Q4 2023 Ares Management Corp Earnings Call

Participants

Greg Michael Mason; MD of Public IR & Communications; Ares Management Corporation

Jarrod Morgan Phillips; Partner & CFO; Ares Management Corporation

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

Brennan Hawken; Executive Director and Equity Research Analyst of Financials; UBS Investment Bank, Research Division

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

Luke Bianculli; Research Analyst; Goldman Sachs Group, Inc., Research Division

Michael C. Brown; MD; Keefe, Bruyette, & Woods, Inc., Research Division

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

Michael Patrick Davitt; Senior Analyst of US Asset Managers; Autonomous Research US LP

Nicholas George Benoit; Research Analyst; Barclays Bank PLC, Research Division

Steven Joseph Chubak; Director of Equity Research; Wolfe Research, LLC

Presentation

Operator

Welcome to the Ares Management Corporation Fourth Quarter and Year Ended Earnings Conference Call. (Operator Instructions) As a reminder, this call is being recorded on Thursday, February 8, 2024.
I'll now turn the call over to Greg Mason, Co-Head of Public Markets Investor Relations for Ares Management. Please go ahead, sir.

Greg Michael Mason

Good morning, and thank you for joining us today for our fourth quarter and year-end 2023 conference call.
I'm joined today by Michael Arougheti, our Chief Executive Officer; Jarrod Phillips, our Chief Financial Officer; and Carl Drake, who has moved to a new advisory role within our Public Markets Investor Relations team. We also have a number of executives with us today who will be available during Q&A.
Before we begin, I want to remind you that comments made during this call contain forward-looking statements and are subject to risks and uncertainties, including those identified in our risk factors in our SEC filings. Our actual results could differ materially, and we undertake no obligation to update any such forward-looking statements. Please also note that past performance is not a guarantee of future results, and nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase an interest in any Ares fund.
During this call, we will refer to certain non-GAAP financial measures, which should not be considered in isolation from or as a substitute for measures prepared in accordance with generally accepted accounting principles. Please refer to our fourth quarter and full year earnings presentation available on the Investor Resources section of our website for reconciliations of the measures to the most directly comparable GAAP measures. Note that we plan to file our Form 10-K later this month.
This morning, we announced that we declared a new higher level of quarterly dividends, starting with our first quarter common dividend of $0.93 per share on the company's Class A and nonvoting common stock, representing an increase of 21% over our dividend for the same quarter a year ago. The dividend will be paid on March 29, 2024, to holders of record on March 15. Jarrod will provide additional color on the drivers of this increase later in the call.
Now I'll turn the call over to Mike, who will start with some fourth quarter and year-end business highlights.

Michael J. Arougheti

Great. Thank you, Greg, and good morning, everyone. I hope everybody is doing well.
We're pleased to report that we ended a great year of execution on many fronts with a very strong fourth quarter. Despite a difficult year for fundraising across our industry, we experienced strong demand for our funds, raising more than $74 billion in 2023, including more than $21 billion in the fourth quarter. This was our second largest fundraising year, and it was a record amount of capital raised directly from institutional investors. We entered 2024 in the enviable position of having more than $110 billion in dry powder to invest in what we believe is an attractive vintage, providing the opportunity to drive strong earnings growth in the years ahead.
In the fourth quarter, transaction activity picked up as market participants gained greater certainty with respect to interest rates and the economy. Against this backdrop, we were able to leverage our growing investment platform to record our strongest quarter of deployment for the year, which matched our second highest quarter on record. Our Q4 deployment jumped more than 40% compared to our third quarter, and we're encouraged that higher-than-typical levels of activity for this time of year have spilled over into the first quarter.
We also continued to deliver strong relative investment performance for the year. And in fact, our U.S., Europe and Asia direct lending strategies generated double-digit returns in 2023. We believe that our consistent performance through cycles is resonating with investors, and our LPs are committing additional dollars across our broad set of strategies.
For the year, we drove double-digit growth across many of our key financial metrics, including 19% growth in AUM and management fees and 17% growth in our fee-related earnings. I'd add that our fee-related earnings, excluding FRPR, increased by more than 20% year-over-year.
We believe that our ability to generate this level of fee-related earnings growth in a market where M&A activity was down over 35% speaks to the resiliency of our management fee-centric business. Going forward, we believe that we are headed for another strong year as Jarrod will walk you through a little later in the call, but I do want to highlight a few key points.
First, we believe that the expectation for lower interest rates and better-than-expected economic growth is viewed as a significant relief for the deal markets. And we expect it will help drive higher transaction activity to start the year. We also believe that other factors like the aging of private equity dry powder and the demands by LPs to return capital are also supportive of higher activity. Fortunately for us, we believe that we're well positioned for a pickup in deployment activity due to the significant investments that we've made, adding 230 net investment professionals since the peak in market activity in 2021. We've built an origination engine that's capable of doing much more and an increase in market activity should enable us to drive efficiencies across our greater headcount of investment professionals.
Secondly, we believe that we're approaching a step function in the growth of our net realized performance income. We're nearing an inflection point and a recognition of net realized performance income from our European waterfall funds that have been performing and growing since 2017, and therefore, we expect to ramp up this year and an acceleration in 2025 and beyond. As an added benefit, if market transaction activity does in fact improve, we could see more of this income pulled forward from realizations, but it's still too early to make that call. Overall, we believe our business is well positioned to operate in a variety of market environments. We're resilient in tougher, slower markets but can see deployment and realizations accelerate during more active market environments.
Third, we have a lot of momentum with our investors as we experience strong demand for not only our private credit strategies but also our opportunistic real estate, real estate debt and our secondary strategy offerings. In 2024, we believe that we're set up for yet another strong year of fundraising as some of our largest fundraises spilled over into the new year, and we're launching several new large funds with expected closings this year.
Let me walk you through some recent activities to provide insights on where we stand heading into the new year.
For the fourth quarter, the $21.1 billion we raised was our third highest quarter on record and just slightly behind what we raised in Q3. In our credit strategies, we continue to make great progress, raising our third U.S. senior direct lending fund with another $1.8 billion in new equity commitments in Q4, bringing the total equity commitments to $8.3 billion at year-end with total investment capacity of $15.2 billion, including anticipated leverage. We've already surpassed the $8 billion in LP commitments from our previous vintage, and we anticipate a final close in the second quarter with the ability to add further leverage capacity thereafter.
Our sixth European direct lending fund raised another EUR 1.3 billion in equity commitments and a EUR 2.5 billion leverage facility during the fourth quarter. With over EUR 550 million closed thus far in the first quarter, our equity commitments for this new fund now total EUR 11 billion. And with anticipated leverage, the fund has over EUR 16 billion of investable capital. We've essentially matched the size of the previous vintage, and we expect further upside into a final close later in 2024.
Pathfinder II held a final close in October, only 7 months after its first close. The fund received $6.6 billion in total commitments, surpassing our $5 billion target. The fund hit its hard cap and was almost 80% larger than its predecessor fund. And as with its predecessor fund, Pathfinder II is structured with a unique charitable tie-in whereby at least 10% of the carried interest will be donated by Ares and the team to support global health and education initiatives. To date, the Ares Pathfinder family funds have generated returns that would result in approximately $19 million of charitable contributions.
We raised another $900 million in equity commitments for our fourth U.S. opportunistic real estate equity fund bringing total commitments to over $2 billion, exceeding the previous vintage. Within real estate, we also raised another $500 million in debt and equity commitments in our European real estate debt strategy, bringing total assets to approximately $2.4 billion. Within private equity, we raised $1.4 billion of commitments during Q4, and we'll continue our fundraising throughout most of 2024.
In secondaries, we held a final close for our Real Estate Fund IX, raising $3.3 billion in commitments, inclusive of affiliated co-invest vehicles. This latest fundraise matched the size of the predecessor fund, which was the largest real estate secondaries fund closed in the market to date. We now have completed the top 2 largest real estate secondaries fundraisers, which puts us in a great market position.
Fundraising in the wealth management sector continues to be an area of focus, and we see significant growth potential here over the next decade. We're starting to see an acceleration within the wealth management channel as our broadening set of products is attracting a growing number of distribution partners.
For the fourth quarter, we raised $1.3 billion in equity commitments. For the full year, we raised $3.6 billion in equity commitments and nearly $5 billion, including debt commitments. According to third-party industry data, we were ranked in the top 3 among the public alternative managers in overall wealth management fundraising in 2023 as we were able to gain market share in a difficult environment.
Our strong momentum in the fourth quarter has carried over into January as we had our largest month ever for wealth inflows, totaling over $600 million across our 6 products. Now after putting in place the infrastructure over the past 18 months, we're also set to see our international fundraising efforts materially increase in the first half of this year.
Let me walk through an update on a few of these wealth products. Our non-traded BDC, ASIF, raised nearly $500 million in equity commitments during the fourth quarter. And our European equivalent, AESIF, raised over $150 million closing on January 2. During January, these 2 funds raised an additional $350 million in the aggregate, which underpins our expectation for continued strong fundraising in the wealth channel during 2024.
Within private equity, we're now seeing a significant ramp in our Ares Private Markets Fund or APMF, which launched on its first wirehouse in September and raised roughly $240 million in the fourth quarter. And with over $800 million in assets today, the fund is continuing to gain scale and momentum.
Our 2 non-traded REITs raised $273 million combined in the fourth quarter and more than $1.3 billion for the full year. Both funds continued to generate positive net flows for both Q4 and the full year as we meaningfully outperformed the overall non-traded REIT market on a net flow basis.
Another area of high strategic focus is our affiliated insurance business. Aspida finished the year with nearly $12.5 billion in assets, more than doubling its $6 billion in AUM at the beginning of last year. And we remain on track with our target of $25 billion in AUM by the end of 2025. Aspida has now achieved operational scale and is generating attractive returns for both annuity holders and Aspida equity investors.
We had very strong deployment in the fourth quarter totaling $24 billion, matching our second highest quarter on record. Fourth quarter deployment across the credit group increased nearly 60% over the third quarter driven by strong results from our U.S. and European direct lending and alternative credit groups. Jarrod will discuss our fund performance in more detail, but our investment portfolios continue to be in excellent shape. We continue to see strong EBITDA growth across our credit and private equity portfolios. And in fact, we saw an acceleration of EBITDA growth to approximately 8% year-over-year within our U.S. Direct Lending segment.
Our corporate credit portfolios, which were more than 95% invested in senior debt at the end of the year continue to have low defaults and lower-than-historical levels of loan to value. Our global real estate portfolio continues to experience resilient fundamentals due to our allocation to the best performing sectors with 50% of the gross portfolio in industrial assets, 24% in multifamily and another 13% in similar adjacent sectors like student housing and self-storage.
We're meaningfully underweight in U.S. office at about 4% of our total real estate portfolio and less than 1% of our AUM. Our opportunistic real estate and special opportunities teams recently formed a joint venture with a leading owner and investor in commercial real estate in New York. The JV has commitments of $500 million, and we'll seek to invest in high-quality distressed office buildings in New York as capital for the asset class has become increasingly scarce.
And now I'd like to turn the call over to Jarrod for additional commentary on our financial results and our outlook for the year. Jarrod?

Jarrod Morgan Phillips

Thanks, Mike, and hello, everyone.
Despite a difficult market backdrop for deployment and monetizations, we experienced double-digit year-over-year growth in nearly every key financial metric, including management fees, fee-related earnings, realized income, AUM and FPAUM.
Our management fees increased 19% for both the fourth quarter and for the full year driven primarily by strong deployment of our invested capital, especially within our global direct lending and alternative credit strategies.
In the fourth quarter, FRE totaled $369 million, an increase of 10% from the fourth quarter of 2022 despite a steep decline in FRPR from real estate funds that contributed $65 million in FRE in 2022. For the full year, FRE exceeded $1 billion for the first time in our company's history and increased 17% from the prior year.
Of course, our year-over-year FRE growth was partly impacted by the fact that we did not generate any FRPR from our nontraded REITs as we expected. Our FRE, excluding the FRPR specifically from our real estate nontraded REITs, increased 25% over 2022, a little ahead of our 20%-plus guidance that we provided a year ago.
Our FRE-rich earnings remain a key differentiator for Ares as FRE again accounted for more than 90% of our realized income in 2023. Our FRE margin totaled 41% for the quarter and 40.9% for the full year. Excluding FRPR, which has a lower margin due to the contractual compensation ratio we've discussed in the past, our core FRE margin was 41.8% for the fourth quarter, which was up 120 basis points versus the comparable margin a year ago.
With over $74 billion raised in 2023 and an available capital balance of over $110 billion, we expect to see continued margin expansion as we deploy our capital. We continue to believe that we're on track to reach our goal of roughly 45% core FRE run rate margin by the end of 2025.
Let me turn to our fee-related performance revenues or FRPR. FRPR totaled $180 million in 2023 compared to $239 million in 2022. In the fourth quarter, FRPR from our credit group totaled $166 million, which was about $46 million above the high end of the guidance we provided on last quarter's conference call. A large part of this outperformance was driven by higher-than-expected loan pricing as a result of tighter credit spreads as well as positive currency movements into year-end. The remainder of our FRPR was generated in our secondaries group from APMF, a retail-focused product. We are excited about the momentum for APMF and could see growing contributions to FRPR as the fund scales.
As I mentioned, we did not generate FRPR from our 2 non-traded REITs during 2023. And both AREIT and AI-REIT will need to make up for negative returns in 2023 before earning any FRPR. Fundamentals across these real estate funds remain resilient, however. We will likely need to see interest rates moderate and cap rates stabilize before these funds can generate additional FRPR. For this reason alone, it is more likely that we would see FRPR from the 2 non-traded REITs resume in 2025 as opposed to 2024.
Our realization activity increased significantly in the fourth quarter compared to Q3 with realized net performance income totaling $77 million in the quarter, including $57 million of European-style waterfall funds. For full year, nearly 70% of our realized net performance income came from European waterfall-style funds. In addition, we also generated net realized performance income from incentive fees, which recur on a regular basis that are not derived from perpetual funds. In 2023, we generated $27.5 million in net realized performance income from non-European style incentive fees, up from $20 million in 2022.
As I talked about before, European-style waterfalls are relatively predictable within a given time horizon, but can vary as to the exact quarter in which they'll be received with the fourth and second quarters typically the most common for larger amounts. In reviewing last quarter's estimate for 2024 European waterfall-style net realized performance income, we recognized about $13 million that was pulled forward into this fourth quarter. That said, our expectations for the next 2 years are modestly higher with approximately $420 million of net performance income from European-style waterfall funds. Of this amount, we expect approximately $145 million in 2024 and $275 million or more in 2025.
Over the long term, we're targeting more than $3.5 billion of net realized performance income over the life of these European-style funds already raised. As we have discussed, the timing of the early fee recognition depends on -- partially on market transaction activity levels.
In 2023, our balance of net accrued performance fees increased 10% to $919 million and nearly $700 million of this amount with an EU-style waterfall funds. The increase was largely driven by the deployment of incentive-eligible AUM that yields in excess of the hurdle rates leading to growth of our incentive-generating AUM and the compounding of higher floating rates, particularly in our private credit funds. Realized income for the fourth quarter totaled a record $434 million. And for the full year, realized income exceeded $1.2 billion, a 12% increase from 2022.
For the full year 2023, our effective tax rate on our realized income was 9.1%. Last year, we benefited from tax deductions related to the exercise of options by employees. These options were granted as part of the IPO and are set to expire on the 10th anniversary of our IPO this year. As a result, only a trivial amount of these options remain unexercised. And accordingly, significant related tax deductions associated with the options will not recur. Therefore, we anticipate an effective tax rate on our realized income to be in a more normalized range of 12% to 15% in 2024.
As of year-end, our AUM totaled nearly $419 billion, up 19% over the previous year and was driven almost entirely by organic growth. Our fee-paying AUM totaled nearly $262 billion at year-end, an increase of 13% from year-end 2022.
Our available capital totaled $111.4 billion. So we have nearly $63 billion of AUM not yet paying fees available for future deployment, representing over $621 million in incremental potential future management fees.
As Mike highlighted, our portfolios continue to perform very well. For the full year, we experienced double-digit returns in our U.S., Europe and Asia direct lending strategies as well as in our special opportunity strategy. Within real assets, our infrastructure strategies performed in line with expectations, delivering a high single-digit return in volatile markets. In real estate, our returns were impacted by higher cap rates and interest rate volatility, which pressured valuation. However, the underlying property fundamentals remained resilient, and we believe we are well positioned to generate strong performance once cap rates stabilize. For example, in 2023, our industrial portfolio saw a 50% rent growth on the same-store new and renewal lease rates, and our multifamily portfolio continue to see positive rent growth.
Now let me provide some comments on our go-forward outlook and our new dividend level. We anticipate that our fundraising momentum will continue with additional closes on our large fundraises and process, as Mike stated earlier, coupled with recent or effective launch this year of 4 more significant fund series across our strategies. We expect these larger fundraises will be supported by our ongoing and growing inflows from smaller co-mingled funds, wealth management funds, insurance, SMAs and other open- and closed-end vehicles. In fact, we expect to have approximately 35 different funds in the market across 17 of our strategies in 2024.
Although it will be unlikely that we match the amount we raised in 2023, we expect it to be another strong year. And we are already well ahead of our pace to reach our target of $500 billion in AUM by the end of 2025. Keep in mind that our fee-related earnings trajectory is more dependent on the pace of our deployment rather than fundraising activity. With a record amount of dry powder, we're well positioned for higher deployment if market activity levels remain stronger.
This leads me to our dividend. At the beginning of each year, we set our quarterly dividend at a fixed level for the coming year. Based on the significant outperformance of our fee-related earnings relative to our dividends and our strong growth prospects for FRE this year, we've elected to increase our quarterly dividend to $0.93 per share on the company's Class A and nonvoting common stock, a 21% increase compared to 2023.
Finally, we continue to be on track with our 2021 Investor Day guidance of FRE and dividend per common share growth of 20% or more through 2025. And I'm pleased to announce that on May 21, we will hold another Investor Day to coincide with the 10-year anniversary of our public listing on the New York Stock Exchange. At that time, we'll provide an update on our business goals and objectives.
I'll now turn the call back over to Mike.

Michael J. Arougheti

Great. Thanks, Jarrod.
In closing, we believe that we're very well positioned for the year ahead with a record amount of dry powder, a more promising market outlook, an expanded and more diversified investment platform and a strongly performing portfolio. The investments that we've made in new personnel, new strategies, new vehicles and new distribution across the platform over the past few years are beginning to contribute more meaningfully to our business. For example, we're seeing momentum in our insurance, wealth management, infrastructure, secondaries and Ares Asia platforms.
Our fund performance also continues to be a source of differentiation, and our brand is strengthening with our investors and prospective portfolio companies. Collectively, our business is positioned to deliver strong relative returns for our fund investors, drive further growth in assets under management and create better operational efficiencies in the years to come. And as Jarrod mentioned, when you combine our strong FRE growth prospects with the inflection point that we're now reaching with our European waterfall realizations, we're poised to generate meaningful realized income in the years ahead.
I continue to believe that one of our greatest differentiators is our people and our culture. And as always, I'm so proud and grateful for the hard work and dedication of our employees across the globe. I'm also deeply appreciative of our investors' continuing support for our company.
And with that, operator, I think we could now open the line for questions.

Question and Answer Session

Operator

(Operator Instructions) Our first question comes from Steven Chubak with Wolfe Research.

Steven Joseph Chubak

So I wanted to start off with one just on the Alt Credit outlook. Just given some expectation that Basel III end game proposal could get watered down, I was hoping to get your perspective on the deployment opportunity in Alt Credit. Do you still see a substantial opportunity in areas like ABF and [RedCap] trades despite some of that potential softening? And what are you hearing from your bank partners specifically?

Michael J. Arougheti

Yes, it's a good question. We've talked about this before. Obviously, we were early, I think, in identifying the growing opportunity in Alternative Credit. I think it's important that people appreciate like so many things happening in private credit right now with both secular and cyclical.
So a lot of the secular trends that have been driving more capital formation in Alt Credit actually started post the GFC with the dismantling of the larger securitization apparatus on the Street and the proliferation of smaller finance companies in the wake of the GFC. And that trend, call it, the first wave has been very much intact for the last 10 years and has given us a nice backdrop to grow what we think is a market-leading business there.
Obviously, now with Basel III and some of the challenges that I think we all saw emerge in the banking sector generally early last year, there is an accelerated cyclical opportunity, obviously, to partner with banks largely in our Alt Credit business to help them navigate some of their balance sheet challenges. And that's been a keen area of focus but not an exclusive area of focus.
We talked on our last call about a sizable partnership transaction that we did with PacWest. We were public about a recent trade that we did on the risk transfer side. And those dialogues are ongoing and continuing. And I actually think that they will continue regardless of the resolution of Basel III end game.
I think what we learned coming out of the struggles in the sector were largely structural. And once we get past this first phase of balance sheet restructuring and repositioning, I think you're going to have a lot of banks, regional, super-regional and G-SIBs just rethinking core businesses and balance sheet positioning. And we put ourselves out there as a proven partner for them as they go through that.
So I think it's -- it bodes well for continued deployment. We had a very strong fourth quarter in Alt Credit. We're seeing that activity level spill over into the new year, and I'd expect that to continue.

Steven Joseph Chubak

That's great. Appreciate all the color. And for my follow-up, Jarrod, I was hoping to dig into some of the drivers of the dividend increase and especially in light of some of the constructive comments you made on FRE and deployment. Just given the magnitude of the increase, assuming a normal 75% payout, some of the share creep, it does imply close to 30% FRE growth in the coming year. Just wanted to get a sense that that's a reasonable expectation for FRE expansion. Maybe just help unpack some of the drivers of that FRE uplift.

Jarrod Morgan Phillips

Sure thing. And I think when we set our dividend policy out back in 2021, one of the things we articulated was that we pegged it with FRE but didn't necessarily match it perfectly to FRE. So as FRE grows, so do we expect the dividend to grow. And for the last couple of years, as I think everyone knows, we've had outpaced FRE growth against the dividend growth. And so certainly, that gives us a bit of a tailwind as we're determining what the dividend is.
And as we look forward, and we expect a positive year of deployment, especially with what we saw in the fourth quarter and what we've seen in terms of some of the trends so far this year, that gives us a lot of assurance in setting our FRE expectations as well as the dividend expectations for the year. And then you combine that with some of the EU waterfall guidance that we've provided, and we know that we'll have adequate coverage in terms of what we generate for the year to establish that. So it's not necessarily a 1 for 1, and we haven't historically targeted a 75% or a 90% ratio of what we would pay out for our dividend. So we feel good at that 20% or more level. And we feel like that it is indicative of the positivity we have around FRE growth as well.

Operator

Our next question comes from Craig Siegenthaler with Bank of America.

Craig William Siegenthaler

So our first one is on ASIF. It raised around $2 billion last year. And it sounds like that momentum carries on in January with another $350 million. So I wanted to see if you could give us an update on how many platform shelves the U.S. and European vehicle sit on today? And how many platforms do you expect them to be on by year-end? And also, overall, how important is your long-term track record with ARCC in terms of speeding up the ramp (inaudible) advisors?

Michael J. Arougheti

Sure. Good question. Just to clarify, Craig, the $350 million was both ASIF and its European counterpart, but obviously, strong numbers relative to the momentum that we saw building into the end of the year. I do think that both ASIF and AESIF are benefiting from our long successful track record at scale in the public markets. Obviously, as the market leader in direct lending and having run BDCs through cycles, I think that that is definitely a tailwind. And I think if you look at the early fundraising momentum that we're enjoying in both of those funds, that compares well to competitor products.
One of the reasons that we are so excited right now, both of those products are actually only on one platform. We had our first wealth closing in ASIF in August, and we actually now are expecting to add a significant number of new partners throughout the year, both in the U.S. and overseas, Europe and Asia. So I think you'll see that selling group increase dramatically as we get through the rest of the year. And needless to say that that should result in some pretty good fundraising momentum. Similarly, on AESIF, we have one partner. And our expectation is that we'll probably add 2 or 3 there as well in Q2 or Q3 of this year.

Craig William Siegenthaler

Mike, that's great. And let me just stick with the semi liquids here with AI-REIT and AREIT. How do you expect redemption requests to trend as it looks like investor spend in real estate may have reached an inflection. And also, we did receive some positive guidance on redemptions from your major competitor 2 weeks ago. And then following a potential decline in redemptions, how quickly do you expect sales to snap back just given that they're currently suppressed?

Michael J. Arougheti

Yes, I think -- and we said this in the prepared remarks, we're quite pleased with our performance relative to the rest of the non-traded REIT product in 2023, which was a difficult year just given performance headwinds and some of the redemption conversation around some of our larger peers. But if you look at the performance of both of the REITs, we actually had positive flows in the quarter and throughout the year, which I think is an outlier. I think that's a combination of the positioning of those funds.
There are some unique attributes in terms of our 1031 Exchange product that I think is a little stickier. Those funds are less leveraged. So we're going into 2024, obviously, having seen reduced sales but having positive net flows in both of those products. And my expectation would be that as some of the peer performance improves and people begin to feel like we're hitting bottom on cap rate and interest rates that you'll begin to see sales pick up there. So again, it's still early.
Our experience in January would tell us that the sales are still there. But I think once we get to a place where interest rates are moderating and the redemption narrative within the peer set has moderated, that we'll see ourselves accelerate as well.

Operator

Our next question comes from Patrick Davitt, Autonomous Research.

Michael Patrick Davitt

My first question is on kind of first quarter trends. The ARCC call highlighted current refinancing boom could be a headwind for net deployment in the quarter as M&A deal volumes are still picking back up. What are you guys seeing in terms of that give and take between new deal volume and refinancing outflows as the broadly syndicated and how yield market opens back up. And in that vein, are you seeing borrower interest directing the ship at all yet?

Michael J. Arougheti

Sure. I want to clarify some of the comments that were made on the ARCC call because that is not how I would interpret the commentary. There is a give and take in the market generally that when the markets are accelerating in activity, the banks will get more active, syndicated loan and high-yield market will open up and the CLO machine will turn on.
That's not necessarily a bad thing because that means that transaction activity is picking up, and there's an opportunity to drive higher volumes and higher fees. I think it's important that people appreciate at least from the Ares and ARCC perspective is that we continue to have a very, very strong focus on the traditional middle market. It's a very big part of what we do across the globe. And I think there's a little bit of a misunderstanding that a lot of the growth has come from share gains from the syndicated loan in high-yield market. And as long as we've been doing this, yes, there are moments in time when the loan market is closed. And at the higher end of the middle market, private credit providers can take share. And then obviously, when the markets heal, activity levels pick up. But unlike some of our larger peers, we are not dependent on a transfer of market share from the liquid markets in order to continue to drive the growth and performance that we've seen.
So to clarify, I think, the commentary, I would say the enhanced levels of activity and turning back on of the deal market writ large, I think, right now is significantly more of a positive than a negative. There are significant, what I would call mitigants to refinancing in the private markets unlike the liquid markets that tend to just be price-driven. A lot of that is just relationships. So if you look at our deployment, for example, in 2023, 57% of our deployment in 2023 was to incumbent borrowers. That relationship is critically important and is actually protective of the portfolio. And then when you look at the amount of upfront fees, call protection, et cetera, that exist in these private credit instruments, even as spreads are tightening and capital is flowing into the liquid market, the economics of refinancing take a while to find their way into the market.
So I think as we're sitting here today, I would say it's actually a net positive. We're seeing increased transaction activity, more liquidity in the market. And I think that's generally a good thing.
So I heard some of the commentary on the call yesterday. I don't think that we're looking at a return to normal in the liquid markets is bad for the Ares credit business. I'd also highlight that we are one of the largest liquid credit managers and CLO managers as well. So from the Ares management perspective, as that market opens up, we're a big beneficiary as well.

Michael Patrick Davitt

Great. And then a quick follow-up. Obviously, we get a ton of detailed data on U.S. direct lending portfolios. But could you give us a little bit more detail on how the European portfolios are tracking versus the U.S.? Are you seeing any signs that these portfolios could diverge versus the strong outcomes we've been seeing in the U.S. portfolio?

Michael J. Arougheti

It is remarkably similar. If you look at the EBITDA numbers that were quoted for the ARCC portfolio, it's about an 8% year-over-year EBITDA growth that had accelerated from 6% in the prior quarter. If you look at the European direct lending, which is actually pretty amazing, year-over-year EBITDA growth was 18%.
LTVs are a little bit higher. They're kind of in the 48% range in Europe versus 42%, 43% in Europe. Interest coverage is a little bit higher in Europe, 1.8 versus 1.6. But if you just take all of the different ways to articulate credit exposure, they're largely similar. But we're seeing a surprising amount of momentum and resilience within the fundamental revenue and EBITDA portfolio in Europe right now.

Operator

Our next question comes from Ben Budish from Barclays.

Nicholas George Benoit

This is Nick Benoit on the line for Ben this morning. So in the prepared remarks, the nonaccruals continue to remain low. I believe Kipp noted on the ARCC earnings call yesterday, the nonaccrual rate -- historical nonaccrual rate is about 3%. So how do we kind of think about the macro backdrop for nonaccruals to return back to historic average about 3%? And do you kind of think there's been almost a reset in the direct line portfolio where normalized nonaccruals will stay lower for longer?

Michael J. Arougheti

It's a good question. I think Kipp articulated it well, which is just by definition, given the rate backdrop and the assumption that rates will stay higher for longer, I think you will see an uptick in defaults, but that's not necessarily a bad thing.
And what we keep trying to focus people on is the structural improvement in the leverage lending market, particularly the private credit market in terms of the amount of equity subordination in a lot of these capital structures. And so if you look at loans to value of 42% or 48%, when you look at the structure of the private equity market, there's about $3.5 trillion of private equity sitting at the bottom of a lot of these capital structures with $1 trillion of dry powder to protect value.
And so I think part of what you are seeing is that even if there's a nonaccrual, many of these are unlike prior cycles where you have fundamental underperformance at the company level. They're being driven by higher rates for some of the better performing companies that were able to access more leverage. And those are a lot easier to resolve, both in terms of modification and amendment. But they're also the first places that capital coming in from the private equity sponsors to protect the value below you.
I would say the industry is obviously running higher than we are. I think that we continue to outperform from a credit standpoint. But we're at peak rates. The economy continues to be strong. So if rates stay at this level, I would expect that to tick up a little bit, but I don't think that we're going to return to historical levels.

Operator

Our next question comes from Alex Blostein with Goldman Sachs.

Luke Bianculli

This is Luke on for Alex. I wanted to get a sense for how you're thinking about the growth trajectory of the business outside of credit. And if we can dig into secondaries in particular, you alluded to the state of LP liquidity across the industry. How does that factor in? And outside of that, what do you view as key drivers of growth for the business?

Michael J. Arougheti

Sure. Obviously, we have been diversifying the business for a very long time both in terms of asset class, fund structure, distribution channel, geography. And a lot of those investments, as I highlighted in my concluding remarks, are now bearing fruit and have significant momentum.
Credit as well is not one thing here, right? So when you look at our credit business. It's a host of strategies, liquid and illiquid around the globe at various parts of the capital structure. And while many people feel like those businesses are maturing, if you look at the way that these funds are structured and the way that the performance is stacking, we still think that we have significant growth across the credit spectrum.
It's an interesting comment on secondaries because right now, if you look at the balance sheet of all of these assets, whether it's a buyout or a piece of real estate or an infrastructure asset, everyone is dealing with the same challenge, which is fundamentally strong performance, over-levered balance sheet and a liquidity challenge. And so for the first time in a very long time when we're going through the market transition, the problem or the use case is the same in every market that we're in. It's how do you bring capital into these companies and assets in a way that minimizes dilution, expands duration and runway for the asset owner and a lot of these businesses to not just kind of get to the other side of the rate hiking cycle but to accelerate out of it.
And that's taking any number of forms. It could be through direct lending, where we're making a first or second lien loan. It could come through our opportunistic credit business, where we're doing debt restructured equity investing. It could be PE, where we're coming in with some kind of minority equity, and then it could be secondaries.
So I think the investment thesis for growth in secondaries, again, secular and cyclical. Secular growth is being just driven by the growth in the primary markets on a global basis. And the cyclical opportunity is this need for creative solutions to resolve the installed base. And we are seeing volumes pick up pretty dramatically across the secondaries landscape. And I think we are uniquely positioned given the fact that we have funds in real estate, infrastructure, private equity and credit that could come into these situations at various cost of capital and be a really good solution provider. And maybe stating the obvious, just given the depth of our GP relationships in each of these markets, corporate and real assets, I think we have a really strong origination advantage.
So we are working hard to continue to raise capital in that business. As we talked about, we had a very successful fundraise for our leading real estate practice. Our PMF, which is our non-traded fund, continues to scale into the opportunity. We're having very meaningful early success in growth of our credit secondaries business. So we're enthusiastic about the growth opportunity in the secondaries market and our ability to capitalize on it. And it's actually a really interesting example of an acquisition that we've made and transformed and repositioned into a new market.
But I don't think it's just secondaries. Again, I think it's going to be the full product set that's going to be coming into this market to try to resolve some of these situations.

Luke Bianculli

Sure. Understood. And appreciate all the detail. That was great. I guess if we turn for my follow-up to credit real quick. With the outlook of perhaps a lower rate environment, at least relative to where it is today, how do you think about a potential shift in LP demand within credit? And is there a level at which lower interest rates become more of a headwind for fundraising? Or does the spread above base rates always make it an attractive asset class from an LP perspective?

Michael J. Arougheti

Yes. I think you answered your own question. I mean our experience would be that the investor base is buying the excess return available in these markets relative to the public market equivalents. They're buying lower volatility. They're buying non-benchmark exposures. They're buying active management. But ultimately, we have not seen changes in investor demand through the different phases of this rate cycle or prior. We've been doing this a very long time, and rates go up, they go down. The balls go up, they go down, and we haven't really seen impact on investor demand.
I think we're now at a point in the development of these markets while they're still growing, they are becoming core exposures in most investor portfolios, both institutional and retail. And I wouldn't expect that as rates move that we're going to see capital flowing out. One could argue maybe if rates come down that it could spur increased demand just because of our ability to continue to drive differentiated deployment, access and spread, but that's TBD.

Operator

Our next question comes from Michael Cyprys with Morgan Stanley.

Michael J. Cyprys

Just wanted to circle back to some of your commentary on deployment. Pace of activity continues to pick up for you guys. It's nice growth in the quarter. It sounds like the strength is continuing into the first quarter. So I was hoping you could elaborate on some of the areas of strength where you're seeing the biggest improvement in deployment? How you expect the deployment backdrop to take shape here in '24 relative to '23?

Michael J. Arougheti

Mike, it's a good question. And again, I'll just reiterate what I just said. Every part of the business is turned on right now. We have $110 billion of uninvested capital, which may sound like a lot. But if you look at our 2023 deployment, we deployed close to $70 billion of capital in what most people would argue was a tough deployment year, and that was down from a little over $80 billion in 2022.
So I think we now kind of know what the guardrails are given the depth of the platform and capability set that we have. If you look at Q4 specifically, $24 billion against Q4 '22, which was about $22 billion. So we had a strong Q4 as well year prior, and I think that's a typical seasonal pattern that we see. But Q1, at least in the early goings, feels like it is going to be higher than it normally would be given seasonality. And that's causing, I think, us and others to feel optimistic about activity going into at least the first half of the year.
But it's really across the board because a lot of what we're doing in each of our businesses across credit, real assets, PE, secondaries, like I said, is really coming into a market that is starved for capital with a big installed base of institutional equity that needs a solution. And so I wouldn't really highlight any one as jumping off the page, Mike. It's really -- again, it's across the board, which is quite unique from a deployment setup standpoint because normally, when we're talking about cycles or even different outlooks for rates or the economy, 1 or 2 businesses will pop out, but that's not what we're seeing. They've all been pretty consistent year-on-year and quarter-on-quarter.

Michael J. Cyprys

Great. Just a follow-up question on asset-based finance. I was hoping you could talk about the opportunity that you see in asset-backed finance, big space. Maybe just talk about more specifically where you'd like to expand, steps you're taking to add more capabilities, particularly here in '24? And which parts of the ABF market do you see the biggest opportunity set for Ares?

Michael J. Arougheti

Yes. I mean I think we have probably one of the largest capabilities across the various asset classes in asset-based finance. And it's always hard to say where the opportunity set is going to be. It's a function of what's happening in the broader market.
But I think we are one of the few platforms that has dedicated in-house origination and portfolio management capability across the broad waterfront. And I think it's important that when we talk about asset-based finance and structured products that we are differentiating between the investment-grade side of the market and the non-investment-grade side of the market, meaning the bottom half of the balance sheet. And I think that we have by far the largest capital base and team against the -- what I would call the non-high-grade part of the market. So some of our peers have appropriately articulated, there will continue to be growth in the high-grade part of the space. We are participating in that as well. And I think there will continue to be growth in the non-investment grade part of the market. And I think we have a real leadership advantage there.
Back to the earlier question just about banks and liquidity and risk transfers, we are very active on portfolio acquisitions, partnerships, risk transfers, fund finance. All of the things that are coming out of the transition in the banking market, I'd say, are prominent right now, and I would expect that to continue.
So maybe without getting into too much detail, I would say that that's probably where we're seeing the biggest amount of flow as opposed to saying which corner of the asset-based market we find is attractive because, again, that's always a function of structure, price and kind of where we are with our counterparties.

Operator

Our next question comes from Brennan Hawken with UBS.

Brennan Hawken

Hoping to drill in on FRPR. So it sounds like momentum, you guys feel good about the momentum in secondaries and APMF and real estate, clearly got the message that's on hold. So how should we be thinking about FRPR in credit? It seemed as though the spreads tightening in the year-end. So that's probably not something we should count on. So is it possible to quantify how much of an impact that had? And then how should we be thinking about FRPR and the sensitivity to rate cuts if the forward curve plays out and we see lower policy rates?

Jarrod Morgan Phillips

Sure. Thanks for the question. Overall, I think you caught on with the spreads and that that is a component, and that certainly benefited us at the end of the year here. But it's not the main component. The main component is the interest rate aspect of it, which does -- which has been a pretty big tailwind for this year.
Now the advantage that we have there in terms of looking into this year is that we actually benefit on a lag because the average reset on these interest rates happens about every 6 months. So we still haven't even necessarily felt the full impact of interest rate increases across the portfolio.
So the same way that you think about that lag on the good, it actually happens as interest rates are declining, there's a lag till that impact occurs as well. So an interest rate reset actually doesn't have a huge impact on the overall balance.
We would expect that we could be at or near similar levels if interest rates essentially were not cut significantly and rapidly and if spreads stayed essentially the same and FX rates stayed essentially the same. That would be with the same basic base balance, but we do continue to raise funds as well. And so as we raise funds within those SMAs and these perpetual capital vehicles, that does give us the opportunity to increase the amount that we can earn as well.

Michael J. Arougheti

Jarrod, I would also add, as we talked about earlier, that as rates come down with that lag effect, that usually means a transaction activity is picking up and structuring and underwriting fee contribution flowing through some of those vehicles that generate FRPR would be an offset to the lagged effect of rates declining.

Brennan Hawken

Excellent. I would like to follow up on the point around competition. So Mike, you were pretty clear in addressing why you don't think the loan market is a substantial risk. But we have seen a lot of firms raising money and moving aggressively to grow the private credit offering.
So why is it that other private -- how do you view the increased capital coming into the space from competitors? And what's your expectation for spreads and the potential impact on spreads from all that competition piling in?

Michael J. Arougheti

I've been pretty vocal on this, and I think that you kind of have to distill the signal through the noise in terms of the amount of capital and new entrants into private credit. So first, it's important, if you look at the growth in private credit markets over the last 10 years, it's basically grown at the same compound annual growth rate as every other market that folks participate in. It grows linearly, so it grows in a different way. But if you just look at the actual growth, it hasn't actually outpaced -- it's not frothier.
If you look at the structure of the private credit markets and you say that the biggest users of private credit across the private credit spectrum are institutional equity owners, there's still a significant shortfall of supply of private credit relative to the demand. So just if you use the private equity market as an example, there's about $1 trillion as I mentioned of dry powder in the private equity market today against maybe $200 billion of private credit dry powder. So you've got 20% private credit raised against the private equity installed base. And if you said that roughly 50-50 debt to equity, you need to see a $1 trillion of private credit capital formation just to satisfy the private equity capital that's been raised. And you see similar trends emerging in infrastructure and real estate. So there's plenty of room for growth.
Third, I would just highlight, and if you look at the actual numbers, the preponderance of dollars that get raised and deployed are in the hands of a few large, long-tenured incumbent lenders. That has been the case. That consolidation trend is accelerating. And there are meaningful benefits to scale in private credit, the ability to originate and invest in broader origination teams around the globe, the ability to have flexible capital at scale to drive better deployment in different market environments and so on and so forth. So if you look at the number of people raising their hand that are saying we're in the private credit business, yes, that has increased. But if you look at where the dollars are flowing and the dollars that are getting deployed, the competitive dynamic is not that different.
And as I've talked about earlier with regard to the syndicated loan and high-yield market, I do think that there have been some new entrants that have not been building entrenched origination networks for the last 30 years that see the easiest place to deploy in the larger part of the market, taking advantage of challenges in the liquid market. And I do think that deployment will be tougher there than in the core middle market. But if you look at the core middle market, the competitive landscape is pretty unchanged. And you just look at the deployment numbers that we articulate for our business, if you look at our direct lending business last year, in the fourth quarter alone, we did $14 billion of deployment, which is larger than most private credit managers' total AUM.
So we're -- I don't want to sound immodest, but we continue to execute well given all the competitive advantages we have. And I think we'll continue to do so.

Operator

Our next question comes from Mike Brown, KBW.

Michael C. Brown

Maybe I'll start with a quick follow-up on that FRPR question. Is the answer really the same relative to your part 1 fees in your credit business? So again, as the base rates come down, could that just be offset by greater capital markets and structuring fees? And if that is the case, is that handoff 1 for 1 in terms of timing and magnitude?

Jarrod Morgan Phillips

Yes to the first part of that question. But in terms of 1 for 1, again, there's a bit of a lag. So you can end up with a current interest rate that's ticking a little bit higher because it hasn't reset yet against a macro backdrop that allows for more transaction activity that could actually be a tailwind in your favor. But generally, they're pretty close to 1 to 1. They're going to interact together.

Michael C. Brown

Okay. Great. And then on Pathfinder II, so you meaningfully surpassed your $5 billion target. You hit the hard cap there. What is the potential for this strategy long-term? You're quick, back in the market to raise Pathfinder II. As you progress through the vintages, are there enough opportunities such that this could be one of your largest fund strategies over time?

Michael J. Arougheti

I would say yes, but we should just clarify that I would say fund families, right. So one of the things, again, that I think is important as you're scaling any of these private credit businesses is to make sure that you have different funds for different parts of the market, whether it's different cost of capital or borrower needs or geographic nuances.
So the Pathfinder family has been scaling with good performance, and I would expect will continue. But sitting next to Pathfinder II, for example, is an open-ended core fund that has a lower cost of capital and the ability to invest in a different part of the market. That is similarly scaling well with good performance. We obviously have our affiliation with Aspida that is scaling AUM within the alternative credit business. We have a number of third-party insurance SMAs and partnerships that are growing.
So I would just clarify that the Alternative Credit family of funds, yes, is growing nicely, continues to scale, and I think is one of the biggest growth opportunities that we have here. But you won't just see it within the core Pathfinder flagships. It's going to be the whole family of funds that surround it.

Operator

That does conclude the Q&A portion of the call. I will now turn the call back over to Mr. Arougheti for any closing remarks.

Michael J. Arougheti

No, I don't think we have any. Again, we appreciate everybody's continued support and interest. And we look forward to speaking again next quarter. Thank you.

Operator

Ladies and gentlemen, this concludes our conference call for today. If you missed any part of today's call, an archived replay of this conference call will be available through March 8, 2024, to domestic callers by dialing (800) 753-5212 and to international callers by dialing 1 402 220-2673. An archived replay will also be available on the webcast link located on the homepage of the Investor Resources section of our website. Thank you, and have a great day.