188: Yield, Shield, and Scale: Inside the Ares Management Playbook (With Blair Jacobson, Co-President)

26:23Blair Jacobson:And again, we've made so much progress on that in the last 20 years. But again, overall, finding these loans isn't the tough part. The tough part is what you mentioned earlier, which is screening them, making sure we're getting involved at the right companies with the right risk adjust to return potential in line with what we guided our investors to expect. Okay. So let's switch tack and talk sport. I was intrigued as I looked at your businesses, how this footprint of sport appears to become important. We've had Arctos on the show. I just interviewed Todd Boley at the Money Maze Allocator Summit.

27:01And then I see that you have, correct me if I'm wrong, but extended 500 million of PREF equity to the Chelsea structure. You've got Stakes and Inter Miami and Atletico Madrid. But of course, as somebody like myself who doesn't understand this ecosystem, so I'm going to need your help, is that it's one thing investing in a U.S. locked league where there's no promotion or relegation. It's quite another in Europe where you can be in the Champions League one week and out the next year. How are you targeting your sports investments?

27:33Blair Jacobson:So I think you have to rewind quite a bit. So we've been involved in this business for 10, 15 years. It's a major effort for our firm. We're currently invested, as you alluded to, in something like 15 different sports leagues. We originally got into sports in a major way during COVID when ticket revenues basically disappeared. And these leagues and these teams, which historically had been financed maybe by cheap bank financing or frankly wealthy people and owners, started to think that maybe they should start looking for institutional solutions. And we've been a part of this ecosystem for some time.

28:10Blair Jacobson:So the first thing is that we developed relationships with many of these. And this is a very relationship oriented business, as you can expect. And that's not three months. It's not three years. It can often be five or 10 years in importance. So the first thing is really understanding your counterparty, understanding the team. By the way, it's not all just teams. It's also investing in leagues. And it's not just leagues that you might be familiar with. It's women's volleyball. It's lacrosse. It's sailing. I mean, it's so disparate. It's youth leagues, for example. It's the whole ecosystem. It can be data analytics for sports.

28:45Blair Jacobson:It can be ticketing for sports. It can be equipment. I mean, it's very diverse. But again, when we evaluate team opportunities, another thing to mention is where are we in the capital structure? Go back to what we've been talking about quite a bit. Aries DNA is a credit DNA. It's our single largest business, as we've also mentioned. So therefore, from a downside perspective, how we invest in sports teams is rarely is a pure equity owner. Many of our investments, including some that you mentioned, are structured. Many of them come in the middle of the capital structure with a lot of equity subordination, equity value underneath our loans.

29:28Blair Jacobson:So when we run our downside cases, yes, do we look at if maybe some of the funds dry up due to either relegation or changes in league position? Absolutely. And we want to make sure that we're aligned with the best teams, not, for example, a team that was recently promoted and might be relegated in the next season. Some of the ones you mentioned have been in their respective leagues, in the top of their respective leagues for decades, if not longer. I would say on the team side, that's what we're focused on. So when, in the case of Chelsea, it's a PREF equity, you've got no security, you're taking a view on the likely cash flows and the growth of the franchise,

30:12and I guess it's a matter of public record what the coupon is on that PREF equity.

30:16Blair Jacobson:Put it this way, without getting too deep into confidential details, You know, where we are in the capital structure is different from where the equity holder is, the common equity holder is. And when we think about where our loan to value is based on the company, its revenue profile, not only tickets, a lot of the revenue, of course, comes from broadcasting revenue, comes from league, etc. In addition to just general merchandise sales and other branding opportunities, we feel very good about where we're sitting in the capital structure. And allied to this is the media and entertainment businesses that you're in.

30:53We just did a curated interview with Philip Moros, who runs Cutting Edge Group, which is a fascinating business that's just merged with Warner Brothers Music. How are you thinking about that space? Because, again, lots of variability, one would have thought, in revenue streams.

31:09Blair Jacobson:Yeah, I'm glad that you asked that question, because when we say SME, it's sports media entertainment. Most people stop at the S because it's most visible and really interesting for people. But it is a broad and diversified strategy. And again, go back to what I was mentioning before. We value very, very stable and diversified revenue sources. So to pick another example that should hopefully resonate, we very much like the music royalty space. Right. So for example, again, if we can make a loan to a diversified catalog where you've got a lot of historical operating history in diversification, that's something that we really, really like doing.

31:51Blair Jacobson:Again, probably more from a lending perspective, perhaps, than an equity perspective. But again, as we think about the broad swath of opportunities, everyone is consuming much more media, more broadly. Sports, by the way, is the only thing people still pay for live that's very important. But if you think about the amount of time that people spend on Spotify, streaming music, et cetera, that's another massive grower. So I'd say that our music investing is a bit of a derivative of that trend. I understand. There's other side of your business that's super important is infrastructure. And in reading some of your commentary, and I'm going to quote you, say infrastructure debt provides lower correlation and lower risk.

32:35But axiomatically, it also provides lower expected returns. So how do you think about infrastructure? And it sounds to me like the debt is the piece of the equation where your specialization is. How should investors think about the return of that piece?

32:50Blair Jacobson:Sure. I'd frame it in a couple ways. The first thing to mention is we are engaging in an infrastructure super cycle. The amount of capital that will be required, not only to satisfy mundane needs, fixing roads and bridges and airports and the like, but as we think about energy transition. I mentioned digital infrastructure a little bit earlier as we think about the explosive growth there. All of that will require capital, debt, and equity. I think what we've seen in particular in a European context is that given the fiscal position of the governments around Europe and the UK, the government won't be able to fully satisfy all that.

33:33Blair Jacobson:So the need for private capital is very, very significant. So when we think about pricing infrastructure debt, a lot of it actually goes back to what I was mentioning in the SME context as well, which is to say, if you're backing something with either a long-term contract or revenue visibility, where your counterparties are very, very strong and creditworthy, that makes for a very, very good investment thesis. Where we see infrastructure debt pricing, it's usually a little bit of a discount to sort of equivalent corporate debt. But a lot of that is based on the quality of the infrastructure asset itself and, again, its revenue profile, its contracts, which aren't always available in the corporate world.

34:19Blair Jacobson:So in terms of risk-adjusted returns, we're seeing a lot of interest from our clients who, again, want that yield to focus on infrastructure. And what we're seeing more broadly is the typical context of private credit is corporates. Again, banks are doing a little bit less. It's more in the fore. Private equity firms are big consumers of leveraged finance. They do a lot of business with us. What we're seeing is our asset classes are growing dramatically outside of corporate. That's asset-backed. It is infrastructure. It's many of these other areas. It's real estate debt that are growing dramatically.

34:54Blair Jacobson:So again, we see a big future in infrastructure debt. So having been in the business a long time, only in the last year or so did I hear the term continuation fund. And maybe only a few years before that, that I come across secondaries, particularly credit secondaries. Now, you are strong in both. The cynic will say, particularly when it comes to continuation fund, that's because, you know, the usual exits aren't there. Why are they wrong? Good question. So let's talk first about secondaries. As I think the audience will appreciate, the asset classes that we operate in are illiquid. We do get a premium for investing in illiquid assets.

35:37Blair Jacobson:We also require our investors to agree to a 10, 12 year fund construct in general that is in itself illiquid. However, decades ago, it was discovered that you could have secondaries, which in the original context meant the limited partner investors in the fund could seek to sell or exit their positions to a larger pool of secondary capital. It started with private equity, then moved on to real estate and infrastructure. But now we're starting to talk about credit secondaries. And the high level theme is that you think about the stock market turns over almost 100 % every year, whereas private investments, 1, 2, 3, 4%.

36:20Blair Jacobson:So again, there's some room to grow there. So let's talk now about continuation vehicles. I would say in private equity, they're used for different reasons than what we see in the credit space. In private equity, if you're a manager, you say to yourself, I've owned this company for five, six, seven years. I've built a lot of value. But Warren Buffett doesn't have to sell his companies. He likes to hold them for a long time, continue to benefit from that appreciation. So if I'm the private equity manager, I have this relationship, this sort of vested interest. If I can orchestrate a way for my investors to get liquidity, if they want to, by the way, if they don't, they can roll into this new vehicle.

37:02Blair Jacobson:well, I can continue to manage that company that I've invested so much time and effort into for a longer period of time. That's basically how the CV market works in private equity. Credit's a little bit different. Credit's only a few years old. And the reason for that is this always tracks the development on a lag of the primary business. And again, as private credit has grown, it was only natural that over time, secondaries would start to play a bigger role in continuation vehicles. What we've seen thus far in terms of continuation vehicles for credit is when investors say, I've been in a fund for eight or 10 years.

37:43Blair Jacobson:I've gotten back maybe all of my invested capital. I'm really playing for a little bit more, but maybe I want liquidity sooner. Maybe I have other obligations I need to meet, or maybe I want to reinvest capital in another area. So I think on On a credit side, it's been more of a liquidity management tool for investors. And again, for us as the fund manager, we can continue to manage those exits until they realize. Now, remember, the big difference between private equity and credit is in equity, you control your exit. You can hold something forever. Credit, every underlying loan does have a maturity, usually seven or eight years.

38:23Blair Jacobson:So in credit, those vehicles naturally will have to wind down over time, whereas in equity, they don't. Clear. Thank you. Now, all of this also points to the huge and burgeoning enthusiasm around the asset class. We know where spreads are. They're tight. We might come back to that. I believe you were in the House of Lords undergoing a sort of examination last week about the space. And at the same time, we've got the stock market beginning to maybe it's just a little a temporary loss of enthusiasm. The stock prices of these companies are all a bit weaker as well. What do you think the market's worrying about?

39:07Blair Jacobson:So I think from our perspective, you know, we're very focused on the long term. That's what we tell our investors. You know, do we watch things day to day? Yes. But again, we're much more focused on the long term. However, there has been a news cycle more recently concerning some significant bankruptcies in the United States. Are those related to private credit? Does it presage issues to come in the future? I think you mentioned Jamie Dimon earlier making some comments. And that's a narrative that as a firm we've come out strongly against. We do view these credit events in the U.S. as being a bit idiosyncratic.

39:48Blair Jacobson:Both actually had fraud allegations attached to them. And interestingly, neither had major private credit investors. Actually, the investors in these companies were the broadly syndicated loan markets and also bank balance sheets. So I think our perspective is, you know, these things will happen from time to time, but they don't presage any major issues with private credit, although I think the news is getting their minds around it. And that impacts the public markets. But in fact, what we've come out and said recently in our earnings announcements is the quality of our underlying loan portfolios remains very strong.

40:28Blair Jacobson:And as an example, in the United States, that's 600 underlying companies. It's a pretty good sample set. And what we've said is that profits are growing high single digits, low double digits. We're saying loan to value in those companies is approaching 40%. That means that there's 60 % equity subordination in these loans. And further, in terms of broader credit metrics, those are also trending in a positive way as the companies are growing. And also, as you said, rates are coming down a little bit. So actually, from a fundamental perspective, we think things are in pretty good shape. Maybe it takes the market some time to get their mind around.

41:08Blair Jacobson:That's why we're always very happy to tell the story. I told this story, as you said, last week in the House of Lords. So we understand the concerns. We just don't think that they apply to our business. But the concern that keeps on coming back for me, which is bigger than, you know, Aries, is that the new arrival on the buyer front is individual wealth. I know you said you've dealt with sort of the individual cohort for a long time. But typically, you know, the individual area gets to this stuff, you know, later. a lot of credit can behave like equity when we hit, you know, hit the skids. Do you worry about the sort of the flurry of excitement around private credit, particularly for the individual?

41:56Blair Jacobson:So overall, again, you know, we've offered our private credit vehicles to retail investors through to BDC for over 20 years. It's performed very well through some very difficult times, by the way, through the GFC, Brexit, COVID, high inflation, high rates. So again, I think we've shown over time performance is good. Loss rates are like low single digit basis points, incredibly low. That's now broadening out. It's broadening out first with high net worth investors. We think it's a good thing for them to get access to what institutions have primarily had access to before, but only in the right ways.

42:34Blair Jacobson:These are investors who are very, very carefully qualified. They have to meet many standards and requirements. They also receive significant education through their financial advisors in the first instance. So I think it is a knowledgeable investor who comes into these types of products. And hopefully we believe has been educated about the potential risks and understands those over time. The next wave which is being discussed is making it even broader, in particular, in the United States to 401k clients, I would say in some degree. And can that effectively be a small portion of their portfolio?

43:13Blair Jacobson:Similarly, again, if they're educated, if they're qualified, if they understand what they're getting themselves into, both the risk and the opportunities, we think that's a good thing. Well, I've asked you all my questions, and we've now introduced a section to the podcast. It's the first one today. We're calling it the Outsiders Inquiry. So we go and seek out some questions from folks who know much more than people like myself. And one of them is David Forbes Nixon, who I've known for a long time, founded Alcentra. So he knows the private credit space really well. So he said, given the huge growth in the direct lending market with loans originated by non-banks having bullet maturities and covenant light structures versus the bank originated syndicated leverage loans, isn't there a real risk that we're going to get a lot more zombie companies?

44:00Blair Jacobson:So take a step back. You asked earlier about our screen and our filter. Again, what we're trying to do is lend to the absolute best companies that we can find. We define that in a couple of ways. Number one, as I mentioned, they're growing. High single digits, low double digits. Very profitable. Average margins, 20%, 25%. Importantly, they're in sectors, in industries with good tailwinds. Things like healthcare, business services, telecommunications, software, really good businesses. And from that perspective, again, we've been with these companies for a very, very long time. We're not super worried about zombie companies.

44:41Blair Jacobson:Again, these are companies that have professional owners that are also driving results. One thing to mention as well is 80 or 90 % of the businesses we back have professional ownership in the guise of private equity firms in particular, who also have exit ambitions. So I would say that that's not the biggest risk that would keep me up at night, but I appreciate David's great question. Well, the other one was from Hugh Van Stenis, who was on a few weeks back. And of course, you know well, he writes a lot of it, vice chair of Oliver Wyman. He said, in the flurry of recent credit events, including frauds, is this just symptomatic of a paper cut or something deeper?

45:21Blair Jacobson:So, again, I would say paper cut at best. Going to what I had mentioned earlier, in particular around the U.S., by the way, fraud is really hard to detect. I think it always happens once or twice in everybody's career. We're, that's also why from a credit investing perspective, we have massively diversified portfolios. So if anything does happen, it doesn't impact the portfolio that much. But I should also, you know, go to some pains to mention that those businesses, now there are three that were indicated, and again, potential fraud, this still needs to be investigated. You know, all of those were entrepreneur companies.

45:59Blair Jacobson:None of them were backed by private equity. I think most of our industry faces private equity who are very responsible owners of businesses, very low correlation with fraud. So I think from our perspective, paper cut it best. So we can move to some general questions. And one of them, because we have a lot of young listeners, is when you interview a bright young person who wants to come work at Ares, what are the one, two, or three things that are most likely to make you ask them back for another interview? Sure. I think once you clear the bar of basic knowledge about our industry, our company, and by the way, you need to do some research on a firm that you're interviewing with specifically, you know, as well as basic financial competence and literacy.

46:48Blair Jacobson:I think we're trying to understand things like what motivates you? What gets you out of bed in the morning? Second thing would be, are you a well-rounded person? But it's great to have people who work 24-7, but we do want people to have some balance. I mentioned earlier in my career, in my education, I value this, you know, quite a lot personally. as well. I say third thing is, how much do you know about the world? I always ask people if they read a newspaper every day. By the way, the answer is usually no. I've had two hard copy newspapers delivered to my home for more than 30 years. I feel very strongly that you can't operate in your own silo or vacuum.

47:34Blair Jacobson:You really need to understand what's going on in the economic situation, different companies and politics, et cetera. So say those are sort of the extra ways that candidates can differentiate themselves. Different question. I see you're a fellow of the Saeed Business School up at Oxford. We know Jack Edmondson very well of OSE. And, you know, Will Campion has this great sort of network around Oxford. We've done a few interviews with some of the spin outs as well. We've got Steve Schwartzman, I believe, putting money into a humanities center. Larry Ellison's putting a vast amount of money. I've got two questions.

48:08One is, what does it give you and what do you think you give the audience, which is a cyber business call. And the other is, as there has been some disaffection with US politics, there has been a sense there is some brain drain growing on and Oxford and Cambridge might be beneficiaries. And I wonder whether that's just super marginal being extrapolated because these are big sums of money being invested as well.

48:30Blair Jacobson:So the answer to the first question, I've always valued education very, very highly. My mother was a teacher for 45 years. And, you know, I've always believed that when I have something to give back, given my station, educating that next generation is critical. and I've also believed that universities can benefit from practitioners in addition to academics sharing. So what I usually do is I go, I was actually there last night lecturing as well. I usually teach in a private equity module, but what I tell the students is that if you do not understand the L in the LBO, you don't understand anything and their eyes always light up like, wow, there's more than just the equity side.

49:14Blair Jacobson:So again, bringing the benefits of my 30-year-plus career to these students who are generally just starting to think about or embark on their careers, I think, can be very, very powerful. And I get a lot out of it, too. They always ask very interesting questions that are quite well-educated. Maybe they're getting them from ChatGPT. I'm not sure. I think it's for the Money Maze podcast. But anyway. They definitely get it from you, Simon. So again, I get a lot out of it. I sort of see the gears churning in their brains. And it's something that I'm very, very committed to. And I think when you look at the state of the UK in education, that is one of the principal assets of this country.

49:55Blair Jacobson:You actually mentioned at the very beginning the UK's situation. And despite the politics, despite the economics, it's very well situated globally. It has a longstanding democracy, longstanding functioning economy. But again, the university system here is incredibly powerful. And it would not be surprising in an international world where everything is fluid and people can move around that with additional funding, additional focus, will it draw and continue to draw the best minds in the world to study here and produce? Absolutely. Yeah. And on our summit, we reiterated this sort of, you know, these, if you call them green shoots of recovery, to use a former UK chancellor's expression, there's some really fascinating, outstanding, exciting stuff happening.

50:42Some of it's coming out of the universities, a lot of entrepreneurialism, you know, the narrative is relentlessly bearish around the UK, but, you know, perhaps, you know, it is. It means it's a good time to invest. Yeah, yeah, yeah. Well, you know, BlackRock and others as well has been doing it and you've obviously got this big footprint here. Um, what's the most interesting book you've read in the last year?

51:03Blair Jacobson:Oh, wow. Um, I'll give you a fiction book that I really liked. Um, hopefully everyone remembers the seminal movie Jaws that just celebrated, uh, its, its major anniversary. Um, a UK writer contacted, uh, the Benchley family, uh, who, who guy wrote Jaws and said, I would like to do the following. the most memorable character from everyone thinks it's Roy Scheider, but it was actually Robert Shaw's character, Quint, who was manning the boat. And he gives the seminal speech in the movie about being on the USS Indianapolis, the ship that went down in the Pacific delivering the atomic bomb in the 40s.

51:43Blair Jacobson:And the crew were then basically devoured by sharks. So this writer wrote a book called Quint, a first-person autobiographical novel from his perspective, and it is a fantastic read. Not only do you learn the background of this character, he takes you through what happened on the USS Indianapolis. And I will tell you, you will learn more about sharks than you ever cared to by reading this book. And that was a great fictional novel that I would highly recommend. It's called Quint, Q-U-I-N-T. okay well we'll put that and the link in a in our show notes and final question um you live here in the uk you've got this us sort of you know heritage and you know and actually you know more you know going back if you could only go to one place on holiday for the rest of your life where would it be by the way you're not allowed to say montana because you will have noticed when you came and got these fantastic pictures by davie arrow who is probably the world's most celebrated fantastic He's Ansel Adams quality photographer.

52:49Blair Jacobson:We have a big debate in my family. Some of us are mountain people. Some of us are beach people. I think I would actually err on the side of the beach in that regard. There's a little island 30 miles off the coast of Massachusetts called Nantucket where we often holiday. And if I had one place to go, I think that would be it. So I'm going to conclude because we've talked to quite a lot of the large entities such as Ares and everyone has a, you know, it's a different story angle perspective, you know, history. I mean, what's come through loud and clear to me is the fact that in going outside of the US and going global, you've put boots on the ground in physical locations because it is that being local, which might once have been a slogan of Citibank, but which is clearly happening, you know, with you guys, that it is credit that is your go-to, most comfortable area of expertise.

53:51And in fact, notwithstanding the, you know, some of the negative narrative that has been emerging around, you know, credit losses and these frauds, et cetera, you're feeling pretty comfortable about your, you know, your own, you know, position opportunity. And actually, if I read between the lines, putting the UK aside where, you know, I think we agree on the opportunity set, even in Europe, there is a shift in the structural provision of capital happening, which is, you know, and even Xavier Rowley in an interview we did way back when was bemoaning again that thing, but there is some sense of shift, which is absolutely what, you know, what is needed.

54:30So I've really enjoyed this conversation. I also took that, you know, when you were lecturing at Oxford Saeed Business School last night, you said that the L in the LBO, and for those who didn't quite pick it up, that's of course is leveraged. And that's the great enemy at times if you've not got it right. And, you know, understanding risk, as Todd Bowley said the other day, I'll do credit all day long. Indeed. You know, if I can get in the right position in the capital stack. It's been fantastic to have you here, Blair, today. Thank you very much.

54:56Blair Jacobson:Thank you so much, Simon. It was a great, great session. Thank you.