Ares Management Most Dependent on Management Fees of Large Alternatives Managers

December 2014

A report by UNITE HERE Contact: Alyssa Giachino 310-795-5537 [email protected]

Ares Management most dependent on management fees of large alternatives managers

Ares Management has joined with many of its larger peers to become a publicly traded asset manager, but its focus on fee generation (versus incentive income, investment income, or sources of income linked to investment performance) distinguishes the firm from similar alternatives managers.

As Ares seeks to raise Ares Special Situations Fund IV, an energy “We continue to make infrastructure private equity fund and an opportunistic real estate progress growing our core fund, partners might wonder whether Ares’ dependence on fees management fee business properly aligns the manager’s interest with theirs. and associated fee-related A May 2014 report by Wells Fargo noted, “Relative to its peers, Ares earnings.” has by far the largest percentage of earnings coming from the more Michael Arougheti, Ares President, stable fee business. By way of example, in 2013, Ares derived nearly November 2014 50% of earnings from its fee business versus the industry average of roughly 20%.”1

Ares reiterated its focus on generating fees in its third quarter earnings call, in which President Michael Arougheti told investors, “We continue to make progress growing our core management fee business and associated fee-related earnings.”2

“We estimate that 50% The heavy reliance on fees is not new for Ares; the average of Ares’ earnings will be ratio of fees to total earnings over the past four years was 43%, management fees, versus 10- according to Wells Fargo analysts.3 Fee earnings are projected 25% for peers such as Apollo, to continue to outstrip peers, according to JP Morgan analysis, Oaktree and Carlyle.” which said, “We estimate that 50% of Ares’ earnings will be management fees, versus 10-25% for peers such as Apollo, Wells Fargo, May 2014 Oaktree and Carlyle.”4

1 For 2013, Ares fees contributed nearly half of the firm’s total earnings, representing 47%. By comparison, Ares peers averaged an 18% ratio of fees to total earnings. Oaktree ranked second to Ares in the ratio of fees to overall earnings, but Oaktree’s ratio was 24%.5

SOURCE: Wells Fargo analyst Initiating Coverage May 2014

Similarly, looking at the combined contributions of management, performance and investment fees between Ares and other large alternatives managers, Ares is more heavily reliant on management fees while its peers draw significantly more revenue from performance fees.

Source: JP Morgan Initiating Coverage (management fees include transaction, advisory and monitoring fees)

2 BDC fees beneficial to Ares

Ares Management operates a publicly traded Business Development Company, Ares Capital Corp (ARCC) which managed $9.2 billion in assets as of the third quarter of 2014.6 The BDC represents an important source of fee revenue for Ares Management, comprising 42% of the firm’s management fees in 2013.7

Ares Management serves as an external manager to ARCC, which adds a layer of fees equal to an additional 3% or 4% of assets not present for internally managed BDCs8. A Wells Fargo analyst described this arrangement as “a very friendly fee structure (for ARES).”9

Will Ares seek to extend ARCC’s fee structure to its other funds?

Private Equity, re-evaluating fees

Institutional investors in private equity have been “As firms have ballooned in size the reevaluating traditional fee structures. One private equity management fee has come to represent consultant said in a January 2013 report, “Management tens of millions of dollars—far more fees should be seen as an income stream that allows a than the expenses the firms concerned manager to provide for the stability and productivity of its investment platform, not as a profit center for the actually incur, no matter how plush their firm.”10 offices. Some investors have taken to examining a fund’s running expenses A February 2014 Economist article noted, “As firms to make sure its bosses are not getting have ballooned in size the management fee has come to rich merely by showing up to work.” represent tens of millions of dollars—far more than the The Economist, February 2014 expenses the firms concerned actually incur, no matter how plush their offices. Some investors have taken to examining a fund’s running expenses to make sure its bosses are not getting rich merely by showing up to “We are also starting to experience 1 w or k .” some margin improvement on our

fee-related earnings as we invest and In a recent earnings call, Ares CFO Dan Nguyen said, “We are also starting to experience some margin earn fees on capital invested without improvement on our fee-related earnings as we invest of course the need to incur the same and earn fees on capital invested without of course level of expenses.” the need to incur the same level of expenses.” Nguyen Ares CFO Dan Nguyen, continued, “We expect that our fee related earnings will November 2014 continue to grow from a combination of new capital raises and the deployment of our significant capital, both current and new, against our slower growth rate in expenses.”12

3 Indeed, in 2013 management fees generated by Ares ($517 million) significantly outstripped operating expenses ($364 million).13 Management fees at Ares were 142% of expenses, far ahead of peers (see chart).

(Source: KKR, Apollo, Blackstone, Oaktree 2013 SEC Form 10-Ks)

Even if management fees from Ares’ BDC, ARCC ($111 million in 2013) were excluded, management fees would have still outstripped expenses by nearly 12%.14

Ares private equity group collected $93 million in management fees in 2013 to cover $41 million in expenses, meaning Ares cleared $52 million in earnings15.

Moreover, Ares Management is in the process of expanding its “The bulk of the economic value fee-generating assets in private equity. It recently announced on acquisition will be from the the acquisition of Energy Investors Funds, an asset manager management fee.” focused on the energy sector with $4 billion in assets under management. The deal is set to close by the end of 2014, Ares President Michael Arougheti regarding Energy Investors acquisition, November 2014 pending regulatory approval.16

Ares will begin collecting management fees “in excess of 1.5%” in addition to certain carried interest on EIF funds. Ares President Michael Arougheti described the EIF as having a “much higher FRE (fee-related earnings) margin” and said, “the bulk of the economic value on acquisition will be from the management fee,” in a call with investors.”17

4 Questions:

n Will Ares attempt to export the management fee-heavy structure of its BDC, ARCC, to other Ares funds?

n If management fees outstripped expenses at Ares by 42% in 2013, are Ares’ fees too high?

n Will Ares seek to maintain the share of earnings derived from management fees as it expands through acquisitions like Energy Investors?

n As Ares raises new funds, will institutional investors insist Ares implement fee structures that emphasize compensation for performance to align GP interests better with LPs?

Endnotes

1 Wells Fargo, Initiating Coverage Ares Management, May 27, 2014, page 2 2 Ares Management Earnings Call Transcript 3Q14, Michael Arougheti November 12, 2014 http://seekingalpha.com/ article/2675525-ares-managements-ares-ceo-tony-ressler-on-q3-2014-results-earnings-call-transcript?part=single 3 Wells Fargo, Initiating Coverage Ares Management, May 27, 2014, page 4 4 JP Morgan Initiating Coverage Ares Management May 2014, page 4 5 JP Morgan analyst Initiating Coverage May 2014 6 http://arescapitalcorp.com accessed 11/24/14 7 Ares Management Prospectus, SEC form 424B4, page 31, filed May 5, 2014 8 Wells Fargo Securities, “BDCs, Equity Issuance, Required Returns – A Must Read for BDC investors” January 2, 2014 9 Wells Fargo, Ares Management Initiating Coverage May, 27 2014 10 TorreyCove Capital Partners, Perspective: Fees and Performance January 2013 11 The Economist, “Down to 1.7 and 17” Feb. 8, 2014 12 Ares Management Earnings Call Transcript 3Q14, Dan Nguyen, CFO, November 12, 2014 13 Ares Management Prospectus, SEC form 424B4, page 4 filed May 5, 2014 14 Ares Management Prospectus, SEC form 424B4, page 4 filed May 5, 2014 15 Ares Management Prospectus, SEC form 424B4, page 160 filed May 5, 2014 16 Ares Management Press Release, “Ares Management, LP to acquire Energy Investors Funds,” October 31, 2014 17 Ares Management Earnings Call Transcript 3Q14, Michael Arougheti November 12, 2014