Apollo Global Management and Oaktree Capital Group will thrive in a more upbeat environment through the acquisition of more opportunities.
The sell-off in equities is already overdone with only a few alternative asset managers now trading at significant discounted valuations.
The two companies are exerting efforts to diversify their respective businesses away from traditional distressed credit investing.
There are certainly significant challenges facing most alternative asset managers. Outpacing the index is tough while competition is intense. Fund outflows may be critical if ever an alternative asset manager is underperforming, especially during a bear market. Hedge fund managers are experiencing tougher problems as well.
Goldman Sachs (NYSE: GS) noted that the year 2018 was the first time since the global financial crisis where both the fixed income and the stock markets are down on the year. Both equity and fixed income products underperformed the benchmark on average in 2018. Only 48% of equity Assets under Management (AuM) for the industry was ahead of the benchmarks and 19% of fixed income AuM.
Given this scenario, I can say there are two exceptional alternative asset managers out there that are strongly capable of constantly enhancing their fee-based structures. These two firms will likewise thrive and choreograph a more upbeat pace in the acquisition of more opportunities. These are Apollo Global Management (NYSE: APO) and Oaktree Capital Group (NYSE: OAK).
Apollo Global Management
Permanent Capital Vehicles
APO boasts of the largest permanent capital base in the private equity industry at $124 billion. The company generates 50% of its AuM, and its fee-based income from its permanent capital vehicles. APO has a total of $72.4 billion in total AuM, $26.8 billion in carry-generating income and $29.8 billion in fee-generating income.
This asset manager strategically focuses on its 250 distressed investments with a market value of $13 billion. This is further supported by $34.5 billion in cash reserves. (Credit Suisse, Key Takeaways from Athene’s Investor Day – Raising EPS)
The Shift to Athene: Asset Portfolio Performance
The shift of attention into the insurance business was an unusual move by APO, whose key source of revenue is a leveraged buyout of companies. One of these leveraged buyouts is Athene (NYSE: ATH). The acquisition of ATH could be considered perhaps the best investment strategy of APO in the past decade.
Source: Financial Times, Private equity: Apollo’s lucrative but controversial bet on insurance
ATH is an insurance holding company that aims to invest in fixed annuities. It is destined to attract a large number of attractive opportunities. APO owns 45% of the voting rights of ATH and it also has 10% ownership in ATH. It also managed $85 billion of AuM in accounts owned by ATH. (Credit Suisse, Key Takeaways from Athene’s Investor Day – Raising EPS).
In the long term, the agreed fee structure between APO and ATH is a favorable one. The previous fee structure resulted in the underpayment by APO for its direct origination transactions. On the other hand, it also resulted in overcharging ATH in trying to source its assets from third parties.
I also expect that ATH's product portfolio would improve in time, as soon as the interest rates rally.
Capitalization: A Thriving War Chest
According to Credit Suisse, ATH has a $4 billion war chest sitting between excess capital and debt capacities that it can use to expand its asset base organically or via meaningful strategic acquisitions.
APO earned a hefty $400 million in managing ATH’s portfolio in 2017. The asset portfolio is comprised of credit linked instruments tied to real estate mortgages, aircraft leasing, private equity deals, and corporate debt. (Credit Suisse, Key Takeaways from Athene’s Investor Day – Raising EPS).
Stable Debt Equation - A Sound Balance Sheet
APO has $1.0 billion in cash and cash equivalent and US Treasury securities. It also has $1.1 billion of the general partners and other investments. This is further complemented by the $762 million investment in ATH for a total net value of $3.4 billion as at end-2018. Other liquid assets are comprised of $475 million of net performance fees receivable.
The company incurred a long-term debt of $1.4 billion, with maturities in 2024, 2026 and 2048 further supported by an undrawn $750 million revolving credit facility expiring in 2023. Unfunded general partner commitments valued at $1.2 billion as at end-2018. Of which, $469 million is associated with Fund IX. Share repurchases totaled $191 million in 2018 (Company Investor Presentation. February 2019).
Given the sound balance sheet, I believe that there are more prospects on the liability side of the balance sheet of APO as against its asset side. The company is still in the midst of constructing multiple debt portfolio companies, which are already around ten of them. These new companies will render ATH with sound risk-adjusted loans to support their financial products.
In addition, I also noted that private credit can promote a higher risk-adjusted asset for insurers like ATH, versus the most liquid bonds that usually prevail over their balance sheets. The U.S. financial regulators stimulate a more favorable environment for capital requirements of corporate bonds, while European regulators are more biased on private credit.
Oaktree Capital Group
Fund Portfolio Quality
OAK is considered a major credit-focused alternative asset manager. However, OAK is still lacking in terms of running a large U.S. and global private equity business. It holds a European private equity business but still lacks a significant "core" private equity business in the U.S.
Strategically speaking, the company is planning to expand its real estate franchise. Close to half of its limited partners are located outside of the U.S. Around 62% of the capital for Fund IX came from investors spread across more than 40 countries outside the U.S.
The company is attracted to acquiring large businesses in Core Plus, opportunistic and value add. It is said to be building out its geographic presence by starting a debt product in Asia (Odlum Brown, An Exceptional Asset Manager, and a Depressed Share Price).
Only a decade ago OAK managed to show signs of tangible improvements. In 2008, OAK raised a record $10.9 billion for one of its funds. Subsequently, it placed the raised capital into high-yield debt during the bottom of the capital market cycle. Following the global financial crisis, the price trend for high-yield debt rose higher. As a result, OAK ramped its fundraising activities, thus returning more funds to clients.
Just when things are getting better, OAK managed to win more deals, raising $23 billion in fresh capital. This is considered a record-breaking performance for the alternative asset management firm (Credit Suisse, OAK: Key Takeaways from Meetings with Oaktree's CEO & CFO).
New Opportunities Await
I noted that OAK created significant fund investments over the last decade. This alternative went through a lot of trials. Starting off in expanding its investment and distribution footprint globally, thus meeting the high demands of global regulators, to providing a higher level of transparency and lastly, dealing with some fee income pressures.
I consider OAK is gaining more traction in some of the new growth opportunities that include global credit and infrastructure in balancing its asset portfolio mix from its traditional distressed credit investing.
Asset Portfolio Performance
OAK has an impressive fund performance track record. Based on the report of Odlum Brown, OAK’s closed-end funds have returned 19% annually. It beats the S&P 500 by nine percentage points annually. Notably, these investment returns were not sourced from taking massive risks. Usually, the company is risk averse and would rather choose to invest in safer securities in its fund portfolio, while returns are at low volatility (Odlum Brown, An Exceptional Asset Manager, and a Depressed Share Price).
The company also owns 20% of the fastest growing, long-only bond manager DoubleLine. The fund portfolio is comprised of investment income of $66 million derived from distributions from DoubleLine in 2016. OAK’s distressed debt business peaked at around $30 billion of AuM. It is now only around $16 billion given the high level of capital that was returned to its limited partners (Company Investor Presentation. February 2019).
FRE Per Unit
Source: Credit Suisse Asset Manager Research
I'm optimistic that the sell-off in equities is already overdone with only a few alternative asset managers struggling. The equity market is still consolidating with stocks now trading at significantly discounted valuation multiples on trough cash earnings.
Source: Deutsche Bank
Stock prices now reflect close to a 60% increase in trough cash earnings. It also yielded a 40% build-up in dry powder from the most recent period of market turmoil (late 2015 to early 2016).
Earlier GS in its US Financials Conference 2018 report indicated that cyclical concerns surrounding deteriorating credit pricing and portfolio company performance put significant pressure on the alternative asset managers stocks. This sector fell 29% off of 2018 peaks (down approximately 23% on average) (Goldman Sachs, Oaktree Capital Group: GS US Financials Conference 2018 - Key Takeaways).
To recap, both APO and OAK exhibit an impressive track record which will lead them to a more favorable company outlook. Given the performance of the AuMs, both alternative asset managers continue to acknowledge that the year 2018 is not the best investing environment, given the high public equity valuations, tight credit spreads, and large amounts of global monetary stimulus. However, these two alternative managers are highly proactive in finding pockets of opportunities across the globe such as in the case of Athene for APO.
I believe that the success of ATH with APO will further drive APO to acquire another insurance company. Obviously, this insurance company would create more synergies to build up its insurance operations and fee income.
On the other hand, I believe OAK would also be constantly searching for a new source of "permanent capital" just like APO to enhance its fund portfolio. I believe OAK would need good timing that would perhaps be in a bear market. The time when acquisition targets are trading at discounts to book value.
Lastly, I’m also positive that these asset managers are exerting much effort to diversify their respective businesses away from the traditional distressed credit investing, transportation infrastructure, and emerging market fund. These asset managers will be more prudent in capital preservation and capital deployment for new opportunities.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.