Looking Beneath the Private Credit Headlines w/ Ares' Kipp deVeer

0:00Credit is a business where as you get bigger you get better. That's Kip DeVier, co-president of Aries Management. For more than two decades, Kip has helped grow Aries from a private credit specialist into one of the world's largest alternative investment platforms. Few investors have had a closer view of how private credit has evolved or deeper insight into the concerns of oiling the market today. The whole tip to the headlines, which are quite negative, we're actually not seeing any fundamental sort of underpinnings that would say their problems in private credit. Today on Dry Powder, we'll look beneath these headlines and examine what's actually happening in private credit. We'll also explore whether AI is creating real risks for software lenders or whether the lingering fear of a SaaS apocalypse is turning out to be far less disruptive than many feared. I'm Hugh McArthur, Chairman of Baines Global Private Equity Practice, and this is Dry Powder.

1:03Kip, welcome to Dry Powder. It's a pleasure to have you on the show today. Thanks so much, you. It's really nice to be here. Appreciate it. As I understand it, you've been at Aries for about 22 years, Kip. And you've really grown tremendously, obviously, in credit where you're very well known, but also private equity, second Aries, real estate, some other real assets. How have you managed to develop a competitive edge across so many different types of businesses? Yeah, I mean, I think a lot of what we've done here is no one at our firm really are traders, right? So we think about, you know, how can we establish businesses that can build a competitive edge that's lasting and that's sustainable over time? Credit is a business where as you get bigger, you get better. So if you're a player in the loan market and you're a player in the high yield market, and then you become a player in the private credit market, these things all create real advantages. And the same is true of real assets, whether it's real estate debt or infrastructure,

2:04secondaries. It's all about having experts in local markets, but making sure that those experts in their niches all collaborate well and use the advantage of the scale that we have. You know, folks, so we say public equities, other places, there aren't huge scale advantages in my mind in those businesses, in credit in particular, but also in some of the real assets businesses that we've developed. There are real scale advantages from playing in these markets day to day across geographies, across asset classes, both primary, secondary, et cetera. And we've just really tried to create a culture and a team at the firm that really leverages that and takes advantage of that. I agree with you, Kept. Scale actually can be a big competitive advantage, certainly in asset classes like credit and some other real asset classes. Some of the pushback you tend to hear in the market is, yeah, but you get to a certain size and you really can't generate outsized returns anymore because you're just too big

3:06and you have to do everything and things become middle of the fairway deals, if you will, no matter what private asset class you're involved in. How do you, at Aries, actually utilize your scale in order to generate better returns? Yeah, I mean, I think it's all just investing in the platform, you know, so I think it's adding capabilities, right? So I'll give you one example. Maybe they get to your question, but, you know, we grew up on the direct lending side as a sponsor coverage focused business, right? So we were doing mostly private equity deals. Something like eight or ten years ago, we said we really need to add more capabilities to go direct to company. And we actually started building out distinct industry teams. So where we stand today, we've got a dedicated power renewables, oil and gas, all of that team, we've got a healthcare and life sciences team, which allows you to jump in a much different way into that industry because of capabilities.

4:10We've got a dedicated software and services team. We have a dedicated financial services team. And what that allows you to do is it makes you better, it makes you smarter on the LBO financing that you're doing. But it also puts you into the room, going direct to company with CEOs, with really differentiated industry knowledge. So when you step into the room, you're not learning about a company, you're sort of already well kind of steeped in the vernacular that comes with some of these more specialized industries. And I think that's differentiated, you know, you're not putting a generalist into the room, you're putting somebody in who has real market knowledge, industry knowledge, company knowledge. And that allows us to do a lot more direct to company stuff than we were doing probably 10 years ago. And I think that's made a big difference. Right. Now, one of the areas where you've had tremendous success scaling is obviously in private credit, many different elements of private credit.

5:11There's a lot of debate about private credit right now, specifically the health of the private credit industry, frankly, without a lot of data that I can see that would say that there's a problem there. But what is your take on the state of private credit markets today? I'll answer the simple part of the question first, which is, you know, we're actually not seeing any fundamental sort of underpinnings that would say their problems in private credit, art portfolios, whether it's the corporate credit portfolio, the asset-based portfolio, the real estate lending portfolio, the inferp—they're all very healthy, you know, and I could take through some boring metrics of how we think about it, but relative to historical standards, you know, non-accruals, defaults are low. There's good profit growth and underlying portfolio companies. Look, we participate in all of this markets. They've all become institutionalized sort of accepted markets or they are they more efficient

6:12than when we started in the business 25 years ago. They are. They're orderly, we have to be at the market. I think we're one of the couple of market leaders that are driving terms and pricing and all of that. But we see the spaces, frankly, very healthy, rewarding for investors, whether it's our institutional investors or our retail investors, the risk premium that we're continuing to capture relative to public markets is attractive. So long as your funding allows for illiquidity, which inherently is part of the picture. But look, I mean, our idea 20 something years ago was generate 8 to 12 percent returns in a liquid credit and all of these assets for folks that find that attractive. And we've done that for a long period of time at scale. And you know, one of the things that we talk about at Bain is that you expect to see people doing better and people doing not as well in any industry, including the private markets.

7:13How do you see the performance dispersion between more established managers such as yourselves and private credit and some of the newer entrants playing out over the next few years? Is there going to be a diversion there? Yeah, I mean, we see, you know, there is a broad brush that tries to paint, you know, the industry as how is everyone doing? I think there are two, three, four, five people that have real advantages. Whether it's people, whether it's origination, whether it's scale and flexibility of capital commitments, I think that over time has continued to drive our outperformance. I don't know if it's necessarily new entrance, but certainly folks that don't have those advantages, i.e. or smaller or, you know, less diverse in terms of what they're able to source. There is adverse selection, whether it's an LBO financing, if you're a private equity firm that's trying to raise, you know, billion dollars to go do a deal, you don't call 25 people, you call two or three people, right?

8:16And our advantage is we're one of the first couple of calls. Our goal is to be one of the first couple of calls. And we want to be at the front end of that, we want to lead structuring, we want to lead pricing, we want to run the docs. A lot of what we pass on, yeah, for whatever reason tends to go to others. And I would argue that, you know, that's probably less attractive than the stuff that we're able to lean into. So I think you're seeing that dispersion in results. I think you'll continue to see that dispersion of results. So he's asked me, you know, if I want to allocate to direct lending, how do I do it? And I say, pick two or three of the top five managers. Right. So there is an undeniable benefit in being the first to get a look at any potential investment opportunity. I mean, we think we're financing the best companies and the best transactions and the best opportunities. And we think the stuff that falls to at least our cutting room floor maybe ends up somewhere

9:16else and it's less attractive. And yeah, for sure. Now, Kip, you mentioned software earlier, but I want to come back to it because it is just so out there in there's so much noise in the marketplace. You know, people are talking about in the conferences that I go to. This word says, Paka looks we've all had to live with now for the past few months and wondering if there is some endemic issue because of the size of the software market in the biote industry that is infecting somehow private credit. You're not seeing that is what I'm hearing you saying your portfolio at all in software. Now, we're not. My simple answer is I think it's more of a problem for the owners of some of these assets than it is for the lenders to these assets. We developed both on the biote financing side but also the direct to company side. What I think is significant expertise in that part of the market maybe 15 years ago. I mean, with the folks that were early said, you know, we're kind of orienting towards

10:19these strategies. We need lenders. We need you guys to come with us and did a lot of work there. It has and continues to be if not the best close to the best performing sort of industry segment in the portfolio, both in terms of growth, in terms of credit metrics. But I think the issue is, you know, there have been very high purchase prices paid for these companies. Right. Yeah. And by the way, you know, reasonably high leverage on the underlying debt that you're talking about for the most part, companies that got bought for pick a number 20 times EBITDA that got leverage six or seven times. The lenders have quite a lot of room for reduced valuations. I think what's going to happen over the next couple of years is we're just going to have to see some market testing and some resolution. So is the company that got paid 20 times four is that worth 12 times? Is it worth 14 times? Is it worth 16 times? I don't know. But I think the question is more for the equity than it is for the debt.

11:22And look, I mean, AI is not like a brand new thing that just showed up. Right. I mean, this was part of our underwriting. This was part of our investment committee discussion, which is as technology changes, do we have impact in the portfolio? We weren't really leaning into companies that we thought would be materially disrupted by AI in the first place. So I think we're pretty well set up. And it's not something that's a significant concern for us these days. Let's talk a little bit about the fuel that keeps this investment machine going. Can you take us inside of one of your recent fundraising efforts, Kip, and tell us a little bit about how a sophisticated IR team that you have at Aries really works through? What's becoming quite a difficult fundraising environment across multiple private asset classes? So we have about 150 salespeople on the institutional side, right? And they're dispersed globally. US, Europe, and the APAC region. And then we have around 150 folks on the wealth team that's alter a different channel.

12:22We obviously have products that sell to traditional sovereigns, pensions, insurance, et cetera on the private side. And then wealth is obviously the other piece of it. We're actually outraising our fourth comingle sort of regular way direct lending fund. So despite some of the, you know, non-traded BDC redemptions and all that, we're actually seeing tremendous interest from our institutional investors in our regular way loan product. But it's performance first, right? And if the performance is there and there's belief in the strength of the platform and the franchise, it works. Now, you're absolutely right that, you know, performance trumps everything when it comes to raising money. One of the interesting things you said, Kip, is that you've got over 100 people in your wealth IR team that sort of raising from that channel. How does private wealth fit into Aries overall fundraising strategy? Yeah.

13:22So we've tried to expand obviously into that channel because it's a creative, but we're also bringing, you know, what we've done on the institutional side to a different client base. But we've tried to be tailored in terms of how we access it. So we've kind of leaned on three themes. So one is, you know, durable income in the private markets, right? And that's, again, something we can bring from the credit franchise to a retail investor despite some of the redemption, you know, headlines. Most of the US wealth channel is actually not the returner of capital. It's coming from elsewhere. So our US wealth clients largely through the wires are very sticky. The second piece has been tax advantage, real assets. And the third has just been diversified equities. So we have both the secondaries and a private equity strategy that sell into that channel. We don't want to be, you know, everything to everybody.

14:23We want to focus on two or three themes that we think we can be really, really good at and deliver on and build those in scale. So we have, I think it's nine products in that channel today. I don't think it's going to grow to 20 anytime soon, you know, sort of eight to ten products there where we think we're really, really good and can offer, you know, everything that Aries brings to that investor. And he said we don't want to be super, super reliant on that channel for capital. So I think we found the right balance. Now, you obviously kept in one of the most successful firms in fundraising and you've got a large team. You've done very, very well in terms of the AOM organically raised over the past years. What does it take beyond the performance that we've talked about to win in today's fundraising environment? What do you see as the other key elements here? Well, I mean, I think certainly the firm broadly that we've built as a platform is compelling

15:23for folks. And when we talk about some of the things that we were touching on before, you know, the scale advantage, but also the diversity of the markets that we plan. So we talk about the size of our team and the consistency of that team. I mean, our nine person investment committee when direct lending, I mean, I think the newest tenured member joined in like 2008. So it's just sort of like the consistency of the approach and the consistency of the results. The firm is a whole the diversity of markets that we plan. I think there's just a lot of trust that, you know, as this market in alternatives has grown and consolidated, you know, there are some folks at the top again who have a very, very significant, easy to underwrite track record of generating better than average results with frankly not not a lot of blips along the way.

16:25I mean, especially in credit, right? I mean, credits about, you know, not making mistakes, not losing money. Right. So when you throw someone a 20 plus year track record that's a hundred plus billion dollars of, you know, invested capital on the direct lending side, that consistency of people approach at scale, I think, is is something that's, you know, frankly, pretty easy to market and contributes to the fundraising success. On the next episode of DriveHunter, Kippleshare, where Aries is most excited to deploy capital next. We now have a hundred plus billion dollar real estate business that lends in the US, lends in Europe, but their focus has been playing to the areas of the new economy. So it's a lot of multifamily. It's a lot of industrial and logistics and it's increasingly in digital and data centers. I'm Hewbeck Arthur. Thank you for listening.