- Ares Management is a consistently growing asset manager that has performed well in both good times and bad.
- Assets under management hit a record high despite the pandemic-induced economic downturn.
- The firm is firing on all cylinders with continued AUM growth into Q2 and plenty of dry powder to deploy.
Ares Management (NYSE:ARES) is a premier asset manager that has shown resiliency and an ability to thrive during recessions and the current pandemic-induced downturn. Through shrewd capital allocation and prudent risk management, Ares has managed to grow AUM during both good times and bad. Although shares are not exactly cheap, I believe the company has a long runway of fee-generated earnings growth ahead through the trend of increasing capital flows to capably managed private funds.
Source: Company Website
Ares Management is a global alternative investment manager founded in 1997 that operates in the three complementary segments of Credit, Private Equity, and Real Estate. Ares currently has $148.6 billion in total assets under management (AUM), with about 76% of fee-paying assets in credit-related investments, 15% in private equity assets, and the remaining 9% in Real Estate. It has a stable and high-quality investor base that includes pension funds, insurance companies, banks, sovereign wealth funds, and university endowments. The company generates revenues from charging AUM base and performance incentive fees.
Source: Q1’20 Investor Presentation
Ares pulled off another strong quarter with Q1 being the twelfth consecutive quarter of sequential fee-related earnings (FRE) growth, with FRE of $93 million, representing a 31% YoY growth. Fee-paying assets under management (AUM) growth also showed no signs of slowing down during COVID-19 as it crossed the $100 billion mark for the first time in company history, with $6.6 billion being raised in just Q1 alone.
Source: Q1’20 Investor Presentation
This is highly encouraging and suggests that the client base may have shifted funds out of the perceived riskier stocks and into lower-risk credit-related investments that are the bread and butter of Ares. Interestingly, this is reflective of Ares financial performance during the Great Recession, in which it grew AUM and management fees at compounded annual growth rates of 39% and 28%, respectively, from 2007 to 2009.
Source: Q1’20 Investor Presentation
What’s even better was that the company saw continued capital inflows to the tune of $2 billion during the height of the pandemic from April to early May, with much of it (74%) coming from the existing investor base as a sign of confidence in management. Management also expects strong fundraising throughout 2020.
I also like the fact that Ares has $33 billion of dry powder to invest, enabling the company to take advantage of depressed asset prices during the pandemic. This gives the company flexibility during a downturn such as this, by not forcing it to sell assets for a net loss to meet financial obligations and is a sign of a prudent, risk-averse management style. In addition, what gives me confidence is that the company’s credit-related assets sit higher on the capital stack, which helps to mitigate losses in the event of a portfolio company default, as the CEO noted on the conference call:
On a related note, our capital base is meaningfully over-weighted to more resilient credit-based strategies that invest at the top of the capital structure and by definition take the last loss on investment. Not only this credit provide more stability in values, but it is also easier and quicker to deploy in volatile markets when equity risk is more difficult to price.
The impressive 31% fee-related earnings growth was due to strong management fee growth of 17%, far outpacing the general and administrative expense growth of 12%. This is because many of its funds are mature with the capital raising and operating expenses related to fund origination having already been incurred in prior periods. In other words, the company is now reaping the benefits of a steady stream of income from established funds. This helped the firm achieve a 35% margin in 2020 so far, a 1% improvement from the end of 2019.
Further tailwinds for the company include the $23.1 billion of the company’s AUM that is currently not paying fees. At 15% of Ares’s total AUM, this has the potential to materially boost earnings growth for the company down the line. Longer term, I see management firms such as Ares with private equity funds benefiting from the recent move by the Department of Labor allowing mainstream investors to participate in privately managed funds in their retirement plans.
As with any asset manager, management reputation is extremely important as perceived transgressions can lead to an exodus of capital and materially reduce assets under management, thereby reducing the management fee revenues they receive. While Ares has had a strong track record of rewarding investors since its founding in 1997, this is something investors should be mindful of.
In addition, fee compression can occur if there are unfavorable supply and demand dynamics for its funds, especially if there is increased competition for private investment dollars. While Ares has consistently grown its AUM over time, it is something investors should keep a watchful eye on.
Ares has shown resiliency through past and current difficult economic environments. It has consistently grown assets under management and set a record in the latest quarter. I believe Ares is in a solid position to benefit from an expanding and loyal investment base that generates steady fees for the firm, and from the anticipated tailwind of mainstream investors shifting retirement account dollars to privately managed funds with the latest Department of Labor action.
At the current price of $39.50 and a P/E of 23 as of writing, I believe shares are somewhat undervalued. I have a buy rating on shares with a P/E of 25 and a target price of $43, representing a 10%+ one-year total return with dividends, and I anticipate double-digit annual returns thereafter.
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