Q2 2023 Ares Management Corp Earnings Call

Participants

Carl G. Drake; Partner, Head of Public Markets IR & Corporate Communications; Ares Management Corporation

Jarrod Morgan Phillips; Partner & CFO; Ares Management Corporation

Michael J. Arougheti; Co-Founder, CEO, President & Director; Ares Management Corporation

Adam Quincy Beatty; Equity Research Analyst of Financials for Brokers and Asset Managers; UBS Investment Bank, Research Division

Alexander Blostein; Lead Capital Markets Analyst; Goldman Sachs Group, Inc., Research Division

Benjamin Elliot Budish; Research Analyst; Barclays Bank PLC, Research Division

Brian J. Mckenna; VP & Equity Research Analyst; JMP Securities LLC, Research Division

Craig William Siegenthaler; MD and Head of the North American Asset Managers, Brokers & Exchanges Team; BofA Securities, Research Division

Finian Patrick O'Shea; VP and Senior Equity Analyst; Wells Fargo Securities, LLC, Research Division

Kenneth Brooks Worthington; MD; JPMorgan Chase & Co, Research Division

Michael J. Cyprys; Executive Director and Senior Research Analyst; Morgan Stanley, Research Division

Patrick Davitt

Rufus Hone; VP & Associate; BMO Capital Markets Equity Research

Presentation

Operator

Welcome to Ares Management Corporation's Second Quarter Earnings Conference Call.
(Operator Instructions)
As a reminder, this conference call is being recorded on Tuesday, August 1, 2023.
I will now turn the call over to Carl Drake, Head of Public Markets and Investor Relations for Ares Management.

Carl G. Drake

Good afternoon, and thank you for joining us today for our Second Quarter Conference Call.
I'm joined today by Michael Arougheti, our Chief Executive Officer; and Jarrod Phillips, our Chief Financial Officer. We will also have a number of executives with us today who will be available during the Q&A 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. And nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase and interest in any Ares Fund.
During this call, we will refer to certain non-GAAP financial measures, which should not be considered in isolation from or as a substitute for measures prepared in accordance with Generally Accepted Accounting Principles. 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.
Note that we plan to file our Form 10-Q later this month. This morning, we announced that we declared our third quarter common dividend of $0.77 per share on the company's Class A and non-voting common stock. Representing an increase of 26% over our dividend for the same quarter a year ago. The dividend will be paid on September 29 to holders of record on September 15.
Now I'll turn the call over to Michael Arougheti, who will start with some quarterly business and strategic highlights.

Michael J. Arougheti

Thanks, Carl, and good afternoon. I hope everybody is doing well. During the second quarter, the equity and credit markets generated strong investment returns as the U.S. economy remained resilient despite a rapid increase in interest rates over the past 12 months. While transaction activity remains slower than last year, it is recovering modestly as market participants gain more confidence in transacting with improved visibility to the end of the Fed hiking cycle.
Although activity is slower than we'd like, it's still a good environment for us, as we believe it favors private capital managers with broad and deep sourcing capabilities, scaled and flexible capital, significant relationships and well-known brands. In fact, our deployment picked up notably versus the first quarter, and our pipelines are generally higher compared to 3 months ago.
As I'll discuss a little later in more detail, portfolio fundamentals are positive and stable. Credit quality across our debt portfolios continues to be above historical averages and we're seeing continued solid cash flow growth across our corporate credit, private equity and real estate portfolios. During the second quarter, our business continued to deliver strong and consistent growth with management fees, fee-related earnings and after-tax realized income, all -- around 20% or better on a year-over-year basis.
Our strong fundraising momentum continued with over $17 billion raised in the second quarter, and we continue to see very strong follow-on demand from our existing clients. Our private credit strategies continued to drive our growth as investors consolidate capital with scaled credit managers and recognize the attractiveness of the market opportunity, our competitive advantages and our long-standing successful track record.
In Q2, we raised an additional $3.9 billion for our sixth European Direct Lending fund, bringing the total initial closing to $8.6 billion. We expect several large subsequent closings over the next several months with the final closing likely held in early 2024. We continue to expect that the size of this fund will exceed that of the prior vintage.
In Q2, we also raised an additional $1.8 billion for our second alternative credit fund, bringing the total initial closing to $3.5 billion at quarter end. We're currently at $4.4 billion and in the next few weeks, we expect commitments will exceed the fund's initial $5 billion target. We expect the final close within the next 3 months to be oversubscribed at our hard cap of $6.5 billion.
Other notable fundraising highlights in the second quarter included a partial first close through our second climate infrastructure equity fund of nearly $500 million and additional real estate fund closings of $1.5 billion, including nearly $500 million in our real estate debt funds and $600 million in U.S. opportunistic real estate equity strategies, including co-investments.
We continue to see strong institutional demand for real estate debt due to the general risk-off sentiment in the banking sector and the outsized return opportunities to inject capital at conservative levels with reset valuations. In addition to the subsequent closings in Alternative Credit and European Direct Lending, we had some additional significant fundraising here in the third quarter as well.
Last Friday, we held the first close of our third U.S. Senior Direct Lending fund, in the aggregate, we received $5.1 billion of commitments from investors and including anticipated fund-level leverage which would close gradually in the coming quarters as needed, this translates to a total expected investable capital base of more than $8.5 billion.
Based on our current subscriptions and the existing investor pipeline, we anticipate the total fund size will be well in excess of the previous vintage, which raised $8 billion in equity commitments and approximately $14 billion in total investable capital.
So all told, as of the date of this call, we've raised approximately $7.3 billion of capital, thus far, in the third quarter on top of the more than $31 billion raised in the first half of the year.
Let me now provide an update on our efforts in the strategically important wealth management and insurance channels. We raised over $300 million across the 2 non-traded REITs in Q2, and we continue to be net positive on inflows for the quarter, including capital raised through our 1031 Exchange solutions.
We recently added a third wirehouse for our diversified REIT as well as a global private bank for both REITs. Our recently launched nontraded BDC, ASIF was added to a wirehouse late in Q2. And early this month, we expect initial inflows of approximately $175 million from the wealth management channel, alongside expected additional capital from several new institutional investors into that product.
We have ambitious global product expansion plans, and we've made the investments in personnel and infrastructure to launch certain credit products into the European and APAC wealth management markets later this year and into next year. We also formally launched AccessAres, a comprehensive online platform that offers product agnostic and educational content and thought leadership for the wealth channel.
Within our affiliated insurance segment through Aspida, we saw $2 billion of new annuity premium inflows from both our retail and reinsurance platforms in the second quarter. In the first half of 2023, Aspida has issued $3.6 billion in annuity premiums and has grown to approximately $9.5 billion in AUM. We continue to see significant demand for annuities, allowing us to generate attractive spread opportunities. Management fees have nearly tripled over the past year, and the business continues to gain notable operational efficiencies as it scales.
For 2023, we remain on track to be notably above our $57 billion fundraising total from last year. We have about 30 different funds in the market. And in addition to the progress and updates I outlined earlier, in the second half of the year, we expect closings in our inaugural credit secondaries fund. Our third infrastructure secondaries fund, our seventh corporate opportunities fund, along with additions from smaller funds, perpetual capital vehicles, managed accounts and CLOs.
Looking forward, over the next several quarters and depending on the pace of deployment, we would expect to launch a number of our largest closed-end commingled fund series, including our third U.S. junior debt fund, our third special opportunities fund and our fourth European value-add real estate equity fund.
With respect to our investing activities, we deployed more than $15 billion in the second quarter, a 17% increase versus a seasonally slow first quarter, led by our leading private credit strategies, particularly in U.S. direct lending and alternative credit. Private credit is clearly taking a larger share of the market, and we believe that we're participating in that trend when we look at our deployment versus the market. We continue to see strong demand for our private credit solutions as our brand and reputation provide advantages in winning new transaction mandates.
In an environment where new M&A volumes are light, our incumbency across thousands of borrowers is a significant benefit in driving origination activity. Deployment for our alternative credit group has been particularly strong and we anticipate deployment in this strategy to remain at elevated levels in the near future. With its focus on asset-backed investments and significant capital available for deployment, alternative credit is well positioned to partner with regional banks and to provide attractive solutions for both investors and the regional banks. For example, in June, our alternative credit funds acquired PacWest lender finance portfolio, which totaled $3.5 billion of commitments and $2.1 billion in funded investments.
Our alternative credit group continues to benefit from its large scale, deep team and strong track record. With approximately $28 billion in AUM and nearly 65 investment professionals in our alternative credit group, we believe that we are the largest player in the private credit segment of asset-backed finance, and this scale advantage enables us to transact with size and flexibility that is not easy to replicate.
In European Direct Lending, quarterly deployment was a little softer as certain large transactions slipped and closed early in the third quarter. This bodes well for the third quarter and the pipeline has picked up considerably. Due to weaker competition from banks and certain private credit managers, we're seeing significant relative value opportunities in high-quality companies with attractive pricing terms and structures.
In real estate, while we remain very selective and volumes remain slow, we're finding interesting opportunities, particularly in real estate debt and across the platform in sectors where we have differentiated sourcing and operating capabilities.
Turning to portfolio quality. Across our more than 1,700 portfolio companies firm-wide, we continue to see strong fundamentals. Credit quality remains remarkably resilient despite the historic increase in market interest rates and certain inflationary pressures. In Ares Capital Corporation, which is a good barometer for the overall U.S. direct lending business, non-accruals declined slightly in the second quarter, and they remain well below 15-year historical averages, and the pace of amendments in the portfolio remain at stable levels.
Across the U.S. direct lending portfolio, EBITDA growth remains in the high single digits over the most recent reporting period and were invested at a weighted average loan-to-value of 42%. Our loan-to-value has meaningfully improved from where we and the markets were 10 to 15 years ago as private equity sponsors have been contributing significantly greater amounts of equity capital to fund transactions, which reduces our risk.
In Europe, our portfolio performance is similar with 10% EBITDA growth across our direct lending portfolio and limited non-accruals, while we continue to benefit from higher floating rates. Our global real estate portfolio also continues to perform well, supported by our significant weighting in the market's best performing sectors of industrial and multifamily which collectively account for 75% of our global real estate portfolio's gross assets with another 13% invested in our favorite alternative sectors, including self-storage, triple net lease and single-family rental.
While higher cap rates have negatively impacted valuations and we're seeing some decelerating rent growth, aggregate fundamentals remain positive in the portfolio with growing cash flows, limited vacancies and continued demand for our properties.
In our 2 largest segments, we're seeing comparable rent growth of 8.5% year-over-year in multifamily and same-store rent growth in industrial remained above 70% over the last 12 months. Our private equity portfolio generated strong returns in the quarter, primarily related to continued EBITDA growth and partially due to the successful IPO of Savers Value Village, which is a meaningful position in certain ACOF and ASOF funds.
Across the portfolio, EBITDA grew 11% year-over-year, while valuation multiples generally remained flat quarter-over-quarter. So overall, we continue to see strong fundamental performance across our portfolio, strong fundraising demand, particularly in private credit and interesting deployment opportunities across our investment groups.
And before I hand the call over to Jarrod, I'd like to touch on our recently announced financially and strategically accretive acquisition of Crescent Point Capital. Crescent Point is a leading Asia-focused private equity firm with $3.8 billion in assets under management and a team and platform that we've been courting for several years. With Crescent Point, we believe that we have an excellent team with deep market insights, a strong track record and most importantly, a great cultural fit into our platform.
This transaction, which is expected to close in the fourth quarter adds to our significant presence in the Asia Pacific region, including 50 additional investment professionals, and we now have direct sourcing capabilities across credit, private equity and real assets through our Ares Asia platform.
We view the Asia Pacific region as a significant future growth area for us, and this acquisition helps expand the breadth of our products in the region.
And now I'd like to turn the call over to Jarrod for comments on our financial results. Jarrod?

Jarrod Morgan Phillips

Thanks, Mike. Hello, everyone. Thanks for joining us today. This quarter, we continued to experience strong growth in our financial metrics, including management fees, fee-related earnings, realized income, AUM and FPAUM compared to the second quarter of 2022.
Our FRE-rich business model continues to deliver consistent 20%-plus growth despite the significant market volatility we've experienced over the past year. Net realized performance income also increased 50% year-over-year, driven by a pickup in realizations from our European waterfall funds, leading to a 26% increase in realized income year-over-year.
Our fundraising strength was highlighted again in the second quarter as investors continue to entrust us with more capital, due to our ability to consistently invest in attractive assets and deliver strong performance throughout market cycles.
We ended the second quarter with $378 billion of AUM, and we're on track to meet or exceed our target of $500 billion and more by 2025. With $96 billion of available capital and several large fundraisers ahead of us, we have a great line of sight on our FRE growth and operating margin efficiencies for the next few years.
From a revenue perspective, our management fees totaled over $621 million in the quarter, an increase of 18% compared to the same period last year, primarily driven by deployment of our available capital in our credit group. Other fee income of approximately $30 million was up 35% from the second quarter of 2022, driven by structuring fees and infrastructure debt, additional structuring fees and direct lending as well as capital market advisory fees at our broker-dealer, which was recently licensed to participate more broadly in capital market transactions that may provide an additional revenue source for us prospectively.
FRE totaled $266 million, an increase of 21% from the second quarter of 2022, driven by higher management fees from deployment over the last 12 months as well as a slower pace of hiring in the first half of 2023. In a market environment that continues to be characterized by volatility and lower transaction volume, our ability to demonstrate consistent strong growth in management fees and FRE is a significant differentiator for Ares.
We remain confident in our ability to maintain 20% or better FRE growth, annually, through 2025. Excluding the FRPR from the non-traded REITs as we discussed on our call in February. Our FRE margin in the second quarter was 40.8%, roughly a 70 basis point improvement from the 40.1% in the second quarter of last year and a slight improvement from the first quarter of 2023.
We expect to see margin expansion occurring in the back half of 2023 and continuing into 2024 and 2025. Deployment speed will ultimately dictate the pace of margin expansion, but we remain confident that our stable, growing management fee model will enable us to reach the 45% plus run rate FRE margin target by the end of 2025 that we guided to 2 years ago.
As it relates to FRPR this year, we continue to expect approximately 95% of our FRPR to be realized in the fourth quarter of the year. Currently, the potential FRPR from our credit funds is tracking well ahead of last years. We're experiencing the benefits of a higher interest rate environment, while seeing some modest tightening in the spreads.
This forecast is still subject to the total return performance of the strategies for the full year, including changes in market values. Regarding the FRPR from our real estate group, as of June 30 the 2 non-traded REITs had not accrued any incentive fees on their balance sheets. Our realization activity picked up in the second quarter after a slow start to the year. Our more stable and predictable net realized performance income from European waterfall style funds totaled $30 million in the second quarter, modestly above the expectations we outlined on last quarter's call.
In addition, we had realizations in our private equity group and American style funds, totaling $9 million of net realized performance income and another $3 million net from crystallized incentive fees from alternative credit funds. In total, we recognized $42 million in realized net performance income, a 59% increase from the second quarter of 2022.
As we discussed on our first quarter call, we do expect some lumpiness in our European waterfall realizations throughout this year and next year before we begin generating more consistent performance revenue. For the remainder of this year, we expect over 90% of our remaining European waterfall realizations to be recognized in the fourth quarter.
For 2024, we remain confident in our expectation of $175 million in European waterfall realizations with potential upside. Even with the higher realizations, our net accrued performance receivables grew to $960 million, up 8.8% versus the first quarter and up more than 15% year-to-date.
Notably, approximately $55 million of this increase comes from our credit funds. Where we're seeing the benefits of higher interest rates compounding above our fixed hurdle rates, along with the credit -- solid credit fundamentals as Mike described earlier. Unlike equity-style funds, where increases in performance fees are based on capital appreciation, driven by market multiples and EBITDA growth. Credit funds generate consistent, predictable growth and accrued performance fee income when the underlying assets generate yields above fixed hurdle rates, assuming stable credit fundamentals. This difference is one of the reasons we believe our European waterfall style funds are more predictable and a clear differentiator for Ares.
Of the $960 million of net accrued performance receivables, $670 million or nearly 70% were in European style waterfall funds, of which $371 million is from funds that are past their reinvestment periods. We now have $115 billion or over 50% of our incentive eligible AUM and European-style waterfall funds. We expect this balance will continue to grow as we raise additional capital in several of our largest funds, including our sixth European direct lending fund, our third senior direct lending fund, our second alternative credit fund and others.
Realized income in the second quarter totaled $312 million, up 26% from the year ago period. After-tax realized income per share of Class A common stock was $0.90, 22% higher than the level of the second quarter of 2022.
As Carl mentioned, we declared a dividend in the third quarter of $0.77 per share of Class A and non-voting common stock, up 26% year-over-year, and we remain on track with our objective of providing 20% annual growth in our dividends for the next 2 years. As of June 30, our AUM totaled $378 billion, and our fee-paying AUM totaled $242 billion.
We continue to grow our AUM not yet paying fees available for future deployment as our fundraising outpaced our deployment. This amount now stands at $55.6 billion at quarter end and has increased 33% from the beginning of the year. This represents over $550 million in potential incremental future management fees.
Regarding fund performance, we generated attractive performance across each of our credit strategies, which generated quarterly gross returns, ranging from 2% to over 10%, and our primary credit strategy composites, in private equity, both of our core investment strategies generated strong relative returns for both the second quarter and last 12 months.
Our special opportunities composite generated gross returns of 8.1% in the second quarter and 20.6% over the last 12 months. Our corporate private equity composite generated gross returns of 5.5% in the quarter and 8.3% for the last 12 months. Within real estate, our U.S. real estate equity composite gross return was up 4.1% in the second quarter and essentially flat for the trailing 12 months as cash flow growth is largely offset by increases in cap rates.
With that, I'll turn it back to Mike for closing remarks.

Michael J. Arougheti

Great. Thanks, Jarrod. We believe the fundamentals of the business are very sound even in the face of economic and market uncertainty. The credit quality and fundamentals across our portfolios are showing resiliency and strength, and our asset-light balance sheet and FRE-based financial model have helped to insulate earnings from the significant market volatility experienced over the past year. While market transaction volumes remain slower than typical, market repayments were also slower and it's been considerably easier to protect our best assets. We believe that we're advantaged due to our large and diverse direct sourcing capabilities that can gain share in these environments. And we believe that we're very well positioned to capitalize on the pent-up demand for transactions when the capital markets environment ultimately improves.
The demand for our funds continues to be robust as we gain wallet share and add promising new clients. And this is driving a large and sharply growing amount of available capital for deployment, which provides meaningful visibility for continued earnings growth, dividend growth and margin expansion in the coming years.
In short, we remain confident that our business is positioned to continue delivering strong results for both our fund investors and Ares shareholders, regardless of the economic picture. As always, I'm grateful for the hard work and dedication of our teams around the globe and I appreciate our investors' continuing support for our company.
Operator, I think with that, we can now open up the line for questions.

Question and Answer Session

Operator

(Operator Instructions).
Our first question comes from the line of Craig Siegenthaler with Bank of America.

Craig William Siegenthaler

First question is how has Ares' interaction with the U.S. bank industry chain post the March crisis. And this includes -- have you been forming partnerships. And if you can quantify that, that might be helpful. And then also, which of your businesses are you seeing the most deployment opportunities from the bank?

Michael J. Arougheti

Sure. Thanks for the question, Craig. It's still early days in terms of the formalization of any types of structured partnerships, but I would maybe just direct your attention back to the PacWest transaction that we talked about on the prepared remarks as kind of a nice roadmap for how I think Ares and others like us can be a good partner to the regional banks as they transition to the new world, that we're all living in.
I think we're still in the early stages of the transition in the banking market. My expectation is we'll continue to see more consolidation. With that consolidation, I think we'll see secondary asset purchase opportunities and reduced competition in the primary market. I also think the larger banks as they grapple with the new right cap framework, will look to us to partner with them where we can leverage some of their origination and balance sheet, married with our capabilities and access to equity.
I would say the number of conversations that we're having around these types of transactions has been increasing, and it's showing up, first and foremost, in our alternative credit business, which is where we executed on the PacWest transaction. So I would expect this to be a theme for the next year or 2, not month or 2, it's still early, but I think the pipeline is still...

Craig William Siegenthaler

That's helpful, Mike. My follow-up is just on the credit quality front. And I think we all know that the economic data has been quite resilient. But have you seen a pickup in restructuring and corporate lending, just following -- some declines in interest coverage and also if there has been some restructuring, how easy was it to get more cash from the sponsors to help delever the portfolio of company.

Michael J. Arougheti

So the simple answer is, I would say, we have not seen a meaningful pickup. Defaults and non-accruals are still well below 15-year historical averages. Kipp talked about on the ARCC call that we've actually seen a stabilization even in modifications and amendments and the bulk of the conversations are being driven by cost of capital as opposed to fundamental underperformance.
I'd highlight what we talked about in the prepared remarks that the credit portfolios are sitting in a loan-to-value in the low 40s, 42% in the U.S. There's a significant amount of equity subordination in the bulk of these capital structures in the hands of institutional equity owners of real assets and corporates that have a lot of dry powder.
So in terms of willingness to support performing companies that have capital structures [drop down], I'd say that we've been very happy and pleased with the support we're seeing from our clients, and I'd expect that to continue.

Operator

Our next question comes from the line of Alex Blostein with Goldman Sachs.

Alexander Blostein

So you mentioned that your deployment pipeline is tracking higher than it was, I believe you said 3 months ago. So can you unpack that a little bit maybe across which type of strategies and the pace of deployment that you expect over the next 12 months relative to the prior 12 months?
I heard you on the Alt Credit, which is obviously super interesting, given what's going on with the banks but maybe we can just broaden out the deployment opportunity a little bit more broadly.

Michael J. Arougheti

Yes. It's moving around a bit, Alex. So I can't give you -- I'm not going to give you any specifics business by business. I would say, generally, even in a slow M&A environment, we're finding good deployment across the credit landscape and the opportunistic landscape to bring capital into businesses that are in need of liquidity to either play offense or defense.
And as we're seeing broadly in the market, and it's true in our portfolio as well, a lot of our private equity clients are focusing inwardly on their existing portfolios. And we're seeing a fair amount of tuck-in acquisition activity and growth investment. So as a proxy, if you look at ARCC in the quarter, 70% of the deployment in the quarter, which is high relative to our historical levels was into the portfolio.
That compares with roughly 50%. So one of the benefits we have, given our incumbency and the number of portfolio positions we have around the globe, is that we can stay active in an environment like this even when M&A is down.
We are seeing the pipeline build deals logged quarter-over-quarter, 20% quarter-over-quarter growth. I think my own view is we're going to see a pickup in transaction activity towards the back half of the year. I think there's a fair amount of pent-up demand we're now getting to the end of the hiking cycle, and I think people are going to be more willing to transact.
It's always tough to answer that question in the middle of August because there's naturally a slowdown. So how people are feeling this week and next week is probably not the best proxy. But my sense is the shadow pipelines are developing. And to your point, I think alternative credit and opportunistic credit in all of its forms is probably where we're going to see the biggest growth going into the back half of the year.

Alexander Blostein

Great. Super helpful. My second question is around maybe zooming out and thinking through the wealth channel dynamics that you outlined in your prepared remarks. So maybe give us a little bit of a roadmap of how you see ASIF evolving from here. It sounds like you guys got on one large platform last quarter. Early days, I think you said about $175 million of net inflows that you guys saw in there. But maybe how are you thinking about ASIF getting on other platforms sort of time frames.
And the wins that you have seen so far in that particular channel, do you find that coming from advisers that are already familiar with the products that are investing maybe within other parts of the private credit spectrum? Or these are kind of FAs that are new to the product set?

Michael J. Arougheti

So we've been very pleased with the progress in ASIF specifically and the growth in the wealth channel more broadly. Obviously, on the heels of the Black Creek acquisition and transition to Ares Wealth Management, we've been making meaningful investments in product development and distribution. So we've added our private markets fund around our PE and secondaries business.
Obviously, we continue to grow the non-traded REITs. And ASIF is a real bright spot building off of our traded BDC track record. I'd remind you that we seeded that fund with a meaningful institutional commitment earlier in the year. And so the number of the $175 million coming out of wealth was just the initial inflow that we saw here in the back half of this quarter as we began to distribute.
So that's actually a pretty strong number and gives me cause for optimism. My expectation is that we will begin to add new partners around the globe in the fourth quarter of this year. And then my expectation is we'll probably add another U.S. wire in Q1 of 2024 to continue the distribution of that product.
In terms of the adviser behavior, it's hard to say. I mean we obviously have a strong brand through the BDC and the non-traded REITs and the mortgage REIT that -- I think the brand is pretty well developed. My sense is that those that are investing in ASIF are probably invested somewhere else with Ares as kind of the initial uptake. But I think given our brand and track record across the BDC and private credit market, I think we'll see deeper penetration as the product rolls out.

Operator

Our next question comes from the line of Benjamin Budish with Barclays.

Benjamin Elliot Budish

Maybe first on the acquisition, Crescent Point. Can you maybe talk about what this business does, besides kind of the high level steps you mentioned earlier, what it sort of adds to the picture, are there cross-selling opportunities? Are there more informational advantages? More distribution? How do you see it sort of fitting into the existing Asia business and maybe contributing to growth there?

Michael J. Arougheti

Sure. As we've articulated, on prior calls, our goal, overtime, is to have our Ares Asia business look a lot like our U.S. and European business, meaning representation from each of the asset classes across the entire geography. And as I mentioned in the prepared remarks, what this acquisition does by filling in the private equity sleeve now has us able to originate and invest in private credit, private equity real assets and secondaries, given the existing capabilities that we have.
Telling you what you probably know, those markets are still less mature, less evolved from a private standpoint. And so while we have expectations for meaningful growth, those markets need to continue to develop in order for us to see the type of scale in these markets that we have here. So I think that's more of a decade-type trend than a couple of quarters, but all of the pieces are in place.
What this business does for us is, it gives us a meaningful equity capability, particularly in geographies where we can create synergy with our debt platform, notably in China, Southeast Asia and India, which are very interesting markets, India probably top of the list right now.
What is interesting about that market, and it's not that it's dissimilar to what we're seeing in other parts of the world. But given the stage of development in those markets. I think the lines between debt and equity and debt and structured equity are fundamentally blurrier in that part of the world.
And so adding sourcing and investment capabilities deeper down the balance sheet to marry with our opportunistic credit, I think, will actually have a pretty meaningful sourcing synergy emerge. So pretty excited about it and hope to expect to see it close next quarter.

Benjamin Elliot Budish

Great. That's really helpful. Maybe just one more for Jarrod. You mentioned in the prepared remarks that there's potential upside to the realizations from the European waterfall opportunity. Is there any way to kind of give that any context or any way to size that? Is it sort of a matter of -- the rate curve has kind of gone up since we've last spoken and that leads to incremental upside from the floating rate debt? Or any other kind of color you can give to help us think about what that might look like.

Jarrod Morgan Phillips

Yes. Thanks for the question. I appreciate it. It's a lot of what you just outlined there that as the rate increases, we see those rates reset and against the fixed hurdle rate that allows accrue more over time. I kind of remind you the guidance that we gave for this year, we really expect to see -- we're still in that early stage of these European waterfalls. So we expect to see it more centered around the fourth quarter and then moving into 2024 is where we see that upside, and that upside is driven by those increased rates, maybe a little bit of an extended duration on these assets and then them paying off or then entering into their full European waterfall during 2024.
So that's a lot of what's driving the upside. And you can really see where that's manifesting itself in the accrued net performance fees on the balance sheet and you can see how that's gone up year-to-date.

Operator

Our next question comes from the line of Brian Mckenna with JMP Securities.

Brian J. Mckenna

So just drilling into performance a bit here. You had a few strategies that really outperformed during the quarter, including alternative credit, which was up nearly 7%, Asia credit increased north of 12% and then special opportunities was up about 8%. So could you just talk about some of the underlying trends for these strategies. Specifically, what drove the outperformance? And then what's the outlook for all these in the back half of the year?

Michael J. Arougheti

Yes. I think hopefully, it's pretty self-explanatory. I mean if you -- the bulk of what those strategies are focusing on is opportunistic credit investing largely with floating rate instruments. So I think you're getting twofold impact. One is just the benefit of increased coupon as rates go up. And two, if you think about the flexibility of those strategies, for example, Asia being a special sit strategy, ASOF having the ability to invest in rescue capital and special situation that's very thematic and on trend in terms of the need for capital.
Given what's going on in the market in terms of the supply-demand imbalance of liquidity, denominator effect and people's need to make their equity capital bases last longer. I would expect that trend to continue and you called those out, but I would also highlight that if you look at some of the regular way credit strategies, U.S. direct lending, for example, put up a 5% composite return in the quarter, which is pretty significant as well. So I think it's a combination of right product for the market and increasing base rates.

Brian J. Mckenna

Got it. Helpful. And then just a follow-up on the FRE margin. When you look across the businesses, the margin within credit is in the mid-60s. While most of the other segments have margins in the low 50% range. So I guess, is there any opportunity to increase the margin in some of these other businesses? And if so, where could they expand to over time?

Jarrod Morgan Phillips

I think it's really a simple answer -- go ahead, Mike.

Michael J. Arougheti

Go ahead, Jarrod. Go ahead.

Jarrod Morgan Phillips

Yes. No, I was going to say it's really all in line with the 45% guidance that we've laid out. As we've built out our credit business overtime, certainly become the largest business since probably the most at scale. A lot of it is using the platform to continue to build that scale. It's deployment of the assets on that and subsequent fundraisings being larger than the prior vintages.
As that deployment and those fundraisings occur, that's what really provides the tailwinds and uplifts the margins. So when we talk about our 45% plus run rate at the end of 2025, it's really coming on the backs of, like you said, the expansion of margin in a lot of those areas is we still believe that there's a lot of growth across the platform, in the different areas that we invest in. And you can see that manifesting itself in that expansion of margin and the increase in revenues as well.

Operator

Our next question comes from the line of Patrick Davitt with Autonomous Research.

Patrick Davitt

It sounds like there's a much better quarter-over-quarter trend happening in European direct lending pipelines versus the U.S. So through that lens, do you have any indications that this could be the beginning of a longer-term step change in direct lending market share growth there, potentially catching up with the U.S.? Or is there more of an idiosyncratic blip happening for some reason?

Michael J. Arougheti

Yes, there's nothing idiosyncratic. I mean it's interesting. Our market position in Europe, is as crazy as this may sound, is probably stronger than our position here in the U.S. We were effectively first in that market and have created a size and scale advantage that very few people, I think, have come close to. So some of that is timing, as we mentioned, of some deals, meaningful deals slipping quarter-over-quarter, but I would just highlight, I think our European direct lending franchise, as indicated just by the success and speed of this most recent fund, I think, is pretty unique.
If you look at the growth and ultimate size of that business relative to the U.S., it has been catching up. Similar to what I just said about the APAC region. Europe was fairly well behind the U.S. market in terms of its development, and we've seen it grow to track the U.S. growth over the last 10 to 15 years. And as the market develops more, I could see us taking even more share, but that's a pretty significant market position we have there, and I think it's going to continue.

Operator

Our next question comes from the line of Adam Beatty with UBS.

Adam Quincy Beatty

I just wanted to ask about private credit pricing and cost of funds kind of from the borrower perspective. Just wondering, given the elevated level of rates, whether you're seeing issuers maybe either hesitate or react differently just to the cost of funds, there's -- despite the economic resilience that you noted, there is still some cohort out there that believes we might get a pivot or a rate cut sometime in '24. So just wondering, are folks, obviously, those with financial flexibility, maybe holding off for that or otherwise differentially reacting to pricing these days?

Michael J. Arougheti

Sure. Obviously, the transaction volumes being slow, I think, is largely driven by a rapid change in the cost of capital. Obviously, to the extent that you put a capital stack in place with an expectation of a 4% cost of funds, and that's now a 10% cost of funds, that's going to meaningfully hamper your financial flexibility.
And on new deals, whether it's real assets or corporates, obviously, you have to now look at the cap rate and valuation environment and the cost of capital. And what that's really done is for those that want to transact, it's created lower leverage and the need to put more equity. And so if you look at the equity contributions in the market today, they're approaching 57%, which is a huge level relative to historical standards.
And so for those that want to transact, they're bridging it with equity. The one thing I would highlight about the private credit asset classes, it's obviously floating rate. It's painful on the up, but it obviously can give you some relief on the way down. And while we tend to have modest call protection structured into a lot of our investments, I think for those that want to play offense, there's a willingness to accept a higher cost of capital given the flexibility to prepay and to benefit from rates as they come down.
And that's why I think once we get to this agreement that the hiking cycle is over and everybody can underwrite what their cost of capital is you should see deal flow pick up.

Adam Quincy Beatty

Makes sense. Thanks Mike. And then just turning to some of the realized carry, maybe away from the European waterfall structure, you saw a pickup in that. And just wondering to what extent maybe that suggests some loosening of the market there, what the outlook might be for Ares in the short to medium term around sort of American style realized carry, particularly in private equity.

Michael J. Arougheti

Jarrod, do you want to handle that one?

Jarrod Morgan Phillips

Yes. No, absolutely. Look, I think what we had in our private equity group this quarter, we did have some sales of some public positions that we had, had in the portfolio for a while. So there was some additional selling of those assets. Overall, we are extremely excited in the private equity portfolio to have the Savers Value Village IPO that happened towards the back half of the year.
But that didn't -- for back half of the quarter, that didn't resulted in any monetizations as it was a primary offering, but it was great to see that IPO and that IPO will be so successful. Otherwise, we continue to look at the markets and look for opportunities. There are opportunities for accretive sales and when they happen, we'll look to take advantage of that.
But I wouldn't say that there's been a huge turn and that there's a lot of monetization on the forefront. It's being opportunistic and intelligent with what we're looking at and taking advantage of opportunities as they come.

Operator

Our next question comes from the line of Michael Cyprys with Morgan Stanley.

Michael J. Cyprys

If we look across the industry, broadly losses and credit seem to be a lot lighter than many would have expected, despite 500 basis points plus increase in base rates, but we have seen a deterioration in this coverage. So just curious your views around that, how do you expect defaults and losses to trend as you look out the next 12 to 24 months?
And maybe you can just remind us on what portion of the credit portfolio companies have hedged out their interest rate risk, how that's evolved? And how do you think the timing for those hedges to roll off?

Michael J. Arougheti

Yes. So as I mentioned earlier, the credit performance continues to be below historical averages. I think as we get to later cycle and we have the lag effects of the rate increases, you will naturally see defaults tick up, but I don't think that they will get to the levels that we've seen in prior crisis. You've seen interest coverage levels stabilize.
And I think what is different, this go around, if there's a big thing to highlight again is the amount of equity subordination and equity dry powder that exists in the market is fundamentally different than we've had in prior cycles. So my own expectation is a lot of these companies that are either seeing slowing growth or deteriorating performance with challenges on the coverage side that the resolution will largely come through transfer value from the equity to the debt, as opposed to losses given a spike in defaults.
That's generally what we saw through COVID. It's generally what we've seen in the early behavior in this cycle, and I would expect that to continue. So defaults will go up, but that is not cause for concern I actually think that it could result in higher rates of return across the private credit landscape as there's a transfer of value from the equity to the debt in order to bridge to a lower rate environment.

Michael J. Cyprys

And then just on the interest rate hedges. Just curious any color around that.

Michael J. Arougheti

Yes. It's been running around 30% on the private side. But I would say that, that's not really a panacea just in terms of the rolling structure of those hedges. So I think early in the rate cycle, that was a little bit more of a benefit than I think where we are today.

Michael J. Cyprys

Great. And just a follow-up question, if I could. On Crescent Point, I believe you guys had taken a minority -- or excuse me, BlueCove. I wanted to ask on that one. You guys took a minority stake in BlueCove in the quarter. That's, I think, a systematic credit shop.
I'm just hoping you might be able to talk a little bit about the strategic rationale behind the minority stake, how you think about their capabilities and how that might be additive to your platform and your clients?

Michael J. Arougheti

Yes, it's still early. They are a scientific fixed income manager. So they're applying technology and quantitative tools to the management of fixed income largely on the high-grade side in this evolving world of technology, both in terms of innovation, opportunity for growth and disruption, we felt that it was important for us to understand what that technology was and what opportunities it could create for us for our traditional liquid credit business.
They're great partners. They have a very strong track record of business building from their time at Blue Bay. And time will tell in terms of what that market develops into. But the investment thesis for us is that the world of scientific fixed income management, particularly around the high-grade part of the world will continue to grow. And I think that they are one of the leaders and real innovators in that part of the market.

Operator

Our next question comes from the line of Finian O'Shea with Wells Fargo Securities.

Finian Patrick O'Shea

Another on alternative credit and the market opportunity from banks pulling back, to what extent do you acquire those new borrower relationships and how durable are they, say in comparison to what you've seen in corporate credit.

Michael J. Arougheti

It's a great question, Fin. I think they're quite durable. If you just take, for example, the PacWest transaction, they were close to 90 individual borrower platforms within that lender finance book, if my memory serves me correctly. And while it's a discrete loan book, those are platforms that are originating new assets and will have new financing requirements and needs over time.
So there is an element to this transition of the assets that should grow our client base. The other thing, as I mentioned earlier, that we are mindful of, because we want to be good partners to our bank partners is that what -- I think they're all going to be focused on is how do I maintain my relevance with my client based on the capital that I have?
And how do I partner with friendly capital providers like Ares in order to support that client in the most effective way. And so I don't think that every one of these transactions is about clients wholesale leaving a bank and coming to Ares. I think it's more about how can we work together to support that client over time. And at least in the early days, that's generally how we're experiencing it.

Finian Patrick O'Shea

And then just a small follow-up. Noticed a small jump on the insurance investment on the balance sheet. Can you touch on that and if it relates to any change in strategy there?

Michael J. Arougheti

No, there's no changes to...

Jarrod Morgan Phillips

We're saying the same thing, Mike. No, it doesn't relate to a change in strategy. It's just the timing and us taking a look at what there is in the insurance business and how best to support it and its growth. Our overall goals remain the same, to ultimately be around less than 20% owner of Aspida as we grow it. But at a time when it's an extremely attractive product in the marketplace, we want to make sure that we're able to support it as best we can, and sometimes that's using our balance sheet capital.

Michael J. Arougheti

I'd also highlight, too, that's reflective of an increase in the value of that investment, given the underlying performance of the platform.

Operator

And our next question comes from the line of Ken Worthington with JPMorgan.

Kenneth Brooks Worthington

I think we've danced around this for a couple of prior questions, but on the bank partnering opportunity, with a focus more on the direct lending side than the Alt Credit side, A couple of questions here. First, have there been any changes to the direct lending markets in the aftermath of the collapse of some of the mid-cap banks that -- changes that may persist?
Second, has Ares seen opportunities to pursue business in direct lending that might have logically resided within some of the collapsed or weakened banks? And then ultimately, do you see the bigger, longer-term opportunity in terms of partnering with the banks within Alt Credit or direct lending. Like where does this ultimately fit in, overtime, within Ares?

Michael J. Arougheti

Sure. So in terms of the direct lending business, I wouldn't say that there's been a meaningful uptick in business as a result of some of the regional bank challenges. A lot of those balance sheet, if you look at them, are largely going to be around small business, consumer and commercial real estate lending.
So if we're talking about the regional banks, I would imagine that the bulk of the primary market opportunity that gets created for us is going to be in and around the commercial real estate lending and commercial real estate opportunistic equity side of our platform. That said, I would expect that with consolidation, we'll see some loan portfolios free up that could be interesting for us.
The broader opportunity is going to be also in the larger banks as they wrestle with increased regulatory capital requirements. And I think that is largely going to be a story for alternative credit. You'll see, again, opportunities for partnership. I think you'll see certain banks exiting certain businesses where they've maybe been overexposed or over-indexed, but look to maintain market share and client relationships, and I think we can be a good capital partner there.
So I think alternative credit, at least vis-a-vis the larger banks will be a disproportionate beneficiary. And then with regard to direct lending, there's obviously been a trend in place for the last number of years that larger transactions are finding their way into the private market and out of the loan and high-yield market, that gets more and more pronounced in difficult market environments.
So the current environment we're in is no exception. If you look at buyout activity, 85% of leverage buyout financing activity happened in the private markets this quarter, and I think last quarter as well. And so this theme of private markets offering value to issuers when the loan and high-yield market are challenged, I think will continue, and we saw that in full display in the first half of the year.

Operator

Our next question comes from the line of Rufus Hone with BMO Capital Markets.

Rufus Hone

I was hoping to get your thoughts around the potential for higher capital markets fees now that you can participate in transaction fees to a greater extent. I don't know if you'd be able to lay out any early ambitions that you might have around that and how quickly those fees could start to build?

Michael J. Arougheti

I would say they will be modest contributors over time, as you began to see play out in this quarter. I would highlight, though, that unlike some of our peers, a lot of those distribution type fees are actually finding their way into our underlying funds and driving higher IRRs at the product level.
And so while we do have certain strategies where we're obviously sharing in origination and distribution fees with our clients, we made the determination early on in the development of Ares that those fees were for the benefit of our investors and really driving higher relative return.
Which I think maybe is one of the reasons why we're enjoying such comparative success on the fundraising side. So I think you'll see it scale over time, but I don't think that it will become an overwhelmingly large number just based on the structure of the business today.

Operator

And we have reached the end of the question-and-answer session. Therefore, I will hand it back over to management for closing remarks.

Michael J. Arougheti

Great. We had nothing further. We thank you for your time today and your continued support. We hope you enjoy the rest of the summer, and we'll look forward to catching up again next quarter. Thank you.

Operator

Thank you. And 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 August 29, 2023, by dialing (877) 660-6853, and for international calls by dialing (201) 612-7415. For all replays, please reference conference number 13738839. An archived replay will also be available on a webcast link located on the homepage of the Investor Resources section of our website.