Earnings Call Transcript - APO Q3 2023

Operator, Operator

Good morning, and welcome to Apollo Global Management's Third Quarter 2023 Earnings Conference Call. During today's discussion, all callers will be placed in listen-only mode. And following management's prepared remarks, the conference call will be open for questions. Please limit yourself to one question, then rejoin the queue. This conference call is being recorded. This call may include forward-looking statements and projections, which do not guarantee future events or performance. Please refer to Apollo's most recent SEC filings for risk factors related to these statements. Apollo will be discussing certain non-GAAP measures on this call, which management believes are relevant in assessing the financial performance of the business. These non-GAAP measures are reconciled to GAAP figures in Apollo's earnings presentation, which is available on the company's Web site. Also note that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase an interest in any Apollo fund. I will now turn the call over to Noah Gunn, Global Head of Investor Relations. Please go ahead.

Noah Gunn, Global Head of Investor Relations

Great. Thanks, Donna, and welcome again everyone to our call. Earlier this morning, we published our earnings release and financial supplement on the Investor Relations portion of our Web site. We reported strong third quarter financial results, which included record quarterly FRE of $472 million, or $0.77 per share, and record quarterly SRE of $873 million, or $1.43 per share. Together, these two earnings streams totaled $1.3 billion in the third quarter, increasing more than 30% year-over-year and reflecting solid execution from both our asset management and retirement services businesses. Combined with principal investing income, HoldCo financing costs and taxes, we reported adjusted net income of $1 billion, or $1.71 per share, up 23% year-over-year. Joining me this morning to discuss our results and strong relative positioning in further detail are Marc Rowan, CEO; Scott Kleinman, Co-President; and Martin Kelly, CFO. And one quick plug before we proceed. In a couple of weeks on the afternoon of November 14, we will be hosting a deep dive presentation on our platform origination strategy, a top area of investor focus, which will provide insights into various platforms in detail how, in aggregate, we believe they provide a competitive and sustainable advantage to Apollo in sourcing excess spread. A live video cast of this session will be available through our Investor Relations page. And with that, now back to our regularly scheduled earnings programming. Marc?

Marc Rowan, CEO

Thanks, Noah, and good morning to everyone. We had another strong quarter in a challenging financial environment. To highlight our performance: FRE increased by 29% year-over-year, SRE rose by 36% year-over-year, and we have seen margin expansion for three consecutive quarters. Our inflows for the third quarter reached $33 billion, totaling $125 billion year-to-date, with $36 billion deployed, indicating solid momentum in both segments of our business. Our business model is robust, and we anticipate inflows of around $30 billion for Q4, which would bring our total inflows for the year to $150 billion. The positive momentum we see suggests we will continue to perform well as we head into Q4. Although the quarter is still ongoing, all indicators point to sustained momentum. In global wealth, I want to acknowledge the hard work of our team; we currently have seven perpetual wealth products available in the market. Scott will provide more details on this. Additionally, our origination volume is projected to exceed $100 billion on an annualized basis, reflecting that the entire business is functioning effectively, and we are well-positioned to leverage current market conditions. Higher interest rates generally benefit our business. Credit represents a larger portion of our business mix compared to most peers, a position we have developed over many years. We concentrate on senior secured debt at the top of the capital structure, distinguishing our approach from conventional views of private credit. Our objective is to build a sustainable business that can endure economic challenges while capitalizing on favorable conditions in the credit market. To illustrate, Athene's impairments are at or below last year’s levels, and we expect this trend to continue. The overall portfolio remains in excellent condition. On the equity side, our strategy of focusing on purchase price has proven advantageous. There is significant capital available in private equity, although many investors are hesitant because they are unsure how much of their existing capital will be required to address issues in their portfolios. Our discipline over the past decade has minimized our need for corrections, allowing for substantial deployment, which Scott will elaborate on in our private equity and hybrid sectors. If you find something attractive in the equity market right now, considering the geopolitical context, economic recession concerns, and high-rate environment, it is likely to be very appealing. Overall, I believe equity deployment in 2023 will yield excellent results. So what exactly is happening? Let me share my perspective on the current state of markets, particularly in private markets. Reflecting on my 39-year career, I believe we have benefited from four tailwinds: a general decline in interest rates, significant monetary expansion, fiscal stimulus boosting future demand, and the advantages of globalization. Given these factors, it's no surprise that risk assets, equities, and real estate have performed well in the past. However, I question whether these conditions still hold today. There are arguments regarding potential headwinds or simply a lack of tailwinds now. What I see suggests that relying on past trends will not serve as a reliable guide for future investment success. The previous decade has been an anomaly that will not replicate itself moving forward. The investment strategies that thrived in the previous environment may not yield similar results now. Moreover, notable changes have occurred in market structures over the years, particularly after 2008. During that year, we faced a severe risk to our financial system, leading to a complete overhaul of market operations. Although Apollo and others may not have recognized these shifts immediately due to subsequent monetary expansions, the current landscape reveals their effects with increasing visibility. Three key points of change merit attention. First, regarding liquidity, dealer capital supporting trading has declined to about 10% of what it was pre-2008, while markets are now three times larger, resulting in reduced public market liquidity. We witnessed a significant market dysfunction last year in the UK’s liability-driven investment sector, which signals that liquidity challenges may become more common. Investors are beginning to realize that liquidity is often only available during market upswings, not downturns, indicating that we should brace for heightened volatility and reduced liquidity in public markets. Second, I focus on the evolving role of banks. Dodd-Frank was intended to limit the power of major U.S. banks after the crisis. However, today, U.S. banks account for about 20% of debt capital in markets, with the remaining 80% supplied by investors like you. The recent events surrounding SVB, First Republic, and Credit Suisse further suggest a trend toward debanking. Regulatory demands, such as requiring banks to hold more capital, compel them to downsize or reduce business lines. This process of debanking is just beginning and signifies a transition where investment products traditionally found on bank balance sheets will increasingly be made available to you, the investors. Third, I want to address the impact of indexation and correlation in trading. Today, around 80% of trading volume relates to the S&P 500, with ETFs comprising 60% of our markets. A small number of stocks dominate performance, with ten companies contributing almost all year-to-date returns, trading at high price-to-earnings ratios. This concentration risks exposing the retirement systems and fiduciary assets to vulnerabilities. It's crucial to reconsider the historical perception that public markets are safe and private markets are risky. Both public and private can carry risks, and I believe investor sentiment will evolve in this direction. Turning to private credit, this sector is gaining prominence in our industry. There is considerable media coverage and discussion among peers. For us, private credit has been a fundamental component, with nearly $500 billion held within this space. Our workforce comprises 2,600 people involved in Apollo Asset Management, plus another 4,000 individuals across 16 platforms focusing on creating credit. While lending to buyout sponsors can be profitable, it risks becoming commoditized due to the influx of capital and low barriers to entry. Investors are gravitating toward firms that have established ecosystems and proven track records, avoiding the distractions of short-term market trends. Private credit encompasses a broader change driven by the debanking phenomenon; in essence, everything on a bank's balance sheet is private credit. Current media focus on leveraged lending represents only a small segment of this opportunity. The majority of private credit we pursue is actually investment-grade. Our discussions around private credit will increasingly require precise language and greater understanding. Investors are facing challenging questions regarding the classification of private securities as alternatives or fixed income, which can drastically impact demand for such assets. Given the illiquidity environment in public markets, many institutional investors and family offices could benefit from private credit investments if returns justify the risk. Meanwhile, aside from the business itself, we focus on talent. We're dedicated to building a strong partnership culture, with the aim of being the best workplace for our partners, ensuring long-term retention of their expertise. We've seen two generations of mentors emerge within our firm to train younger members, fostering an ecosystem that supports their development. We aim to deliver predictability to shareholders by prioritizing highly predictable metrics, like FRE and SRE, while addressing the volatility of PII, which has seen a significant decline this year. Our intention is to adjust compensation strategies by offering more PII to employees and less FRE and SRE, aligning stakeholder interests with our vision for sustainable growth. At our Investor Day two years ago, we set targets that today, Martin will confirm, we are not only meeting but are poised to exceed. He will discuss updates, focusing on the next generation of leadership, highlighting four individuals capable of steering our company forward. Their growing responsibilities now encompass broader organizational oversight, leading to compensation adjustments aligning them with our long-term goals. In closing, we are on course to fulfill our five-year plan, with various initiatives already surpassing expectations. We look forward to our next Investor Day in 2024, where we will discuss future direction. Our overarching aim is to achieve our set goals while preserving our unique culture, prioritizing sustainability over being the largest or fastest-growing entity in the industry. With that, I will turn it over to Scott.

Scott Kleinman, Co-President

Thanks, Marc. Unlike many in the industry, the current market backdrop, marked by higher interest rates, heightened volatility and economic uncertainty is where we thrive. It's good for our core investing businesses where we are asset selectors with a value orientation, not momentum or volume traders. It's also good for Athene's business where higher for longer rates drive more volume and better profitability. And it can benefit our capital solutions business where companies can access creative financing solutions when traditional sources of capital are less plentiful. This is the true power of our aligned asset management and retirement services business model, which should only increase as we continue executing on our growth objectives. As you've heard us say before, the foundation of our business is providing excess return per unit of risk. And this is evident in our strong investment performance. In the yield business, our corporate credit, structured credit, and direct origination strategies all appreciated between 3% and 4% in the quarter and between 12% and 17% over the last 12 months. We've seen particularly strong performance in certain underlying strategies, including Apollo Debt Solutions, which posted a total net return of 16.5% for Class 1 shares over the last 12 months. Performance in our hybrid value franchise also remains robust, with the portfolio appreciating 4% in the third quarter and 11% year-to-date. In private equity, our flagship strategy appreciated 3% in the third quarter and 16% over the last 12 months, including 22% LTM for Fund IX specifically, as the underlying portfolio companies continue to generate healthy earnings growth and are actively managing inflation by achieving greater operational efficiencies. The portfolio is well diversified and has an average purchase multiple of slightly over 6x, offering significant downside protection should economic conditions worsen. In terms of investing activity, we remained active during the quarter, putting $36 billion of capital to work across the platform. Investment activity across the yield platform accounted for the vast majority of capital deployment in the quarter as we continue to capitalize on two primary interrelated themes, global debanking and lack of public market liquidity. Our ability to provide scale capital solutions with flexibility and certainty has made us a lender of choice in today's backdrop. With that said, we're picking our spots and remaining highly disciplined in our underwriting criteria given the potential economic pressures of interest rates remaining higher for longer. This is the playbook we've used time and time again, strong defense during times of uncertainty, leading to effective offense during periods of dislocation. For our hybrid business, the pipeline of deployment opportunities is also expanding. Sponsors and corporates alike are seeking structured financing alternatives to access liquidity and refinance capital structures, which is driving heightened demand. This trend is especially evident within our hybrid value strategy, where the deployment pace in our second vintage has been strong, as well as our S3 business where we've invested more than $1 billion of capital into equity and hybrid solutions so far this year. And in private equity, we remain very busy with capital deployment activity reaching $11 billion over the last 12 months. With reductions in broad market valuations, we're seeing a wider opportunity set that fits our strategy, particularly in take-privates and carve-out transactions. As a leading franchise with a longstanding track record, we remain confident in our ability to source financing, deploy capital, and appropriately capitalize during challenging market environments, which was recently showcased by the sizeable closings of Univar and Arconic in August. Moving to our capital raising results, we generated $33 billion of total inflows in the quarter, primarily comprised of the $13 billion of inflows from Athene and very strong third-party fundraising of $14 billion. Investor preferences have shifted in favor of credit over the past year, and we've been capturing this demand through our full product suite, spanning corporate credit through total return and Apollo Debt Solutions, going anywhere opportunistic credit through Accord and Accord+, and our newly launched asset-backed finance franchise. All of these are important to our growth objectives in the yield business over the next 12 months and beyond, which will position us with even more dry powder for what we expect to be an attractive credit investing backdrop. Additionally, we spent a lot of time and resources positioning ourselves for the next wave of growth in our asset management business, which we've discussed is concentrated in six complementary areas where we believe we have a competitive edge. Fundraising for these initiatives accounted for more than 25% of total third-party capital raised in the third quarter, including capital for direct origination and multi-credit sidecars and for AAA. We also expect to hold closes for our inaugural equity secondaries and clean transition equity funds over the next couple of quarters, which are two exciting areas of expansion within our equity business. Of course, an important component of our capital raising efforts this year and going forward is everything we're building in global wealth. This area continues to be a steady march for us as we roll out product, expand distribution, invest in technology, and continue to educate the marketplace. We believe all these components have led to a differentiated platform offering for several reasons. First, excess return. As I mentioned earlier, our primary goal is to drive excess return per unit of risk for our clients. Through our tailored product suite, individual investors get to the same sourcing and underwriting resources as our institutional clients and our own balance sheet. Second, customization. Individual investors consume product in a different way. To meet this need, we've taken institutional-like offerings and adjusted them into structures for the retail market, and in some cases designed products specifically with the individual investor in mind. We offer seven families of perpetual products today for both U.S. and non-U.S. global wealth investors and have a handful more in the pipeline. Third, education. We believe the benefits that alternatives bring to a diversified portfolio are still widely misunderstood by retail investors and are often equated with high risk, high fee products. To combat this mischaracterization, we've leaned in on education through Apollo Academy, which recently crossed the one-year mark and has more than 10,000 financial professionals registered as members. And lastly, commitment. As a leadership team, we've made an internal and external commitment to this initiative, which has translated into a couple of important benefits, including allocation of resources both organically and via M&A, and with speed to market that has allowed us to grow as quickly as we have. Despite all the progress we've made thus far, it's still early days and we see a long runway of growth ahead of us in what we view as a massive addressable market. Given our emerging growth prospects relative to more mature wealth platforms, we feel confident in our ability to drive this continued growth, even if faced with a more challenging retail market backdrop. Turning to Athene, organic inflows totaled $13 billion in the third quarter, bringing year-to-date inflows to $44 billion. Retail annuity sales drove half the quarterly activity with business that was underwritten to very strong returns. Volume has been increasing in that channel to begin the fourth quarter with approximately $2.5 billion of annuities sold in October. In flow reinsurance, Athene is continuing to see a steady build in volumes driven by new distribution partnerships in Japan and the U.S., as well as strong volumes from existing counterparts. We expect flow reinsurance inflows to exceed $10 billion this year, implying healthy inflows again next quarter. For pension group annuities, despite the low activity in the third quarter, we see a solid pipeline of opportunities including one deal that already closed in October. It's worth noting that this business has now generated $50 billion of cumulative volume since Athene entered the channel in 2017, leading the industry during that timeframe. Based on the momentum we see across Athene's business, we remain on pace to generate $60 billion plus of total inflows this year.

Martin Kelly, CFO

Thanks, Scott, and good morning, everyone. So as Marc previewed, we reported another very strong quarter of results as we continue to execute against the financial targets we laid out at the beginning of this year. Markets have changed quite significantly since then, marked by even higher interest rates and increased economic uncertainty, yet we've remained confident throughout 2023 in meeting or exceeding our initial financial targets for the year, as further evidenced today. With these results, we believe that we're beginning to gain recognition for the predictability, consistency, and differentiated growth of our earnings profile, anchored by our two primary earnings streams, FRE and SRE. I'll address five topics in my remarks today. One, earnings growth and outlook in our asset management business; two, the financial impact of the compensation awards we announced today; three, earnings growth and outlook in our retirement services business; four, credit performance in Athene's portfolio; and five, capital allocation priorities. Starting with our asset management business, our 7% increase in quarterly FRE continued to be driven by solid revenue growth and expense discipline. Year-to-date, FRE revenues are higher by 25% against a 21% increase in FRE expenses. Our capital solutions business achieved a new high in the third quarter amidst a robust year of growth. We're very pleased with the expansion of this business, which is on track to meet its five-year revenue plan in just two years. We'll spend some time during our platform origination presentation on November 14 discussing the breadth of this business, and it's important to our fixed income replacement strategy. Specific to Fund X in the quarter, management fee growth of 5% included a $24 million catch-up for Fund X and its final close, with Fund X fees in the quarter being $14 million higher than the prior quarter considering catch-ups in both quarters. Our focus on scaling the asset management business is evident in our compensation costs, which were flat in the quarter and up 14% on a year-to-date basis. Underpinning this is a moderation in our headcount growth and an emphasis on building our team in India, which recently crossed 500 employees or close to 20% of our total headcount. Our non-compensation costs are in their last year of sizeable growth, reflecting a step up in our investments in global real estate, technology, and product distribution. Combined, this has driven strong positive operating leverage, resulting in more than 150 basis points of margin expansion year-to-date versus the prior year period. Based on our visibility into the fourth quarter, we remain confident in achieving 25% FRE growth in 2023, as previously communicated. Looking ahead to 2024, we expect FRE growth between 15% and 20%, consistent with our FRE growth expectations in a year without a flagship PE fundraise. The outcome is somewhat dependent on the environment with current expectations around the middle of that range. This outlook is guided by a strong fundraising outlook, our holding more than $45 billion of uninvested capital with management fee potential. Our current plan to repeat the very successful year in capital solutions in 2023 and low double-digit expense growth. We anticipate a further approximate 100 basis point improvement in our FRE margin next year as a result. The compensation awards we announced today amount to approximately $550 million of award value at grant, equating to approximately 1% of our share count and include two components. One, for senior leaders, the exchange of the majority of existing and expected future compensation in the form of FRE, SRE, carry, and stock for newly issued vested stock. And two, the reallocation of those savings and the expected issuance of a modest amount of additional carry to other employees and a further exchange for FRE in stock. This exchange and reallocation is accretive in value, and we expect will create an opportunity for a further reduction in our FRE compensation ratio which we currently believe will be around 23% by 2026 before further reallocations. It will also create a reduction in stock that we expect would have otherwise been issued and will increase our cyclical average PII compensation ratio to an expected range of 65% to 75%, outcomes that we believe are well aligned with shareholders, as Marc described. Turning to our retirement services business, we generated SRE of $873 million in the third quarter or 168 basis points of net spread. This included some offsetting items that when adjusted for resulted in normalized SRE being roughly in line at $879 million. In terms of balance sheet growth, net invested assets ended the quarter at $208 billion, down $6 billion versus the second quarter, reflecting the buy down by ADIP2 of $7 billion of organic inflows from the first half of the year and the $3 billion transaction with Venerable, more than offsetting positive net flows within the quarter. Invested assets attributable to third-party investors in ADIP now exceed $50 billion, representing 20% of Athene's total invested assets. As third-party capital, ADIP has multiple benefits, including validating Athene's business model, providing capital support, driving greater profitability on business retained and enhancing AGM's overall group capital efficiency. We expect to close out 2023 with a normalized SRE growth rate exceeding 30%, reflecting our expectations for strong organic inflows in the fourth quarter, a lower core outflow rate, ADIP growth participation, and a normalized net spread of approximately 165 basis points in the fourth quarter. As you are aware from comments we made when we issued the mandatory convertible preferred stock in August, and as evidenced by our retirement services business exceeding its five-year earnings target in two years, we have benefited both from meaningfully higher volume growth and asset returns. It is important to budget a continuation of that growth rate. Having said that, we continue to expect low double-digit normalized SRE growth in 2024 after adjusting for the ADIP buy down and Venerable recapture, driven by, one, continued scaling of asset growth due to an abundance of organic growth opportunities across our four business channels. Cumulatively, we expect that to be at least $70 billion in 2024. Two, funding this growth with existing capital resources, including third-party ADIP capital. And three, on spreads, expected non-normalized net spreads of around 165 basis points for the year assuming the current forward curve. Athene supports every dollar of liability growth with approximately $0.08 to $0.10 of capital, which we invest alongside the dollars of cash taken in from policyholders. So while Athene continues to underwrite new business to historical targets of around 115 basis points or better at the product level, the marginal SRE spread is much higher in the current environment, closer to 170 basis points year-to-date. As it relates to credit quality, Athene's portfolio continues to be in a very strong position. Total impairments over the last 12 months have amounted to just 13 basis points, close to Athene's long-term average. Athene's investment portfolio is concentrated in high-quality senior secured assets with an approximate 95% allocation to fixed income, of which 95% or so is rated investment grade. It's noteworthy that Athene's credit losses have been disproportionately concentrated in investment grade corporate bonds purchased in the market, as opposed to private investment grade credit that we originate, underscoring our confidence in the credit quality of originated credit. We believe that Athene has the most transparent financial disclosure amongst its peers. And in line with that philosophy, Athene began publishing historical credit losses in their fixed income investor presentation last quarter, which will be updated in conjunction with our next call next week on November 9. As it relates to capital allocation, the construct we laid out two years ago at our Investor Day remains largely intact, with delays in exiting private equity investments impacting the timing but not the expected quantum of carry to be generated. Meanwhile, Athene has been maintaining its consistent dividend up to the holding company in a significantly more attractive growth backdrop amid rising rates. To support this, we have increased participation from ADIP and issued the mandatory convertible preferred stock in August, the proceeds of which were downstream to Athene. At the same time, the sheer number of organic growth opportunities at the asset manager and a targeted 20% return on group capital by growing Athene has resulted in little need to invest in the business through M&A. Balancing all these dynamics, we expect to continue immunizing all regularly equity-based compensation when it's issued. And we expect to immunize both the dilutive impacts of the mandatory convertible preferred stock and the vested stock awards we announced today over the next few years as capital is available, targeting a share count of 600 million shares outstanding. We anticipate additional capacity within our current five-year plan, but back-ended to consider opportunistic for share repurchase in addition to. And with that, I'll turn the call back to the operator for Q&A.

Operator, Operator

Thank you. The floor is now open for questions. Our first question today is from Patrick Davitt of Autonomous Research. Please go ahead.

Patrick Davitt, Analyst

Hi. Good morning, everyone. I know early days, but could you address your view of the potential risks to your business from the new DOL rule published yesterday? And within that, remind us, if at all, how dependent Athene is on distributors that might be charging the junk fees they're talking about? Thank you.

Marc Rowan, CEO

Okay. Thanks, Patrick. It's Marc. So what came out yesterday is not much different than what the industry saw seven years ago. Seven years ago, we and the rest of the industry prepared and actually made changes, extensive changes to how products and fees and features were disclosed. And so truthfully, not much new. In terms of your question on exposure of the business, about 10% of our business is through wholesalers. Another 10% is also to accounts but it's through banks that would have a very easy time adjusting to this because they essentially already charged that way anyway. So specifically, roughly 10% of the business is focused and not really worked up about it. This is where we were prepared to be seven years ago. And I think we're still a ways away from a final rule here anyway.

Operator, Operator

Thank you. The next question is coming from Glenn Schorr of Evercore ISI. Please go ahead.

Glenn Schorr, Analyst

Thanks very much. I wonder if we could just revisit two things that you said. You gave us good guidance or thought process on next year, so the 70 billion for next year. I'm curious if you could talk about that shift that we saw in the quarter, inflows into Athene were low because the shift over to ADIP. What should we expect of that $70 billion next year? And should we even be focused on it? Because I think in line with this DOL question, I think there's this notion that the retail flows are higher quality and some of the other funding agreements are stop gaps. But I wonder if you could talk to the quality of the four channels and if you debunk any of that, and how we should think about that shift going forward?

Marc Rowan, CEO

Glenn, it's Marc. So we've been watching this for the last 14 years. Fundamentally, there is no difference in the quality of any of these four channels. We run a business around cost of funds. Sometimes various channels are attractive, sometimes other channels are attractive. What we're seeing is there's a fundamental demand, not just in the U.S., but everywhere in the world, for guaranteed income. People need retirement solutions. If you look at the vast pools of capital in the U.S., for instance, in 401(k), where there's $8 trillion to $10 trillion, we force people who need returns the most to be daily liquid for 50 years. What we're doing as a country makes little sense. Consumers know that. And so what they've done as soon as they have access to their funds, increasingly, they are in higher rate environments, seeking out guaranteed lifetime income. The demand we're seeing on annuities, either directly or through reinsurance is fundamental. Reinsurance, again, no different to us than direct business other than it tends to be in markets or in market segments we don't serve or don't serve yet. So I don't feel there is any difference one way or the other in the way these things go. As it relates to the broader question, we have a choice. We have a choice of the capital intensity of our business. If we want to be more capital intensive, we put up $0.08 to $0.10 of every dollar. And we retain 100% of the business. If we do that, SRE grows faster because we're retaining more business. And it grows faster because we tend to earn 15% year-in and year-out on the capital that we put up. Really good option. We have, as you know, made a business decision that on the margin, we tend to fund around a third, between 30% and 40%, depending on the mix of business and the regulatory source of the business of every new deal which means that we put up 30% to 40% of that $8% to 10% and that will alter the SRE growth rate. I think what we've said to you over the long term is that we expect the retirement services business to be a low mid double-digit rate of return grower. At every quarter, Jim Belardi, Grant Kvalheim, and team are embarrassing us. And this year, as you know, it's up 30%. What we're seeing this year is what Martin detailed. Not only are we seeing fundamental demand for guaranteed income, which is driven by secular trends like you and I getting older, but we're also seeing widening spread. We are reluctant to budget increased spread of 160, 175 basis points, which is 30 to 50 basis points above what Athene has done historically. But if we continue to see the scale of debanking in the investment grade segments of the market, I think we will continue to put up spread, but that's not how we budget and that's not how we telegraph where we think we're going. We think the prudent thing is to budget the way we have historically and let the performance speak for itself.

Operator, Operator

Thank you. The next question is coming from Michael Brown of KBW. Please go ahead.

Michael Brown, Analyst

Hi. Good morning. So I appreciate the commentary on the spreads within Athene. I guess one thing I was trying to think through is the higher short-term rates have been a meaningful tailwind for the earnings on the floating rate asset side. As we perhaps get closer to the end of the Fed's rate hiking campaigns, are you thinking about taking any actions there to reduce that downside risk if short-term rates do start to come down? Thank you.

Marc Rowan, CEO

So we are plus minus $30 billion of net floating rate assets. If you look at the growth of the business over the next two or three years and you consider the mix of our liabilities, we will want to be, two or three years from now, $30 billion of net floating rate assets. Having said that, we probably are relative to our liability position $10 billion to $15 billion excess floating rate assets over what we would want to or consider a long-term prudent position. You should expect that we will take action over the near term to reduce the short-term mismatch reflecting that, and that's factored into everything that we've discussed with you today.

Operator, Operator

Thank you. The next question is coming from Alex Blostein of Goldman Sachs. Please go ahead.

Alex Blostein, Analyst

Thanks. Good morning. I was hoping we could dig in a little bit more into some of the retail products you mentioned, which seem to have pretty good momentum here in the quarter, in particular AAA. I know the product is a bit complicated. So maybe give us sort of a breakdown of composition across various channels and sort of fee paying AUM between kind of third party and Athene as well as how kind of gross sales conversations are unfolding on that side of the channel? Thanks.

Martin Kelly, CFO

Sure. So, on the AAA side, we've been actually very pleased at how sales are progressing there. So we had our best quarter yet, a little over $700 million in the last quarter for AAA. So week-by-week, month-by-month, we are getting AAA onto more selling platforms, more sales agreements. So progress is good there on the retail side. We expect this to continue to grow, as you know. The retail business is all about getting onto more platforms, more bankers, more selling agreements not only AAA but all our products, ADS, ARIS. This is how we are progressing. This is why in my prepared comments, I just talked about we're finishing up year two of our global wealth focus and we just see so much more positive momentum as we get these selling agreements signed up in place, product-by-product, area-by-area, region-by-region, just a huge opportunity. So really positive momentum across all the products we have in market right now. Like I said earlier, we have seven product families out there right now. We have a few more coming in 2024 where at that point we feel like we'll have a fairly complete lineup across the asset classes. And so yes, good progress.

Marc Rowan, CEO

So I'm just going to leave you with this following sense, Alex. What we're trying to do here is similar to what we're doing in the rest of the business. As you know, I've said publicly, certainly for high net worth families, family offices, I think they will be 50% plus alternatives over the next five years. And we're seeing that kind of uptake and traction. The difference between where we are and where I think we're going to be is only education. When we say we're on a platform, one of the big private banks, it may be 5% or 10% of the financial advisors. This is an education, an evangelical activity, with more and more converts every day. And so if you take AAA, and I know you premised your question as a complex product, I'll make it an easier product. You can buy the S&P 500 at a 50 PE or you could buy roughly the same historical return at a much higher Sharp ratio and give up liquidity. That is the choice we're actually seeing investors make. And while private markets are something that many on this call and we are very familiar with, the vast majority of investors, thinking back over the 40 years, have been doing just fine owning the S&P and the 30-year Treasury. And my point of starting where I started is I don't think with the absence of tailwinds, people are going to get the same performance. I don't think what I'm saying is all that controversial. We're now just in a period of education where people consider what does the market look like? How do I invest without tailwinds? What does it mean that public markets are less liquid on the way down? What does it mean to have debanking? What does it mean to have indexation and concentration? I believe when you look forward at asset management more generally over the next five years, you're going to see an asset management industry that is continuing to grow in its passive strategies. I think you will see boutiques who offer access to uncorrelated returns, or at least non-market correlated returns, such as ourselves and others grow. I think the tougher part of our industry, which you're already seeing is active management, harder and harder for active managers to produce good returns, certainly in fixed income. I question whether there's any alpha left in publicly traded fixed income markets. And given indexation and concentration, I think it's very, very difficult in equity markets. So I like where we sit. I like our hands of cards. It does not mean, again, we're going to be the biggest or the fastest growing. In the retail market, we want to be thought of as prudent and creative, growing our footprint every quarter, but not spiking it, taking too much money at a point in time to chase a hot strategy just makes no sense. It ultimately produces concentration risk, which some of our peers have seen by taking too much money at a point in time. Slow and steady, constant build is what we're seeking to do.

Operator, Operator

Thank you. The next question is coming from Michael Cyprys with Morgan Stanley. Please go ahead.

Michael Cyprys, Analyst

Hi. Good morning. Thanks for taking the question. Just wanted to circle back to your commentary, Marc, on the DOL proposed rule. I was hoping you might be able to just elaborate a little bit on what aspects of the rule you find most troublesome for the business? And then what specific actions to products and features can be taken to address the rule? And then I think you mentioned about 10% of the business may be most impacted. I think it was in the wholesale channel. But what are other levers that you might be able to pull such as maybe altering the distribution strategy and maybe even thinking about going direct, because it doesn't change the overall demand side to your earlier point that retail investors still have a demand for income.

Marc Rowan, CEO

Okay. So, look, it starts with investor demand for guaranteed lifetime income or guaranteed income is going up. And I think investors will ultimately seek out places to do that. Historically, products like annuities have been very complicated because they offer a variety of options and other things, and therefore they have had more of a complex sell. Therefore, you have needed advice and that advice has therefore a more expensive distribution than something you can buy off the shelf. I remain skeptical on direct distribution. But I also see the proliferation of distribution. Increasingly, financial products like guaranteed income are being sold through the banking system and are being sold through RIAs. If you focus in on the specific issue, these are not issues of closure. They're actually not issues of product features. We and many in our industry have already made the changes going back seven years, because that was just best practice. I think there will be more pressure on fees. That clearly is what it's at. And we can have both sides of that. I'm not going to say it's good or bad. But I've watched in other places around the world where the focus has been on fees. Take Australia, you have the biggest or the best retirement system anywhere in the world, $3.5 trillion for 28 million of population. Well, they have a big problem there. They actually legislated out all the fees. So now there's no advice. No one provides advice. And so at 65, when people get their big lump-sum distribution from the superannuation product, they don't know what to do with it, and people are dying between 35% and 40% of their retirement income intact. The government doesn't like that because there's been no advice on what I'll call decumulation. How do you set yourself up to live through however long you're going to live given increasing life spans? Eventually, I believe we're going to come to a sensible place that may be lower fee and distribution. Truthfully, it doesn't bother me in the slightest bit, a small piece of the business. I don't think this is going to result in fundamental changes in distribution. I think it may change how products are priced, and that's okay.

Operator, Operator

Thank you. The next question is coming from Brian Bedell of Deutsche Bank. Please go ahead.

Brian Bedell, Analyst

Great. Thanks. Good morning, folks. Thanks for taking my question. Maybe just to zoom in, Martin, on the FRE guidance, the 15% to 20% next year. For the higher end of that or getting close to the higher end of that, would it be capital markets or capital solutions fees is the biggest swing factor? And then if you could just comment on the trajectory of that. Definitely, certainly much better again this year than last year. And I think your guidance was for flat solutions fees baked into that 15% to 20%. So maybe the trajectory of that and what drivers would increase the solutions fees a little bit faster?

Martin Kelly, CFO

Great, Brian. What I meant is that this is our current best estimate. We are focused on all the fundraising initiatives that Scott mentioned, investing in an environment that suits our investment strategy, and continuing to expand our capital solutions business. We have made assumptions regarding each of the three areas, and any of them could impact the guidance I provided. We will discuss capital solutions more on the 14th, as it's a key objective of the day to connect that with our origination strategy and our focus on fixed income origination and distribution. In my comments, we are assuming it's flat. There could be upside, but we are very pleased with the growth of the business. Achieving a five-year plan in two years is quite remarkable. We are dedicated to further developing that business and replicating our past success, with a primary focus on credit and gradually expanding to co-investments over time.

Operator, Operator

Thank you. The next question is coming from Brennan Hawken of UBS. Please go ahead. Brennan, please make sure your phone is not on mute.

Brennan Hawken, Analyst

Thank you. Thanks for taking my question. I appreciate it. Sorry if this is a bit remedial, but cost of funds came down quarter-over-quarter. I don't know of another company in financial services where cost of funds came down. So could you maybe speak to what drove the lower cost of funds, whether or not there were any one-time items and how sustainable that is?

Martin Kelly, CFO

Yes, you should consider the normalized net spread. That's why we emphasize looking at the net of the two. We experienced a benefit in the cost of funds this quarter related to the Venerable reinsurance transaction, which we mentioned last quarter. This played a role in our cost of funds and was adjusted in the net spread. Therefore, I would regard the 165 basis points as our current best estimate, accounting for factors such as the Arco buy down during the quarter, which are temporary rather than ongoing.

Marc Rowan, CEO

But I'm going to use this to make a point, which I've made previously. When you originate new product, you originate a product that is protected by surrender charges, market value adjustments, or in the case of PRT, is fully locked in. You should therefore be willing to have a higher cost of funds for fully protected product because you can invest against it. It gives you longevity. It gives you certainty. We have four different channels and we look at each of the four channels on a regular basis, and we try to keep our cost of funds low because we know if we have a low cost of funds, if we're not good investors, we can earn spread. And if we're good investors, we can earn a lot of spread. What's happened in our market is you now have a number of entities who have seen what we have built and are late to the game. The way they intend to get into this business or trying to get into the business is to buy back books of business. Buying a back book of business with degraded surrender charges and integrated market value adjustments in a low-rate environment may be sensible, because in a low-rate environment, the contract rate is above the rate in the market, therefore you expect the book to behave predictably. But in the market we're in right now, for someone to buy a secondary book of business and pay for a cost of funds in excess of that of retail kind of tells you all you need to know about the quality of the business that people are buying. And I encourage you to push as hard on cost of funds across the board. It ultimately simplifies what is a very complex business. We're in the spread business. Having a low cost of funds is really important.

Operator, Operator

Thank you. The next question is coming from Ben Budish of Barclays. Please go ahead.

Ben Budish, Analyst

Hi. Good morning. And thanks for taking the question. I wanted to ask about the old return of the Athene business; it's been below the sort of normalized 11% for several quarters. Anything in particular to call out there? I know we always spend some time trying to triangulate what it might look like, and there are many kinds of components to that. Any color on sort of the key drivers over the past year or so? And what do you think might get that back to sort of the normalized expectation going forward? Thanks.

Marc Rowan, CEO

Sure. The old portfolio consists of 150 different positions, roughly half related to our origination platforms, about a third associated with funds and hybrid products, and the remaining quarter comprises bespoke and direct investments. Overall, we still view that portfolio as yielding approximately 12% over the last couple of quarters. In light of the current environment, there has been a slight slowdown in appreciation, similar to trends seen in the broader market, but we have no fundamental concerns regarding its contents. As we have mentioned before, that portfolio is expected to provide around 8% in very challenging years, up to 18% in exceptionally good years, and between 12% to 15% as a normal expectation. We do not see any changes to that outlook.

Operator, Operator

Thank you. This brings us to the end of the question-and-answer session. I will turn it back over to Mr. Gunn for closing comments.

Noah Gunn, Global Head of Investor Relations

Great. Thanks for your help this morning, Donna, and thanks again everyone for joining the call. Just a couple of reminders. We would encourage you to participate in Athene's fixed income investor call next Thursday, November 9, and then our origination deep dive that we mentioned on November 14. If you have any questions regarding anything discussed on today's call, as usual, please feel free to reach out to us. Thank you for your time.

Operator, Operator

Ladies and gentlemen, this concludes today's event. You may disconnect your line or log off the webcast at this time and enjoy the rest of your day.