Apollo Investment Fund IX launched without a target or a hard-cap. The firm wanted to take the temperature of the market before putting a number on it.
“We thought we could do better than [the $18.38 billion Fund VIII], but you don’t really know until you hit the road and start talking to LPs,” Apollo Global Management chief financial officer Martin Kelly told delegates at the 15th annual CFOs and COOs Forum in New York at the end of January.
“We had internal targets, or ambitions, aspirations, but we didn’t have a hard-cap.”
The fund attracted more than $30 billion of investor demand, despite eliminating a fund-wide fee break for investors above a certain threshold, which the firm offered on Fund VIII. Cutting the fund off at just under $25 billion was, said Kelly, a case of “simple math”: the firm typically deploys around $4 billion per year, and the fund has a six-year investment period.
So it was that in less than a year the firm shattered the record for the largest-ever private equity fund that had been held by Blackstone for a decade.
The $24.7 billion Fund IX played a major role in the growth of the firm’s assets under management, up 30 percent year-on-year to nearly $250 billion, according to Apollo’s end of year results. Its private equity assets under management hit $72 billion, up from $44 billion at the end of 2016.
While speedy, the fundraising was resource-intensive.
“The fundraising went better than we could have hoped for, and it was a pretty quick process,” Kelly said. “Fundraising is hard work, and it takes a lot of time and effort and travel and due diligence, and we focused pretty hard on it.”
Fund IX has 350 distinct limited partners, with 85 percent of Fund VIII LPs reupping, many of them with larger tickets. More than 60 percent of the dollars came from outside the US, compared with around 20 percent three or four funds previously.
How does Apollo manage such a large LP base? By standardising as much as possible.
“We try to have all investors subject to a similar process,” Kelly said. “As soon as you start to deviate from that you create exceptions, and exceptions create work and potential issues.”
Thanks to streamlined and scalable processes across the business, Apollo has not had to make new hires on either the finance team or the investment professional side on the back of the fundraise.
“We’re at a point where we’re really quite scaled and we have domain expertise in the 10 industries that we cover on the deal side, and then the finance and compliance and marketing teams are pretty well scaled around that,” Kelly said.
The scalability of the process is, of course, “not infinite”, Kelly said, “but we can absorb extra funds and work flow really without adding much in the way of costs and people”.
As with prior Apollo flagship private equity vehicles, Fund IX will focus on three strategies: distressed debt, corporate carve-outs and opportunistic buyouts. The mix will depend on the broader investment environment.
A recommendation document prepared by StepStone Group for the State of Connecticut Retirement Plans and Trust Funds during the fundraise indicated the firm intended to invest 20-25 percent of the vehicle in distressed debt opportunities, up from less than five percent in Fund VIII.
For the moment, “it’s not a reality in this climate, but it could become so if there is a recession”, Kelly said.
“As we look forward, if rates inch up and there’s not a big dislocation in the bond market and equities are sideways to up, and commodity prices don’t make a correction, then we’re in the same environment we’ve been in for the last few years and I expect we’ll keep doing the same types of transactions,” he said.
“At some point the recovery will turn, at some point we will have a recession, [and] when the cracks appear we will pivot to a distressed-for-control investing orientation.”
“We don’t have LPs who are clamouring for 15-20 percent returns”
Transactions in the fund will be underwritten to 2x multiple on invested capital and a net internal rate of return of 20 percent. Apollo’s private equity track record since inception is 39 percent gross IRR and 25 percent net.
“The bar around that is 61 percent gross on one of our funds and 12 percent gross on the lowest-returning fund. That fund was an ’06 vintage raised right before the financial crisis which actually turned out to be top quartile for its vintage, but it had the lowest return among our flagship PE funds.”
Apollo’s own analysis shows 50 percent of the value it creates for LPs is on the buy, Kelly said. As such, purchase price is extremely important.
“In our most recent fund the average purchase price is just under six turns of EBITDA, and that compares with a US industry average of 10 and about 11 in Europe. There’s enormous discipline that’s put into what are we paying for, what’s the downside, what could go wrong.”
Despite putting such an emphatic stamp on the private equity scene last year, the asset class is not the biggest business line for Apollo by quite some distance. More than $164 billion of its AUM is in its credit strategy.
The credit business is where most of the firm’s growth has come from in the last decade, and Kelly expects this to continue, driven in part by investor demand and banks stepping out of the business due to regulatory change on both sides of the Atlantic.
“We see a particular need for yield in a low to negative real rate environment. We don’t have LPs who are clamouring for 15-20 percent returns. Investors want 6-8 percent, 5-7 percent returns, but in a yield spectrum which is, for us, we define credit as 5 percent business and up, which is loans. It’s not CUSIPS, it’s not traded, there’s no bonds that we trade as part of our funds.”
Looking to the future, Apollo plans to find ways to grow its nascent real estate business, as well as make inroads in infrastructure. Kelly also sees robust growth on the horizon for the firm’s permanent capital vehicles, the best example of which is fixed-annuity insurance company Athene.
“We see that as a way to grow out our business both here and in Europe,” he said.
“We think the opportunity to do that in Europe is vast actually, with Solvency II coming in and restrictions on the insurance companies,” he added, referring to the European regulatory framework for EU insurers launched in January 2016.
As of 31 December, Apollo had just over $100 billion of AUM across seven permanent capital vehicles. The compound annualised growth rate of the firm’s permanent capital AUM since 2010 has been 47 percent.
Apollo also has around $20 billion in managed accounts, which range from $250 million-$500 million up to $4 billion-$5 billion. The demand for these vehicles, which Apollo invests across its products according to a pre-agreed set of criteria, is episodic, but tangible.
“We’re very, very cyclical, we’re volatile in terms of our earnings, and so how do we appeal to shareholders and provide the right information to do that?”
“It’s quite negotiated, it’s quite bespoke, and that’s where it’s harder to scale because investors want information, they want things done a very particular way for their needs, which is understandable,” Kelly said. “But it’s good business and I think it’s something we see, our competitors all see, and I expect that to continue.”
Apollo is, of course, a listed company, and therefore has public shareholders to answer to. Over the last couple of years Kelly has spent a lot of time visiting current and prospective shareholders to understand how they view and value the firm.
“We’re very, very cyclical, we’re volatile in terms of our earnings, and so how do we appeal to shareholders and provide the right information to do that?” Kelly said.
“We had to create a language internally at the firm which was, ‘What are the most important metrics for us in terms of running the firm? How do we assess the performance of businesses today as they grow, as we start new products or new asset classes, as we look to buy things? What’s important and how do we condense all of the metrics that we use into a handful that we can use as an objective measurement against new business?’ It’s been a fairly long process to do that, but we think we’ve got a pretty good handle on that now.”
The firm’s latest results should give investors something to smile about: Apollo posted economic net income of $3.57 per share for the year, up from $2.36 per share for full-year 2016. This was mainly thanks to strong private equity performance, with almost 30 percent appreciation for the year.