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During the month we exited the position in KKR. Since the position entered the portfolio in 2020, it has been a very strong source of returns for AGT. Our thesis was simple: that the listed alternative asset management sector was systematically undervalued, and that KKR (and Apollo, which we also own) was itself undervalued relative to peers.

The market perception of alternative asset managers was – and to an extent still is – that they are high beta plays on risk assets. While we concede that both KKR and Apollo have more on-balance sheet risk than peers, our contention was that the market underestimates the defensive characteristics of scale-advantaged managers that earn fees on long-dated committed capital, and the powerful tailwinds for structural growth across the industry. Evidence for this has been borne out in results and was clearly articulated at the recent investor day we attended in New York City in April. Over time the market has come closer to our way of thinking and the shares have re-rated significantly to reflect the company’s attractive long-term growth prospects.

Over the course of the investment, KKR generated an ROI of +217% and an IRR of +59%, which compares to returns of +40% and +14% for the MSCI AC World Index (all in GBP).

KKR’s shares had already enjoyed a strong November when an announcement was made on 29-November that sent the shares up another +9%, to end the month +37% higher than where they began. The news that KKR was to acquire the 37% of insurer Global Atlantic that it did not already own was taken well by the market, as was the accompanying announcement of a further shareholder-friendly change to the company’s compensation structure.

There were strong gains across the listed alternative asset managers in general, with share prices continuing to exhibit a far higher beta than can be justified by the underlying businesses themselves where a majority of revenues are derived from committed long-duration assets under management. While KKR’s balance sheet investments should, ceteris paribus, translate to greater volatility than peers, we continue to believe the market misunderstands both the composition of this portfolio (increasingly comprised of defensive long-dated “core” private equity positions) and the quality of its asset management business. In the words of KKR co-CEO Scott Nuttall, Global Atlantic – the life insurance business in which KKR acquired a majority stake in 2020 – has been a “home-run investment”. With Global Atlantic’s assets more than doubling from $72bn at the point of acquisition to $158bn today, it is hard to argue otherwise, with KKR’s ownership also helping scale its real estate credit and asset-based finance businesses whose assets sit well on insurance company balance sheets.

The remaining stake in Global Atlantic is to be purchased at book value, the same multiple as the original acquisition and a low valuation for a mid-teens ROE business. Crucially, the $2.7bn acquisition price is being funded entirely in cash. There had been some fears, given the right the minority shareholders had to force KKR to either list the business or acquire it from them, that KKR would issue shares to pay for it. This is where KKR’s remarkably strong balance sheet has come into play, with the company having $3.8bn in cash as at the last quarter end and with long-term fixed rate debt in place (at a weighted average interest rate of 3.9% and maturity of 2041).

Separately, KKR also announced another change to its compensation framework. KKR was one of the pioneers in recognising that there was an arbitrage to be had from increasing the compensation load on carried interest/performance fees (assigned an implicit lowly multiple by the market) and reducing compensation paid from fee-related revenues (which are valued much more highly by the market given their highly visible and predictable recurring nature). To that end, in 2021, KKR implemented a 60-70% compensation load on realised carried interest/performance fees and 20-25% on feerelated revenues. These ranges have now been further modified to 70-80% on realised carried interest/performance fees and a reduction to 15-20% on fee-related revenues.

Just after month-end, the latest changes were announced to the S&P 500 index constituents. While neither KKR nor Apollo were selected for inclusion, we believe it is a case of when rather than if they will be added following Blackstone’s admission earlier this year. With estimates of forced buying of up to 20% of each company’s free float following an entrance to the index, the impact when it comes could be very powerful indeed.

KKR was our fourth largest detractor, its share price ending the month down -9% and almost -40% below its Nov-21 peak. In contrast, the S&P 500 has declined only -14% over the same period, suggesting perhaps that KKR is regarded as a levered play on financial markets. While KKR does have a large balance sheet of investments in its own funds and also operates a capital markets business subject to cyclicality, similarly weak share price performance from balance sheet-light peers from their Nov-21 highs (e.g. Blackstone -34%; Carlyle -46%) implies that this view extends across much of the listed alternative asset management (AAMs) sector.

We believe this perception is misplaced. For the most part, the AAM’s assets under management (AUM) are not at risk of redemptions, nor are meaningful proportions of their fees subject to mark-to-market risk. I.e. the vast majority of assets are tied up in long-term or perpetual fund structures with management fees charged on committed capital. In the case of KKR, almost half of its AUM is either perpetual capital or long-dated strategic investor partnerships (separately managed accounts in which capital is recycled following exits); just 10% of AUM is from vehicles with a life of less than eight years at inception.

Second quarter results have confirmed the resilience and defensive characteristics of scale-advantaged AAMs with KKR‘s fee-paying AUM growing +20% year-on-year. While its fee-related earnings fell -2%, this was entirely driven by a decline in capital markets fees (to which we assign only a modest multiple in our sum-of-the-parts valuation) with management fees up +36% (and +5% quarter-on-quarter).

A combination of shorter gaps between fund raises (due to more rapid deployment) and the “denominator effect” (under which some institutions have become overly-allocated to Alternatives due to the fall in public markets) has resulted in now widespread reports of LPs facing indigestion, spurring fears around fund-raising prospects. Importantly, however, KKR –  along with its listed peers – benefit in this environment both from LPs prioritising relationships with larger managers and from their diversification across asset classes given the “indigestion”  referred to above primarily relates to private and growth equity fund raises. KKR is also in the enviable position of having already raised its latest flagship private equity funds over the last couple of years. Furthermore, just 35% of KKR’s AUM is from private equity funds vs double that ten years ago.

In recognition of the increased significance of their Real Assets business (Infrastructure and Real Estate), KKR recently hosted an analyst presentation at which they highlighted that 30% of growth in total management fees has come from Real Assets over the last three years with the segment’s AUM three times what it was in 2019. Given institutional investors are under-allocated to Infrastructure and with continued heightened inflationary concerns, we expect KKR’s Real Asset business to be an even more material contributor to future growth on the back of further international expansion and penetration into the still-nascent retail market.

Given its resilience and secular growth prospects, the 11x stub fee-related earnings multiple on which we estimate KKR currently trades (or 16x if we punitively assign zero value for earnings from carried interest) represents, in our view, one of the most glaring mispricings in our portfolio.

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.

KKR’s shares are now up +46% over 2021. Despite this bringing the total return on our position – acquired in the first half of last year – up to +140% (a more muted +113% in GBP), we believe KKR has an extended runway ahead of mid-teens AUM and earnings growth and we still see considerable upside in the position. The company’s Investor Day earlier this year and subsequent Q1 results confirmed the business is firing on all cylinders with assets under management at the end of the first quarter standing +77% higher than a year prior. While this figure was boosted by the acquisition of life insurer Global Atlantic, organic growth of +30% is indicative of KKR’s advantaged position within an industry itself benefitting from robust secular tailwinds. We expect annuity provider Global Atlantic, in which KKR now has a 61% stake, to accelerate KKR’s growth even further over the coming years as a source of low-cost liabilities. Crucially, the acquisition means permanent capital now accounts for a third of AUM, providing even greater stability and visibility to fee revenues.

KKR’s moves to grow its platform beyond traditional private equity have paid off, with 57% of AUM growth between 2010 and 2020 derived from businesses that did not exist ten years ago. While private equity now accounts for ~40% of total AUM (down from ~75% upon listing in 2010), even that figure understates the actual level of diversification with the private equity platform now spread across Asian, European, longer-dated “Core” funds, as well as specialist growth equity (healthcare and technology) funds, in addition to the original US business. These fund-raising efforts and rapid deployment have led to record levels of embedded gains both in terms of unrealised carried interest and balance sheet investments gains, and should translate to elevated levels of income from these sources over the next few years. We value KKR on a sum-of-the-parts basis, and believe the company’s most valuable “part” – fee-related earnings (i.e. from base management fees) – has been made even more valuable by changes made earlier this year to the compensation structure that will see a heavier compensation load instead placed on carried interest.

KKR (2% of NAV) is a US-listed alternative asset manager which we invested in at an estimated 45% discount to
NAV. We believe there are multiple secular tailwinds favouring KKR, many of which are misunderstood by the
market:

KKR operates in a highly attractive industry, with secular growth driven by increasing institutional
investments in alternative assets, underpinned by a “lower-for-longer” rate environment.

Its full suite of alternative strategies – private equity, credit, real assets – allows it to cross-sell to its LPs, and
benefit from institutional investors looking to consolidate their GP relationships.

Investments in developing new strategies over the last ten years should start to see increasing performance
fees as these mature and scale. Up-front investment in these areas has stifled margins, which we expect to
increase from here.

One of KKR’s differentiating factors is its very large balance sheet consisting of investments in, and coinvestments
alongside, its own investment funds. As well as generating attractive returns in its own right in a
fee-free manner for shareholders, the balance sheet also allows for potentially higher growth than peers
given it can be used to support/seed new investment strategies.

The long-duration nature of the capital managed by alternative asset managers results in stable and highly
visible revenues, with carried interest (performance fees) consistently undervalued as an income stream by
the market.