Ares Management Corporation (NYSE:ARES) Q3 2022 Earnings Conference Call October 27, 2022 10:00 AM ET
Company Participants
Carl Drake – Head, Public Markets, IR
Michael Arougheti – CEO
Jarrod Phillips – CFO
Scott Graves – Partner, Co-Head, Private Equity Group, Portfolio Manager and Head, Special Opportunities
Conference Call Participants
Craig Siegenthaler – Bank of America
Alex Blostein – Goldman Sachs
Patrick Davitt – Autonomous Research
Benjamin Budish – Barclays
Brian McKenna – JMP Securities
Gerald O’Hara – Jefferies
Finian O’Shea – Wells Fargo Securities
Adam Beatty – UBS
Rufus Hone – BMO Capital Markets
Michael Cyprys – Morgan Stanley
Operator
Welcome to Ares Management Corporation’s Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. As a reminder, this conference call is being recorded on October 27th, 2022.
I will now turn the call over to Carl Drake, Head of Public Markets, Investor Relations for Ares Management.
Carl Drake
Good morning, and thank you for joining us today for our third quarter conference call. I’m joined today by Michael Arougheti, our Chief Executive Officer; and Jarrod Phillips, our Chief Financial Officer.
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 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 not be considered in isolation from or as a substitute for measures prepared in accordance with generally accepted accounting principles.
Please refer to our third-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 fourth-quarter common dividend of $0.61 per share of our Class-A and non-voting common stock, representing an increase of 30% over our dividend for the same quarter a year-ago. The dividend will be paid on December 30th, 2022, to holders of record on December 16th.
Now, I’ll turn the call over to Michael Arougheti, who will start with some quarterly financial and business highlights.
Michael Arougheti
Great. Thank you, Carl, and good morning everyone. I hope you’re doing well.
In the face of geopolitical tensions and rising inflation, energy costs, and interest rates, our business continues to generate steady growth and deliver strong relative performance for our investors.
During the third-quarter, we continued our strong growth in our AUM and fee-related earnings despite the challenging environment and a continued slowdown in overall primary market activity.
Our suite of products continues to resonate with our investors as we raised more than $14 billion of gross commitments for the quarter, bringing the year-to-date fundraising total to more than $44 billion. We’re pleased with the breadth of our fundraising activity to date, which only included $2.1 billion in fundraising this year from our largest commingled funds.
The flexibility of our investment strategies is also reflected in our steady deployment, which remains strong and was relatively flat versus our activity levels a year-ago. These factors drove growth in our AUM metrics, management fees, fee-related earnings, and realized income ranging from 21% to 28% on a year-over-year basis.
Before I walk-through some quarterly business highlights, let me start by framing why our business has been so resilient during volatile markets like we’re in today. It all starts with our management fee-centric business, which provides a more stable realized income compared to more performance fee-based and balance sheet heavy business models.
For example, on a year-to-date basis, we generated more than 90% of our total fee revenues from our management fees and over the same period 92% of our realized income was derived from our fee-related earnings. This rich mix of FRE based earnings has also been steadily increasing over the past three years.
Another important component of our business is our asset-light balance sheet, with balance sheet investments representing less than 0.5% of our total AUM. In addition to generating strong returns on equity, this means that we’re less susceptible to changes in-market values for risk assets, particularly during times of high market volatility.
The structure of our AUM and long-dated and perpetual vehicles also provides insulation from client withdrawals. About 88% of our AUM and 95% of our management fees are from either long-dated funds or perpetual capital vehicles. And due to the long-term nature of this capital, we have not experienced significant redemption issues during volatile periods. This enables us to be patient investors and utilize the capabilities of our experienced teams and our significant dry powder to make new investments and to support portfolio companies during more difficult markets.
We believe that the nature and mix of our AUM also provides stability. Approximately 60% of our assets under Management are tied to a diverse range of credit strategies. These credit investments provide protection from declines in valuation multiples during economic downturns since our credit positions are generally in the top half of the capital structures of our portfolio investments.
In other words, across the spectrum of private assets, our AUM focus in credit is generally positioned to have comparatively less risk. We believe this also provides meaningful benefits to both our fund investors and to Ares stockholders during rising interest-rate environments, as more than 90% of our debt assets firm wide are floating-rate and can earn higher income as interest rates increase.
As an example, ARCC reported on Tuesday that its core earnings would have been 8% higher at the prevailing short-term rates at September 30th been in effect for the entire third-quarter. As rates continue to increase, this should continue to enhance Ares Capital’s core earnings as evidenced by the 17% year-to-date increase in ARCC’s third quarter dividend, and it provides for the potential for increased ARRC part one fees as well, all else being equal.
Across the rest of our asset mix, we believe that our growing AUM and real assets with investments in real estate sectors with strong rent growth and an infrastructure assets that have built-in inflation escalators will be well-positioned to perform in the current market environment. We also believe that our private equity business is also differentiated with its focus on resilient, less cyclical, higher growth industries along with its flexible capital strategy of deploying assets across debt and equity in distressed and other opportunistic assets.
So turning to deployment. The current market environment is providing opportunities for us to continue to take market-share and be a consistent capital provider when other traditional providers and public sources are retrenching. Our significant dry powder and the flexibility of our strategy has enabled us to provide a variety of capital solutions to private companies or to play in liquid markets as relative value shifts.
Our deployment for the third quarter remained strong at $18 billion, with more than $12 billion in our credit strategies during Q3. We actively invested across the credit spectrum, including take privates, add-on acquisitions, secondary market purchases, financing asset portfolios, and many other types of situations.
Nearly half of our activity in our U.S. and European direct lending businesses combined in the quarter was tied to existing incumbent borrowers and our focus continues to be on larger upper middle market companies.
In real assets, we selectively invested over $1 billion, primarily in our core real estate segments of industrial and multifamily, and we invested $0.5 billion across our infrastructure strategy. We also deployed over $2 billion in private equity across both our ASOF and ACOF strategies.
Our special opportunities team is very excited about the opportunities being presented, particularly investing in high yielding debt in the more volatile liquid markets. Our secondaries group deployed over $500 million as they’re seeing increasing transaction activity for both LPs seeking liquidity and GPs seeking additional capital for growth.
And we’d expect secondary opportunities to gain momentum over the coming quarters as private equity investors and managers seek solutions for the capital allocation and balances that they’re facing. We also invested $1.4 billion across Ares SSG and via our affiliated insurance platforms.
There’s been a lot of discussion in the market about the denominator effect in slowing allocations to alternatives by investors. Through the end of the third quarter, we have not experienced this to the same degree and we understand others have.
Our leading floating rate credit strategies and real asset strategies also continue to resonate with investors as they are seen as either beneficiaries or insulated from some of today’s market headwinds. Overall for the third-quarter, we raised $14.2 billion across more than 50 different funds and accounts with more than 90% of the direct capital derived from our existing investor base.
One highlight for the quarter was our final closing of our inaugural sports, media, and entertainment fund at $3.7 billion in commitments within the fund and related vehicles. This strategy is a great example of how we can leverage our team and the advantages of our broad platform to create exciting new adjacent strategies for our investors.
ASOF II raised $1.3 billion during the third quarter and just held its final closing at its hard cap of $7.1 billion, which is more than double the size of our inaugural fund from three years ago. At quarter end, our 10th U.S. value-add real estate private equity fund held its final closing at $1.8 billion, well ahead of its target and over 75% larger than its predecessor fund.
And we’re pleased to report that our infrastructure debt strategy is being well received as we closed on another $500 million, bringing the total amount of AUM to $3.9 billion for our fifth fund. We also increased our AUM in our first Australia and New Zealand direct lending fund as we continue to build out investment capabilities and capital in the Asia Pacific region.
Within real estate, our fourth U.S. opportunistic fund, which was recently launched, has attracted significant interest from investors and is expected to hold the first closing in Q4. With a $3 billion target, we anticipate that the early closings will equal or exceed the size of the predecessor fund.
Our perpetual capital funds also continued to see strong inflows. Our two non-traded REITs raised approximately $850 million of equity commitments during Q3 with approximately $100 million in redemptions. Overall, debt and equity commitments raised from perpetual funds totaled $4.2 billion during the third-quarter as perpetual capital increased 24% from the year ago period to $89 billion. We expect to add at least one wirehouse for non-traded REIT distribution during the fourth quarter with more expected next year.
Our affiliated insurance company, Aspida, is beginning to gain momentum and at $1.2 billion of new annuities in the third quarter across its reinsurance platform and new retail platform that launched at the end of June. Aspida now has over $4.5 billion in AUM of which a little over 50% is now sub-advised by our own investment teams.
We’re also excited about the expanding opportunity set for our secondaries business. On November 7th, we’ll be completing the final step of our integration process and fully transitioning the Landmark business to be referred to as Ares Secondaries to better leverage the platform and the strength of the Ares brand.
We continue to invest heavily in the Secondaries Group by adding senior talent, including real estate capabilities in Asia Pacific, and our new revenue synergies are playing out as we expected. We plan to launch our third infrastructure secondaries fund and we expect to launch new strategies within credit and private equity secondaries. The retail private markets fund is also starting to see inflows pickup, and we’re partnering with retail technology platforms to enable access on wirehouse platforms next year.
Now, let me turn to the future pipeline. As discussed on our last earnings call, we were at the beginning stages of launching a significant fundraising cycle for a number of funds where the predecessor funds were among our largest commingled funds. In addition to our ongoing activities with perpetual funds, managed accounts, and our existing commingled funds we’ve had in the market this year, we have recently launched or expect to launch commingled funds in the next three months that will target more than $45 billion, inclusive of fund leverage.
We continue to expect first closings of some of these new funds in the first-half of 2023. This $45 billion of target fundraising includes our two largest fund series, our sixth European direct lending fund, and our third U.S. senior direct lending fund, along with others including our second flagship closed end alternative credit fund, our seventh corporate private equity fund, our fourth U.S. opportunistic real-estate fund, our second climate infrastructure fund, and our third infrastructure secondaries fund.
As the public markets continue to report losses across equities and fixed-income, our fund results were generally strong across our various credit, real estate, and private equity strategies. In direct lending, our senior direct lending and junior direct lending strategies generated gross returns of 1.4% and 0.3% for the quarter and 12% and 6.7% for the last 12 months respectively.
European direct lending returns also held up well, totaling 3.4% in the quarter on a gross basis and 11% for the last 12 months. The European direct lending portfolio is benefiting from lower overall leverage, strong interest coverage, and generally strong covenant packages.
Real estate continued its strong performance as our U.S. equity composite generated gross quarterly returns of 2.8% and 33.4% over the past 12 months along with increased NAVs for both of our non-traded REITs. Our focus on industrial and multifamily continues to generate strong performance based on the fundamental tailwinds for rent growth, generally in excess of inflation in these sectors. Our European real estate composite declined 1.8% growth for the quarter, but increased 9.4% for the trailing 12 months.
Our private equity portfolio performed particularly well during the third quarter, despite the overall declines in the public equity markets. Our ACOF composite increased 2.7% growth in the quarter and is up 10.7% over the past 12 months, primarily driven by strong revenue and EBITDA growth across the portfolio, as we’ve invested behind resilient sectors with attractive secular tailwinds.
Our special opportunities business continues to thrive in this environment, not only raising and deploying a significant amount of capital in the quarter but also generating strong Q3 gross returns of 4.1%. Over the past 12 months, ASOF I has generated gross returns of 9.8%.
In secondaries where returns are reported on a one quarter lag basis, our private equity strategies declined 5.6% on a gross basis, largely related to currency depreciation related to our European assets. But over the past 12 months, the strategy is still generated a positive 14.8%. Real estate secondaries was very strong, up 6.4% on a gross basis in the quarter and up 45.4% over the past year.
And now with that, let me turn the call over to Jarrod to walk through our third quarter financial results in detail and to provide an updated outlook. Jarrod?
Jarrod Phillips
Thanks Mike. Hello everyone. And thank you for joining us again this quarter.
As Mike mentioned, our third quarter results emphasized the resilient nature of our business as we delivered strong growth in management fees, fee-related earnings, and fee-paying AUM. Our quarterly management fees increased 23% year-over-year to $552 million driven by continued deployment and growth in our fee-paying AUM.
Our other fee income totaled $28 million in the third quarter, up over $5 million in the second quarter and more than double a year ago. The quarterly increase was driven predominantly by property-related development fees from our non-traded REITs in addition to our typical capital structuring and origination fees and certain of our direct lending perpetual funds.
In the third quarter, we generated $233 million of FRE, an increase of 28% over the third quarter of 2021. As expected, we had virtually no fee-related performance revenues during the third quarter and we continue to expect 90% or more of our annual FRPR to occur in the fourth quarter.
Through September 30th, our non-traded REITs had agreed $159 million gross performance participation for Ares. As these funds pay on an annual basis, this value is not included in our accrued net performance income or our fee-related performance revenues since it remains subject to the fund’s future returns.
FRE as a percentage of realized income was over 95% in the third-quarter, driven by the steady growth in our management fees and more modest net realized performance income. Our FRE margin for the third quarter was 40.2%, up slightly over the second quarter and up over 100 basis points versus the third quarter of 2021.
We continue to feel good about the 45% margin target as well as the other targets we laid out at our Investor Day last year. We generated $11 million of realized net performance income roughly in-line with the third quarter of 2021 and down slightly on a year-to-date basis compared to 2021.
Realizations this quarter were driven mainly by exits in our real estate equity funds, which has performed well and are now approaching the end of their fund life. Realized income for the third quarter totaled $243 million, up 22% year-over-year. After-tax realized income per share of Class A common stock was $0.75 for the third quarter, up from $0.62 in the third quarter of 2021 and well ahead of our declared dividend of $0.61.
As we highlighted at our Investor Day last year, we have been meaningfully scaling our European waterfall funds over the past five years and many of the early funds are beginning to season. We continue to expect to ramp-up in their contribution to realized net performance income in the years ahead with accelerated growth thereafter as larger funds begin to contribute.
In total, we have $105 billion in European waterfall style eligible funds, of which about $80 billion in credit or credit life funds, which we believe should build a growing base of more consistent net realized performance income in future years once we reach the harvesting periods for these funds.
Looking at the realized performance income potential in our European waterfall funds over the next few years, we currently have approximately $20 billion in incentive generating AUM, primarily from funds that are out of their reinvestment period. In these funds, we currently have approximately $300 million of accrued and accumulated net performance income, and we expect to realize the vast majority of this amount over the next two years. We expect the recognition of this income to ramp-up over the coming quarters with roughly one-third in 2023 and then two-thirds expected to be realized in 2024.
In the current fourth quarter, we are anticipating some early European waterfall distributions, totaling roughly $40 million in realized net performance fee income related to the strong returns in our funds this year. We continue to have significant value in American style waterfall funds that are eligible for realizations as well, where we’re being patient due to the current softer realization environment and these private equity strategies.
Our accrued net performance income, which includes both European and American waterfall style funds, increased 5.8% in the quarter to $888 million and is up nearly 10% year-to-date despite the difficult market backdrop. This increase was largely due to increases in EBITDA offsetting multiple compression in our private equity portfolio and rising interest rates and the credit portfolio, increasing the yield of those investments further in excess of the fixed hurdle rates of the funds.
Turning to our AUM and related metrics, our assets under management totaled $341 billion, an increase of over 2% quarter-over quarter, and up 21% from $282 billion in the third quarter of 2021.
Our AUM growth was driven by strong fundraising across the platform. Importantly, we generated these inflows with only $2.1 billion in closes this year from any of our five largest flagship funds as the expansion of both our product set and distribution channels continues to increase our fundraising capability.
Going forward, our fundraising pipeline is as strong as Mike stated. The significant number of sizable flagships will have in the market is expected to set us up for an increase in fund raising for 2023 compared to 2022. Our fee-paying AUM totaled $219 billion at quarter-end, an increase of 3.5% from the second quarter and up 27% in the third quarter of 2021. Our growth in fee-paying AUM was primarily driven by deployment in our direct lending, alternative credit, real estate debt, and special opportunity strategies, which are all paid on invested capital.
Having significant amount of dry powder, should be highly advantageous as we navigate future volatility. As of September 30th, our available capital totaled nearly $88 billion, and we ended the quarter with over $45 billion AUM not yet paying fees available for future deployment. As a result, we remain well positioned to capitalize on current market dislocations.
Looking at our historical pace of deployment, we have generally deployed our available capital over an 18- to 24-month period. However, we recognize that periods of extreme volatility can impact our deployment pace.
Finally, our incentive eligible AUM increased by over 15% year-over-year to $198 billion, of this amount $66 billion was uninvested at quarter end, which represents a meaningful amount of potential future value creation opportunities for us.
So in summary, we believe the combination of this available capital with our management fee and FRE rich business in asset-light balance sheet, positions us well in this uncertain environment.
And with that, I’ll now turn the call back over to Mike for his concluding remarks.
Michael Arougheti
Thanks Jarrod.
I believe our results underscore the durability and consistent trajectory of our business and our ability to take advantage of weaker competition during times of volatility and uncertainty. Over the past two quarters, the global equity markets declined more than 20% and banks and the liquid credit markets have been severely constrained.
During this time, we’ve delivered strong relative investment performance across most of our funds, continued growth in AUM, management fees and fee-related earnings, and improved our operating margins even while continuing to scale our platform. While there are clearly challenges that lie ahead, we have a deep and experienced team that has demonstrated an ability to grow consistently through volatile markets.
The combination of our experience, sizable platform, portfolio positioning, long-dated capital base, and ample dry powder, all provide us with the tools that we need to generate successful investment outcomes for our clients, which in turn we believe will drive successful results for Ares’ stockholders.
I’d like to end by expressing my appreciation for the hard work and dedication of all of our employees around the globe. I’m also deeply thankful to our investors for their continued support of our Company.
And with that, I’d just thank you for your time today. And operator, could you please open up the line for questions?
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from the line of Craig Siegenthaler of Bank of America. Please go ahead when you’re ready, Craig.
Craig Siegenthaler
Good morning Mike, hope you and the team are doing well.
Michael Arougheti
Thanks Craig.
Craig Siegenthaler
So we appreciate the updated commentary on the European waterfall opportunity. It looks like the 2023 and ’24 performance fees are mostly going to come from a handful of 2017 and 2018 vintage drawdown funds in private credit. But the subsequent vintages have scaled larger. So does this mean this European waterfall ramp will continue beyond 2024 with the newer vintages, or is this fee stream going to be more cyclical and could exhibit some deceleration like your American waterfall funds?
Jarrod Phillips
Hi Craig, it’s Jarrod. Thanks for the question. I think the way you’d want to think about it is, and we’ve talked about it a lot – it will track similar to how management fees also. As we deploy, we earn more management fees. In this case, that’s what we think so exciting about these European waterfall style funds is that as the subsequent vintages have been raised larger and as they’re deploying, they’re often deploying at a yield on the individual assets above the hurdle rate.
So they’re building that pre-balance over time. So we actually expect a steady and growing balance of accrued related to these, European style waterfall and that it would continue period-over-period, much like management fees do.
Craig Siegenthaler
Jarrod, that’s great. Just as my follow-up, you had a really strong quarter on the investing front. Credit drove 12 out of the 18 can this, trajectory sort of continue? And are there any headwinds to investing, especially on the credit side of the business, where I think you’re more flexible versus some of the other funds where you need more willing sellers?
Michael Arougheti
No, I think deployment can continue. As we talked about in the prepared remarks, Craig, the beauty of the platform is; one, it’s diversified by asset class and by geography, and the bulk of our strategies have the ability to pivot into the liquid markets when we get into a volatile backdrop, move up and down the balance sheet. So not surprisingly, even when primary market slows, we still have the ability to deploy pretty actively, and that’s showing up in the numbers.
Craig Siegenthaler
Great, thank you guys.
Michael Arougheti
Thanks Craig.
Operator
Thank you. We now have Alex Blostein of Goldman Sachs. You may proceed with your question.
Alex Blostein
Hi, good morning everybody, thanks for the question as well. I wanted to start off with a question around retail strategy. AREITs one and two, I guess, seen pretty good flows in the quarter at about $1 billion. We’ve obviously seen a slowdown from some of the larger peers. I think you’ve been adding distribution partners over the last couple of quarters?
So, help me maybe dissect a little bit how much of the continued strength in fundraising for those vehicles has been a function of new platforms versus same-store sales generally remaining pretty strong. And then, I guess, as a follow-up to that, what are, the sort of near-term plans for the further sort of expansion in the retail channel?
Michael Arougheti
Sure, thanks, Alex. So good news, bad news is that the two non-traded REITs raised $842 million in the quarter, which was up from $818 million last quarter. And I think also importantly, those inflows came against some fairly insignificant outflows, which is what we saw last quarter as well. I think quarterly redemptions this quarter were about $85 million. And so I think we are outperforming the peer set, both in terms of the inflow and the net.
That’s the good news. The bad news, if you want to call it that, is we’re actually still doing that with our existing selling group so all of that is same-store. As we talked about in the prepared remarks, we expect to add one-wire platform for the non-traded REITs by the end of the year, and have a pipeline of other partners that we would expect to bring online into the new year.
Alex Blostein
Great, that’s helpful, thanks Mike. And then my…
Michael Arougheti
Sorry, you just asked about product expansion. I think folks are aware we have our PMF product, which we referenced in the script as well. We’re beginning to see inflows accelerate there. And we are in registration, as people know, with ASIF, our private BDC, which we are hopeful will be well received given our private credit franchise.
Alex Blostein
Awesome, thanks for that. My follow-up was for Jarrod just thinking through the follow-up to Craig’s question around the European waterfall. Obviously, that will create a bit of more recurring nature to the overall earnings base for Ares in addition to, obviously, very strong growth in management fees in FRE. How does that inform your dividend philosophy? I think, for now, the dividend is largely tied to the direction of fee-related earnings growth?
But with lots of visibility into realized income or realized performance fees from European waterfall style funds, should we be thinking that your approach to dividend will sort of include that? In other words, the payout, as a percentage of FRE, could ultimately increase and the direction of travel is meaningfully higher from here?
Jarrod Phillips
It’s something we’ll continue to monitor, certainly. However, as you know, being a balance sheet like manager, we pride ourselves on our flexibility and our ability to take advantage of different markets and opportunities. And I wouldn’t want to guess what might be available to us as these really come on in earnest, and I’d want to maintain our flexibility in regards to that.
So if there was an acquisition opportunity or organic growth opportunity that, that cash would be well suited to investing, I wouldn’t want to take that opportunity away. But it’s certainly something that we’ll always be aware of as we’re mapping out what our dividend will be.
Alex Blostein
All right, we’ll stay tuned. Thank you.
Operator
Thank you. We now have Patrick Davitt of Autonomous Research. Please go ahead when you are ready Patrick.
Patrick Davitt
Hi, good morning everyone. You mentioned the $1.2 billion of organic growth from the insurance platform. They just launched annuity writing there in June. So is that a good kind of baseline to think about the run rate organic growth from that annuity writing or do you expect it to continue to ramp from here?
Michael Arougheti
My expectation is it will ramp from there. To remind folks, we talked at our Investor Day that prior to being onboarded onto the Ares platform, that distribution engine was originating close to $2 billion per year organic. We’re obviously quickly getting to that level, but I think we went into this endeavor with a view that as we scale that we would be able to do better than that.
So I think it is a very exciting baseline given how early we are in the underwriting [maneuvers] having started only at the end of June, but my hope and expectation would be that as we continue to scale the capital base, the speed of those numbers could grow.
Patrick Davitt
Great helpful. And a quick follow-up, you mentioned the non-traded REIT accrual of $159 million. Are there any other chunky 4Q crystallizations you have – visibility on other than that in the European waterfall you pointed out?
Jarrod Phillips
Yes, to be clear, the REITs are in [FRPR], and they’re not included in our accrual. The other amount that comes into FRPR – is the perpetual capital related to the credit funds. We have about $10 billion of AUM, and we had about $10 billion last year as well. There’s a couple of factors to take into consideration there, which is, you have the rising interest rates that benefit it, but credit spreads, as they widen within a given year, they can be a little bit of a drag.
So I think, all in, when you consider what we have from the REITs and what you have from the credit side, that we’d expect that number to be slightly larger than it was last year. But overall, there’s a lot of inputs that will go into it in the fourth quarter in terms of what credit spreads are doing, what interest rates do and as well as the fair value of the assets of the REIT.
And in terms of the realization that we had, the realization that we had – the realization that we had or that we mentioned there of $40 million, that’s really related to our European-style waterfall that pay periodically in order to make certain tax payments that are required by those funds. It’s not the start of the European waterfall in earnest, which we really look to 2023 and 2024 for.
Patrick Davitt
Got it, very helpful, thank you.
Operator
Thank you, Patrick. Your next question comes from Benjamin Budish from Barclays. Please go ahead when you are ready.
Benjamin Budish
Hi guys, thanks so much for taking question. I just wanted to check on the $45 billion you mentioned from the flagship fund rating cycle. I think last quarter you talked about $30 billion coming from just four funds. Does the $45 billion include like an upsized expectation for the four or is that just you’re now sort of including a broader expectation from more strategies?
Michael Arougheti
Yes, I think given the attractiveness of the deployment environment and the demand that we’re seeing from our investors for some of our core credit fund, that’s a reflection that we’ve actually pulled one of our flagships up in the fundraising queue to raise it earlier than we had originally anticipated.
Benjamin Budish
Okay, great, that’s very helpful. And, then I kind of wanted to follow-up on the retail side. Can you maybe talk about — it sounds like a flows are kind of continue really nicely. What’s the sort of competitive environment like — I’m kind of thinking specifically like the wirehouses where you’re already distributed; how often are advisors deciding between Ares fund versus competitor, how much exclusivity is there? Just how should we kind of think about that?
Michael Arougheti
Yes, I think the good news is, the market is still fairly fragmented, but in my opinion beginning to consolidate, and it’s consolidating with managers like Ares who have a couple of things going for them; one, a broad and diverse set of products that’s attractive to the financial advisor and retail community; two, strong performance in those products; three, a commitment to distribution in education in that channel as evidenced by the 130 plus people that we have in and around our Wealth Management Solutions business; and four is a deep and long-standing relationship with the street and the wire platforms having raised and manage things like ARCC and ACRE and all work institutional funds that already sit in the hands of a lot of high-net worth clients.
So there are others that have those competitive strengths but they are few and far between. And if you look at the published results of whose taking share, I think we are slowly creeping up the lead tables at the top in terms of those that are seeing incremental flows.
I can’t tell you exactly to be honest how an adviser in the field is choosing to put their client into these products, whether they’re choosing an Ares real estate product alongside another competitive product, or they’re choosing one. But if you look at the flows, they are broad-based, they are deepening.
We’re actually seeing the number of advisers that we’re doing business with increasing. And we’re actually seeing the average ticket increase. So the numbers would tell you that, even if the advisers choosing between competitive product, that we are actually doing business with more advisers to a larger dollar amount per adviser.
Benjamin Budish
Okay, great. Thanks so much for taking my questions.
Michael Arougheti
Thank you.
Operator
We now have Brian McKenna with JMP Securities. Your line is now open.
Brian McKenna
Great, thanks. So the closing of your second special opportunities fund is very timely. So $7 billion of dry powder — $7 billion of dry powder, what specific areas of the market are most interesting right now to invest into for this fund? And then returns for the first vintage are quite impressive with the 26% net IRR. So what’s the expectation for returns in the second fund?
Michael Arougheti
Hi Brian, we’re fortunate that Scott Graves who runs that product is here with us, so I’ll let him answer that.
Scott Graves
Good morning. The market for the ASOF strategy is obviously very attractive. It’s a strategy which will pivot on a relative value basis between what we’re seeing in private market debt and equity hybrid securities against the backdrop of secondary market solutions at a discount.
That relative value bounces back and forth, and it’s done in multiple times this year. In the first quarter, private markets were clearly our focus, now is where we refined it at around the value. We obviously saw a significant trade-off in secondary fixed income, accelerated into that market in the second-quarter, saw the rally coming off of the second quarter earnings, pivoted back to privates, now we’re pivoting back to publics.
So it tends to move back and forth. But this strategy is really ideal for what we refer to as vintage diversification. So when you see other more traditional illiquid alternative asset strategies decelerate in deployment due to a lack of transaction volume, this is a strategy which can accelerate into that market and create that vintage diversification.
Brian McKenna
Great, thank you.
Operator
Thank you. We now have Gerald O’Hara of Jefferies. Your line is now open.
Gerald O’Hara
Great. Thanks and good morning folks. Appreciate the color on the future pipeline, whole host of funds coming to market. Perhaps, you can give us a little bit of incremental color on how we should think about the FRE margin from there. Is it going to be a function of those raised and deployed and invested? Is there any sort of possibility of kind of a step-function there as one or multiple funds kind of go-live in their investment cycle? Or anything that you could perhaps give us some increment incremental context, that would be helpful.
Michael Arougheti
Sure, I’ll remind you, and we really looked into this year, like I said, at the beginning of the year, that this was a year we’d be making investments in our people and our technology so that we could prepare for what we knew was coming pretty large fund raise cycle. So ultimately that fundraise cycle will take anywhere from a year in that range, and we’ll still be hiring behind that. And then as we deploy that, the majority of those funds are earning management fees upon deployment.
So that will, as you’ve noted, allow us to accelerate our margins. So if you look at and what we’ve laid out as our margin target of 45% plus. That’s why we reaffirmed that in the script, and if we feel comfortable there, as this is an accelerant to that; the ability to deploy these funds will certainly be very margin-accretive.
Jarrod Phillips
Jarrod here. Just to clarify that, if you look at which funds we referenced were in that pipeline, the bulk of those are our largest credit funds which pay on deployment. But one that is not is our seventh corporate private equity fund which pays on committed. So to the extent that that is successful in 2023 in raising, you will see a step-function margin improvement in that particular part of the business.
Gerald O’Hara
Okay, that’s helpful. Thank you. And then just as a follow up, I just kind of reading headlines this morning, you kind of see the term golden age for private credit. And clearly, you all are at the forefront, but as I sort of think about to put myself in the shoes of perhaps and the dominant or pension plan allocator who’s looking at public credits that are perceived at least with potentially less risk and now higher yield, how are the competitive dynamics kind of shaking out with your private credit opportunities versus other opportunities or fixed income products in the market?
Michael Arougheti
Yes, there’s a lot to unpack there. So I’m going to try to be succinct, and if you want to drill down on any particular standing. First, you have to differentiate between performance of fixed rate, fixed income within traditional investor portfolios in the form of sovereign debt, investment grade debt, and high-yield debt. And obviously, when rates are going up, you have the dual impact of value declines in the existing book and increasing pressures at the company-level.
So I think there’s a, lot of folks that are just dealing with the rapid decline in values that has come with the rapid rise in rates. That actually makes private credit and other floating rate fixed income product all the more valuable and important to start to recoup some of those losses at this point in the rate cycle.
So I think, first, I just want to make sure that we’re differentiating that. The positioning between private credit and traditional fixed income is often balancing act. I think right now they’re having two totally different experiences on either side of the house in terms of the rate move.
In terms of private credit and its competitive positioning, and I think Scott hinted at this. Right now if you look at the traditional markets and their ability to provide liquidity to private companies, I don’t know if we have a golden age of private credit going on, but we have a golden age in some respects of private markets in the sense that we have more companies in the private markets than we ever had before.
They’re staying private longer. Public markets are getting more and more concentrated. I think people are reevaluating the value of liquidity in the public markets. So there’s more capital that is finding its way into those private markets and that maybe, I didn’t see the headline what people are referring to.
So again, that structural shift in the markets in the economy, right now the public markets for all intents and purposes are not opened as a provider of capital to growing private companies. The leveraged loan market is largely unavailable. The high yield market is largely unavailable.
So from a competitive positioning standpoint, having the amount of dry powder that we have across the platform I think we feel great about the competitive positioning. We’re in a position now to be one, if not the only type of liquidity providers that are active in a market like this.
Gerald O’Hara
Okay, that’s perfect. Thanks for the color.
Operator
Thank you. We now have Finian O’Shea of Wells Fargo Securities.
Finian O’Shea
Hi, good afternoon or good morning. Sorry, another one on deployment. We’re seeing headlines of a move back toward all-cash buyouts. Is this something you’re seeing more widely in middle-market private equity? And understanding that a lot of these companies will eventually borrow or lever up, is there an impact from that that is more or less favorable to direct lending?
Michael Arougheti
Yes, I don’t know if I would say that based on what we’re seeing, and Mitch and Kipp are here with me as well, that we’re seeing all-cash buyouts in the pipeline. I think what you may be referring to is, if you just think about what’s going on in the private equity universe. Valuation multiples are obviously compressing, given the change in discount rate and against the rise in interest rates.
There’s a lot of price discovery happening in the market, in the primary market in terms of where transactions will clear. And I think the leverage providers like us have been pretty disciplined around where we’re willing to attach from a leverage standpoint and at what price and what terms.
So to the extent that there is a disconnect between the leverage finance markets and where a private equity buyer would like to clear a transaction, I think they will use incremental cash to bridge it. So maybe the way to think about is not all-cash but higher cash contribution in order to clear quality transaction in today’s market, but I don’t think that we’re seeing a move to all cash. But to your point, is it good for private credit, I think the answer again in a market like this where liquidity sources are scarce, limited, and we’re one of the few that have scale and flexibility, I think it’s going to be a pretty good vintage course.
Finian O’Shea
Thanks, that’s helpful. Just a small follow. I think you mentioned the base rate impact would be another approximately 8% improvement for the fourth-quarter for performance. Is that the extent of it in the context of the today’s LIBOR curve, or is there still a visible uptick into next year?
Michael Arougheti
Yes, so just to clarify that, 8% was just reciting what Kipp and Mitch and others have talked about on the ARCC call, which was all else being equal if we just enjoyed the in-place rise in rates, income would have gone up 8%. So the answer is, there is absolutely more to go to the extent that we have continued rate increases which we all expect.
And the reason that we talked about the 8% is the way that these flowed through the portfolio companies and then ultimately into our portfolios is it backward-looking averages, and so it takes a couple of months to get the full effect of any rate increase. So if we maintain the current trajectory rate increases, you’ll continue to see that phenomenon.
And I think as Jarrod mentioned, most of the incentive fees that we earn off of our floating rate credit funds are against fixed rate hurdles. And so not only are we delivering higher ROE in distributions at the portfolio level to our investors, but it has a meaningful impact on the incentive fee-generating opportunity that we have in our credit book.
Finian O’Shea
Thank you.
Operator
Thank you. We now have Adam Beatty with UBS. Your line is now open.
Adam Beatty
Thank you and good morning. Couple of follow-ups on Aspida. I appreciate the comments earlier around organic growth and the kind of sizing that out. Just wanted to get your thoughts on how you’re thinking about potential inorganic opportunities there, number-one, from what you’re seeing in the marketplace and also, number two, from a perspective of balance sheet capacity? Thank you.
Michael Arougheti
Sure. So the way that we set up Aspida intentionally was to have side-by-side pillars of our organic annuities and life business next to our Aspida reinsurance business which gives us the opportunity to look at organic annuities distribution, flow reinsurance, and then inorganic opportunities all side-by-side. And what we are trying to do there is make sure that we understand the ROEs that we can generate in each of those opportunities as we use our capital.
I think the good news is given the market right now that we’re in, we are generating higher ROEs. I think that we originally underwrote just given where we’re able to price liabilities against the assets that we’re generating. So our view right now is all three of those are attractive and scaling.
And the inorganic opportunities we’ve talked about are pretty significant and growing. We continue to see traditional insurance companies simplify their business models and look for either reinsurance partners or look to sales of portions of their business to folks like Aspida, so I think the inorganic opportunities as good as we’ve seen.
In terms of balance sheet capacity, I would maybe just remind you, our view as a balance sheet light asset managers that we have been growing that platform largely with third party capital. And so while we made a significant upfront investment to get all the capabilities and talent around that business, the scaling from that formation moment has been largely done with third-party capital, and I would expect that to continue.
Adam Beatty
That’s great, thank you Mike. Just one follow-up on that around the changing rate regime. Do you expect that to change the opportunities for inorganic growth one-way or the other? Thanks.
Michael Arougheti
Yes, I do. I think there are a number of catalysts that will bring assets into the market. The changing rate regime is one of them. So like I said. I would expect that the pipeline of inorganic will largely pickup over time, rates being one of the drivers.
Adam Beatty
Okay, super. That’s all from me today. Thank you.
Michael Arougheti
Great. Thank you.
Operator
[Operator Instructions] We have the next question on the line from Rufus Hone of BMO Capital Markets. May proceed with your question.
Rufus Hone
Great. Good morning. Thanks very much. I wanted to come back to some of the comments you made around private credit. And I was wondering whether you’re seeing any differentiation between the U.S. and European direct lending businesses in terms of the fundamental performance of the company’s you lend to. And the credit metrics you’re seeing across the different geographies seen from the ARCC call that the U.S. business hasn’t seen much change in recent months, and I’m just wondering if you feel the same about Europe? And more generally, when do you expect some credit deterioration to start to come through? Thank you.
Michael Arougheti
Sure. So the simple answer is, as we sit here today we are not seeing material, credit weakness in any of our credit portfolio. So you talked about ARCC. On our most recent earnings call, we highlighted that nonaccruals were low at 1.6% of the portfolio at cost, meaningfully lower at fair value. And if you look at that Company, it has almost 20-year history, the 10-year average was about 2.5%.
If you look at our European direct lending investments, actually stronger fundamental performance in terms of interest coverage, leverage and some underlying metrics just based on how those portfolios were positioned going into the current environment. So again, very low nonaccruals and strong performance.
And we see that in the liquid markets as well, right? If you look at coverage levels in the high-grade market, I think we’re pushing 10 to 11 times interest coverage in high grade. We’re at five to six times interest coverage in the high-yield market, well in excess of two times coverage in the loan market. So there’s a lot to be concerned about on the forward trajectory for the global economy.
But these portfolios are going into this uncertain period with a lot of fundamental strength and just given the interest rate environment that we were in, while the rate of change is significant, the absolute level of interest rates, at least until this point, has not shown up in any kind of portfolio distress. When will we see it you asked, I wish I had a perfect crystal ball to tell you. I do think that the European economies will have a different experience just given the structure of the economy, and how they’re experiencing inflation versus how we are.
But I’m not as anxious maybe as some of the public markets are indicating we should be just given the strength of the underwriting. And as I said in our prepared remarks, the bulk of these assets are controlled at the top half of the capital structure with a significant amount of structural protection around them and a lot of equity subordination from institutional equity providers that is there to help these companies get through uncertain times.
So I think we are appreciative that we all should expect that it’s going to become more challenging before it becomes less challenging. But going in with a lot of strength, and we’re not seeing a lot of differentiation right now between the U.S. and Europe.
Rufus Hone
Thank you.
Operator
Thank you. We now have Michael Cyprys of Morgan Stanley. Your line is now open.
Michael Cyprys
Great, hi good morning, and thanks for squeezing me in. Just wanted to circle back on the portfolio marks that you guys took in the quarter, I was hoping you might be able to elaborate a bit on what some of the drivers were of the positive marks that you had in real estate and PE in a period where markets were broadly down, and we had seen some others take some markdowns on their books that looked pretty strong for you guys?
And then in credit, it seemed a bit more mix. Some of your credit strategies were marked up, but then when I look at the AUM role for credit that was negative there. So I was hoping you could maybe unpack what was positive versus what was negative and markdown in credit?
Michael Arougheti
Yes, I think we said it in the prepared remarks, I don’t think that there’s that much more to drill down on the – if you look at private equity in the ACOF funds, what that’s a reflection of is the sectors that we are invested in, including energy, our higher growth, higher return on invested capital type businesses. And so, the pace of EBITDA growth across those portfolios, which was in the mid to high single-digits, outpaced the deterioration in valuation multiple.
Same thing for our real estate business, as we talked about, given our rigorous focus on industrial and multifamily, we continue to see very significant increases in rents and lease rates, continue to see very healthy occupancy rates. So the fundamental performance continues to outpace any deterioration in value that’s being caused by a shift in rates. In terms of credit, again, most of the credit portfolio, as you saw this with ARCC.
Are modestly down on book value, largely as a reflection of the rate environment, but again, are growing through that. And don’t forget the value of current income in this rate environment. So the way to think about the attractiveness of the private credit markets is, if you see a 300-basis-point increase in base rates, 150 to 200 basis point increase in spreads, you’re accumulating a significant amount of excess return relative to where you were six to nine months ago.
And so even if you are absorbing a decline in your NAV of 1% to 2%, the all-in return in those portfolios continues to be meaningfully positive, which is why I think it’s so attractive to investors and is proving to be quite durable. So we’re not really seeing significant underperformance on the credit side of the house.
Michael Cyprys
Great, and just a follow-up. I know you guys have flagged the significant floating rate exposure that you guys have on the credit book. But just any help on how you think about the credit impact to those issuers of having to pay a lot more in terms of interest income? How are they protecting themselves?
How much of that is hedged out on that side? How you view that as a potential credit negative event for the issuer? And what happens with those hedges rolling off over time? How do you think about that and protect those issuers?
Michael Arougheti
Sure, so a couple of comments here. One, we obviously are very actively engaged with these portfolio companies. One of the benefits of being in the private credit markets the way that we are as the lead agent lead investor, we’re highly engaged, so yes, there is a fair amount of hedging that is going on in the underlying portfolios. Those will eventually roll off and/or become less effective than they were maybe six to nine months ago.
But there are effective hedges in place that is muting the impact from a coverage standpoint at the portfolio company level. I just want to take a step back because usually when we’re talking about future risk of recession and default rates, we’re talking about it coming off of, to my earlier comment, much weaker fundamental performance and not really attributing it to a rise in rates. So one way to think about this is all of the value of the rate increases that is theoretically challenging the companies is coming to us.
And now everybody is waiting to see if earnings decline. But as of now, all of that “value transfer” has come to us as a private credit owner, whereas in past cycles, you would have the opposite, that the bulk of the decline in credit coverage would be coming from earnings degradation that would be harmful to us as well as harmful to the equity.
So now we get to go into this cycle to the extent that the company gets somewhat challenged from the combination of continued rate increases and earnings declines where we have the flexibility to work with our equity partners in those portfolios to resolve the liquidity needs of the company. And obviously, we’ve been doing this for a long time. That could take the form of increased interest, but increased noncash interest.
It could take the form of structural accommodations. It could take the form of allowing cash to come into the business in the form of equity or subordinated debt below us. So there are a lot of tools that you will use as you’re transitioning. But I think it’s important that people appreciate, through the lens of the private credit, most of that value and yours to the benefit of the private credit portion of the capital stack sitting at the top half of the balance sheet.
And is not that it’s a good thing, per se, for the company, but it is a transfer of value from the company to the credit or from the equity to the credit. And that’s generally how this has played out in past cycles as well. But we’re still a long way from that. Like I said, there’s a pretty significant amount of broad-based health across the portfolios. And while the rate increases have been significant, this market has thrived and flourished in a 5% base rate requirement before. So I think people need to have some historical perspective as well.
Michael Cyprys
And what portion would you say is hedged or protected at the portfolio company level?
Michael Arougheti
I think in the U.S. book, it’s about 30%. And in the European book, it’s significantly higher than that.
Michael Cyprys
Great, thank you.
Michael Arougheti
Sure.
Operator
Thank you. I would now like to hand the call back to Michael Arougheti for some closing comments.
Michael Arougheti
I don’t think that we have any other event to say thank you for your continued support and your time today, and we hope that you have a wonderful end of the year and look forward to catching up around our fourth quarter earnings in the New Year.
Operator
Thank you for joining. That does conclude today’s call. If you missed any part of today’s call, an archived replay will be available through November 28, 2022, to domestic callers by dialing +1 866-813-9403, and to international coolers by dialing +44 204-525-0658. For all replays, please reference the access code 492022. An archived replay will be available through November on the webcast link located on the homepage of the Investor Resources section of our website.
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