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This $112 billion firm can't wait for the next downturn

Bloomberg logoBloomberg 6/14/2018 Sridhar Natarajan

The economy is going gangbusters, corporate profits are at record highs, and the world is awash in liquidity.

In short, it’s the perfect time to get ready for the downturn. Or so say the folks at $112 billion investment firm Ares Management.

As the ebullient 10-year credit market continues its run, Ares is placing a big bet on buying the debt of troubled companies when the economy flattens. The Los Angeles firm has carried out an expansive effort to rebuild its distressed-debt team under Oaktree Capital veteran Scott Graves over the last year.

The real challenge will come when it sets out to court investors to raise money. That won’t be easy in these times. Many people say such talk of a new distressed cycle is premature. Others who’ve stepped in early expecting a downturn have been left twiddling their thumbs. And Ares itself was stung by a move into energy credits back in 2015.

But David Kaplan, an Ares partner, is undaunted.

"You need to be prepared like good boy and girl scouts," said Kaplan, a co-founder of Ares. "It isn’t an accident that when people are feeling reasonably good about the world and markets, we are putting the pieces together to take advantage of things when they correct."

Vulture Investors

Others are positioning for the fall, too, notwithstanding the naysayers. At Oaktree, Graves’s previous home, there is an expectation of an avalanche of troubled credit that could top $1 trillion that vulture investors will need to pick through, according to Jay Wintrob, the chief executive of Oaktree, one of the world’s largest distressed-debt shops.

Ares’s decision to rebuild came during its bad experience with energy-company credits. After raising $1.5 billion in the summer of 2015 for its last distressed-debt fund, plunging oil prices sent credit markets into a tailspin. Ares dived headfirst into some hairy credits like Breitburn Energy and Midstates Petroleum.

The investments proved to be concentrated, long and wrong. Oil continued to crater. At one point, the firm had big markdowns in the first $250 million it deployed, people with knowledge of the matter said, asking not to be identified as the information isn’t public. Over the last year, the firm has stabilized the energy fund, the Ares Special Situation Fund IV, putting more than $1 billion to work.

Private Equity

But as the fund bled money, Ares executives decided they wouldn’t abandon the distressed market. They shifted the investments to its private equity umbrella and picked Graves to assemble his team. Most of the previous crop of distressed-debt professionals soon exited the firm.

Among his hires were Craig Snyder, a former GSO Capital Partners trading head and portfolio manager, and Aaron Rosen, an analyst who worked previously at Citigroup Inc.

“I viewed this strategy as a startup inside a $100 billion AUM organization,” said the 47-year-old Graves. “It was too good an opportunity to pass up.”

Graves’s ties to Ares colleagues go back to his undergraduate days at UCLA. He roomed with Matt Cwiertnia, now one of the heads of Ares’s North American private equity group. Graves later worked under the tutelage of Bruce Karsh, arguably one of the biggest exponents of distressed-debt investing at Oaktree.

Bigger Checks

Graves’s group is starting to flex its muscles as it ramps up. One significant investment came when Ares teamed up with Goldman Sachs Group Inc. to deliver a financing deal for The Fresh Market Inc., a struggling retailer that needed an injection of new capital, people with knowledge of the matter said. Graves’s team has also joined with other larger funds within Ares to help write bigger checks.

For the most part, though, it continues to take the small nibbles, awaiting, like most others, for the big dislocation to hit.

"As we look at the market backdrop today, there’s a tremendous amount of liquidity that masks some of the risk factors that may be lurking underneath," Kaplan said. "We don’t time cycles. But it is a law of nature that the catalysts will come together and cause a correction."

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