Welcome to the Ares Management Corporation Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded on Wednesday, August 5, 2020. I would now like to turn the conference over to Carl Drake, Head of Public Company Investor Relations for Ares Management. Please go ahead, sir.

Good afternoon, and thank you for joining us today for our second quarter 2020 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, David Kaplan, Co-Chairman of our Private Equity Group; Kipp deVeer, Head of our Credit Group; and Matt Cwiertnia, co-Head of our Private Equity Group, will be available for the question-and-answer session. Before we begin, I want to remind you that comments made during this call contain forward-looking statements and are subject to risks and uncertainties, including those identified in our risk factors in our SEC filings. Our actual results could differ materially, and we undertake no obligation to update any such forward-looking statements. Please also note that past performance is not a guarantee of future results. During this call, we will refer to certain non-GAAP financial measures, which should not be considered in isolation from or a substitute for measures prepared in accordance with generally accepted accounting principles. In addition, please note that our management fees include ARCC Part I fee. Please refer to our second quarter earnings presentation available on the Investor Resources section of our website for reconciliations of the measures to the most directly comparable GAAP measures. Please note that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase an interest in any Ares Fund. This morning, we announced that we declared our third quarter common dividend of $0.40 per share, representing an increase of 25% of our dividend for the same quarter last year. The dividend will be paid on September 30, 2020, to holders of record on September 16, 2020. We also declared our quarterly preferred dividend of $0.4375 per Series A preferred share, which is payable on September 30, 2020, to holders of record on September 15. Now I’ll turn the call over to Michael Arougheti, who will start with some quarterly financial and business highlights.

Great. Thanks, Carl, and good afternoon, everyone. I hope everyone is healthy and safe, and I wish you and your families well. So now with the full quarter of the impact of the COVID pandemic behind us, we’re pleased that our results continue to be strong, and we couldn’t be more proud of how our employees have adapted to the current challenges. Our consistent revenue and earnings growth reflect our resilient management fee-centric business model and our steady growth in clients and AUM in the global market for alternative investments. Our second quarter was our 13th consecutive quarter of sequential fee-related earnings growth with FRE of $97 million, an increase of 26% from the same period last year. In addition to reporting record FRE, our second quarter also set new records for most of our other key metrics, including management fees, AUM and fee-paying AUM. Our second quarter FRE margins reached a post-IPO high, as we continue to gain efficiencies of scale and experience slower operating expense growth. The second quarter was one of our best fundraising quarters ever, with more than $9 billion raised, including approximately $5 billion from funds in our private equity group, and our momentum across the platform is continuing into the second half of the year. Our strong fundraising has set us up well for future growth in management fees and earnings, which could be seen by the sharp increase in our available capital and shadow AUM, as Mike McFerran will discuss in a little bit. From a market perspective, the traded equity and debt markets have been very volatile in the first half of the year, with a quick dramatic sell-off in March, followed by a historic rally in the second quarter as fiscal and monetary stimulus poured in with unprecedented speed and scope.…

Thank you, Mike. Hello, everyone. I hope you and your families are safe and well. I will begin with some highlights on the quarter and then provide a more in-depth review of our results and current financial position. The second quarter was our 13th consecutive quarter of sequential FRE growth. The steady growth is driven by our management fee-centric business model, which drove 84% of our realized income in the second quarter. Our FRE margin stands at over 34%, as we continue to scale and improve margins. The over $9 billion of gross fundraising helped assets under management and fee-paying AUM reach new highs, which increased 11.5% and 18%, respectively, over the last 12 months, and this fundraising drove our shadow AUM to $27.8 billion. During the quarter, we saw a fairly broad-based recovery in the performance of our significant funds across credit, private equity and real estate. We also realized a portion of our position in Floor & Decor, a highly successful publicly held position in our Private Equity Group, which supported our realized income this quarter, despite the muted overall realization environment. Now let me take you through the results in further detail. Fee-related earnings for the quarter totaled $97 million, an increase of 26% from the second quarter of 2019. Year-to-date, our fee-related earnings of $190 million was up 28% from the same period last year and highlights our continued growth trajectory, even through times of significant volatility. Fee-related earnings growth was driven by 13% management fee growth from the prior year period as well as a decrease in general and administrative expenses, which declined over $5 million from the second quarter of 2019 in part due to continued travel restrictions. As we grow our AUM and fee-paying AUM through fundraising and deployment across several new strategies,…

[Operator Instructions] And our first question will come from Robert Lee with KBW. Please go ahead.

Great. Mike, maybe starting with the fundraising that you mean including this good quarter and still pretty positive about the outlook, I’m just curious, maybe specifically within PE, it had a good first close. But I mean, do you still feel, at least with ACOF, I guess it is fixed? I think previously, you’ve kind of suggested, I forget the number, about 30% upsizing is kind of what you’re thinking for that. Does that still seem like a reasonable objective of given the environment?

Yes. I think it’s a reasonable objective. One thing I would clarify in the prepared remarks, too, one of the things that makes us unique in terms of our approach to distressed investing is that our special opportunities/special sits capability sits in our private equity group for a lot of reasons we articulated historically in terms of the need to not just be buying distressed securities in the public markets, but to be able to leverage private market origination and portfolio management to improve those situations. So when I think about capital raising and capital deployment in private equity, I think of that whole complex, SOF plus ACOF. And when you look at the success that we had in SOF, given the positioning of that fund and the market opportunity ahead of us, as well as the momentum that we first closed on ACOF, I think our aggregate capital raising plans for that group should continue to meet, if not exceed the targets.

Okay. Great. And I know you’ve talked about the success you’ve had with new LPs and bringing them on board the last couple of quarters with some of the fundraising. But kind of prospectively, I mean, since, I guess, some of what you saw this quarter was kind of in-process before everything hit or has everything hit, I mean, do you sense any kind of change as you’ve kind of looked further down the path in terms of the ability to get that incremental new LP? Is that kind of I assume that, but maybe not, but isn’t those processes starting to slow down and maybe kind of, from here, even though you’re optimistic, maybe kind of getting maybe become more dependent on existing LPs over the next couple of quarters versus bringing on that incremental new LP?

Yes, it does. The simple answer is no. But obviously, there’s still a lot of uncertainty in the world. As we talked about in the prepared remarks, I actually think, when we all went to a remote work environment, it actually benefited the larger managers who had deep embedded relationships and managers who are already in market with large fund offerings that actually take advantage of distress. So when you look at our positioning coming into 2020, we had already been actively premarketing and marketing a lot of the funds that we’re raising now, and I think that’s one of the reasons why we’ve seen continued momentum toward potentially another record fundraising year. I would have had a little bit more concern earlier in the year, but we’re actually seeing a lot of the institutional investor platforms adapt their processes for remote work, and we’re seeing a healthy amount of new LPs come on to the platform as well. So at least, what we’re seeing today, Rob, I’m not seeing any change in behavior. I’d actually become more optimistic that folks are now able to diligence new products and new strategies that should benefit some of the offerings later in the year.

Okay. Great. And if I could maybe just one more quick one on SSG. Any I mean, you mentioned it is completed a fundraising. But I think you talked about potentially a new one with the first one with since being onboard. But can you maybe update us a little bit on kind of how we should think about the financial impact, I know it’s fairly modest, but how we should think about that and how that may flow through the P&L.?

Yes, happy to. So just to remind folks, SSG, as I mentioned, has about $7 billion of assets under management. As it sits today, it has two core investment offerings. One is what we refer to as special situations, which is kind of the founding strategy of the group getting back to their tenured AM. And then the second is what we refer to as secured lending, which is more akin to what we all would think of as regular way direct lending. SSG had a very meaningful close on its fifth special situations fund in the fourth quarter of last year prior to our announcement and then launched post the announcement, but pre-closing their latest secured lending fund. And that’s the fund that I referred to in the prepared remarks with which had significant momentum, as you would imagine given the world that we live in. The financial impact, you’ll start to see reporting next quarter now that we’ve closed July one or two and likely will be reported in a separate segment, along with other strategic initiatives that we’re undertaking at the management company, so you’ll begin to see the financial impact. The deal is accretive given the nature of the deal that we structured and the momentum that the company has. Our long-term ambition is to see SSG grow to be not just in the credit business, but to expand its product set and its reach into the other capabilities that we have here, i.e., real estate, private equity, infrastructure, etc. So we have pretty big ambitions, and I think that we had a pretty good playbook given our historical success scaling the businesses that we have in North America and Europe. And a lot of the strategy teams that are working with SSG on that blueprint and business plan are the same folks that have actually executed on the expansion plans in other places as well.

The next question will come from Gerry O’Hara with Jefferies. Please go ahead. Gerald O’Hara: Great. Perhaps one, sir, just around deployment. And if you could maybe add some context around the environment as it relates to what you mentioned in the prepared remarks with respect to still some runway before we start seeing regular-weight private equity deals return. And I guess, just trying to get a sense of what the opportunity set could be for your now record levels of available capital and as your latest vintage private equity fund starts to come online.

Sure. I’ll give you my view, and then I’ll let Matt or David give you some PE-specific commentary if they feel like it. But just to contextualize our deployment, in the second quarter of 2019, as I mentioned, we deployed about $4.1 billion in our drawdown funds. If you look at the number in Q2, that was about $4.7 million. Interestingly, we deployed about $5.5 billion in Q1 in drawdown funds, which I’ll come back to. And if you were to look at the $4.7 billion, that number would grow to about $5.9 million when you include the non-drawdown funds. So deployment has been consistent. And if you remember what we talked about on the last earnings call, the way that we’ve kind of simplified the framework for how we’re going to invest through the crisis is, in Phase 1, which was kind of March into the first week or two of April, there was so much volatility and dislocation in the liquid markets that we were very active there, and that’s why you saw a little bit of a spike in the Q1 deployment. We’re now in Phase 2, which is kind of a focus on the existing portfolio, provide capital to incumbent relationships, build liquidity bridges to the extent that you can and get paid to do so and then begin to go on offense in terms of the new issue market. And some of the things that we talked about in the prepared remarks in the alternative credit, direct lending and special ops parts of our business, I think, are pretty good indicators of the types of opportunities that are coming our way. And then when we get to Phase 3, which is a little bit more market stability, a little bit more earnings visibility and normalcy in the market, that’s when you see more regular weight deployment, but still very, very attractive rates of return because, typically, you’re getting paid significantly higher rates of return for significantly lower risk given the change in the multiple in the leverage environment. So we’re still squarely in that second phase, but I think as we’re getting deeper into this health and economic crisis and a lot of the companies have built liquidity bridges in March to June based on a view that we would have a V-shaped recovery or a snap back or that the fiscal stimulus would actually support meaningful economic growth, I think, are beginning to grapple with the reality that the liquidity bridges that they’ve built may not be long enough. And so the pipeline is starting to reaccelerate around being a solutions provider for some of those companies that are high-quality franchise companies or assets that just aren’t that have no access to the capital the way that we are. Gerald O’Hara: Okay. That’s helpful.

Matt, do you have any color commentary you’d like to add on PE?

Sure. This is Matt Cwiertnia. So from a private equity perspective, I think we think our flexible capital mandate right now is probably as relevant and balanced as ever. We see things really both on the distressed side and on the traditional side. One thing I’d point out on the distressed side is the small and medium businesses or the middle market are really struggling more than you would be led to believe if you just follow the S&P 500 or the NASDAQ. And so we are seeing a number of really private rescue capital opportunities on the distressed side because the middle market doesn’t have the access to some of the government programs that the large caps do. And on the traditional side, as Mike alluded to, there are just some industries and some companies that are doing OK and have growth opportunities in front of them that can go and play offense. So I think the backlog for traditional throughout the industry and certainly for ourselves, it is growing. I think, in the second half of this year, if this stays on trend, I think you’ll see more regular way private equity here before the end of the year and probably bigger in the second half than you saw in the first half. Gerald O’Hara: Okay. Helpful comments. And just perhaps one follow-up. You’ve obviously been active with SSG and as well as SMBC. But Mike, could you perhaps give a sense for what the firm appetite is perhaps even capacity for additional strategic partnerships and M&A-type activity at this point in the cycle?

Sure. The appetite is significant, as we’ve talked about historically, but the bar on inorganic growth continues to get higher for us just as we scale we’re finding that we can build businesses by doing team with that or team builds, use our capital scale to fund them and drive meaningful growth. So our alternative credit group, our special opportunities, those are groups where we were able to engage in meaningful team builds. And you’re seeing the value creation come through in the successful fundraising in pretty short order. So as we talked about historically, when we’re going to do M&A, it has to check three simple boxes that aren’t always that easy to check. It has to be financially accretive, and the economics need to make sense. We need to have a path to add value to the business, but we also need to see that, that business is going to add value to our platform by bringing differentiated distribution or information or capability. And then it’s got to be a great cultural fit, and the cultural fit piece is probably always the hardest to check the box on. SSG did all of those things for us, right? They gave us a meaningful beachhead with a tenured manager in a region where we just did not have a scaled presence, the cultural fit, good economic value proposition and now adding things to it should be fairly straightforward. So I think we’re going to continue to look to fill in product gaps, geography gaps, distribution gaps through acquisition, but the bar is pretty high. One thing I will remind everybody, through prior downturns, we’ve been very acquisitive, both within portfolio companies like ARCC, subsidiary companies or at the management company. And when you think about deployment, we tend to see acquisition opportunities arise when we get into this type of dislocation. So while we’re obviously working with our corporate strategy teams to proactively identify assets and companies that would be good additions to the platform, markets like this tend to present opportunistic opportunities as well. And I think we’ll begin to see that develop into the back half of the year.

[Operator Instructions] And our next question will come from Mike Carrier with Bank of America. Please go ahead.

Mike McFerran, just given the current margin, the fundraising outlook, the deals and then the current backdrop, just any change in how you’re thinking about the outlook for the margin over, say, the next one to two years versus some of your comments?

No, no change at all. I think the margin is consistent with what we’ve said since our fourth quarter call, which is we expected that to deliver a 34% margin this year, or at least 34%, and we thought we would hit a run rate of 35% this year. If you look at the margin for the quarter, it’s over 34%. We feel, as we’ve talked about in past calls that you referenced, Mike, that as we continue to grow, we capture benefits of scale and we continue to identify operating efficiencies and leverage those, and all that leads itself to margin expansion, which we think is just going to continue. So I don’t see any obstacles to that in the years ahead.

Okay. And then just as a follow-up. Given some of your guys’ comments and like what we see in terms of divergence between the public and some of the private markets, it makes sense that there are multiple points of opportunities are attractive. But just in terms of the current portfolio companies, maybe how are they holding up in this backdrop, areas that you’re seeing, maybe some challenges versus in the portfolio where you’re seeing relative strength, once we kind of get out of that, you could start to realize some of the investment.

Yes. So it’s a simple question with not a straightforward answer just given the breadth of funds on the platform and the breadth of assets that we touch. So I’ll simplify the answer if you want to drill deeper on any piece we can. But Id’ say, generally, the underwriting going into the downturn was extraordinarily sound across the entire portfolio. And you’ll see that, for example, Kipp talked about on the ARCC call that while we’re dealing with some challenges as would be expected in the portfolio, the fact that we are underweight, the most heavily impacted industries is beginning to bear fruit and shall benefit. The fact that we are underweight, hospitality and retail in our real estate portfolios, both debt and equity, is a huge benefit. So I think a lot of this came down to good conservative positioning and cyclical industry avoidance going into the downturn, which now positions us, combined with the liquidity that we have within each of our funds, to continue to play offense and drive value. As we talked about in the script, probably the one place where we’ve seen the most negative return has been in our energy portfolio. It’s not surprising. And if you look at the performance, as we talked about in the PE composite, if you look at the nonenergy returns this quarter and the regular way portfolios, you would have seen roughly 20% type return. So the focus on healthcare, technology, differentiated consumer, that’s actually playing out well for us. And I think that’s pretty consistent across the entire platform, regardless of the business or the geography.

Our next question will come from Adam Beatty with UBS. Please go ahead.

I wanted to ask about CLOs, both in the Ares managed book and then more broadly across the environment. There was some concern before the pandemic and then kind of a spiking concern as the pandemic hit, and it seems as though that the outcome, so far, at least, has been milder than some had feared. So I just wanted to get your observations in terms of the fundamentals and also the trajectory of rating agency activity and whether that’s a concern.

Yes. Sure. So I we never fully appreciated the significant concerns that the market and maybe the media had with regard to the CLO market. And if you go back and look at CLO performance, particularly on the rated tranches through the financial crisis, it’s a pretty good indicator that the self-healing structures within CLOs is pretty resilient. And so we’re not surprised to see that resilience playing out now. The other interesting thing is when you look at the structure of the loan market today versus the structure of the loan market through the GFC, CLOs currently represent probably 65%-plus of the loan buy in the loan market, which is significantly higher than it was the last go around. And maybe not so obvious, that’s actually created a significant amount of stability because you don’t have frantic selling, which is obviously muting some of the downward pressure on price and just creating overall price and pricing stability in the market. So if you actually look at CLO exposure to the weakest loans in the loan market, they’re underweight relative to the 35% non-CLO buyer, which is actually a pretty good indication both to the credit discipline of the CLO managers themselves, but also kind of the imposed discipline that the structured places on those buyers. There is always, and we’ve talked about this, a risk that with continued downgrades that CCC baskets are triggered and OC tests are triggered, and that has some implications for the structures. But again, even in cases where that happens, they’ll be able to heal themselves. So we’re still quite constructive on CLOs. Obviously, the new issue market has slowed. But for the embedded universe of CLOs, both as a CLO manager and as a buyer of rated and non-rated tranches of other people CLOs, we still see them as very resilient and very durable.

Excellent. And then I just wanted to ask about the insurance channel, kind of separate and apart from any delays and what have you with Pavonia just in terms of the level of activity and demand that you’re seeing and kind of what you’re able to do kind of pre-closing on that transaction to kind of do a pre-build or what have you.

Sure. Thanks, Adam. So yes, with regard to Pavonia, as we talked about on our last call, the closing has been delayed, but we’re still optimistic that it will happen in the near future. The good news is because of the structure of that transaction, we’ve been able to do, to your point, all of the pre-work on new product construction, getting the distribution engine ready to turn on when we close that transaction. I think folks are also aware that when we talk about Ares Insurance Solutions and Aspida, it’s not just the organic distribution of the origination business, but there’s a view that we also have an opportunity on the M&A front to grow through acquisition and to build a reinsurance platform alongside the annuities platform. So even though the Pavonia acquisition has delayed all of the work around building the M&A and reinsurance pipeline, it has actually been going quite smoothly and has a lot of momentum. So we’re happy with where that is. And then secondly, as we’ve talked about before, while Pavonia is an important piece of the insurance strategy here at Ares, the insurance strategy is multipronged and includes things like building up our IDF complex, continuing to drive strategic partnerships with insurance companies around certain parts of our private credit business, continuing to distribute product to our insurance clients, and those are all scaling a long time as well. So I would say we’re as bullish as we’ve ever been about the insurance opportunity, and I think we’re executing well. We’re anxious to get our Pavonia deal closed, but it’s not preventing us from making progress in other business.

And the next question will come from Kenneth Lee with RBC Capital Markets. Please go ahead.

Just one following up on your prepared remarks in regards to how portfolio realizations could be slow, just hoping that you could just further expand upon your comments and perhaps just talk about some of the key factors that could be keeping the utilization slow, despite the current equity markets.

Sure. I’ll give you my view. And then again, Matt or David should be able to give their view. We’re seeing activity pick up. The challenge, I think, that you see in kind of regular way transaction flow putting the public markets aside for a second is when you were dealing with either liquidity challenges or liquidity uncertainty or a lack of earnings visibility. It’s just hard to clear equity, right? The bid-ask spread on equities can be pretty wide as people are trying to figure out what 2020, 2021, 2022 earnings are going to look like. And then two, which is benefiting us on the direct lending and private credit side, availability of debt capital to certain companies and certain assets is constrained in that challenges valuation. So I don’t want to give the impression that we think that there is 0 path toward realization. I just think that we need a little bit more visibility around earnings and liquidity positioning for certain companies to start to get back to a regular type of cadence around transaction flow. But to the public company side, as you mentioned, and that’s why I do think that we’ll have an opportunity, and the AZEK IPO is a perfect example of that, particularly for the non-COVID-type companies, AZEK being one of them making building products, we saw huge investor demand, a really attractive valuation and then an acceleration to valuation post-IPO. So I think that the public markets will continue to be constructive for realizations. I don’t know, Matt, do you want to add any color on top of that?

Sure, sure. Yes. From a private equity perspective, I would say, everything Mike is saying is spot on. And especially July, that bid-ask has been people trying to figure out on the private side, can we get to a deal. I do think there’s a bit of a rate of change in the market, meaning a bit of warming in the market, where even week by week right now, people are becoming more optimistic and narrowing that spread, such that if you saw that continue, I do think post-Labor Day, you could see a pickup in transactions and then, for us, potentially in realization. So I think that has been true. And if it stayed the same as July, I think that statement would be true. But there is some optimism, I think, on the traditional side that buyers and sellers are going to get together a little bit more often, and that would include some of our portfolio companies that might be ready for realization come the back half of this year if the environment continues to improve.

Great. Very helpful. And just one follow-up, if I may. I wonder if I could just get your latest thoughts on FRE growth in the near term given that there’s a lot of factors at play here between the fundraising as well as the ongoing capital deployments.

Kenneth, it’s Mike. I would just reiterate, and I think our numbers are expressing this as you look at the year-over-year growth. But I know the last couple of quarters, we’ve highlighted that we believe between capital we’ve already raised, I’d point you to the AUM not yet earning fees, where there’s a significant amount of what we’ll call just natural revenue growth built into the capital we have today just from deployment. That, combined with the continued margin expansion we’re seeing, and then Mike obviously talked in detail in the prepared remarks about the meaningful amount of capital raising we’re having, all of that combined, we feel like will lend itself to just reiterating the expectation that we have high conviction, we’ll be able to continue to grow FRE 15% or better because I’m not putting magic behind the 15%, although it’s kind of a round number. But again, when you looked at our Q1 growth year-over-year, our second quarter growth year-over-year, first half of the year growth year-over-year, we’re obviously running ahead of that and expect we will continue to do so.

Our next question will come from Chris Harris with Wells Fargo. Please go ahead.

Yes. A follow-up for Mike McFerran on expenses. Mike, you mentioned G&A was a little light in the second quarter due to travel-related restrictions. Assuming those restrictions remain in place, is this a decent run rate for G&A spend? Or is there some spending that’s going to pick up in the second half of the year, which would potentially drive the number up?

Look, it’s SG&A is going to be have a little bit of movement around, and we had a little bit of travel, obviously, we’re saving money because it’s a fraction of what it was. Yes, my best guess would probably I would expect to be seeing G&A run between $41 million $40 million to $41 million, all else being equal. It has to as Mike mentioned, with all the capital raising going on, there’s obviously some expenses we incur with that. The pace at which we can do other things, we do spend obviously a bit. While we’re saving a lot in travel, we do lean in on other aspects of this, with supporting our employees of technology and other services. But I think kind of like a $40 million expectation, $40 million, $41 million is realistic.

And Mike, I’ll just add, maybe just a quick oversimplification, but I think it’s important is, obviously, when we’re spending on things like travel or entertainment or conferences, all of those things tend to come against incremental fundraising and incremental deployment. So I would even say that anything above Mike’s target would probably come with corollary increase in revenue and would still continue to be accretive to the development of FRE and FRE margin.

Yes. I agree with that.

Okay. If travel comes back, a higher number than $40 million to $41 million.

Yes. I still think we’re going to be able to run the business. Yes, I still expect G&A to kind of run rate when travels back to be in the low-40s quarterly.

Our next question will come from Michael Cyprys with Morgan Stanley. Please go ahead.

Just as you think about product level profitability, I was just hoping you talk a little bit about your approach to product and strategy level of profitability. How do you approach and think about that? Which strategies do you think will be the make the biggest contribution, helping improve the overall profitability over the next couple of years? Imagine the special sits fund will be very meaningful this year and into next year. Which other strategies come to mind? And which ones, in your view, would probably have to wait a couple more years for more scaling?

Sure. Again, a simple question, but not a simple answer just given the breadth of number of funds and strategies on the platform. As you would probably expect prior to launching any new product, we go through a pretty exhaustive strategic and operational review of the product in terms of assessing investor demand, thinking about the operational complexity of the product, the cost to raise it, the cost to run it and, then obviously, the long-term business plan around the products and what that means for the development of FRE and, ultimately, shareholder value of the management company. And that’s a very rigorous process, and not every idea gets through that filter. And I actually think that’s a big part of the evolution of the industry where you learn as you mature that not all AUM is good AUM, and you have to focus on scale of the profitable AUM. And so you are seeing that in places like special opportunities and alternative credit, where we’ve gone out against the business plan, hired 15 to 20 people over a multiyear period, incurred that expense with a very high level of conviction around the business plan. So you did highlight two recent initiatives that you should expect to see some pretty dramatic margin scaling because we’ve already incurred the expense to hire the team, put the process in place, raise the capital, but those funds pay on invested. I think you should expect, given the upcoming fundraise in our European direct lending business, as we talked about in our prepared remarks, even though that business already runs at a pretty healthy mature margin, but just given the scale of that fund, that you’ll see some margin expansion there as well. Real estate, as we’ve talked about historically, is actually running at the lowest business line FRE margin, but it’s growing its FRE margin quicker than other parts of the business. So we are beginning to see the benefits of scale roll through as we’re getting through this most recent fundraise cycle with our U.S. op fund and our value-add funds. So I think you’ll continue to see margin scaling there, but we still have some scaling to do to get to the types of margins that we enjoy in the mature credit and mature PE businesses. So as I was saying, expectations also that, hopefully, SSG will run at a more mature margin just given the size of that business relative to its capital base as well.

Great. And maybe just a quick follow-up question, apologies if I had interrupted you. The sound quality is not that great on my line given the storms. But just on strategic partnerships, I think you had mentioned it’s another growing part of the firm. Maybe you could just update us on some of the initiatives there. Maybe just some of the capital you have in these strategic partnerships, how is that trending, what initiatives you have in place? And how do you think about scaling those strategic partnerships over time? I imagine those are highly customized offerings. What are you doing about it? How do you think about scaling that?

So strategic partnerships, I’d say, take many forms. And I just want to clarify, we have certain strategic partnerships that are more partnerships around a specific part of the business, whether they’re capital provider or a strategic LP. So a good example of that would be the SDLP unitranche joint venture that we have within ARCC. We then have strategic partnerships, which are bespoke and customized relationships with some of the larger institutional LPs around portions of our business, and that has been a big growth area for us. So when you look at managed accounts as a percentage of our AUM, you’ll see that it’s a pretty healthy number. Those are slower to develop in terms of the sales cycle because it’s not like a commingled fund where you launch a product, set up a data room, do your transactional market and close. It’s much more consultative. It’s much more collaborative. And the whole process is geared toward trying to be a solutions provider for our larger clients. The good news is, as we continue to broaden out the product set, we have a much more robust offering to meet the needs of the clients. And so we are seeing an acceleration in the number of conversations that we have with our LPs. Another thing that we’ve had to do, as we staffed up around that opportunity, is we’ve built out a client strategy and solutions team that’s focused on the entirety of the client experience front to back. And it’s there where we’re working on all of the risk analytics and portfolio modeling to help drive the collaboration around what those relationships could look like. So I can’t be too specific, but it could be someone gives us capital to invest in a global direct lending mandate. It could be that someone says, "I want you to tactically take advantage of distressed opportunities that you see in these specific industries," and it really runs the gamut. And we’re offering ideas to our clients where we see value, and they’re coming to us where they have a need. And you hope that where we see value and where they have a need that there’s an intersection of opportunity. And that’s kind of how we, at a high level, think about driving that part of the business.

Our next question will come from Alex Blostein with Goldman Sachs. Please go ahead.

This is Daniel Jacoby filling in for Alex. Just quickly on the credit management fees, looks like ARCC base management fees and Part I fees came down a little bit quarter-over-quarter. Can you just help us get a little bit of a look underneath the hood as to what’s kind of going on there and how we should think about the outlook for fees generated from ARCC going forward?

Sure. Mike, do you want to handle that?

Yes, sure. Yes, I think between the base management fee and the Part I fee, the combined decline quarter-over-quarter was about $5 million. I think, as you know, it’s going to be the management fees are a function of gross assets at ARCC. So and then as far as also transactional activity, which supports the Part I, look, I think and I would refer to Kipp, but if you look historically at that fee, there’s as the business continues to grow, there’s an implied steadiness to it because the business is so big, so you don’t see a lot of volatility that would be, again, albeit saying come in about $5 million quarter-over-quarter. I would highlight, I think we’ve touched on this before, that about 60% of the Part I is paid out as comp, so the impact to FRE is a smaller impact from that because there’s an offsetting compensation benefit.

Yes. Daniel, there was also a nuance, I don’t know if we can cover it off-line if I don’t do a good job articulating it. But when we work to get the leverage available to BDCs from 1:1 to 2:1, and we restruck the management agreement, we accepted a lower fee above the 1:1 leverage. So the fee steps down, I believe, from 1.5% on assets to 1% for all assets above 1:1 leverage. And ironically, and I don’t think that this was the original intent, so it’s a little bit of a perversion of that original contract intent to align interest with the shareholders as we levered potentially lower ROA assets to drive ROE and growth in the dividend. What happened I think in Q1 and Q2, because it’s an average look back on assets, because of the write down of the assets in the book in Q1, you actually saw leverage go up through the write down of NAV as opposed to the leveraging of the balance sheet through incremental debt. And so as a result, to Mike’s point, you had a little bit of a hit because the gross assets were lower and then you had a modest hit because you triggered the 1% above the 1:1 leverage for assets that, in the prior quarter, were actually operating below the 1:1 because of the NAV. So as NAV improves, which it did this quarter, and we expect it will continue to, and as deployment continues, and as Kipp talked about on the call yesterday, we have about $4 billion of available liquidity at ARCC, we’d expect to see that fee continue as it was.

Got it. That’s very helpful color. And then just secondly, on Sumitomo, can you maybe just walk us through what you anticipate is kind of the economic benefit from this partnership and how we should think about kind of the contribution to AUM, the prepaying AUM to management fees from this partnership?

I can’t I’m not going to go into specifics on the business plan yet. But as we execute, I think we’ll come back and we’ll be able to articulate the initiatives that we’ve executed on with them, and you guys can see what the impact is. We’re still in the early days. But as we talked about when we announced the partnership, we have been working through a pipeline of strategic opportunities to leverage their balance sheet, both in existing businesses and new businesses, and we’re executing well against that. So we’ve had already a number of situations where they’ve made large capital contributions into various portfolios and business launches that, we think, will be accretive, either because we’re launching businesses at the management company or because they’re providing creative and efficient financing solutions into some of our funds and some of our subsidiaries. So stay tuned for that. But as we continue to execute, I think we’re going to have some pretty good examples to share with all of you. The second piece, which we talked about, which will take a little bit more time, was just thinking long term and strategically about the distribution opportunity for alternative product in Japan. I think it’s as we talked about in prior calls, now that we have SSG and we have a broader product set in region to complement our U.S. and European offering, I think that, that distribution partnership potential has improved. And then third, we’ve talked a little bit just about capital markets collaboration and ways to work together given the size of their balance sheet and the size of our capital base and relationships to drive value. That also is going to take some time, but I’m still optimistic. So stay tuned on it, but without getting into the details, we’ve already made significant progress, and they followed through pretty helpfully with the capital commitments that we expected here in the first couple of months that I mentioned.

Our last question will come from Robert Lee with KBW. Please go ahead.

Well, I have some question on I guess, related question on taxes excuse me, the dividend taxes. So if I remember correctly, you kind of try to set the dividend each year to kind of the I remember you have kind of, I think, after-tax FRE may be headed. So I guess, the first part of that is a given last quarter kind of at the $0.40 and it doesn’t seem like you’re kind of quite at the $0.40 after-tax FRE yet. Is it fair to think that, that’s kind of how you’re thinking about it developing toward the end of this year. And then next year, where have you kind of think FRE could finish the year is kind of how you’ll think about the dividend next year?

Yes. Rob, I think that’s pretty close. I mean, if you recall, as we’ve described this, we thoughtfully used the term pegged because we didn’t want to ever get caught up with doing a fixed time period, look back or look forward. So instead, our view is to peg the dividend growth to what we believe would be the expected after-tax FRE growth. So obviously, the two variables there are FRE growth and tax rates. To that end, and we should probably highlight, we’ve been keeping our effective tax rate on FRE quite low. I know earlier we had probably guided that would be something more in the 8% to 11%. I’d say, for this quarter, the tax rate on FRE was just over 2.5%. For the year, it feels like it’s probably going to be sub-5 is my best guess today. But obviously, there’s different variables that can impact that. But I think as we look to future dividend growth, it’s going to be the trajectory of as we expect FRE to grow and how we think about the after-tax mix of that. But again, I wouldn’t you highlighted the numbers for this quarter, I think that’s accurate because, and if you saw this last year, if we were generating $0.40 after-tax FRE two quarters in, that I think we would have underground the dividend because that’s something, I think, that kind of sets us throughout the year. So I we kind of would to your point, I think that we would look at where we expect it to grow next year. And obviously, our Board will make the decision as we head into Q1.

Great. And then maybe the second part, you mentioned some kind of tax on Tesla’s has been running low. It seemed that maybe unusually low this quarter. What should we you mentioned the 5% on FRE. I mean, how should we be thinking about kind of realized income? And would it should we expect it to kind of normalize into next year?

As we’ve said in the past, it’s obviously going to be heavily dependent on realizations. So a meaningful dollars of realizations later in the year would push the rate, I’d probably say, realized income north of 10%. For the year, based on our commentary on the call about as we think about the environment today, I kind of feel like it’s going to be probably still in that 9% to 12% range, probably a little closer. So I think it probably most likely will be 10-ish or under. But I guess, it’s going to be a function of realization. So tax, if we more realizations, when you have a little bit higher effective tax rate, but not a bad thing.

This concludes our question-and-answer session. I would like to turn the conference back over to Michael Arougheti for any closing remarks. Please go ahead, sir.

Thanks, operator. We don’t have any other than I want to reiterate that we hope that everybody stays safe and well, and that’s true for you and yours. And I just want to thank everybody at Ares for the incredible work. I don’t think anybody on this call, whether it’s Ares or elsewhere, has fully appreciated what it would take to continue to drive our businesses forward in their remote environment. And when you look at these results and the amount of work that went into it, I just wanted to make sure that we thank everybody, again, for all the hard work to continue to deliver these types of outcomes. So I hope everybody enjoys the end of summer and look forward to catching up on next quarter’s call.

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 September 2, 2020, by dialing (877) 344-7529 and to international callers by dialing 1-412-317-0088. For all replays, please reference conference number 10145530. An archived replay will also be available on the webcast link located on the homepage of the Investor Resources section of our website. Everyone, have a great day.