the asset class performs. When you look at how it's been performing against liquid alternatives, we would expect the demand to continue. So just to put that in perspective, as I mentioned, in fiscal 2018, our European direct lending business delivered 16.2% gross rates of return across that composite. If you look at our U.S. direct lending business, as we talked about ARCC, but it's true across the platform 12% plus type rates of return. And when you compare that against the liquid leverage finance benchmarks, whether it's the Credit Suisse Leveraged Loan Index, which was scrapped by with a 1% annual return or that BAML High Yield Index, which was down 2% for the year, people are beginning to see the durability of the return opportunity in private credit. It's a large, large addressable market that demand for credit continues to grow and so we would expect to continue to see growth there. In terms of how investors are accessing the growth, we offer ARCC as a daily liquidity public vehicle for folks to get access to private credit strategies. We offer co-mmingled funds to your specific question that are locked up GP/LP structures that typically have a life of eight years to 10 years with extension, and on average have an investment period between four years and six years. So when people are allocating into the space, it's with an expectation that you will be investing that fund over a four year to six year period. The nice thing is not only they locked up, but most of these private credit funds have recycled, so to the extent that that velocity in the portfolio of two to four years that I mentioned comes through that capital stays on the platform to reinvest. Maybe stating the obvious, because these are private illiquid securities. It's very hard to own and manage them in anything other than a long dated locked up co-mingled fund or permanent capital structure.

Got it, great. Thanks for that. And then Mike, just a follow up question for you just around the capital. Obviously nice to see dividend increase and the buyback here. Can you talk a little bit about the pace of buyback and whether or not you plan to be more opportunistic and more kind of systematically to be in the market. And also, I guess the follow up to that looks like your debt balances picked up a little bit on the balance sheet. Anything we need to be mindful of in terms of potential M&A?

Sure. On the -- why don't we start the last part of that first. On the debt balance in the balance sheet, revolver had more on it at year end and prior quarter that was really a function of timing for the most part, yearend compensations done at December. A lot of management fees and yearend fees are collected in January. So there's been no fundamental changes in our use of debt or debt profile. We still remain frankly pretty low levered as a firm. On the first part of buyback. We had a program in place. So, the point we will be more active, we definitely can't be any less active. So, I think with that we announced, what we said in the call was our intention of the buyback program primarily is to try and pursue our share count neutrality strategy, where we would intend to opportunistically repurchase shares as they have asked from employee awards. And again, while we haven't committed to any specific range, the $150 million program size gives us flexibility to do so. And look, if market conditions warranted it, we would consider opportunistic buybacks in excess of those.

Yes. So the way we probably structured the program is, we would have both 10b-5 and 10b-18 in place to allow us to accomplish both objectives. That's something that we're thinking through in terms of the execution of the plan. But as you saw in the fourth quarter, the market sometimes overreacts, and that overreaction shows up in our stock. And I think with the plan we would absolutely be in the market acquiring shares to the extent that we saw that kind of dislocation again.

Yes. No doubt. Thanks so much.

Thank you.

And our next questioner today will be Craig Siegenthaler with Credit Suisse. Please go ahead. Q - Craig Siegenthaler Thanks. Good morning, Michael and Mike.

Good morning.

Good morning, Craig.

So, correct me if I'm wrong, but it doesn't look like any of your products are near capacity constraints. And also because your investment performance is broadly strong what is your view of long term AUM growth here? And also just kind of a follow up to that, what is the economic -- what is the economic sensitivity to that AUM growth because in 2008 in the financial crisis, your AUM growth actually accelerated during that period.

Yes. I think you actually answered the question for us, Craig. The nice thing about the addressable markets that we operate in are they're massive, and they're global. And while we have leading market shares in certain of those markets, even where we have a market-leading position, it's probably in the sub-5% range. So, we're going to continue to experience growth across the platform as we penetrate these large addressable markets, but it should not in any way feel capacity constrained. We do not put forward long-term asset objectives. We're investment managers and we focus on delivering great investment performance and have always had a view that when we deliver great investment performance, our assets grow. But what we can tell you is based on the breadth of product that we have here and the forward view on fundraising, I think you should continue to expect the same type of growth from us that you've seen historically. And that's been 15% plus type rate of growth in most of the metrics that you guys are following for the foreseeable future.

Got it. And then just if I can have one follow-up here. Given that ARCC now is planning to releverage up in the 0.9 to 1.25 zone. Could you remind us what level of management fees and incentive fee level ones this will translate into? And also, how quickly will it take you to get up in that zone because I don't think you can actually start until June of this year?

Yes. So one thing to clarify, ARCC, I would encourage both to go look at what that company accomplished in Q4 and through 2018 speaking maybe for my partners who are a little modest the other day was nothing short of remarkable in terms of monetizing the ACAS acquisition and rotating that portfolio. They recently announced another dividend increase a meaningful special dividend, and I think are demonstrating to the market that there's still a lot of embedded earnings growth as the company relevers. The origination platform that exists here should allow ARCC to get higher and to leverage pretty quickly. We were roughly 0.6 to 1 net of cash at the end of Q4. That number is moving up as we approach the June that is 0.7 moving up as we approach the June transition date. And I think as Kipp and Penny and Mitch talked about on that call, we'll be slowly moving the leverage up as we approach June, and then through the June date we would expect to keep investing into leverage. In terms of the dollar value of investing those funds, as Mike mentioned, I think if we were to go to the midpoint of that range, it would represent about $50 million of incremental fee coming out of ARCC and that is in addition to the roll off of the ACAS fee waiver, which is another $40 million of gross fee. So pretty meaningful when you think of it in terms of the percentage of existing revenues coming off the ARCC platform.

Thank you, Michael.

Thanks.

And our next questioner today will be Kenneth Lee with RBC. Please go ahead.

Hi. Thanks for taking my question. Just within the credit business, wondering if you could give us a little bit more detail into what drove the elevated realized performance income in the quarter? Thanks.

Sure. The biggest driver of that was actually this ARCC outperformance I just referenced. There is a significant amount of realized gains that were monetized throughout the course of 2018 largely out of the legacy American capital book. And if you look at the contribution that was about $15 million of the $48 million of realized performance fee came from that single fund. We had some credit realizations within some of our alternative credit strategies, which also drove it, and then the bulk of the remainder came out of our real estate portfolio. As I mentioned earlier, our opportunistic strategies in the U.S. have been very actively monetizing what has been a fantastic portfolio.

Got you. Very helpful. And just one follow-up. Within the direct lending franchise maybe some updated commentary on what you're seeing in terms of competitive activity, whether you're seeing rational behavior among the new entrants into the marketplace, and also I think you briefly touch upon this in the prepared remarks maybe a little bit more details on terms of how you saw the lending terms change in the fourth quarter? Thanks.

Sure. So, I never like to say that people are acting rationally or irrationally, because I don't know of any investment manager who makes an investment believing thing that they're taking inappropriate risk on behalf of their investors. So I would maybe phrase it differently, which is, given the attractiveness of the asset class that I highlighted, we are seeing more capital in the market and we're seeing more capital in the hands of people who frankly have not been investing in the asset class as long as we have. And that probably leads them to take certain risks that may be other more seasoned investors won't. But we'll only know that when we come through the next dislocation and we can see the dispersion in return. The other thing that we talk a lot about in direct lending and I mentioned in the script. It's worth highlighting again is when you look at our deployment throughout 2018 in U.S. and Europe, and that gross deployment was probably close to $17 billion in direct lending across those two geographies in our drawdown funds and ARCC. 50% of that deployment was to incumbent borrowers, which means that if those are high quality companies that we're investing behind, it's likely that new market entrants are not seeing that. And I'd venture to say that the other large market participants see a similar type of incumbency benefit so that available market for that new entrant who doesn't have the competitive advantages of scale and origination and balance sheet etcetera, is probably already fishing in a much smaller available market than we are, and that does run the risk of adverse selection. I think, the good news is, while Q4 as I said was primarily technical it did bring some sobriety back into the market in terms of pricing and structure. Generally speaking, we've seen spreads increase in the New Year somewhere between 50 basis points and 75 basis points in our direct lending strategies. Generally speaking, we're seeing better documentation in things around covenant levels and definitions of EBITDA and EBITDA adjustments. So there has been a dose of conservatism put back into the market as a result of the volatility we saw in Q4. I would expect that to persist -- I think the market has kind of absorbed that and settled out at a new level which we're happy about obviously because we're generating higher returns we were a couple of months ago.

Great. Thank you very much.

Thanks, Ken.

And the next questioner today will be Chris Harris with Wells Fargo. Please go ahead.

Hey. Can you guys talk to us a little bit about what you're seeing in Europe, the economic conditions over there seems to be a lot worse than they are here. And then related to that, your performance in Europe continues to look really good. So again, can you square that with what appears to be much more difficult macro environment there?

Sure. So just to remind folks, where we -- where we are in Europe in terms of geographies. The bulk of our business in Europe today is in our direct lending business, in our real estate private equity business and in our liquid credit strategies buying euro bank loans and bonds. We tend to focus predominantly on Western Europe and we predominantly focus on, what I would call, more healthy geographies as opposed to Iberia and the periphery. So with that framework, we tend to be much more active investing in the German market, French market, the U.K. market which I'll come back to in a second, and less so in some of the developing Eastern European economies, although we're seeing great relative GDP growth there. And then, it depends on the business. In the real estate market the bulk of that GDP is concentrated in the gateway cities. And so the strategies there tend to have us focusing in and around gateway cities in real estate. And in the private credit business, it's much more broadly distributed across Europe and geography. What I will say is following, unlike the U.S., Central Bank continues to be accommodating in Europe which has been constructive for liquidity in the market and asset prices. Despite commentary to the contrary, we think that that will continue. Bank liquidity and bank competition has changed dramatically. So we're seeing much less competition from the bank market across the board. That's been constructive for our business. And generally I said this in our prepared remarks, in the credit business, which is where the bulk of the deployment comes from, low and slow GDP growth tends to be very constructive for private credit, extends duration, allows you to maintain high asset spreads, etcetera, etcetera, so the kind of low and slow growth GDP is good for the private credit business. The U.K. is probably been the one area where we've seen meaningful market changes as you would expect, given the uncertainty around Brexit, and that's played out in a couple of ways. We've seen deal flow shifting out of the U.K. market and more broadly into the continent in places like France and Germany. We have seen some reduction in asset and property values in the core U.K. markets, but generally that market has slowed appropriately just given all of the uncertainty. And I don't think that we will see deal flow return to prior levels until we get clarity as to what the path for Brexit will be and what the ultimate economic impact will be in the UK market. So if you look at our deployment, we've seen a meaningful shift out of that core UK market to more of a Pan-European…

Thank you.

And the next questioner today will be Michael Cyprys with Morgan Stanley. Please go ahead.

Okay. Good morning. Thanks for taking the question. So you guys continue to raise record amounts of capital and investing back into business. Just hoping you could help flesh out where specifically you're investing back in the business today. And as you look out over the next three years what would you say is on your to-do list in terms of incremental investments in the business, if you could speak about investment capabilities. You're thinking about distribution, technology just hoping you could help flesh all of that out. Thank you.

Sure. We've talked about some of these in the past, that I'll reiterate it just to give some context. So, one strategy that I reference was our opportunity fund, special opportunities fund. We began talking about adding people there, I guess, now, two years ago. We've since hired about 18 new professionals into that part of our business out ahead of the launch of this very exciting product that we just talked about, and our P&L had been burdened with all of those additions and people, let alone the infrastructure to support those people, a good 12 months to 18 months before we formally launch to fund there. We're making similar investments in and around our real estate credit business, continue to add people and capabilities to support what we think is a very high growth area for us. And so, while our AUM continues to ramp, we're not seeing a dollar for dollar impact on the profitability of that business just yet. And then lastly, which we mentioned this in the prepared remarks we continue and will continue to add meaningful resources and infrastructure around our alternative credit businesses, which is really everything we're doing in non-corporate lending across a whole host of interesting asset classes. We have, as you've seen, continued to invest in geographic expansion. Europe was non-existent for us 10 years or 11 years ago. That now represents probably 25% of the firm's AUM and growing. We have a full pan-European office footprint. We continue to grow that. We just actually opened up an office in Amsterdam. So I think you'll continue to see us increasing our geographic footprint as we push into some local markets that we think are interesting. And then in distribution, we actually quantified some of that in the prepared remarks. Three years ago across our distribution and IR groups, we had about 64 people, that number is 95 and continuing to grow, and it's growing globally. And I think some of the results you're seeing in fundraising are just a direct reflection of those investments that we've been making over the last three years to five years. And then, on retail distribution, we did talk about it in prior calls, but it's worth mentioning, we have put meaningful investment into the development of our non-traded retail distribution and integral fund business as well as our private bank distribution capability. And we're starting to see significant momentum in both of those channels as well.

Great. Thanks for that. And just a follow-up question. Maybe shifting gears to the broader exit environment. Just curious if you could talk a little about how you see that shaping up? And then if you look at your accrued carry balance nearly $250 million in accrued carry receivable today. I guess just what period would you expect that to be realized over -- I think, if you look back historically, it looks like you've kind of monetized the receivable balance over about two and a half years on average, how does that sound to you with respect to where you see the funds today and you could touch upon the backdrop of should that be a little bit slower or faster. Thanks.

I'll give you a broad response, then maybe David wants to just chime in terms of what we're seeing from realization and monetization backdrop within the PE portfolios. But, look, we have such a diverse pool of funds and investments that we're consistently in deployment and harvest mode. And so, obviously certain market environments are more conducive and constructive for exit than others, but every quarter, just given where funds are in their lives and given where various strategies are you're going to see fairly consistent level of deployment and monetization. I think your assumption around our historical pace is probably accurate. As Mike mentioned, we would expect our shadow AUM to be deployed, somewhere between 18 months and 36 months depending on the shape of the market. I think the same would hold through therefore for realizations. And if you go back to the $120 million number that I referenced earlier and you look at the accrued balance, which by the way has gone up as the markets have rebounded, that would correlate also to that kind of 18 month to 36 month timeframe. David, you want to give any specifics just on what we're seeing generally in the market and liquidity for quality assets.

For quality assets, there is no shortage of a bid, if you will maybe a couple of quick statistics, which is there is somewhere around $900 billion of private equity dry powder in the market today. And as of the third quarter I believe in 2018, we hit as we monitor purchase multiples over last 20 years. We hit an all-time high on average of about 11 times. So if you have a quality asset, there is capital absolutely available with multiple folks chasing it. So we continue to see a reasonably constructive exit environment today.

Any notable or large exits in the pipeline at this point to speak of in terms of where the pipeline stands at exits today versus a quarter ago?

Yes Mike, we can talk specifically about individual companies other than to say, as we mentioned, some of our legacy PE funds are at that stage of their life cycle where we're continually looking for opportunities to monetize.

Great, thank you very much.

Thank you.

And this will conclude our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

I don't think we have any. We appreciate all the time you spent with us. And again, Happy Valentine's Day. I hope you enjoy a wonderful day with your loved ones. We'll talk to you next quarter.

Ladies and gentlemen, this concludes our conference call for today. If you missed any part of today's call, an archived replay of this conference call will be available through March 14, 2019 by dialing 877-344-7529, and to international callers by dialing 1-412-317-0088. For all replays, please reference conference number 10127774. An archived replay will also be available on the webcast link located on the Home page of the Investor Resources section of our website. And you may now disconnect your lines.