Earnings Call Transcript - GCMG Q2 2024

Operator, Operator

Good day, and welcome to the GCM Grosvenor Second Quarter 2024 Results Webcast. As a reminder, this call will be recorded. I would now like to hand the call over to Stacie Selinger, Head of Investor Relations. You may begin.

Stacie Selinger, Head of Investor Relations

Thank you. Good morning and welcome to GCM Grosvenor’s Second Quarter 2024 Earnings call. Today I am joined by GCM Grosvenor’s Chairman and Chief Executive Officer, Michael Sacks; President, Jon Levin; and Chief Financial Officer, Pam Bentley. Before we discuss this quarter’s results, a reminder that all statements made on this call that do not relate to matters of historical fact should be considered forward-looking statements. This includes statements regarding our current expectations for the business, our financial performance, and projections. These statements are neither promises nor guarantees. They involve known and unknown risks, uncertainties, and other important factors that may cause our actual results to differ materially from those indicated by the forward-looking statements on this call. Please refer to the factors in the Risk Factors section of our 10-K, our other filings with the Securities and Exchange Commission, and our earnings release, all of which are available on the Public Shareholders Section of our website. We'll also refer to non-GAAP measures that we view as important in assessing the performance of our business. A reconciliation of non-GAAP metrics to the nearest GAAP metric can be found in our earnings presentation and earnings supplement, both of which are available on our website. Our goal is to continually improve how we communicate with and engage with our shareholders and in that spirit, we look forward to your feedback. Thank you again for joining us, and with that, I'll turn the call over to Michael.

Michael Sacks, CEO

Thanks, Stacie. We had a strong second quarter, building on our recent momentum. During the quarter, fee-related earnings increased 20% and adjusted net income increased 29% over the prior year. Our private markets strategies continued to grow, with second-quarter management fees growing 11% year-over-year. Private markets now comprise 71% of our total assets under management. Our fee-related earnings margin was 40% for the quarter compared to 31% at the end of 2020. We continue to believe that we have opportunities for further FRE margin expansion in the future. The fundraising environment continued to improve in the second quarter. We raised $1.8 billion, a 26% year-over-year increase, and that brought first half new capital raised to $3.4 billion, a 45% increase from the first half of 2023. Our pipeline has grown nicely throughout the year, and we expect fundraising in the second half of the year to exceed that of the first half. We’ve spoken often about the strength of our diversified platform and recently about our confidence in demand for infrastructure and credit strategies. Infrastructure was again the greatest contributor to our quarterly fundraising, with over $600 million raised for the strategy in the quarter, followed by private equity and private credit. Year-to-date we’ve raised $750 million for dedicated credit programs, and we expect our credit platform to see significant growth going forward. Our private markets specialized fundraising of $1 billion so far this year is a great start and we are well on pace to see materially higher fundraising levels there than we saw in both 2022 and 2023. All of our private markets strategies delivered competitive performance, and we believe clients remain appreciative of our value add. Absolute Return Strategies' investment performance was again strong, building on the very solid first quarter. Our multi-strategy composite generated a 2.4% gross return in the second quarter, outperforming indices and peers. Gross returns for our composite are 7.4% year-to-date and 12.3% over the last twelve months, and we realized $10 million in performance fees so far this year. As a result of the good performance, our ARS pipeline has expanded meaningfully over the past year, during which we’ve raised $1 billion for the strategy. We did have net ARS outflows during the quarter, which resulted from the partial restructuring of one client portfolio. The outflows were at a lower than average management fee, leading to an uptick in our average ARS management fee rate. We expect total ARS management fees for Q3 will be roughly flat compared to the third quarter of last year. The recent volatile markets are the type where Absolute Return Strategies typically show well. Having been through a number of market cycles over the past 35 years, I have great confidence in our ability to add value in difficult market environments. Over the past three years, we’ve raised $1.8 billion from the individual investor channel. Earlier this year, I told you that expanding our products and distribution in that channel was a strategic priority. We made good progress in that regard this quarter. First, we are excited to share that we will serve as core independent manager for a private equity interval fund focused on private equity co-investments and secondaries. In addition, we secured a $300 million anchor commitment that we expect will seed an infrastructure product targeting the individual investor channel. We look forward to telling you more about these efforts in the future. Whether the strong long-term demand outlook, our history of high re-up rates, our expanded pipeline or our operating leverage, there are a number of factors that lead to our confidence regarding the back half of this year and our longer-term goals, which Jon will address now. We have a lot of ways to win and are confident in our value proposition for clients, shareholders, and team members. And with that, Jon, take it over.

Jon Levin, President

Great, thank you, Michael. This quarter I will address our previously stated goal of doubling our 2023 Fee-Related Earnings in five years. For historical context, from 2020 to 2023, we grew our Fee-Related Earnings at a 14% compound annual growth rate, and our platform is stronger, and the opportunity set is even more compelling now than it was back in 2020. There are five pillars to our growth: capital deployment, expanding with our existing clients, new client acquisition, scaling new initiatives, and margin expansion. Starting with our embedded growth from capital deployment. Over the last three years, on average, $3 billion of our annual FPAUM growth has been simply from turning on fees in existing programs where the capital had already been raised. Going forward, embedded growth will come from converting our $7.3 billion of contracted not yet fee-paying AUM into fee-paying AUM. We are particularly excited about putting client capital to work in what is an increasingly compelling investment environment. Turning to our existing clients, we have a proven track record of expanding our existing client relationships through successful re-ups and the broadening of the relationship. Last quarter, I spoke about how re-ups provide embedded growth, as they occur at 90% rates and at an almost average 30% increase in size. In addition, we’ve consistently had success earning our clients’ trust and expanding with them into new areas. Currently we’re seeing great traction with our existing clients around high-growth areas, such as infrastructure and private credit and into direct-oriented investment strategies. Approximately 50% of our top clients work with us in more than one investment vertical. Third, we are entering harvest mode on strategic investments we’ve made over recent years. One example is our private markets specialized fund franchises, as highlighted on slide 17 of the presentation. Since 2020 we have grown these private market specialized fund franchises by a 23% annualized growth rate as measured by capital commitments, and the opportunity persists going forward in both the more mature and the newer fund series. We’re fortunate to have such great loyalty from existing clients. More than 80% of our fundraising each year typically comes from those relationships. However, we also have success with new client acquisition both in markets where we already have a presence and over time in markets and channels where we are seeking to build our business. We’ve invested in our teams and seen early success in Europe, Australia, and Canada, but we have only scratched the surface of the opportunity set in those regions. Additionally, insurance and individual investors represent a massive opportunity for the alternatives industry, and we’re in an ideal position to capture share in both of those channels. Finally, while revenue growth will be a key driver to reaching our 5-year FRE goal, so is margin expansion from the operating leverage embedded in our business. Achieving our goal assumes continued FRE margin expansion, extending the margin enhancement we’ve enjoyed since going public. Beyond our FRE growth potential, we also have massive incremental incentive fee opportunity. It is unique in that it’s twofold – in both annual performance fees and through carried interest. Both of these earnings streams have been suppressed over the past couple of years, and while the exact timing is hard to predict, if we are successful in achieving our FRE growth targets, our growth outcomes in Adjusted EBITDA and Adjusted ANI should exceed that of FRE. We enjoy industry tailwinds and a platform which has the breadth and flexibility to compete effectively in this exciting market. With that, I’ll turn the call over to Pam.

Pam Bentley, CFO

Thanks, Jon. We are pleased with our strong results in the second quarter. Assets under management were $79 billion as of quarter-end, a 4% increase from a year ago, and Fee-Paying AUM also increased 4% year-over-year, ending the quarter at $63 billion. Contracted-Not-Yet-Fee-Paying AUM ended the quarter at $7.3 billion, a 9% increase from a year ago due to stronger fundraising over the last 12 months. Private markets were once again a key growth driver, with private markets Fee-Paying AUM growing by 7% year-over-year. As of quarter-end, our private markets business represents 71% of total AUM and 66% of our Fee-Paying AUM. We expect the double mix shift in our business to continue – first towards private markets and second towards direct-oriented strategies, which comprised more than half of our private markets AUM as of quarter-end. Private markets management fees grew 11% year-over-year due to strong specialized fund fundraising and catch-up fees of $2.6 million in the quarter. Private markets management fees, excluding catch-up fees in the quarter, grew 6% year-over-year, in line with our guidance last quarter. We expect a similar year-over-year growth rate in private markets management fees excluding catch-up fees in the third quarter. For the full year 2024, we reaffirm our expectation of double-digit private markets management fee growth excluding catch-up fees. At the beginning of the year, we spoke about our expectation that our Absolute Return Strategies management fees would stabilize in 2024, and we are still on track to meet that goal. Second-quarter ARS management fees increased 3% year-over-year, and we expect third-quarter ARS management fees to be consistent with the third quarter of last year. As Michael noted, investment performance has been very strong, positioning us to generate meaningful potential performance fees this year, and client interest in the strategy has grown. Turning to incentive fees, we realized $16 million in the quarter, comprised of $4 million in ARS performance fees and $12 million of carried interest. Our gross unrealized carried interest grew approximately 4% year-over-year to $810 million as of quarter-end. As Jon noted, we believe our incentive fees provide significant embedded earnings potential, which we look forward to being unlocked as the capital markets and M&A environment improve. As we realize both higher performance fees and increased carried interest, we believe that we have a compelling opportunity to increase the margin on the firm share of incentive fees to levels at or above last year. Turning to our expenses, as expected, second-quarter FRE compensation was $38 million. And we expect a similar level in the third quarter. We remain disciplined in managing expenses, and Non-GAAP General and Administrative and other expenses were $20 million in the quarter, again in line with our expectation. We expect similar levels next quarter. Pulling together these factors, on a year-over-year basis, Fee-Related Earnings grew a healthy 20% in the quarter and 22% year-to-date. Adjusted Net Income grew 29% in the quarter and 34% year-to-date on a year-over-year basis. Our FRE margin grew from 36% in the second quarter of 2023 to 40% this quarter. While there may be quarterly margin fluctuations, we enjoy significant operating leverage and still expect our overall FRE margin for 2024 to exceed last year. Our balance sheet is strong, and during the quarter, we successfully took advantage of constructive capital markets to extend our term loan by two years to February 2030, while decreasing the spread on our debt by 25 basis points, from 250 to 225, and upsizing the aggregate principal by $50 million. The incremental cash will be used for general corporate purposes, continued investments in the business, and opportunistic stock repurchases. We are maintaining a healthy quarterly dividend of $0.11 per share or an annualized yield of more than 4% as of last Friday. There is room for future dividend growth as we enjoy positive momentum in our earnings. We also continue to repurchase shares under our repurchase authorization plan and are focused on managing dilution from our stock compensation program. In the quarter, we repurchased $30 million of stock, leaving $35 million in our share repurchase program as of quarter-end. To close, we have confidence in our 2024 financial objectives and look forward to the opportunities ahead to deliver value to our clients and shareholders. Thank you again for joining us. And we're now happy to take your questions.

Operator, Operator

Thank you. Our first question will come from Bill Katz with TD Cowen.

Bill Katz, Analyst

Thank you very much. Regarding ARS, I appreciate the clarification about the significant withdrawal that affected the quarter. Looking ahead at the residual platform, can you provide insights on the concentration risk related to other potential large withdrawals, possibly among your top five or ten clients, and how that impacts the assets under management? Additionally, do you have any perspective on potential withdrawals as we approach the second half of the year?

Michael Sacks, CEO

Yes, it's Michael. We do not have any concentration risk in terms of our revenue. As we've mentioned before, while we do have some large accounts with significant assets under management, the larger the account size, the lower the fees tend to be. This means that overall, our firm is diverse with low levels of concentration regarding revenues, which is something we take pride in. Additionally, within our alternative risk strategies, we have various strategies, and when comparing ARS to private markets, our revenue distribution by client shows considerable diversification and minimal concentration. Our objective for ARS this year was to achieve stabilization, which we believe we have almost reached. We previously indicated that there was one client involved, and while it had a low fee, the average fee has increased. We also expect that in the third quarter, management fee revenue will match last year's figures. According to our forecasts, we anticipate that the fiscal period AUM in ARS for 2025 will exceed that of 2024. Performance will play a critical role moving forward, and while there is still time left for flows, this is our perspective, and we believe that stabilizing ARS in 2024 will allow for growth in that segment moving ahead.

Bill Katz, Analyst

I don't know if I can ask a follow-up, but I'm going to throw in anyway. Jon, thanks for the pathway to how you think you can double the FRE between now and 2028, very helpful. Can you break that down maybe one more layer between how you see the dynamics between the assumptions for private markets versus ARS within that construct? Thank you.

Jon Levin, President

Sure, Bill. Happy to do that. I think that the way we would think about that math is not dissimilar from how we've talked about what we look at internally from a budgeting and forecasting perspective, which is a neutral flows environment on the ARS side, but getting growth from compounding. We've talked about the fact that generally speaking we use a high single-digit number for gross returns depending on the specific strategy and then continuing the trend of what we've seen in private markets, which has been low double-digits to almost low teens growth on the private markets revenue side of things. And so I think that longer-term those kind of assumptions we used to budget and forecast the business on a longer-term basis would be similar to how we would look at it over a five-year period. I think once you get into breaking down how those numbers get there it's a lot of what I talked about on the prepared remarks in terms of embedded growth we have from CNYFPAUM, embedded growth we have from the relationships that we have, as well as the broadening of those relationships, and the new client acquisition opportunity. And I don't think that when we talk about these outcomes, we're really giving or counting on what I would call some of the more outsized opportunities you might have from things like real explosive growth in the individual investor market and things of that nature.

Ken Worthington, Analyst

Good morning. Thanks for taking the question. So maybe digging a little deeper into wealth management and your growing and deepening presence there, can you talk about how you see Grosvenor as being different in terms of either product design or product focus versus what the market already sees and what's resonating with the distribution channels. You mentioned Infra is the latest here. In my mind, it's really sustainability and impact investing where you seem to be different than peers? And what is the opportunity set there in wealth?

Michael Sacks, CEO

Sure. Ken, it's Michael. I believe the opportunity in wealth management, particularly for us, is quite substantial and is not limited to a narrow focus. There is a significant potential across various products and strategies. It's a major channel that has yet to be fully explored for alternatives. Currently, balance sheet allocation in this area is concentrated among a relatively small number of well-known brands, but this is expected to increase. While we recognize the opportunities in infrastructure and sustainability, there are also prospects in private equity and credit yield products. Over the next five to ten years, we anticipate much more diversification within this channel and a broader array of names on platforms compared to today, where the majority of alternative names are largely dominated by a handful of leading players. We see considerable opportunity there.

Ken Worthington, Analyst

Okay. Great. Thank you. And then just on the absolute return business, you highlighted the concentration redemption from that one client. Was that the vast majority? Was it half? What portion of the Elevated redemption...

Michael Sacks, CEO

No. It was a very significant majority. The client continues to work with us, and we expect to see some of that come back in different strategies over time. As we described, it was a restructuring and reallocation of a client portfolio. It was a top-down macro situation with a client that we still work with and want to continue working with moving forward.

Ken Worthington, Analyst

Thank you. The gross contributions are still at very low levels. In the past, you mentioned that several strategies were performing well and might start attracting assets. What are your thoughts on this? Should we anticipate an increase in gross contributions?

Michael Sacks, CEO

I believe that trying to time inflows and outflows from quarter to quarter is not effective. You should have a simplifying assumption to build your models, and we are happy to assist you with that. I mentioned earlier that we expect paying AUM and ARS to surpass 1124, although we need to get through the end of the year, as performance will play a significant role in that. From our perspective, things have stabilized, and I believe we will experience growth over the next several years. However, this growth will not be linear or occur every quarter in a stepwise fashion. We have navigated through many cycles in this industry, and that is my view.

Crispin Love, Analyst

Thanks. Good morning, everyone. Appreciate taking my question. Just first on fundraising. TE has been pretty stable here for a few quarters. Infrastructure improving. But can you just discuss the outlook for the back half of the year? You mentioned the second half seems better than the first. But just curious if you could drill a little bit deeper there the key areas of opportunity across private markets. And then just has the pipeline changed at all compared to the numbers you discussed last quarter. I think I might have missed that in the prepared remarks that you mentioned? Thanks.

Michael Sacks, CEO

The pipeline is strong. We previously stated that we have approximately $4 billion in potential re-ups. To give you some perspective, we raised $3.4 billion in the first half of the year, and we anticipate that the second half will be even greater. Of the re-ups mentioned last quarter, around $3 billion are still in the pipeline, which is a positive indication. We also have several specialized funds that are currently in the market, and we've had a solid start to specialized fundraising this year. We expect this trend to continue, leading to a successful year in specialized fundraising. Additionally, we are gaining new clients and deploying capital effectively, with existing clients moving into new strategies with us. Therefore, we are optimistic about our fundraising efforts in the second half of the year.

Jon Levin, President

I would like to emphasize the point Michael made about new client acquisition. We have several leading indicators that reflect activity levels in this area, such as the number of RFPs in the market, the volume of marketing presentations we are preparing, and the overall busyness of our sales team. All these metrics indicate that the current environment is certainly more active than it was a year ago, and it appears that activity levels are generally higher across the board.

Crispin Love, Analyst

Great. I appreciate that. I have one last question, mainly regarding the macro situation. Recently, we have observed significant volatility, particularly late last week and into the start of this week. Credit spreads have increased, and discussions about a recession have resurfaced. Additionally, there are expectations for rate cuts of around 100 basis points before the year's end. Considering all of this, could you talk about how it affects your outlook or the potential for deal activity in the industry? Also, what are the possible consequences for GCM, whether they are positive or negative in private markets or ARS, or do you consider it mostly an uplift? I would appreciate any insights you can provide. Thank you.

Michael Sacks, CEO

Yes. Generally, volatile markets tend to highlight the appeal of alternative strategies. In fact, I think that's the main takeaway; during extremely volatile markets, our alternative strategies receive greater appreciation from clients. That’s been our experience, and it holds significant importance. Regarding the impact of rate cuts over the next two to three quarters, the slowdown in the economy and the increased probability of a recession reported by some has risen from 25% to 35% over the past few weeks. However, this doesn't significantly influence our operations or our perception of opportunities, nor does it affect our short-term or intermediate results. None of these factors lead to real changes in our longer-term five-year outlook.

Stephanie Ma, Analyst

Hi, thanks for taking my question. Just wanted to get your latest thoughts on private credit. How do you think about that asset class as we head into potential rate cuts? And against the changing macro and rates backdrop, how are you thinking about expanding origination capabilities or other interesting areas of opportunities? Thanks.

Michael Sacks, CEO

Thank you for the question. As we mentioned in our prepared remarks, private credit is set to continue its growth trajectory. Our perspective remains strong regarding our business's outlook over the next five years, unaffected by short-term developments. Private credit is a growing sector, and we expect its share of the global balance sheet to increase in the coming years. Our outlook remains unchanged, and we believe this trend will persist. We've indicated that our pipeline includes a significant amount of private credit opportunities for the remainder of this year and into next year, and we're excited about it. We anticipate growth in all channels, including individual investors and institutions, and across various private credit strategies, which presents us with encouraging opportunities.

Stephanie Ma, Analyst

Great. Thank you. Maybe just one on FRE margins. I appreciate your aspirations over time. But any other color you can provide on cadence or trajectory? What are some of the steps to get there between ongoing mix shift of the business and realizing benefits of scale? And then also maybe you can tie into there some ongoing areas where you continue to invest behind? Thank you.

Michael Sacks, CEO

Sure. I'm not sure if Pam wants to address the margin question since she already touched on it to some degree. To clarify, we believe we have strong margin performance this year and are experiencing some operating leverage. We highlighted that we expect continued operating leverage and margin improvement over the next several years, which both Jon and I mentioned. We are keeping a close watch on our expenses and managing headcount effectively. We are also focused on aligning the interests of our team and shareholders, and all of these factors contribute to our margin opportunities. Pam, Jon, do you have anything to add?

Jon Levin, President

Yes, I would just add one other point which is these businesses and you've seen it obviously not just in our business and the margin enhancement we've had over the last few years. But I think you see it generally in the marketplace or businesses that are good businesses. They benefit from the tailwinds. They benefit from the revenue trends, and they allow you to care for your existing people appropriately from a compensation perspective, while also investing in your business and still have operating leverage and margin enhancement. So I don't think it's the type of thing where you go from one quarter to the next quarter, and all of a sudden hit your margin goal. I think it's the type of trajectory that you've seen over the last few years, where you get it as you're having revenue growth and get it kind of ratably or somewhat linearly over time. And I think, if you look at us relative to other businesses in our space, you can get a sense for where margins can kind of go over time. I think the important part of what we're speaking to in terms of a five-year perspective is just the different vectors of growth, the multiple ways to win, the optionality you have you can't predict everything five years out. But I think as we look across the board of all the different things that are going on at the business, we feel good about the revenue growth and therefore feel good about the ability to continue to have the operating leverage in the business.

Michael Sacks, CEO

And in terms of what we're investing in, we've discussed the individual investor channel as well as other distribution channels that we have and will continue to invest in. You have seen our investment in credit investment capability over the past several quarters, and we are clear that we see this as a valuable growth opportunity. Therefore, we are investing in several areas where we believe we can achieve significant results from those investments.

Bill Katz, Analyst

Okay. Thanks for taking the extra questions. Just zoning in on the opportunity for performance fees. So wondering, if you could answer a couple of questions. I appreciate the market has been particularly volatile in the last week or so, but putting that aside how should we be thinking about any kind of cadence in terms of line of sight of activities that you might be seeing? Which portfolios, do you think it comes out of as you sort of array between sort of 2013 and to current? And then finally, Pam, you may have said this and I apologize, I may have missed it. How do you sort of see the aggregate comp ratio on the variable incentive migrating as the quantum of dollars were to increase? Thank you.

Michael Sacks, CEO

Let's address the margin first. Pam mentioned in her remarks that as the revenues in the incentive line increase, the margin will also rise from the levels observed in the previous couple of quarters. Most of the ARS portfolios include a performance fee component that, along with the private markets carry, adds to our incentive fee line. Some of this was recognized from last year, and a bit this year already, but the majority will be finalized at the end of the fourth quarter. Thus, we cannot count that revenue until it is confirmed. However, there is certainly a revenue opportunity for 2024, and excluding the recent fluctuations as you suggested, this is a significant revenue opportunity. We included projections in our earnings deck based on a base case assumption, and we were outperforming that assumption by the end of the second quarter. There is potential revenue, but it will only be realized when it materializes. We will need to see where things stand on December 31.

Jon Levin, President

Yes. Michael mentioned this, but it's clear to us since we experience it daily. Sometimes performance fees may not be finalized in the fourth quarter due to certain portfolios having fiscal years that don't align with the calendar year. However, as Michael pointed out, most portfolios measure performance fees based on the calendar year, which is why we observe most crystallization in the fourth quarter. Additionally, I want to emphasize that most of our ARS portfolios for clients are multi-strategy portfolios. While some may focus on specific areas like equity or credit, the majority are multi-strategy, incorporating equity, credit, relative value, and macro strategies. The positive performance we've noticed this year and the capital protection we've managed during recent challenging market conditions reflect broad-based strong performance and solid alpha generation.

Operator, Operator

Thank you. And that does conclude the question-and-answer session. I'll now turn the conference back over to you.

Stacie Selinger, Head of Investor Relations

Thank you. Thank you, again for joining us today. We appreciate the questions and the engagement, and we look forward to either following up or talking to you again next quarter.

Operator, Operator

Thank you. And ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. We hope everyone has a great day. You may all disconnect.