Ares Rose-Colored Portrait of Performance: Ares Management Fund Name, Pitch Materials Obscure Facts about Performance

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1 April 2017 A report by UNITE HERE John Valinch jvalinch@unitehere.org Ares Rose-Colored Portrait of Performance: Ares Management Fund Name, Pitch Materials Obscure Facts about Performance Key Points: The SEC s Office of Compliance, Investigations, and Examinations (OCIE) noted in 2014 that performance marketing by private equity firms was an area of particular focus for the agency. Ares Management restarted the numbering of one series of real estate funds, obscuring a poor record of past performance by predecessor funds. In pitch materials for Ares Special Situations Fund IV and Ares European Real Estate Fund IV, the firm utilized aggregate reporting measures for past performance rather than reporting the weaker performance of its most recent predecessor funds. Despite target returns advertised in Ares investor materials, only one private equity fund and real estate private equity fund actually realized the firm s performance forecast. 1 Questions: Why did Ares re-number and rename Ares Real Estate Investment Fund VI into Ares Real Estate Opportunity Fund? Are Ares investors receiving a complete picture when the firm pitches previous performance histories over long periods of time, while the most recent funds in the real estate group-for instance-have underperformed? Is Ares presenting an overly optimistic forecast for fund performance by advertising fund success over long historical periods instead of focusing on more recent performance? Alternatives manager Ares Management maintains $99 billion in assets under management (AUM), yet none of the firm s real estate funds have performed in the top quartile of peer funds. 23 This report explores Ares Management business decisions that have obscured the historical of performance of some of its funds.

2 SEC Points to Problematic Reporting by Private Equity In a May 2014 speech at the Private Fund Compliance Forum Andrew Bowden, then Director of the SEC s Office of Compliance, Investigations and Examinations (OCIE), discussed the propensity of some private equity managers to present misleading valuations of their funds during the marketing period of a new fund. For example, Bowden noted that since the private equity fundraising market continues to be tight for some advisers, we expect marketing to continue to be a key risk area. He went on to note that performance marketing was an area of particular focus. 4 Ares Restarts Numbering for US Opportunistic Real Estate Funds Private equity fund naming conventions assist investors by indicating the type of fund they are investing in, and offer a marker by which to evaluate past fund performance. With a clear progression of fund names, an investor can more easily tell which comparable predecessor funds have succeeded and which funds performed poorly. Many of Ares Real Estate Group s (formerly AREA Property Partners ) opportunistic real estate funds have underperformed peer funds. 5 AREA Real Estate Investment Funds III and IV both ranked in the 4 th quartile among peer funds, while AREA Real Estate Investment Fund V ranked in the 3 rd quartile. 6 When Ares Management acquired AREA Property Partners in 2013, it changed the name of AREA s most recent opportunistic real estate fund from AREA Real Estate Opportunity Fund VI to Ares Real Estate Opportunity Fund VI. Ares then changed the name again to Ares Real Estate Opportunity Fund, dropping the fund number. From Ares April 2015 investor presentation: Ares US Real Estate Opportunity Fund, L.P. ( AREOF, f/k/a Ares US Real Estate Opportunity Fund VI, L.P. and prior to that, AREA Real Estate Opportunity Fund VI, L.P., vintage 2012). When Ares went to launch its next opportunistic real estate fund it called the fund Ares US Real Estate Opportunity Fund II, implying that Fund VI was its first opportunistic real estate fund. Ares later changed the name of the successor fund to Ares US Real Estate Development and Redevelopment Fund II. 7 In sharp contrast, Ares maintained the numbering of the its better performing value added real estate fund (Value Enhancement Fund) series. 8 2

3 Again from Ares investor presentation: Ares US Real Estate Fund VII, L.P. ( US Fund VII, f/k/a Apollo Value Enhancement Fund VII, L.P. or VEF VII, 2008 vintage) Ares recently started fundraising for Ares US Real Estate Fund XI, the most recent in its valueadded real estate fund series. 9 Was it appropriate for Ares to restart the numbering of its opportunistic fund series but not its value added fund series? Aggregate Fund Performance Reporting Obscures Recent Underperformance Not only did Ares s decision to restart the numbering of one of its fund series obscure past fund performance, but Ares has also presented an optimistic view of recent performance by reporting aggregate performance across multiple funds rather that reporting performance of the immediate predecessor vehicle. In pitch materials to the New Mexico State Investment Council for Ares Special Situations Fund IV, the firm utilized aggregate reporting measures for past performance rather than reporting the weaker performance of its most recent predecessor funds in May Ares repeated this process in June 2014 while pitching Ares European Real Estate Fund IV to the Illinois State Board of Investment. 11 In a 2014 presentation to the New Mexico State Investment Council regard Ares Special Situations Fund IV, Ares reported aggregate performance for Ares Special Situations Funds I-III to the organization claiming a record of success with gross IRR of 20.6% (2.0x MIC) and a net IRR of 16.1%. 12 Yet Ares most recent predecessor, Ares Special Situations Fund III, had only generated a 15.86% IRR as of mid-year 2014 according to another LP. 13 The fund has seen its IRR since inception 3

4 decline precipitously since then. As of the end of the first quarter 2016 Ares Special Situations Fund III had generated a net IRR of 1% and a multiple of Similarly, Ares June 26, 2014 presentation to the Illinois State Board of Investment on Ares European Real Estate Fund IV utilizes aggregate performance reporting and cites historical realized/ unrealized 17.2% gross IRR and 1.6x gross equity multiple across a 19 year period. 15 Yet as of June 30, 2014, a limited partner in the immediate predecessor fund, 2007 vintage Ares European Real Estate Fund III, reported that the fund had generated a net IRR of just 7.05% and a multiple of 1.28x since inception. 16 Fund III s performance has since declined further as of mid-year 2016 an LP reported that Ares European Real Estate Fund III had generated a net IRR of 3.15% and a multiple of 1.15x. 17 In other words, by reporting aggregate performance across multiple funds rather than the performance of the most recent fund in the series, Ares was able to report substantially better looking performance. Are Ares investors receiving a complete picture when the firm pitches previous performance histories over long periods of time, while the most recent predecessor funds have performed worse? Are Ares target returns unrealistic given historical performance? In a November 2016 investor presentation, Ares laid out its net target returns in a slide entitled What We Do the Strategies We Manage. If Ares fund performance reported by Preqin were held to Ares own standard, then only one of Ares private equity funds (ACOF III with 21.7%) met the firm s target returns for Corporate Private Equity (18%-22%), none of the special situations funds hit its targets, and only one real estate private equity fund (AREA Value Enhancement Fund VII with 15.6%) hit its target (12%- 18%): 4

5 A footnote to the graph notes No assurance can be made that targeted returns will be achieved and actual results may differ materially. 5

6 Endnotes Ares Management Private Equity and Real Estate Funds Underperform, Pgs Spreading Sunshine in Private Equity 5 Preqin Fund Manager Profile for Ares US Real Estate Group. Accessed November Ibid Ibid materials_webv.pdf. Pg Ares Management Presentation for Ares European Real Estate Fund IV on June 26, Ares Management Presentation on Ares Special Situations Fund IV to the New Mexico State Investment Council Ares European Real Estate Fund IV Presentation to the Illinois State Board of Investment Real%20Estate%20Final.pdf 6