So What’s The Deal With Apollo’s AAA?

AAA sounds a lot like the prefix to your local dry cleaner or local self-storage looking to be at the top of the old yellow phone book. But alas, here we are with another acronym, this time short for Apollo Aligned Alternatives, a retail-oriented fund that targets 12–15% net returns and debuted at $15 billion.

During a prior earnings call, CEO Marc Rowan declared,

I believe that [AAA] has the potential to be the largest fund across the Apollo platform by this time next year.

2Q22 APO Earnings Call

The single largest active fund by next year will likely be PE Fund X at $25 billion next year. So he hopes to exceed that figure, with the caveat that $10 billion of today’s $15 billion comes from the equity side of Athene’s insurance “float.” Moreover, it’s an outlier as a potential flagship fund because its asset mix resembles little else in the industry:

But if one is to try to understand AAA, one can pull the curtain back just a hair and see that the real question is, “What is the deal with Athene?” And that makes AAA all the more clear.

Yield

Rowan grew up within corporate private equity. Apollo’s calling card was, and still is in some sense, complex or distressed situations that result in control positions. He was a key player in Apollo’s success since its founding in the early 1990s. But by 2009, he started to ponder where Apollo’s position was, in relation to a broader spectrum of risk.

So I sit with the guy who runs the State of Illinois pension fund. And his problems are our problems. He has a group of retirees who deserve and are promised pensions. He has an obligation on his balance sheet that is discounted at 8%.

And so the question that he is asking, and that we ask him sometimes is:

Are we better off being really smart with your money, and investing only a little bit of money at very high rates of return? Or are we better off investing a lot of money at middle rates of return?

I don’t know.

Rowan 2009 Speech

Turns out, in that moment, Rowan may not have known which customer he wanted to focus on within a lower return segment, but his desire to focus on lower returning but far larger markets was clearly seeded.

Shortly after, or concurrently with the above quote, Rowan inked a partnership with life insurance industry legend Jim Belardi, who compounded annual earnings at 34% at SunAmerica from 1990 to 1998, when he received a Godfather acquisition offer from AIG. The two teamed up to reincarnate fixed and fixed indexed annuity writer SunAmerica, denovo. At the time, legacy life insurers, or specifically annuity writers, were weighed down by their prior back-books of business with the introduction of the zero percent interest rate policy by the Federal Reserve. Annuity holders were not letting go of their annuities at the typical rate of the past because, why would you? Earn 5% fixed or pull money and reinvest near zero—an easy choice. The insurers had not planned for this and were stuck paying out larger amounts for longer than they had predicted while lacking the higher-yielding assets to fund these payouts.

Rowan and Belardi founded Athene, their annuity business, on the premise that they could build a mono-line annuity writing vehicle that could help legacy players get out of their upside-down books of business and utilize the Apollo platform to source more complex and higher-yielding investment grade debt that the legacy insurers lacked the skillset to acquire. With this, Rowan’s beachhead for attacking a low return segment that dwarfs the addressable market of opportunistic private equity, was established.

At the time of Athene’s founding, Apollo was overwhelmingly still a private equity shop. Fast forward 13 years from Athene’s founding, and 70% of Apollo’s assets under management are mostly investment grade credit assets driven by Apollo’s insurance affiliates and partnerships (Athene, Athora, Venerable, Catalina, Challenger, FWD, etc.) and co-investors (that often are competitors of Athene). As such, Rowan quietly built Apollo’s Yield business into a behemoth by virtue of his work at Athene and its affiliated insurance partners.

Yield, Hybrid

Athene’s investment book comprises 95% debt (primarily investment grade) and 5% equity. While 5% equity appears small in the context of its significance to Athene, note that an insurance vehicle is about 12x leveraged. If the equity book falls by 25%, wiping out a mere 1.25% of Athene’s overall investment book, the shareholder equity supporting Athene is diminished by a whopping 15%. One can’t put Charlie Munger or Joel Greenblatt in charge of this sort of portfolio, as stability of the portfolio is a most definitely worthwhile pursuit over hero status.

Rowan has personally shepherded Athene’s equity book over the past decade to invest in a way that kept the duration of the equity book low and cash distributions high, as opposed to the general drift of the overall investment industry towards higher multiples and longer dated cash return profiles. Athene’s need for this sort of investment profile gave birth to the Hybrid business at Apollo.

[The] Hybrid business [is] a little bit different. [The] Hybrid business right now, [is] the midpoint between debt and equity. This [segment] is the beneficiary of institutional misallocation of capital. So I’ve said already, I think the world is totally awash with capital in almost every asset class. Hybrid is one of the few places where there is not too much capital chasing too few deals. Here, if you think about a typical [institutional investment] consultant and a strategic asset allocation, they typically will have alternatives in a strategic asset allocation accounting for a huge part of the return of the overall portfolio. Therefore, institutions who are consultant-driven tend to allocate to alternatives for highest rate of return rather than for best risk/reward. There is simply no bucket in the vast majority of pension funds, sovereign wealth funds or other large consultant-driven institutions for something that is a tweener, lower-risk, lower-reward equity. As a result, returns here are really good.

2021 Apollo Investor Day

What does that sort of investment look like in practice? Apollo splits its Hybrid practice between debt and equity biased products. As one example, consider Hybrid Value’s [equity] transaction with Expedia in 2020 when it placed, along with Silver Lake, $1.2B in preferred stock (along with $2B in debt from credit funds) at 9.5% with warrant kickers to compensate for call rights. No runaway upside exists in exchange for greater downside protection.

And Rowan went on to describe Hybrid’s fit with Athene’s equity book:

There is no better risk reward in fund format for Athene than hybrid value. Think of it downside protected equity, mid-teens returns, not a lot of volatility. That is among the largest investments that Athene has in fund and fund format.

2021 Apollo Investor Day

Hybrid is now a $60 billion business, larger than most investment firms. Together, Rowan and his efforts via Athene have been responsible for the roughly 70% of current AUM represented by Yield and the 11% attributable to Hybrid, totaling a whopping 81% of AUM (~$430B). In this lens, it starts to become clearer why Apollo’s prior CEO pushed Rowan to be CEO a number of years ago (answer: no), again in 2019 (no again – busy with insurance), before finally relenting in late 2020 so long as Rowan could proceed with swallowing Athene whole.

One has to wonder whether Apollo would just be another version of TPG without Athene (and with Josh Harris at the helm).

Yield, Hybrid, and Asset Originators

While Athene was a minority investment for Apollo in the past, Apollo merged entirely with Athene in 2021. Rowan described his reasoning in part:

One thing we have not forgotten at Apollo is when the market does not understand something. We are supposed to back up the truck and buy the cheap asset.

2021 Apollo Investor Day

The financials landscape, namely the more old-line financials versus FinTech upstarts, has been relatively cheap in recent times. Today, financials are littered with single-digit P/Es, especially if the company has a whiff of sensitivity to credit defaults or insurance policy risk.

Rowan filled Athene’s equity book not only with Hybrid investments but also with financials for the benefit of Athene. Namely, he has loaded up on loan originators that, when their paper is securitized, can feed the other 95% of Athene’s balance sheet consisting of investment-grade debt.

There is nothing more strategic across what we do. We get $35 billion of organic inflows every year and growing. That’s a huge part of our franchise. Asset origination this year, as I said, is $80 billion. Most of the asset origination platforms, which not only benefit Athene and Athora but benefit Apollo across the asset management landscape, are owned by Athene. They’re not owned at Apollo. 

2021 Apollo Investor Day

So overall, not only has Athene’s insurance business driven the creation of Apollo’s Yield and Hybrid businesses, but its equity book is buying strategic assets for the Apollo engine that provide the dual benefit of high cash-on-cash returns to the equity book and a source of credit assets for the insurance affiliate balance sheets.

Yield, Hybrid, Asset Originators, Alts Partnerships

Alas, there’s more. In the past year or so, Apollo has partnered with four different investment firms to date. Jim Zelter, Apollo’s Co-President described why:

We see ample white space opportunities tangential to our existing businesses that can drive accelerated growth above our base case targets. There are a few very large and growing sectors, which typically trade at higher multiples, where we have not been historically active such as fintech, life science and software.

Over the past 18 months, we’ve selectively cultivated strategically and economically aligned partnerships with best-in-class managers in each of these areas to expand the breadth of our platform and expertise. 

Apollo 3Q-22 Earnings Call

They include fintech PE firm Motive Partners, Euro life sciences VC Sofinnova, credit firm Diameter, and enterprise software and gaming firm Haveli. In each case, Apollo was able to come to the table with a unique proposition. They offered a menu of options, including an equity stake for growth capital, large investments in their underlying funds, and collaboration on distribution, capital markets, etc. While there are many out there that provide GP equity solutions, few can offer massive fund investments, as that requires material use of balance sheet capital.

With Athene, Apollo can augment its offer to buy a strategic stake with its holdco capital by buying IG securitized credit for Athene’s debt book or funding PE funds, warehouse lines, CLO equity tranches, etc. from Athene’s equity book.

In the case of Diameter, it is a direct competitor of Apollo, so why? Rowan explained:

Large UK-based alternatives competitor wants to start a broker-dealer competitive with Apollo, we provide the funding for it. Large US-based sponsor wants to start a BDC, competitive with our BDC, we warehouse the assets for them and help them launch it. CLO manager wants to compete with [our CLO division], we agreed to buy a portion of their debt and a portion of their equity. We are in an ecosystem where the value [is so large ] – we cannot do 100% of everything.

2022 Athene Retirement Services Day

So via the sheer firepower on both the debt and equity sides of Athene’s book of investments, it can offer a gigantic balance sheet to potential partners to either fill whitespace that fits its long-term vision or fund a direct competitor given the size of the market. And its offer is one that few others, if any, are configured to do.

Yield, Hybrid, Asset Originators, Alts Partnerships, AAA

Enter AAA. Alternatives as thought of in the past were primarily opportunistic, or better described as “high-octane” investments. Big returns.

That said, they aren’t a good fit for retail investors. Fund investing requires investing across generations to do it right, having lines to draw cash as necessary, sophisticated due diligence, and high minimums. Retail requires a lot of the opposite. One-time investments, immediate deployment, high diversification, and for the sake of a large product runway on the part of the sponsor—an investible universe that is very large. A return hurdle of low versus high teens opens up the investable universe dramatically.

The AAA effectively took 60% of Athene’s equity book as Apollo’s contribution and raised $5B from three institutional LPs. It is to be seen whether retail is actually interested in this product, so there isn’t much more to say about AAA, let alone speculation.

If successful, the firepower to drive more flow to Yield and Hybrid, to buy and grow asset originators, and to fuel existing and new Alts partnerships will track in excess of the current plan of Athene’s equity book growing from $10 billion to $20 billion by 2025 (currently $12.3 billion). So the story of AAA really is the story of Athene.

A famous entrepreneur poignantly introduced their marquee product as three separate products combined into one. While wholly incomparable, Athene is Rowan’s multi-tentacled magnum opus that has built and productized Apollo’s businesses across Yield, Hybrid, GP Solutions, a potential retail flagship, and more. I haven’t even mentioned the ADIP product Rowan pioneered that will likely sit at >$6B in cumulative capital supporting up to $100B in insurance assets, nor the investment-only tax-deferred VA product comprised of Apollo funds launching next year. The point is, Athene is the paintbrush that Rowan has used to push Apollo in a direction that is deeply distinct from the fairly identical playbooks used by most other comparable companies.

And while AAA specifically remains an odd duck, both in name and in makeup, perhaps I should have listened closer when Rowan said at Investor Day:

Our future is funded by Athene’s equity account. That is the best and clearest way I can say this.

Note: We own shares of Apollo. This isn’t investment advice. Do your own original work you lazy bum.