Carl Drake - Partner and Head, Public IR & Communications Michael Arougheti - Co-Founder & President Michael McFerran - CFO & EVP Kipp deVeer - Head, Credit Group Bennett Rosenthal - Director, Co-Founder, Partner & Co-Head, PE Group

Craig Siegenthaler - Crédit Suisse AG Michael Carrier - Bank of America Merrill Lynch Christopher Harris - Wells Fargo Securities Kenneth Worthington - JPMorgan Chase & Co. Kenneth Lee - RBC Capital Markets Douglas Mewhirter - SunTrust Robinson Humphrey Michael Cyprys - Morgan Stanley Alexander Blostein - Goldman Sachs Group Robert Lee - KBW

Good morning and thank you for joining us today for our third quarter 2017 conference call. I'm joined today by Michael Arougheti, our President; and Michael McFerran, our Chief Financial Officer.

In addition, Bennett Rosenthal, Co-Head of our Private Equity Group; and Kipp deVeer, Head of our Credit Group are here with us and available for any questions. Before we begin, I want to remind you that comments made during the course of this conference call and webcast contain forward-looking statements that are subject to risks and uncertainties.

Our actual results could differ materially from those expressed in such forward-looking statements for any reason, including those listed in our SEC filings. We assume no obligation to update any such forward-looking statements.

Please also note that past performance is not necessarily indicative of nor a guarantee of future results. Moreover, please note that performance of an investment in our funds is discrete from performance of an investment in Ares Management, L.P.

During this conference call, we will refer to certain non-GAAP financial measures such as economic net income, fee-related earnings, performance-related earnings and distributable earnings. We use these as measures of operating performance not as measures of liquidity.

These measures should note be considered in isolation from or as a substitute for measures prepared in accordance with generally accepted accounting principles. These measures may not be comparable to like titled measures used by other companies.

In addition, please note that our master fees include ARCC Part 1 fees. Please refer to our third quarter 20147 earnings presentation that we filed this morning for definitions and reconciliations of the measures to the most directly comparable GAAP measures.

This presentation is also available under the Investor Resources section of our website at www.aresmgmt.com, and we will use as a reference for today's call. Please note that we plan to file a Form 10-Q early next week.

I would like to remind you that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase an interest in any securities of Ares or of any other person including any interest in any fund. This morning, we declared our third quarter distribution of $0.41 per common unit payable on December 1st to unit holders of record on November 17th.

We also announced our regular preferred distribution of $0.4375 per Series A preferred unit with a payment date of December 31st to preferred unit holders of record as of December 15. Now I'll turn the call over to Michael.

Thanks, Carl. Good morning, everyone, and thanks for joining us.

This morning we reported record fee-related and distributable earnings for the third quarter as we benefited from the continued growth of our platform as well as strong investment performance. We are pleased to see our fee-related earnings margins reach 30% for the first time as a public company due to the significant growth that we're experiencing in our management fee revenue.

On top of the higher core earnings, we also took advantage of favorable market conditions to partially monetize a few of our private equity positions and to drive higher distributable earnings. In addition, we reported solid economic net income, over $100 million for the third quarter, bringing our year-to-date ENI up 38% over the comparable a year ago.

Mike McFerran will walk you through our key metrics a little bit later and you'll find that we're generating significant year-over-year growth in all of our important earnings and AUM metrics, which we believe bodes well for strong future cash distributions in the years to come. So we've talked about on prior calls there are still several important themes that continue to drive the growth of our business.

WE continue to see some of the strongest demand for alternative investments in over a decade. In an environment characterized by high liquidity and low rates, institutional and retail investors are seeking current yield and higher returns and they're increasingly turning to proven alternative managers that can deliver these returns with less volatility, particularly with turn income.

This desire for income can be seen through our AUM growth from insurance clients, which contributed 27% of the direct capital we raised over the last 12 months as part of the total $16 billion raised in that period. Large investors have continued to consolidate their relationships with managers like Ares that can deliver more customized solutions across a broad range of product offerings.

During the last 12 months, our existing investors contributed approximately 70% of the new capital we raised. In order to meet this growing demand, we continued to innovate by offering adjacent strategies and new fund offerings that can accommodate the particular investment requirements of our clients.

The flip side of this strong demand for alternatives is that it continues to be more challenging to invest at attractive values. We continue to be patient using our specialized sourcing and existing client relationships to identify inefficiencies and we use our origination, creativity and flexibility as advantages across a wide range of strategies.

We're also being highly disciplined in the structuring of our investments to protect our investor and unit holder interests. Fortunately, we have patient, long-term, locked-up and really flexible capital with more than $25 billion of dry powder allowing us to take advantage of market corrections or disruptions as the cycle evolves and find optimal relative value over time.

In the third quarter, we continued our strong fund-raising momentum, raising $5.5 billion across a variety of our strategies, bringing new gross commitments over the last 9 months to $14.1 billion, well ahead of the $11.9 billion for the same period in 2016. During the third quarter, we continued to see significant demand for both our U.S.

and European direct lending funds with approximately $1.5 billion raised in new SMAs and comingled funds. We expect this investor demand to continue as we broaden our addressable market and further scale our platform and product capabilities.

In our inaugural private debt junior capital fund, we raised $409 million during the third quarter and recently held another closing of an additional $1.2 billion. This brings our total commitments to date to $3.2 billion, well in excess of our initial target of $2.5 billion.

We believe that the success of this first-time fund and an expanded direct lending strategy clearly illustrates the potential organic growth embedded in our credit platform. Within liquid credit, we continue to capitalize on our track record and capabilities in the syndicated bank loan sector, pricing 2 CLOs for $1.6 billion including our second largest CLO of $1.1 billion in July.

We also experienced steady flows and new commitments to high-yield funds totaling $331 million. And in real estate, we raised an additional $245 million for our ninth U.S.

value-add fund, bringing total commitments to date to $660 million, well on our way to our $1 billion target. Looking forward, we're currently preparing for several large successor fund raises in credit and real estate including our largest comingled fund in real estate and largest private fund in European direct lending, along with the launch of a new credit fund strategy that's in the pre-marketing and preliminary stages.

Leveraging our investment team's expertise and the collaboration within our platform, we've continued to generate strong investment performance for our clients. As you can see from the earnings presentation that we filed this morning, our returns across our major fund strategies have been consistently strong.

To highlight a few areas, our leveraged loan and high-yield fund composites have outperformed their benchmarks over the last 3- and 12-month periods. Our largest European direct lending funds, Ace 2 and Ace 3, delivered combined gross asset returns of 3.8% for the third quarter and the gross IRR for both funds since inception remains in excess of 10%.

Within our real estate strategy, our 2 largest private equity funds, U.S. 8 and EF 4, continued their strong performance, generating gross returns of 6% and 4% respectively in the third quarter, and 23% and 34% respectively over the last 12 months.

Although our quarterly gross returns in our corporate private equity fund composite were flat for the quarter, this is coming off of very strong last 12-month return for the composite of more than 29%. So while the investment environment requires a high degree of selectivity, as we've discussed, we are still finding quality opportunities with $5 billion invested in the third quarter, of which $3.6 billion was from our draw down funds.

Our deployment continues to be weighted towards our U.S. and European direct lending strategies as we've scaled our platform and broadened our coverage now with over 170 investment professionals and multiple funds serving large and small companies up and down the capital structure.

In our private equity strategy, we deployed $757 million primarily in our corporate private equity funds. During the quarter, we closed an investment in a leading multi-specialty physicians' group to help fuel the company's expansion.

And subsequent to this closing, ACOF 5 is now approximately 19% invested. In our special situation strategy, we're seeking capture strong value in private investments up and down the capital stack in companies where we can underwrite and structure our own upside and downside protection.

We also remain active in some pockets of more liquid securities. And lastly, in real estate, we've been actively investing across both our U.S.

value-add and opportunistic strategies in the multifamily sector where we continue to like the long-term favorable industry dynamics. In Europe, we saw substantial exit activity during the third quarter and we continued to actively invest in markets and assets where we see value.

In particular, we were active in the residential and retail sectors primarily through EF 4, which served as a continuation of our team strategy of aggregating, stabilizing and packaging for sale to institutional buyers portfolios of multifamily residential assets and value-oriented retail in Europe's main metropolitan and suburban areas. So now with that, let me turn the call over to Mike McFerran, our CFO, to give you more detail on our third quarter financial results and our future outlook.

Mike?

Thanks, Mike. As Mike stated, we had a strong third quarter reporting economic net income of over $100 million and generating record levels of fee related earnings and distributable earnings.

In addition, we achieved a key near-term target by reporting operating margin, otherwise referred to as our FRE margin, of 30% this quarter. This represents a significant increase over an average FE margin of 26% for the 7 quarters preceding the third quarter of this year.

With that, I'll take you through our results for the quarter starting with our AUM metrics. Over the last 12 months, our AUM increased by approximately $8.3 billion to end the quarter at $105.6 billion, a year-over-year net increase of 9%.

During the 3 months ended September 30th, our AUM increased approximately 2% primarily due to continued growth in our credit platform across our liquid and illiquid strategies. Over the last 12 months, our fee paying AUM increased by 21% or $12.4 billion to $72.4 billion, During the third quarter, we achieved a 3% increase in fee paying AUM driven by our credit group where our fee paying AUM growth is being driven by capital deployments in our U.S.

and direct lending businesses and the issuance of new CLOs. Fee related earnings for the quarter totaled $58 million, which represents a year-over-year increase of 28%, driven by continued management and other fee income growth, which increased 15% over the third quarter of 2016.

AS I previously noted, our fee related earnings resulted in a 30% margin for the quarter, which compares to an FRE margin of 27% for the same period last year. To provide and update on ARCC's acquisition of American Capital, our team continues to rotate the acquired ACAS portfolio into higher-yielding assets and improve the yield on other low-yielding assets at ARCC.

As a result, we are starting to see the benefit as ARCC Part 1 fees in the aggregate increased from $19.1 million in the second quarter to $24 million in the third quarter, in both cases net of the $10 million quarterly fee waiver. As our team continues to rotate the portfolio, we expect to see a further increase in our ARCC Part 1 fees from current levels.

If we are successful in this execution, this should gradually improve the FRE contribution from ARCC for the remainder of 2017 and into 2018. As a reminder, the $10 million per quarter fee waiver expires beginning with the fourth quarter of 2019.

Our third quarter PRE was comprised of net performance fees of $30.9 million and our investment portfolio generated net investment income of $12.5 million PRE reflects strong realizations especially in our corporate private equity funds, which supported the record level of distributable earnings for this quarter. As we mentioned in our last call, our realizations included the partial monetization of certain public holdings as well as the closing of a majority sales of one of our portfolio companies in the OB/GYN hospital sector and a minority sale of a company in the veterinary hospital and pet boarding sector.

We believe the significant growth in our accrued net profitability fees to $221.4 million, up 57% from $140.9 million a year ago, is a meaningful indicator of the potential growth in our level of realizations in future periods. Of the $221.4 million, approximately half is in our PE business and approximately 65% relates to funds with either annual incentive fees or American-style waterfall carry structures.

In the third quarter, we generated net economic net income of $101.4 million, which translated into $0.40 on an after-tax per unit basis after preferred distributions, compared to $116.7 million or $0.46 per unit a year ago. For the year-to-date period, economic net income was $335 million, up 38% compared to the same period a year ago.

Our third quarter distributable earnings were strong at $105 million or $0.45 per common unit versus $66.7 million or $0.23 per common unit a year ago. As Carl stated, this morning we announced a distribution of $0.41 per common unit for the third quarter.

As a reminder, our after-tax distributable earnings include some tax savings from the one-time deductibility of the acquisition support payment we made in conjunction with ARCC's acquisition of the American Capital portfolio. Before I hand the call back to Mike, I want to spend just a few minutes on a few other key metrics.

First, available capital, which increased 5.1% year-over-year to $25.8 billion. While our AUM not yet earning fees, or shadow AUM, declined from $18.4 billion a year ago to $14.8 billion for the third quarter primarily due to the activation of ACOF 5 management fees.

Of our shadow AUM, approximately $11.7 billion was available for future deployment with corresponding management fees totaling approximately $121.4 million. Approximately 60% of this amount is related to capital we have raised for our U.S.

and European direct lending funds with the largest contributors being our junior capital private direct lending fund and Ace 3. Our incentive eligible AUM increased 18% year-over-year to $60.4 billion, of which $21.7 billion is incentive generating and $22.4 billion is still to be invested.

More than 82% of our incentive eligible AUM that is invested is incentive generating excluding the ARCC portfolio, which is largely debt-oriented and eligible for capital gains fees. AS you see from our third quarter's results, the conversion of AUM not yet earning fees to fee paying AUM continues to grow our revenue base.

As we continue to raise capital, the increasing amounts of AUM not yet earning fees and incentive eligible AUM provide a growing base to increase both fee related and performance related earnings in the quarters and years ahead. With that, I'll hand this call back to Mike for closing remarks.

Thanks, Michael. So in summary, we're really enthusiastic about Ares' growth prospects based on our strong fund-raising and investment performance.

And we have a range of different growth opportunities available to the whole platform. We have 3 very well-positioned businesses, each with meaningful competitive advantages and compelling prospects.

And While I referenced the often challenging investment environment for deploying assets on this call, we're using all of our sourcing advantages and the breadth and scale of our differentiated platform to find attractive assets. I do believe that it's in current markets like the one we're in now where the power of our business model really stands out.

It's even more important to have the ability to evaluate a wide range of assets across multiple strategies and geographies in order to invest wisely. Know that we're working hard together across the entire platform to bring value to our clients and our unit holders.

Thanks again for everyone's time today. And with that, operator, could you please open up the line for questions?

First I just wanted to start with the tax bill. And, listen, I know this was just kind of out yesterday and it may never actually become a law, but I just wanted to get an update on, one, if the corporate tax rate does go to 20%, are you guys interested in converting to a C-Corp?

And then, 2,, there is a bunch of different kind of things in there and also things on small business so I'm wondering if you saw any impact to your direct lending franchise or also your private equity business.

Mike, why don't you talk about [indiscernible]? And I'll pick up the back half.

Sounds good. So, Craig, we've been, prior to yesterday, inventorying and evaluating a long list of considerations as we look at our corporate structure.

And clearly corporate tax rates is one of the key ones amongst those. However, it's not the only consideration.

So with independent of tax reform, we may actually end up concluding that a corp structure would be preferable to us as we work through this now. That being said, clearly a reduction in corporate tax rates to 20% would I think make this really attractive, but we can't say with certainty we would convert as there are other considerations.

I would just add one other thing on the conversion, Craig, which is stating the obvious, is as of now the tax proposal has no mention of any change to the treatment of carried interest. To the extent that that changes, that would obviously factor into the analysis being done by us and some of the more private equity-centric peers alongside us.

In terms of how it's impacting or how it could impact portfolio companies, I think at a high level, to the extent that tax reform is stimulative, given the credit sensitivity of almost everything we do, I think we should expect that it's a net positive for the business. The big question mark is going to be the impact of the interest deductibility and the definitional construct around the 30% cap in terms of how much of a potential headwind it could be in the leveraged finance markets.

Some of that is going to require some more clarity on the exclusion for pass-through entities. Most people probably don't know, but within the leveraged finance markets, I'd venture to say that a majority of borrowers are structured as pass-through entities.

So I think we need some clarity there. We also need some clarity on grandfathering.

But I think generally if you do back-of-the-envelope math and you look at interest coverage throughout the below-investment-grade credit world, I would actually expect the impact to be modest if negligible. And it's likely that it would be a headwind only for the highest leverage providers at the highest rates, i.e.

some of the mezzanine providers and certain portions of the high-yield market. But as you know, the preponderance of the lending that we're doing within our direct lending strategies is oriented much higher up in the capital stack.

The other thing I'd just mention is obviously the combination of lower deductibility and the lower rate should be an offset. And so when we look at the net impact to earnings, again my sense is it should be a net stimulus.

Lastly, is just how does this impact investor appetite. Obviously, as the markets digest this, we're seeing early that it's kind of a non-event.

Obviously, there are some sectors that are bearing the brunt of the impact. But to the extent that this starts to work its way through in to reality, I think there's going to have to be a slight relative revaluation of all of the asset classes.

And back to some of the comments in the prepared remarks, I do think that the diversity of our strategies across equity and debt, performing, non-performing, Europe, U.S., et cetera, presents us with a pretty significant opportunity to take advantage of whatever disruption we're going to see.

Got it. And if could just get one follow up on many of your competitors really are trying to grow credit, kind of get to where you are in direct origination.

Maybe you can just remind us of some of the scale advantages that you have in this business globally and also maybe some of the moats you also have around the business.

Sure. I'll take a stab and then Kipp can chime in.

We've always said from the day that we started the business that the way that we drive outperformance in direct lending is to see the widest available market opportunity and then to drive really high asset selectivity to make sure that we're picking the right credits. In order to do that effectively, you need scaled origination to see those market opportunities.

You need product breadth to make sure that you can service those opportunities when they come on to the platform. And you need balance sheet scale so that the folks that want to borrow from you view you as a full balance sheet solution.

And so everything that we've been doing at Ares over the last 15 years to drive value into our direct lending businesses is oriented around those 3 competitive advantages. As we sit here today, globally our direct lending strategies are in excess of $40 billion.

In our core middle market strategies, we have over 170 people actively originating, investing in the U.S. and Europe.

We've created a product set that allows us to invest in any size company anywhere in the balance sheet, from the smallest non-cash-flow-generating borrower where we're accessing them through an ABL product, all the way up through that upper middle market borrower that finds it more efficient or more effective to borrow from us than doing a capital markets execution. And obviously, we've surrounded that with the scale to make sure that we can service their needs.

The other thing that we have found is that as we've created those competitive advantages, and Kipp talked a little bit about this on yesterday's ARCC call, the value of incumbency, I think, has been surprisingly strong to us and to the market in the sense that now, in any given period, 30% to 40% of our deal flow is just coming from servicing and expanding our relationship to our existing borrowers. Obviously, to the extent that we can get a company onto the platform early in its life cycle, grow with it, support its changing needs and it stays in our portfolio, that's a huge competitive advantage in that underwriting an existing borrower that you've had access to for a number of years is obviously a much different risk proposition than going into the market and underwriting a new credit.

And then, lastly, and we're seeing this show up mainly in our public entities like ARCC, but now to the extent that we're growing our private funds business as well, with scale comes a much more efficient access and diverse access to the capital markets, both private and public and both debt and equity. So when you look at where we're able to borrow and the diversity of the markets we're able to borrow in, it's actually creating an ROE advantage for the funds that we're managing as well.

Maybe first one just on the distribution. It was a healthy quarter.

Mike, you mentioned just some of the realizations that you had in the quarter. If you can just maybe provide us a little bit of color on the portfolio.

When we look at maybe like what's public, what's kind of easier, seasoned, that we could see like exit activity over the next 12 to 24 months. And just any color around that just because you guys it's a little bit tougher, but obviously the environment is fairly attractive.

Sure. Why don't we start with really the two components of DE?

The first is our core earnings contribution and then the second is, as you highlighted, performance fees, which is a combination of returns on our balance sheet from mostly our GP stakes as well as realized carry. On the first, and we talked a little bit about this last year, Mike, in our calls, that the growth of management fees and the increase in FRE was going to result in really a step-up in our core contribution to DE.

So if you look at us for the fourth quarter of '16, I think our core FRE contribution to distributable earnings was about $0.14 a unit. If you look at that for this quarter, it was $0.20.

So that recurring amount continues to increase for us, which we think is an important theme for the business independent of any monetizations or returns on our balance sheet. As far as realization activity goes, for the fourth quarter it's still early.

We've talked about consistently that this is a great realization environment and there's a lot of themes we're working on, but timing is not certain. So what's going to close or could close in Q4 versus early parts of '18 is still in progress.

But broadly speaking, we think in the quarters ahead, we have a pipeline of realizations across our businesses especially in private equity and real estate is really attractive.

Mike, I'd just add, and you can see this in the earnings presentation and you mentioned it on the call, I think a good directional indicator of the incentives potential in the business is just the significant step-up change that we've had in our performance fee receivable, up to $224 million in the quarter, which is obviously a significant increase from the period a year ago. So that incentive income is obviously starting to work its way through the balance sheet.

Yes, that makes sense. And then maybe a quick follow-up.

So just on FRE, so it was a really quarter. You guys have benefitted from some of the fund-raising and the fees turning on this year, Mike, as you mentioned.

Just when we think about like going forward, fund-raising is still pretty active. This quarter was a pretty active deployment quarter.

But then we had the realizations. So do we expect fairly kind of consistent growth versus any significant changes in terms of ramp-ups?

So when you look at FRE growth, I think there's really 3 contributing factors that we'll think about over the next couple years. First is we have AUM raised that's not yet deployed.

So absent another $1 being raised, there is still just shy of $122 million of management fees tied into that, gross. That's obviously gross of any amortization of existing funds that are in runoff.

When you look at the $122 million, 70% of that is tied to our European and U.S. direct lending businesses.

A lot of that is recent capital raised this year and last and which we're doing a nice job on deploying at an attractive pace. So that's part 1.

Part 2, to your point, we're continuing to be very active in fund-raising. The CLOs being issued this quarter.

The real estate funds that Mike talked about, coming in at $3.2 billion thus far on the private credit fun. So all that will be additive to AUM not yet earning fees as we continue to go forward and continue to fundraise with a mix of funds that are earning some of it off a portion of committed and the rest off invested.

And then third, the obvious reminder is, and we mentioned in our prepared remarks, as we walk towards 2019, at the end of that year, the fee waiver on the -- the $10 million quarterly fee waiver on the Part 1 fees turn off. So as we look ahead really over the next couple years, we think we've got a great line of sight for a nice linear progression on top line -- core earnings revenue and FRE growth.

So I wanted to ask you a question on portfolio positioning. As we progress through this economic cycle, how should we be thinking about your portfolio from a risk management perspective?

Are you guys comfortable staying further out on the risk spectrum? Or are you a bit more defensive at this point?

And if you're defensive, what are you doing proactively?

Sure. I'll give a general overlay and then if Bennett or Kipp want to chime in, PE and credit-specific.

As I mentioned, there is a lot to be cautious about. We're late cycle.

We've seen a lot of central bank intervention. And we're going to start working through an unwind.

There's the prospect of rate hikes. There's geopolitical instability, et cetera, et cetera.

So I think everybody's aware of that. Although the unique aspect of what's going on now is I don't think we've ever been this late cycle with this level of fundamental economic strength and the prospect of continued fiscal stimulus.

And so I think when you balance those 2, we are working hard to find attractive assets to invest in where we see value. We are being cautious, but we are in no way out of these markets.

We're finding ample opportunity in each of our businesses to invest money at attractive rates of return. As I mentioned earlier, what's unique about our platform, and I think the large alternative managers in general, is within individual strategies, we typically have the ability to be flexible in the positioning of the balance sheet.

So as an example in our private equity business, in our core flagship funds we have the ability to do distressed for control investing alongside core buyouts and growth equity investing. And so those fund structures allow us to be more nimble, frankly, and more aggressive navigating the cycle than some of our peers.

And generally, because of that flexibility, we can conservatively position but still be in the market. So within our direct lending strategy that means we're likely moving up the balance sheet into more senior secured loans, moving up the size spectrum to finance larger borrowers.

In our real estate lending book, it probably means we're focusing more on top-tier borrowers up the balance sheet. In some of our liquid credit strategies, it probably means that we're moving up the ratings spectrum and shortening duration.

But even with a cautious or conservative positioning, we're finding plenty of attractive opportunities on a relative value basis and absolute value basis to invest in. I don't know if, Kipp or Bennett, you have anything specific you want to add on the specific strategy.

Yes. I would just say on the PE side, we've been super defensive in a couple ways.

One, we've been, as you can tell from this quarter, we've been driving realizations in the portfolio to take advantage of this multiple market. 2, when you look at -- I'd say while we've been really successful deploying capital over the last couple of quarters, particularly from our flagship fund 5, we've been focused defensively.

So if you look at about half of what we've deployed has been in health care in great franchises that are driven by sort of macro factors beyond cyclical issues. And then the other focus has been in energy, both on the midstream side where it will be not significantly cyclical.

There are some strong views into what the cash flows of those companies are and then in rescue capital. So that's the core of what we've been doing has been focused in defensive sectors.

And what we're looking at on the sort of regular way private equity side with companies away from these defensive industries is really looking at significant multiple contraction as we analyze our potential exits. And so therefore that's causing us to be somewhat conservative in what we've been doing on the non-defensive industries.

This is Andy McLaughlin on for Rob Lee. You kind of mentioned that the FRE margin has obviously increased year-over-year and kind of see a good runway for fee paying AUM growth at least.

Where should we kind of think about the margin from here going forward?

I think for any given quarter you could see volatility a little bit with it. But I think over -- if we look across a spectrum of several quarters, we expect it to continue to grow as the business grows.

We highlighted in our prepared remarks that for the last couple years, the margin was on the average 26%-27%. We're at 30% now.

Revenue, as we mentioned, is continuing to grow. So I expect the margin to grow with it.

But for any -- it's not necessarily going to be each quarter you'll see a sequential increase, but for the year, a year from now, I'd expect to see the margin attractively higher than it is today.

Right, okay. And just kind of touching on something that was brought up earlier, fee paying AUM.

Obviously fund-raising has been going fairly well. But as you go forward, given that it's a very attractive environment to realize things, I mean do you see fee paying AUM growing at the same rate or maybe slowing a little bit just because it may be more attractive to realize some things?

I actually think you should expect to see it continue to grow. The underlying trend supporting that is we've been fortunate to see each sequential fund in our flagship family of funds growing meaningfully in size.

So obviously the way you defend against the runoff is that runoff is being replaced with a significantly larger sequential fund. And then, secondly, when you look at things like our junior capital fund, where we are closed on a $3.2 billion fund for a first time step-out strategy, we've been able to leverage the core competencies to put up some pretty big new fund strategies that should be accretive to that number.

So I'd expect that number to continue to grow even in the face of us focusing on realizations.

First, in terms of the transition of the ACAST portfolio, how far along would you say you are through the repositioning? And how are market conditions and maybe even the outlook impacting the speed of that repositioning?

Mike, do you want me to take that?

Of course.

Yes. So just on the ARCC call yesterday, generally as a reminder, we bought a $2.5 billion portfolio.

We've been rotating that. I don't have the numbers in front of me, but I think as we laid out yesterday, we said that we've sold about $1 billion of the portfolio and have generated gains on the sales of that $1 billion and change.

And we also laid out the fact that we thought we had about $800 million, I think the number is $875 million, left to go. So generally we're about halfway there.

And to your follow-on point, the environment for selling things has been very favorable. So I don't want to say we've had positive surprises, but we've had outcomes to the upside, I think, of what we envisioned when we originally underwrote the transaction.

Yes. I'd add just one other number.

You've obviously seen a significant amount of realized gains already working its way through the book as we rotate. But there's also been about $94 million of net asset value appreciation in that asset book over the first nine months [indiscernible] obviously been continuing to work the equity portfolio.

So at least from my perspective, I think it's going as well if not better than we expected and the velocity of the rotation is probably happening a little bit quicker than we would have anticipated.

Okay, great. And then to follow up Craig's, I think, initial question on comprehensive tax reform.

You guys had mentioned in your prepared remarks I think again how well the insurance business is going for you and some of the changes that at least are proposed on the House version are having or would have an impact on certain elements of the insurance business. So you think there's any flow-through on the negative side to you there?

And then conversely, would there be any obvious opportunities for you should these proposals move forward?

Yes. Just to remind people, when we say insurance clients, those are us packaging our investment products for investment largely to domestic insurance companies and foreign insurance companies either through separately managed accounts or comingled funds.

Unlike some of our peers, we don't have any offshore or foreign-domiciled insurance subsidiaries that would be challenged in the face of an increase in cash excise taxes or repatriation tax. So I don't expect it to have a direct impact on our business since we're not running that kind of capital.

And when I look across the universe of insurers that we're typically doing business with, I think it would have a negligible impact as well.

Just wondering whether you could tell us some of the key differences between the U.S. and the EU direct lending markets in terms of returns, growth opportunity, market structures.

Kipp, you want to take that?

Yes, sure. I'm happy to.

I think that the punchline, and I'll provide a little bit more color, is just we see the U.S. market as larger and more developed.

The banks here in the U.S. as they've consolidated over the years, really have exited that market.

And the last downturn in call it '08 we think kind of put a finish to the large money centers banks' interest here in the U.S. As a reminder, we really accelerated our U.S.

direct lending business at Ares even back to '04 and we've seen just continued growth. But I think about it as growing market in the U.S.

where there continues to be quite a lot of investor interest, but the leaders in that market have sort of established themselves and we clearly consider ourselves to be one of the market-leading businesses here in the states. Over in Europe, slower to develop.

Really was a largely bank and CLO market into the downturn, very little direct lending capital. The investor interest there and the momentum in Europe I think started to develop as part of the banking crisis over there, first in the U.K.

and I think now it's spreading to be even more attractive in Europe and on the continent generally. Our European direct lending business today is about $10 billion of capital and I think we see extraordinary interest in that business and a lot of tailwinds for the business there.

So probably less mature, more rapid growth in Europe. And just in term of terms, probably modestly lower leverage in our European direct lending transactions with modestly higher pricing.

So a little bit better risk-reward, I think, in Europe today, but only at the margin.

Got you. And just one more question.

Very strong flows into the U.S. CLOs this quarter.

Maybe you can just share some of your outlook in terms of just client demand overall for that product, the CLOs.

Yes. I mean I'll take that as well.

Our CLO machine is absolutely humming along and I think its only limitation if you asked Seth Browski, who runs our CLO business, is frankly finding enough good assets to buy. Floating rate U.S.

senior collateral, I think, is just viewed as attractive risk-reward and with modest leverage you're still generating pretty interesting returns issuing primary CLOs.

Two questions. First, it's sort of a kind of a hazy strategic question and I don't know if it sounds unduly negative.

I don't mean it that way. But have you ever got to the point where because spreads and yields have gone so low especially in Europe where I think high-yield bonds in Europe are now below the level of U.S.

Treasuries. Have you guys at the point where you're like -- well maybe we will hold off on raising this fund even though there's demand because we just don't want it to have to sit there for a while?

Or do you have enough places and pockets to put it where you're basically taking all comers and being able to keep the fund-raising machine running at full speed?

Yes. I'll make two comments.

And I dint think it's hazy or negative at all. I think we all, as investors in these markets, have to be honest about where we are in the cycle and what the relative value opportunities are.

The first thing I'll say is I think our investors are coming to us because of their frustration with the risk-return opportunity that they're seeing in those more liquid capital markets. So when you look at sovereign bond yields, high-yield returns relative to what we're able to generate in our self-originated illiquid credit strategies, it's that very frustration or irrational pricing behavior that's driving them to our platform to begin with.

And then when they come to the platform, they're typically investing in very long-lived, locked-up strategies with a view that they're going to get exposure to the asset class as the cycle develops. So in illiquid credit strategies, typically we'll be raising 8- to 12-year duration type funds with anywhere from a 3- to 6-year investment period.

And I think our investors would like to see measured deployment in the types of markets that we're in now with an expectation that that capital will be allocated to the extent that we see disruption or dislocation. And obviously when we're having that collaborative consultative conversation with them, it's all about how we see the markets today on an absolute and relative value basis and where we think the markets are going to go.

But that's obviously the nature of our business and it's something that we're more than comfortable with.

Yes. I'll just add on, Mike, to follow along.

I mean it sort of depends on who you are, right? I mean the yield on the 10-year German bund is under 50 basis points, right?

So if that's your alternative in the negative real rates kind of a situation, while the all-in yield on European high-yield to a U.S. investor may look not all that interesting, folks do say European high-yields can be interesting as an alternative to what is on offer in Europe generally.

But no, I mean it's true; I think it's one of the reasons why we're seeing so much interest in our U.S. credit business because of what's deemed to be certainly higher yields here without taking any more risk in frankly all the asset classes we're investing in in credit.

Thanks. That's two very helpful answers.

My second and final question is much more specific. Did you sell any additional floor into core shares this quarter?

And if you did, can you disclose how many or what your position is remaining?

We didn't sell any during this quarter. Remaining position is -- give me just a second -- don't have the numbers here in front of me.

I will tell you we have about, if we converted our remaining holdings based on 9/30 prices, it would equate to about $0.51 of distributable earnings. That gives you the magnitude of what we hold still based on valuation.

Just curious if you could talk about the investments that you're making in the business today? Where are you spending, headcount?

I know you mentioned European direct lending. What sort of investments do you need to capture that growth opportunity?

And just also more broadly across the platform, what investments do you need to capture that growth?

Sure. I think the nice thing is most of our businesses are not capacity-constrained and we have scalable infrastructure already in place.

We do continue to invest behind all of our origination capabilities both in the European direct lending business and the U.S. direct lending business.

We are making meaningful investments in the continued growth and development of our special situations franchise behind Scott Graves, who we hired at the beginning of last year. We've been adding meaningful resources in our structured credit and related businesses as we continue to see meaningful opportunity there.

So from the investment standpoint, there's really no business that we're in where we're not adding resources. Obviously, as we continue to drive the fund-raising, we have to support that fund-raising with investments in asset gathering.

And then in the non-investment functions, as you'd expect, our primary additions have been coming, at least over the last couple of years, in asset gathering and investor relations. And you're seeing the fruits of that investment come through in the AUM ramp.

We continue to invest behind our operational and technology infrastructure just to continue to see leveragability in our margins. And so I think some of that lift that we talked about earlier that you're beginning to see come through the FRE margin is the result of some of the investments we're making in the middle office around scalability and efficiency.

So that's kind of how I'd describe it. But it's really across the board.

Okay, great. And just as a follow-up question.

Given the investments as you've outlined and that you're continuing to invest in the business, how should we think about the incremental margin on new management fees that come in the door? Is it in the 50%-60% range?

OR how should we be thinking about that?

Yes. It's an interesting question and we spend a lot of time reflecting on that because there's a big difference between that steady-state margin versus the margin as we grow.

Obviously, incremental dollars come in at a very high marginal contribution rate. It would likely probably come in in excess of 60%.

The reality is if you're focusing on growth and profitable growth, you're going to borrow from that incremental margin to continue to invest in future growth and the expansion into new strategies. So it's a hard question to answer directly because we don't actually run the business just to maximize marginal profit on marginal dollars raised.

What we've tried to do, and I think we've done successfully, is borrow from that growth to invest in new strategies, new geographies, et cetera, et cetera. And over time, we're getting that linear trajectory in margin, obviously, that we think is for the benefit of all the unit holders.

Just another credit-related question, maybe just looking at it slightly differently. I guess looking across your entire private portfolio of illiquid credits across various vehicles, just curious if there is any comment to be made around change in delinquency trends or any sort of potential cracks in credit.

Obviously, you're coming off a very low base and in the grand scheme of things probably not that material yet, but just curious to hear if there's any sort of incremental change. And if so, industries or geographies would be helpful.

Yes. This is Kipp.

I'll repeat the stat that we laid out for folks on the ARCC portfolio during our call yesterday, which is profits, i.e. EBITDA, in our portfolio companies on a weighted-average basis is up about 4%.

So the portfolio as a whole is performing well. Later in the cycle, probably a few more cracks, but nothing that we're concerned about.

And the way that mitigate that risk, just as a reminder, the nice thing about illiquid credit is you really can avoid industries and you can avoid what we think are obviously potential companies that could have credit problems, right? So it's all about defensive positioning and company selection.

And you'll see if you look through our portfolios, we're meaningfully under-exposed to the industries where we've already began to see the most cracks. So have been meaningfully under-exposed in the oil and gas segment.

We're meaningfully under-weighted retail. So I think a key element of our outperformance in illiquid credit over the years has been industry avoidance in a certain respect.

So we do see more cracks, not even necessarily in our own portfolio, but I think we've been able to sort of carefully avoid some of the pitfalls that tend to lead to higher non-accruals and more defaults in time. And we think our portfolios are built to withstand weaker economic times.

That's obviously what we get paid to do late in the credit cycle.

I'd just make one concluding comment maybe back to Craig's question about scale. Because if you ask that question to certain less-diversified, less-scaled managers, I think you may get a different answer.

And we are seeing in certain corners of the illiquid credit space meaningful credit deterioration and underperformance. And I think it's just worth noting when we talked about scale and how scale actually drives outperformance, you are beginning to see that.

So I would generally agree with Kipp, but as an asset class matter, credit is holding up, but you are seeing significant cracks in certain portfolios that are either down the balance sheet or focused on weaker borrowers different from our credit experience. And I think that does speak to some of the benefits of scale and market position that we highlighted earlier.

Got you. And I guess the point about 4-ish% EBITDA growth from the BDCs in the BDCs portfolio, is that kind of consistent, I guess, of what you guys are seeing in the rest of your private credit stuff outside of BDCs?

Yes.

Great. I don't think we have any.

I just want to thank everybody again for spending so much time with us today and for your continued support. And we look forward to speaking again with you next quarter.

Have a great weekend.