Home Stock Ideas Long Ideas Financials Canada

How Brookfield And Peers Make Money And

How You Can Participate In 2023
Dec. 28, 2022 12:00 PM ET | Brookfield Asset Management Ltd. (BAM), BAM:CA, BN, BN:CA | APO,
ARES, BX... | 220 Comments | 187 Likes

Alexander Steinberg
4.22K Followers

Summary
Big alt managers include 6 companies but 7 stocks. Brookfield Asset
Management Ltd. is now represented by two stocks - asset-heavy BN and
asset-light BAM.

The industry is attractive because the capital supplied by clients remains locked
for many years in private funds providing a stable stream of "sticky" and
relatively high management fees.

The industry has grown at 20% for many years and is expected to continue
similar growth at least for the next several years.

Due to its unique profile, BAM appears to be very appealing. BN seems less
appealing as some of its capital is not efficiently allocated.
asbe/iStock via Getty Images

I have authored quite a few posts on Brookfield Asset Management Ltd.

(NYSE:BAM) and its related companies. But they are designated for people who are
already familiar with the complex world of private equity and alternative asset
managers.

This post is completely different. It is for those investors who are curious about
Brookfield and sense related opportunities but need help to start their journey. You
do not need to know much to understand the content.

There is an additional benefit to this. Once you understand Brookfield, you will also
understand its peers - Blackstone (BX), Carlyle Group (CG), Apollo (APO), Ares
Management (ARES), and KKR & Co. (KKR). This article includes some information
about them as well. Together with Brookfield, I will call these companies the Big Six
of alternative asset management. Several of them have beaten the S&P 500 Index
(SP500) on a multi-year basis. Some of them are also paying generous and quickly
growing dividends that retirees find irresistible.
Until recently, Brookfield's parent company was called Brookfield Asset Management
represented solely by the well-known ticker BAM. It is different now. The parent
company is called Brookfield Corporation (NYSE:BN) and BAM is one of its
subsidiaries (I will explain the details later). We will use Brookfield and BN
interchangeably. What follows is a manual on Brookfield and its peers with more
emphasis on the former for the reasons that will become clear in due course. I will
intentionally oversimplify my story to make it more digestible.

Alternative assets
Almost everybody is familiar with traditional asset managers such as Vanguard.
These companies manage stock, bond, and money market mutual funds and/or
exchange-traded funds ("ETFs") charging small fees for this. For some index
funds/ETFs, these fees are measured in hundredths of a percent of investors'
balances. They can go higher but are typically well within 1%. Both mutual funds and
ETFs are liquid. Investors can easily sell their holdings almost anytime.

Alternative (or alt) asset managers are different. The word "alternative" means that
the assets they manage are different from public stocks, bonds, and cash
instruments. This is true in most but not all cases. For example, Brookfield has a
traditional mutual fund business as well but it is rather small within the company.

The best-known alternative asset is private equity, which implies owning a company
that is not public. From time to time, BN acquires a public company making it private,
improves it one way or another, and sells it several years later to a buyer or through
an IPO at a higher price pocketing a profit. Most alt managers started their business
from private equity activities and the industry is still called private equity sometimes.
But this term is misleading today. Alt managers have increased their scope
dramatically and private equity is nothing more than a segment.

Another familiar example of an alternative asset is real estate. BN has giant non-
public real estate operations, developing and managing different types of properties
starting with storage facilities and ending with skyscrapers in downtown New York,
London, Berlin, Toronto, and Sydney. And everything in between.
One other type of alternative asset is private credit. Loans that banks carry on their
balance sheet are examples of private credit. But typically this term is reserved for
non-bank loans. Since the Financial Crisis of 2008, banks have become strictly
regulated and limited their activities. Alt managers used this opportunity to increase
their lending operations taking market share from banks. Differently from banks, they
often pursue riskier loans. They also operate in distressed and high-yield debt which
can be public or not. Oaktree, one of Brookfield's subsidiaries (Brookfield owns 64%
of it), is a recognized expert in these operations.

Two popular alternative assets today are infrastructure and renewables including
building and operating toll roads, ports, oil and gas assets, airports, solar, wind, and
hydro energy facilities, and so on. Brookfield is leading here and this is, perhaps, the
most exciting part of its business.

There are many other types of alternative assets such as venture capital, hedge
funds, and cryptocurrencies, but they are not important for Brookfield nor for most of
the other Big Six (for Blackstone though, hedge funds represent a separate
segment).

Since alternative assets by definition are not being traded on public markets they are
relatively illiquid. It may take years to improve a piece of real estate or to turn around
a company and sell them. The illiquid nature of alternative assets requires patient
capital.

How alt managers source capital

For purchasing assets, alt managers can use their capital and/or raise capital from
third parties. Some alt managers use very little of their capital in investments and are
called asset-light. Others, like Brookfield, are asset-heavy and may supply 15-25% of
their capital per investment. This is called the alignment of interests between an alt
manager and third parties.
Alignment of interests is an effective tool to attract third parties, but surprisingly it is
less important than it seems. The biggest company in the industry is Blackstone and
they are asset-light contributing only about 0.5% to assets under management
("AUM"). Blackstone has established a remarkable track record, particularly in real
estate, and this track record - a unique intangible asset - appears more important
than a significant alignment of interests.

Since alt operations need patient capital, only institutions with long-term investment
horizons can supply it. Or at least that is how it was in the beginning. Please note
that the industry is fairly young and quickly evolving. For example, more than a
century-old Brookfield entered it only in the XXI century. Blackstone started a decade
earlier.

So what institutions have the longest investment horizon? Pension plans,

endowment funds, and sovereign wealth funds. These institutions became the first
clients of alternative asset managers.

Clients' contributions are aggregated in so-called private funds which are measured
in billions. Private funds get closed once the manager receives enough money for its
plans. These monies remain locked in the fund until it is wound up 5-7 (or even
more) years later. At this point, initial contributions with profits are returned to clients.

Legally, funds are limited partnerships, with the alt manager being the general
partner. General partners typically contribute 2% of the funds' capital but control all
operations. Clients become limited partners and supply almost all capital but have no
say in operations. Asset-heavy managers like Brookfield contribute additional capital
to the funds and become limited partners on top of being general partners.

Once the alt manager invests all money in the fund but long before it is wound up,
the alt manager starts raising money for a new fund of the same strategy. The word
"strategy" is very important here. Alt managers have developed tens of different
strategies. For example, there might be one fund for private equity, a different fund
for real estate, and so on. Moreover, these strategies are subdivided further fine-
tuning to clients' profiles and preferences. In real estate, for example, there are risky
funds with target returns of 20% per annum (so-called opportunistic funds) and much
safer plain vanilla funds with target returns of 7-8% (core or core-plus funds).
Combining all this, alt managers handle simultaneously a lot of different funds that
vary in strategies and vintages. To deal with fundraising, managers form sales teams
that approach clients all over the world directly or, sometimes, through
intermediaries. Sales teams are often completely decoupled from investment teams
and are critical for alt managers.

Clients are paying close attention to the track record of an alt manager and track
their experience with this particular manager. Initially, a giant pension fund can trust
an alt manager with a small slice of its money for a particular strategy. Provided this
experience is successful, the same pension fund can commit more money across
several strategies. Currently, the Big Six have hundreds of big clients worldwide
each, and many invest in multiple strategies.

Private funds sourced from institutional clients have been the major source of capital
for all alt managers. But now all of them are quickly expanding their offerings to
individuals and affiliated insurers trying to reach scale. Some have already
succeeded.

Individuals can invest in Brookfield's three public subsidiaries: Brookfield

Infrastructure Partners (BIP, BIPC), Brookfield Renewables Partners (BEP, BEPC),
and Brookfield Business Partners (BBU, BBUC). Each of them exists in partnership
and corporate forms that differ only in taxation (the letter "C" in tickers designates
corporations). These subsidiaries provide capital to Brookfield private funds and if a
retail investor buys a unit/share, she indirectly becomes a limited partner in several
private funds at once. Since subsidiaries are public, individuals do not have to lock
their capital for many years and can sell units/shares anytime. The volatility of public
vehicles becomes the reverse side of their liquidity. Several alt managers have
similar vehicles.
However, some wealthier individuals are ready to forego liquidity in pursuit of higher
returns. Until recently, they could not do it via alt managers, but this is changing.
Blackstone was the first to offer non-traded real estate investment trusts ("REITs")
and a credit vehicle to individuals via independent distribution channels (banks,
broker-dealers, etc.). Brookfield and others are replicating this strategy now. For
these vehicles, alt managers limit the aggregate amount that investors can redeem -
say, not more than 5% of assets per quarter. Under normal conditions, these
vehicles seem liquid. However, when many investors want to exit simultaneously due
to some financial stress, the vehicle quickly becomes illiquid. It recently happened
with investors in Blackstone non-traded vehicles and may or may not have
consequences for the industry.

Working with affiliated insurers is the latest big trend for alt managers no doubt
inspired by Apollo's example. The idea is rather simple in theory. Certain types of
insurance products, such as fixed annuities, are long-term in nature. An insurer faces
a payout many years after receiving money from an individual (or a company in the
case of a group annuity) which makes annuities suitable for funding private credit.
This channel is already working remarkably well for Apollo. Brookfield is in the
process of building its insurance subsidiary which is expected to contribute to assets
under management at scale quite shortly.

Fees
Without much exaggeration, alt managers are about fees. For asset-light managers,
fees, in one form or another, dwarf everything else. Asset-heavy managers can also
count on returns on their capital and nevertheless fees are the most reliable and
valuable part of their business. This is true about asset-heavy Brookfield. Apollo
might be the only exception, as giant insurance subsidiary Athene prints money with
amazing reliability and grows quickly.

Alt managers are overly creative with introducing various fees. Still, slightly
simplifying, all fees belong to two broad categories: management fees assessed on
AUM similar to mutual funds and performance fees dependent on beating specific
performance targets within funds (much smaller advice and transaction fees are
grouped with management fees).
Alt managers charge rather high management fees that typically start with 1% of
AUM. Since they are charged quarterly and the private funds are illiquid and "sticky,"
with a long duration (or even permanent in certain cases), management fees are
continuous, recurring, and predictable.

Performance fees are fickle. Some of them are assessed periodically but can be
zero if investment targets are not reached. Others (carried interest or carry)
represent a slice of investment gain/income received by an alt manager only when a
fund is wound up provided its investment performance is above a certain hurdle rate.

While lumpy and not guaranteed, performance fees can be quite big. For some alt
managers, they are more important than for others. For Brookfield, Apollo, or Ares,
they are small compared with management fees while for Blackstone or Carlyle they
are comparable.

Importantly, performance fees are in sync with market cycles. When markets are
doing good, performance follows. Management fees, on the contrary, are mostly
independent of the markets and deliver in both good and bad weather.

Asset under management

AUM is the single most important metric for all asset managers as it is directly
related to the size of fees. Unless you believe that alternative AUM will grow at a
high rate, there is no reason to invest in alt managers. The inverse statement is also
true: as long as alternative AUM grow fast, there is little risk of losing money
investing in the Big Six.
The AUM growth is controlled by both supply and demand. Supply denotes assets in
dollar terms that could be turned private provided funding is available. The total
amount of alternative AUM today is estimated at ~$13T with 40% of it in private
equity. This figure should be compared with the global public equity market cap of
~$95T and the global bond market of ~$106T. Bruce Flatt, Brookfield's CEO,
indicates that renewables alone will require ~$100T+ investments over the next 25-
30 years on top of it. This list does not include infrastructure assets that are going to
be built or privatized, real estate, or natural resources. These figures show that the
growth of alternative AUM is hardly limited by supply. What is important to realize,
however, is that the Big Six are expected to benefit disproportionately from this
growth. First, an alt manager needs a big network of offices and professionals to
select the most promising opportunities from the abundance. And secondly, big
transactions (which are often the most lucrative) are simply out of reach for smaller
players. For example, recently Brookfield joined forces with Intel (INTC) to provide
$30B for building a chip plant in Arizona on a fifty-fifty basis. How many companies in
the world can quickly accomplish due diligence and commit to a check for $15B?

Let us turn our attention to demand now. It exists because alt managers deliver
higher returns for their clients AFTER FEES. While it does not happen always, it is
generally the case. Otherwise, sophisticated clients, like insurers or endowment
funds, would not be increasing their allocations to alts.

The slide below displays returns generated by Apollo for different asset classes
(other alt managers present similar slides). Yield is investment-grade private debt,
equity is private equity, and hybrid is everything else. Net returns indicate what
clients received after fees.

Apollo
When we talk about investment companies, Berkshire Hathaway (BRK.A, BRK.B) is
always the first to come to mind. But how many people are managing investments at
Berkshire? I am aware of four. A big alt manager employs hundreds of investment
professionals spread around the world that are sifting through hundreds of
investment opportunities in different industries, geographies, and asset classes. Only
a small fraction of opportunities is selected for investments and leverage is applied to
those few chosen.

Since investment professionals within the Big Six are paid extremely well, investment
talent is flocking there. It is similar to how Google attracts programming talent.
Blackstone reported that for the analyst class position in 2018, only 86 were hired
out of 14,906 applicants. The scale and quality of investment talent represent the
second major intangible asset of big alt managers.

During its last Investor Day in 2018, Blackstone outlined the potential demand for
alternative assets:

Blackstone

The same figures today are, perhaps, 1.5-2 times higher. Importantly, the Big Six
together are within 2% of the total size for each channel. There is plenty of room to
grow, but demand for alts is still more limited than supply.
The crucial figure is the growth rate that alt managers have achieved. Let us take
Brookfield: on Jan 1, 2018, its fee-generating AUM were ~$125B. At the end of Q3
22, they were $356B (prorated for the partial ownership of Oaktree). It translates into
more than 23% CAGR. And other alt managers have reported similar results of
20%+ annual growth in AUM.

One reason for this growth is a higher allocation to alternative assets by big players.
Harvard and Yale endowment funds, two of the smartest institutional players,
currently allocate close to half of their AUM to alternative assets. And they are
beating their peers with lower allocation. Affluent individuals, on the contrary, allocate
less than 10% of their wealth to alts.

Since we are far from saturation both on supply and demand and since alternative
assets deliver, we do not anticipate slowing the growth of AUM within the next
several years. Currently, all of the Big Six are planning their growth at about 20%.

Brookfield's place in the industry

So far, my story has been more or less objective albeit simplified. From now on, it will
include my subjective opinions and preferences.

Even though we are dealing with six companies, we should consider seven stocks
since Brookfield is represented by BN and BAM. BAM is an asset-light manager that
is 75% owned by asset-heavy BN. This structure has been around for only a couple
of weeks and we can only speculate about how it will unfold.

BN and BAM combined represent the second largest (after Blackstone) company
within the industry but several others are very close. In terms of PR, though,
Brookfield must be number one. It is quite clear even from the number of
publications devoted to it on SA. This is intentional as the management is equally
adept in investing and marketing. Brookfield holds annual Investor Days, while the
last Blackstone Investor Day occurred in 2018.
Let us try to make some qualitative conclusions about the industry delaying
valuations until the next section. I generally prefer asset-light managers vs asset-
heavy for several reasons. First, they are much easier to understand, analyze and
value. Secondly, their earnings represent pure free cash flow with almost all of it
being paid out as dividends (90% for BAM, 85% for Blackstone, and similar for Ares).
It is not the same for asset-heavy managers having other uses for their cash flows.
Thirdly, capital, sometimes, is not allocated efficiently. For instance, some of
Brookfield's real estate assets (weaker malls, in particular) are underperforming and
the company is trying to reduce its real estate footprint.

Having said this, I consider Apollo an exception as almost all of its capital is
committed to insurer Athene, a retirement specialist, which is very efficient.

I also prefer managers with big management fees (vs performance fees) as these
fees are stable and predictable.

BAM and Ares are the only asset-light managers focused primarily on management
fees. Between these two, BAM has two important advantages. BAM's strengths are
in renewables (including net-zero transition) and infrastructure where both supply
and demand are the highest.

BAM's other advantage is having the support of its parent BN. Due to Brookfield's
unique structure, BN commits its capital to BAM's funds achieving a material
alignment of interests that no other asset-light manager can enjoy.

Based on all this, BAM appears the most promising stock in the industry. It has
another subtle advantage of being a Canadian company which is often looked at
more favorably internationally.

Even apart from valuations, this line of thinking, however, is open to challenge. For
example, Ares, a credit specialist, is the smallest of the Big Six which makes growth
easier. I also like that it is less known (compared with others of the Big Six) as value
is often found in less crowded places. Surely, KKR and Carlyle have their own fans
as well.

Valuations and dividends

Despite all the internal complexity of alt managers, the investment thesis appears
disarmingly simple. It is especially so for asset-light managers.

Since asset-light managers are paying almost all their earnings in dividends, their
yield becomes an important metric. Let us consider the biggest of them - Blackstone.
Over the last twelve months, it paid out $4.94 in dividends which translates into a
4.94/74.94 ~ 6.6% yield.

If AUM keep growing at 20%, fee revenues should grow at a similar rate. Fee-related
earnings ('FRE') may grow even faster because of margins expansion due to scale
and almost all of FRE (85% per Blackstone's policy) will be paid out. Do you know
many other opportunities to buy a 6.6% yield with an expected growth of 20%?

Other asset-light managers are not far behind. Ares, for example, is trading at a
3.6% yield but it will raise its dividend in about a month. The last raise, in early 2022,
was for a whopping 30% in line with our estimated FRE growth. And do not think it
was a quirk. In 2021, the raise was 25%.

Finally, BAM is trading at a $1.28/28.04 ~ 4.6% and this high yield is sourced
exclusively from "sticky" management fees with the same expected 20% growth.

These opportunities remain salivating even if we assume lower growth in AUM, say,
only 10%. In the next section, we will try to explain why these opportunities have
emerged. Meanwhile, please note that similar opportunities were available before
and ended up in the achieved ~20%+ in total return. In 2018, Blackstone was trading
in mid-thirties and at ~6% yield. The stock has more than doubled since which
translates into ~16% annual appreciation plus a 4-6% dividend.

It is more difficult to analyze asset-heavy managers because they are more complex.
Besides, Brookfield and Apollo reorganized themselves in 2022 (Brookfield - in mid-
December and Apollo on Jan 1) and Carlyle is going through a top management
change. In my opinion, Apollo seems particularly promising for the reasons I already
explained.

Risks and controversies

It is time to visit the dark side. In general, alt managers are not particularly liked by
the public and it may partially explain their valuations. Many people consider them
ruthless and overleveraged predators that make their accounting opaque and inflate
their private funds' returns.

This reputation stems primarily from private equity operations with their leveraged
buyouts. The slogan "Barbarians at the gate" referring to one of KKR's buyouts is still
well-remembered.

As mentioned before, private equity is nothing more than one segment of alt
managers' business today. Private debt, insurance, infrastructure, and renewables
do not have this negative connotation.

But how about leverage? Are alt managers really that leveraged and risky? They
indeed use a lot of leverage but this leverage is non-recourse for the managers
themselves. The parent companies carry either a small amount of debt or none at all.

Let me illustrate that with a simple business case. Imagine you want to enter rental
operations and have enough cash to buy one rental property without any debt but
can also receive a cheap mortgage. Perhaps the best course of action is to buy, say,
3 properties putting 20% down for each leaving 40% of your initial cash as a cushion
for possible misfortunes. If everything goes well, you can buy the fourth property with
20% down and still retain plenty of cash from your initial savings and the newly-
established rental cash flow. With time, you may own multiple rentals and your
position becomes highly leveraged. But is it risky? Not so much because you always
keep a cash cushion and enjoy positive cash flows from many independent rentals.
Even if one of your projects fails, your risk remains limited to this particular property
and you cannot lose more than this property. The leverage is non-recourse to you.

Alt managers utilize a similar structure. They use leverage to produce better returns
in each project (be it acquisition, property, or something else) but the risk remains
contained and isolated within this project. Moreover, asset-light managers have a
negligible risk of losing their capital due to leverage because they invest negligible
capital to start with.
Let us move to the next scarecrow. Are alt managers so complex that it is impossible
to understand their financial statements? This is true as long as one means GAAP
(or IFRS in Brookfield's case) statements. Since alt managers control private funds,
they have to consolidate them in their statements even when their investments in
these funds are negligible. Alt managers control tens of funds and each fund
acquires, turns around, runs, and sells at least several companies (or properties,
renewables, pipelines, etc.). Consolidating many companies of different types and at
different stages of their life cycle makes GAAP statements mostly unreadable. So
each manager publishes non-GAAP statements that exclude these investees and
emphasize primarily fees. These statements are not so difficult to understand
especially for asset-light managers and they are reconciled back to GAAP
statements.

Some people accuse alt managers of inflating their funds' returns to attract "naive"
pension plans. This point of view was popularized in the recent book "The Myth of
Private Equity". The book is entertaining and I enjoyed reading it but cannot agree
with the author. Due to bureaucracy and politics, some pension plans are not the
most sophisticated investors. But I doubt anybody can state the same about other
clients such as big endowment funds and insurance companies. And not all pension
plans are "naive" either. The total number of alt managers' institutional clients today
is likely slightly short of 10,000 worldwide and some of them are the most
knowledgeable investors. Alt managers cannot reach this scale without
outperformance.

Some alt managers are firmly linked to their founders. For example, Blackstone is
associated with Stephen Schwarzman, Carlyle with David Rubenstein, and Apollo
with Leon Black even though the latter is not in charge any longer. When Leon Black
got entangled in bad publicity last year it was immediately reflected in Apollo's stock
price. Never mind that this publicity had nothing to do with the company and that all
big alt managers are dependent on big teams of investors rather than on one
personality.
Now, let me talk about risks that I consider real. The first of them is extreme volatility.
Here is an example: in early 2022, Blackstone was trading at about $130, while now
it is about $75. Nothing particular has happened with the business (I would not
overestimate the recent case of illiquidity of their non-traded vehicles as all alt funds
are illiquid and it was well-known). The slide has been mostly due to the decline of
the stock market and climbing interest rates. This is not an isolated event. Something
similar has happened to Brookfield as well.

I am not sure that this volatility is justified but it is a fact of life. So investors should
be prepared and take advantage of it. I believe Blackstone is so cheap now due to
this volatility, and the same might be true about BAM (though in this case it is also
related to the recent reorg).

Asset-heavy Apollo has been exposed to volatility as well. I opened my position in

mid-2021 when the company announced a merger with insurer Athene. For me, the
case of undervaluation seemed pretty clear. What followed was some rather wild
gyrations. I am holding APO for 1.5 years now and it has delivered 8% of annualized
returns vs -6% for the S&P 500. It seems satisfactory under the circumstances but I
expected more.

The biggest risk is an overestimation of growth rates. I cannot pinpoint any specific
reasons for it but I should mention it as the forecasted growth rates are not
compatible with valuations. Either investors in alt managers will achieve enviable
returns or the real growth will be far below forecasts.

Conclusion
My personal preferences are with asset-light managers and Apollo. BAM seems very
enticing for the reasons I described. The whole Brookfield organization has a habit of
meticulous planning far ahead and recently Bruce Flatt mentioned that the growth of
~20% is already locked in for the next several years.

Asset-heavy BN is a holding company trading below the sum of its parts. BAM
represents close to 50% of its value. If BN performs well, it will be most likely due to
the strong BAM performance. But in this case, it is better to own BAM directly.
Blackstone is very cheap but is dependent on the combination of management and
performance fees and the latter are less predictable. Its AUM are approaching $1T
and it may be more difficult for it to achieve high growth.

I will not be surprised if smaller Ares ends up being the best performer. I do not own
it at this point but may open a position.

This is my first attempt at writing for investors who are not well familiar with the
industry. Dependent on your response I will either continue this effort or drop it
completely.

This article was written by

Alexander Steinberg
4.22K Followers

Ph. D. and MBA. I worked in executive/management positions for big US companies, then ran my own
business for about 15 years, and upon exiting, turned to full-time investing. I primarily manage my own funds

Show More

Analyst’s Disclosure: I/we have a beneficial long position in the shares of BAM, BN, APO, BX either through stock ownership,
options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for
it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Due to the possible escalation of the war in Ukraine, stocks are riskier than usual.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given
as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those
of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment
bank. Our analysts are third party authors that include both professional investors and individual investors who may not be
licensed or certified by any institute or regulatory body.