Low Fees Helps Ares Exceed $10B Private Credit Target

Ares (NYSE: ARES) is wrapping up fundraising with at least $10.5 billion committed to its third vehicle for U.S.-based middle-market direct lending, LP documents show. To stand apart in a crowded field, Ares is wooing investors with below-market fees. It’s not alone.

When the New Hampshire Retirement System went shopping for a direct lending investment, it was confronted with more than 220 funds on offer with a record amount of dry powder already raised.

“There has been a particular influx of capital into private lending strategies where economics and structures are under pressure,” consultancy Callan wrote in a recent investment memo to NHRS. “New entrant activity has also been robust as capital is abundant.”

In the end, the $11.5 billion pension plan committed $100 million to Ares because of its size, experience and track record. And also the cost of fees.

Details of Ares’ Senior Direct Lending Fund III were disclosed at a June meeting of the NHRS, which doubled its 2024 private credit allocation to $400 million. The new fund has already loaned $6.4 billion across 147 deals in the U.S and reports a net IRR of 15.4 percent.

CalPERS announced a $1.3 billion commitment to the fund in March as part of its new expansion into private credit.

Fees

For fees, Ares has split the fund into levered and unlevered sleeves. It will charge a management fee of one percent on assets in the unlevered sleeve and 0.85 percent for levered sleeve deals. LPs committing $100 million or more receive an additional 0.05 percent discount.

“These fees are lower than the typical direct lending strategy management fee of one percent to 1.5 percent,” Callan wrote in the same memo.

Ares also charges a 12.5 percent carry after a five percent hurdle for investments in the unlevered sleeve. In all, Ares expects fees to amount to roughly three percent in aggregate, far less than the 4.12 percent average for the asset class that Cliffwater reported in April.

Ares declined comment.

Race to Bottom

Ares is not alone in offering lower-than-usual fees. New entrants, including traditional PE firms, are jumping into private credit and need a selling point to trump experience.

“As direct lending continues to mature as an asset class, it is becoming more apparent that management fees are being squeezed,” HR consultant Sheffield Haworth wrote in its Private Debt Market Trends report for Spring 2024. “As more traditional managers enter the space, this trend looks set to continue, in particular across senior lending with something of a race to the bottom as far as fees are concerned.”

In one of the most extreme fee cuts, Apollo (NYSE: APO) launched a private credit fund earlier this year with Abu Dhabi’s Mubadala Investment Co. The two committed a combined $290 million to a fund with $450 million in total seed commitments. Apollo waived all of Mubadala’s fees. Apollo cut in half for a year the fees charged to the other LPs.

After a year, Apollo will charge a one percent management fee and a 12.5 percent carry after a six percent hurdle, according to an SEC filing.

Callan compiled a chart of seven direct lending funds recently closed or still being raised while searching for an investment for NHRS, complete with fees on offer:

Returns

Beyond fees, Ares’ size, experience and track record helped win over NHRS.

The private credit specialist has built its global lending team to 180 investment pros and has made 2,280 U.S. direct lending deals for a combined $111 billion since 2004 with a net IRR of 7.1 percent.

Fund I, with a 2018 vintage, raised $3 billion and returned an IRR of 6.9 percent. Fund II, vintage 2021, raised $8 billion and shows a 9.5 percent IRR.

The NHRS commitment is to the unlevered sleeve, which aims for an IRR between 7 percent and 9 percent. Ares also targets annual distributions of between 6 percent and 9 percent.

Strategy

Ares is focusing almost all of the new fund on senior-secured, first-lien positions loans to PE-backed companies, an area Ares CEO Michael Arougheti recently said is growing as private equity sponsors look for cash.

Arougheti says there’s $1.5 trillion of PE dry powder primed for new investments or waiting to be used on existing portfolio companies, transactions that will require leverage.

“Purchase prices have reset modestly to five-year lows, creating more attractive entry points for sponsors,” Ares says in marketing material for the new fund. “We expect LBO volume to increase as sponsors seek to return capital to investors.” 

Ares says the average LBO these days uses 48 percent debt, implying a need for $875 billion in credit. Fund III has already transacted with companies ranging in size from $15 million in annual revenue to $5 billion, writing checks between $50 million and $100 million. Fund III will also consider larger loans.

Ares expects to ultimately deploy $18.7 billion through leverage and recycling principal, selling floating-rate loans almost exclusively to PE-backed companies LBOs and add-on acquisitions.

Ares says half its new deals originate with repeat customers and financing buy-and-build platforms over the last five years has been strong.

Ares expects the majority of the loans to be repaid within four years after and exit, refinancing or other significant liquidity events.