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Apollo (“APO”) shares continued their ascent, rising a further +22% over November, buoyed first by stellar Q3 results and then – just a day later – by a US election result that poured rocket fuel on the US financials sector as a whole – and the alternative asset managers (AAMs) in particular – on optimism around a revival of deal activity and the prospect of a more benign regulatory environment. The shares ended the month at $175. Remarkably, we took the opportunity to add to our position at $100 as recently as August 2024, when the shares overreacted to a Q2 earnings miss.

We believe APO’s share price has led the post-election charge amongst its peers for two specific reasons.

Firstly, there had been growing concerns that its life insurance business, Athene, (more accurately described as Retirement Services), may become subject to increased regulatory oversight given an increasing media focus on “private equity owned insurers”. While even this label is highly misleading, suggesting as it does that insurers like Athene either sit within limited life funds – they do not – and/or that their balance sheets are loaded with private equity investments managed by their owner – in most cases, certainly in Athene’s, they are not – the fact is that the election result reduces the probability of tightened regulation to close to zero.

Secondly, there is a heightened prospect of alternative investments being allowed into the $12trn 401(k) US pension market. While there are no legal restrictions on such pension plans investing in private assets, fears of litigation have prevented any such moves to date.  Such fears are likely to be diminished under a more permissive regulatory regime.

We note APO CEO Marc Rowan’s comment some time ago that “we are likely one administration away” from changes here. It is very possible that the US election result may well mean that administration has arrived. With its experience in retirement services via its ownership of Athene and having been first to identify what Rowan terms the Fixed Income Replacement Opportunity (replacing a portion of the ~$40trn public investment grade market with private investment grade credit), APO is best placed of all its peers to capitalise on an opening up of the 401(k) market.

We bought APO in 2021 at a time when we believed the AAM sector was misunderstood and undervalued; when valuations for balance sheet heavy companies like APO and KKR (AGT also owned KKR until recently) within the sector were overly penalised; and when APO’s share price was suffering from the scandal around former CEO Leon Black’s links to Jeffrey Epstein. Our thesis was that the market viewed the companies as levered plays on financial markets when, in fact, the bulk of their value, resides in their high-quality, visible, recurring, and predictable streams of fee-related earnings derived from management fees charged on long duration capital.

In the specific case of APO, there were also concerns ahead of its merger with its sister company, Athene. Life insurance businesses are, understandably, often lowly rated by the market. But the reasons why they are so – unpredictable liabilities with tail risks (e.g., long-term care) and hard-to-hedge liabilities such as Variable Annuities – simply do not apply to Athene which has a highly focused business model predominantly centred on fixed annuities.

As such, Athene can be looked at as effectively a spread-lending business, earning a spread between the rates paid on annuities and the yields earned on its investments. Its fixed income portfolio (95% of total assets) is 96% investment-grade, with Athene seeking to earn a return premium from complexity and illiquidity rather than from taking duration or additional credit risk and targeting a mid-to-high-teens return on equity. Life insurance businesses are also correctly perceived as being capital intensive, and this was a source of some disquiet when the Apollo/Athene merger was announced. But capital intensity is not a bad thing if one is earning high returns on that capital; and, as we understood at the time, a material proportion of Athene’s growth was likely to be funded by third-party “sidecar” vehicles.

While consensus estimates of forward earnings have increased over our holding period, the bulk of returns have come from multiple expansion as the market has favourably re-assessed the company’s earnings quality and the duration of its growth opportunity.

With our view and that of the market now much more aligned, we sold our position in the first half of December just after the announcement of APO’s inclusion in the S&P 500. This long-awaited event was met with a disappointing reaction by the market, perhaps because the shares being on the cusp of inclusion for so long means it was more priced in than we thought.

We are still pleased with overall returns of +166% and an IRR of +41% over our three-and-a-half year holding period vs. +28%/+9% for the S&P 500 and +42%/+13% for the S&P 500.

Despite AGT’s portfolio having minimal exposure to banks (direct exposure of less than 3% of NAV via our Japanese regional bank basket; additional indirect exposure of less than 1%), the events of the last month have proved painful for our NAV.

Hardest hit was top ten holding Apollo Global (APO), the USalternative asset manager (AAM). At one point during the month, APO’s share price had declined by 23% before recouping some of those losses to finish down 11%. This was within the context of an average 6 % share price return for the AAM peer group. A non immaterial portion of this decline can likely be explained by programmatic sector wide trades of “Financials” stocks.

That said, one can understand that AAMs with insurance operations where asset/liability matching is a key risk should be under more scrutiny than peers running a pure play asset management business. That some AAMs with no insurance exposure were down more than those with suggests the selling was somewhat indiscriminate.

But a closer look at APO’s insurance business is merited.

Following its 1 Jan 22 merger with Athene Insurance, APO has by far the greatest amount of insurance liabilities on its balance sheet of all the AAMs. While classified as an insurance company, Athene is more usefully analysed as a spread lending business. Its most common transaction involves a retail customer purchasing a defer red annuity for a one off lump sum paid up front. In return, Athene promises to make a bullet repayment in eight to ten years’ time that represents a fixed yearly percentage return on the original investment with some additional potential for capped upside based on equity market performance. No taxis payable by the customer until the end of the period, meaning returns compound at a greater rate than they otherwise would.

Athene invests the funds received in a portfolio of securities (94%in fixed income, of which 96% is investment grade) and makes a return on the difference between the yield it generates on those assets and the return it pays out to the policyholder. Athene seeks
to earn a return premium from complexity and illiquidity rather than from taking additional credit risk, and its return on equity has averaged 16% over the last four years (in line with its target of mid to high teens).

As interest rates rose, SVB suffered massive deposit flight from its undiversified customer base. This exposed th e company’s
reckless duration mismatch with its capital base facing erosion from the recognition of hitherto unrealised losses on its long duration investments in treasuries and MBS. Crucially, unlike SVB, Athene’s liabilities are well protected from disintermediation (i.e., policyholders withdrawing to seek higher returns elsewhere as rates rise). Firstly, 30% of its liabilities (predominantly institutional products) are entirely non surrenderable, while a further 52% are structured with penalties for earl y withdrawal.

That leaves just 18% of Athene’s liabilities that could be withdrawn without any surrender charge. Given Athene’s strict liability matching investment approach, these liabilities are backed by the shortest duration assets (floating rate secur ities). Indeed, the
withdrawal of this group of policies could be a net benefit to Athene given it would release capital which could be redeployed to support the sale of better protected products with lower liquidity needs and lower capital requirements. Analysis of historic consumer behaviour also confirms the sticky nature of annuities with even the most troubled institutions experiencing only modest upticks in withdrawals in 2008/09 during the GFC.

Given Athene’s fortress like balance sheet, substantial excess capital, and Apollo’s opportunistic/contrarian investment style, we would expect the company to be a net beneficiary of volatility. We added to Apollo at the March lows at a share price equating to just 10x our estimate of 2023 earnings. Later in t he month, APO management reconfirmed both their 2023 and their long term (2026) targets, with the latter being to double fee related and total earnings between 2021 and 2026.

KKR & Co and Apollo Global Management were two of the largest detractors from performance in April, shaving a combined -99bps off AGT’s NAV as the shares declined -13% and -20%, respectively. We wrote last October that “Driven by persistently strong results, we believe the wider market has begun to better appreciate the high quality characteristics of companies operating within the alternative asset management industry, and the secular tailwinds at their back that we believe are likely to drive growth long into the future.”

Well, if indeed the market had come to appreciate this fact, no sooner was it learnt than it was forgotten. Shares in KKR and Apollo are both down -31% year to date, with other alternative asset managers suffering similar declines. Share price performance suggests investors view alternative asset managers as high beta plays on risk assets; we however contend that such an obtuse view ignores the defensive characteristics of scale-advantaged managers, and the structural growth trends the industry exhibits.

The current assets under management (“AUM”) that alternative asset managers have is for the most part long-term or even permanent and so the risk of redemptions is very limited, while the proportion of fees earned on mark-to-market equity AUM is also very low; future AUM, i.e. AUM growth could in theory be affected of course, but the secular drivers towards greater allocations to alternatives are very much still in place with pension fund clients and SWFs (who form a majority of industry AUM) allocating to alternatives on decade-long views. In this context we believe alternative asset managers can continue to compound Fee Related Earnings (“FRE”) per share at high level for many years to come. Even if one punitively assumes that carry is worth zero, excluding balance sheet investments, KKR and Apollo are trading at 14x / 13x fee-related earnings. We believe this to be great value.

KKR & Co and Apollo Global Management were our two largest contributors over October, adding +1.5% and +0.7% to AGT’s NAV on account of +25% and +31% increases in their respective share prices.

Driven by persistently strong results, we believe the wider market has begun to better appreciate the high-quality characteristics of companies operating within the alternative asset management industry, and the secular tailwinds at their back that we believe are likely to drive growth long into the future. While October was a good move in share price terms for all of the large listed US managers, KKR and Apollo’s moves were particularly outsized.

There was no specific news during the month that drove KKR higher, although read across from the stellar results from early-reporting peer Blackstone (the first to report Q3 earnings) saw KKR’s share price respond well. While Blackstone’s results also doubtless aided Apollo, the latter’s share price performance can be specifically attributed to its Investor Day.

Our investment case for Apollo has rested in part on what we perceive to be the market’s continued misunderstanding of its annuity business Athene (recall that Apollo is merging with Athene), and its failure to appreciate the prodigious amounts of cash flow that the combined entity will generate (and the associated optionality provided by that cash-flow).

While the nature of Athene’s business means it requires a sizable amount of capital on its balance sheet, we think two key points have been missed regarding its future funding requirements. Firstly, the “sidecar” arrangements put in place two years ago whereby third-party Apollo LPs contribute a portion of Athene’s capital requirements; secondly, the growth and scale of Athene’s earnings and resulting cash inflows. Relatedly, we think the recent rebasing of Apollo’s dividend was more significant than the market fully understood.

Marc Rowan, Apollo’s impressive CEO, brought all this together at the Investor Day by disclosing that Athene will only need to fund 55-60% of its annual growth with its own capital. When combined with cash-flows from the rest of the business, and in light of the new dividend policy, he expects Apollo to generate $15bn of cash-flow over the next five years (for context, Apollo’s post-merger market cap will be ~$44bn at the current share price ) with $5bn to be paid out under the new fixed dividend policy, $5bn ear-marked for additional shareholder returns via buybacks or special dividends, and $5bn set aside for “growth investments”.

This last point is of most interest. In the words of its CEO, Apollo is “a growth business that has starved itself of capital” in the past. We concur – the company’s historical pass-through dividend policy has translated to very little retention of capital. With exciting growth opportunities in the mass affluent retail market, where Blackstone’s early success (now running at a remarkable >$3bn of inflows per month) has made its peers sit up and take notice, it makes sense for more capital to be retained and reinvested in the business. We note that KKR was earlier in recognising the benefits of using its balance sheet to accelerate growth, and that KKR have also expressly identified the retail market as a top priority. With their strong brands and distribution networks via their insurance divisions, we are optimistic for the prospects of both companies in this still-nascent growth area.

Apollo also laid out five-year targets for doubling AUM, increasing fee revenue by 2.25x, and increasing fee-related earnings by 2.5x. None of these forecasts/targets should have been a particular shock given the business strength and tailwinds, but Apollo has been very much a sector laggard in share price terms (in part due to the fall-out from the Leon Black/Jeffrey Epstein controversy) and its valuation discount vs peers was looking increasingly untenable.

During the month, we initiated a position in Apollo Global Management (APO), the US-listed alternative asset manager. The APO investment thesis is built on several pillars:

1. Cheapness: APO trades on the lowest valuation of its peers despite a strong recovery from the lows seen in late 2020. We estimate that the fund management business is being valued by the market at an implied 23 times fee-related earnings with no value assigned to future carried interest/performance fees. APO’s share price has lagged peers due in part to the associations of now-departed founder Leon Black with Jeffrey Epstein, which came on top of concerns surrounding the hit to accrued carry as a result of the H1-20 market falls.

2. High quality earnings: 60% of APO’s assets under management are permanent capital, the highest among its listed peers, leading to predictable visible earnings that in our view are deserving of a higher multiple than peers.

3. Exposure to Athene: Athene Holding is a listed fixed annuity provider currently ~30% owned by APO, with APO being the appointed investment manager for Athene’s investment portfolio. Over the course of its listed life, Athene has suffered from generalised market concerns about life insurers (which we believe were unfairly applied to Athene), and specific concerns about conflicts of interest between Apollo’s role as manager and as its largest shareholder. In Mar-21, APO announced an all-stock merger between itself and Athene to be completed later this year. Athene is an attractive business, operating in a sector with strong demographic tailwinds and with a strong balance sheet free from legacy liabilities that will continue to allow it to play a central role in restructuring across the life insurance industry. We know Athene well, having owned it via our successful investment in AP Alternative Assets several years ago.

4. High visibility on future growth: Athene has a significant amount of excess capital which can be invested to earn returns. We estimate that Athene’s USD8 billion of excess capital could support USD80-100 billion of additional investments. The fee-related earnings from this would significantly boost APO’s bottom line.

5. Exposure to a re-inflating economy: While we primarily are invested in APO because of its attractive long-term earnings potential, it also offers the opportunity to benefit from a re-inflating economy. This is true for two reasons: (1) Its private equity portfolio is, in our view, firmly in the “value” camp in terms of valuation and sector exposures, and should benefit disproportionately as the US economy re-opens; and (2) Athene should be a beneficiary of higher rates by virtue of the sector in which it operates and due to its overweight position in floating-rate loans.

6. Index Inclusion: It is likely that, following the removal of its dual share-class structure, APO will be eligible for S&P 500 inclusion. This will spark buying from index funds which, at the margin, is supportive of the share price.

APO sits comfortably in the AGT portfolio, adding to the exposure already provided by KKR. As a reminder to readers, we believe the alternative asset management industry to be a fundamentally attractive long-term investment opportunity, with defensive, high-quality earnings from long-duration assets under management, and growth prospects underpinned by institutional investors’ growing demand for alternative assets. Within this secular trend, we expect larger managers to continue to take market share.