For starters, when you hear asset manager, think of companies like BlackRock, Vanguard, or State Street. These businesses work primarily by overseeing investment funds focused on a range of strategies that collect assets from retirement funds, pension funds, individual investors, and so on, and then charge management fees. So if a Vanguard ETF, for example, has $100 billion in assets and charges a 0.1% management fee, then it’s roughly earning $100 million a year from fees on that massive base of assets.

Those three I just mentioned are the largest asset managers in the world, but they’re primarily focused on public markets. They manage mutual funds and ETFs that invest in publicly traded stocks, real estate funds, and bonds, like corporate bonds or Treasuries from the U.S. government. These are highly liquid assets, meaning they’re easy to quickly buy and sell, since there are large markets for them that trade 5 days a week and are available to almost anyone to access.

Over the last two decades, though, so-called alternative investing has become increasingly popular, entering something of a golden age. Alternative investing is a catch-all term, but whenever you hear alternative investing, just think about investment opportunities that probably aren’t accessible in a brokerage app like Robinhood.

So, this might refer to private equity, where PE firms buy stakes in companies that are typically too small to list on stock exchanges, or private credit, where instead of buying stakes in private companies, they’re lending money to them or even helping finance acquisitions made by private equity companies.

Or, it could refer to private investments in real estate, from infrastructure projects like bridges and roads to housing units or office space.

This is where Blue Owl specializes, and the great thing about its business as an asset manager is that there tend to be much higher fees in the world of alternative investing. In part, that’s because it can be more specialized and also because there’s an element of exclusivity to it, where not everyone can easily invest in these opportunities, so alternative asset managers can correspondingly justify higher fees.

Rather than charging 0.1% or less per year on the investment funds it manages like, say, Vanguard, it might charge 1-2%. And then, the other attractive dynamic about an alternative asset manager like Blue Owl is that much of its assets are permanent capital.

In other words, unlike with an ETF, where investors can sell and effectively pull out their money at any time, the assets that Blue Owl manages are much stickier, which provides a higher degree of certainty that they’ll keep earning the same or higher management fees well into the future.

[00:05:11] Shawn O’Malley: There’s a lot to like about Blue Owl, but before we get more into its business model, let’s start with the story of Blue Owl’s spac. As you might remember, 2020 was an exuberant time in financial markets. With interest rates at zero and stimulus checks sloshing around, everyone and their mother was investing, and dozens of speculative companies wanted to take advantage of that by going public via spacs, which is an acronym for special purpose acquisition company.

These are often referred to as blank-check companies because they are basically shell companies that start trading on stock exchanges with cash as their only asset and a mandate to find a public company to acquire in the next two years.

If they don’t find a business to acquire, the spac dissolves, and the cash is returned to shareholders. Of course, that is no fun, though, so that’s not what happened in most cases. More often, spacs found a target to acquire and merge with, which is a way to effectively bypass the normal IPO process.

With the SPAC already trading publicly, once it merges with a private company, said private company basically takes a backdoor to become a listed stock.

This was naturally ripe for abuse, and we saw all kinds of crazy companies go public through spacs, but as mentioned, Blue Owl is one of the few legitimately profitable and fast-growing businesses to survive from the spac mania.

OWL started out as a SPAC known as Altimar Acquisition Corporation with the stock ticker ATAC and went public on October 27, 2020, at a price of $10.00 per unit in the spac, which included one share of ATAC and ⅓ of a warrant to buy more shares in ATAC at $11.50.

Two months later, a merger deal was announced that included Owl Rock Capital Group and another group called Dyal Capital Partners.

The new entity would have roughly $45 billion in assets under management at the time of the announcement and changed its ticker to OWL, O-W-L. If you look up Blue Owl, you might also find Blue Owl Capital Corp., ticker OBDC, which is a subsidiary of the business we’re talking about today.

For now, I’m going to go ahead and read a passage from the SPAC merger announcement just to add more context, but be warned, it’s packed with Wall Street jargon.

I’ll continue to explain everything more, but here we go, quote: “The new firm’s main business will focus on two of the fastest-growing areas of alternative asset management: Direct Lending, where Owl Rock is one of the leading private credit providers to middle and upper middle-market businesses backed by top-tier financial sponsors, and GP Capital Solutions, where Dyal has been a leader and innovator since its founding. The Owl Rock and Dyal businesses will be autonomous but complementary…

Each business will be led by its current long-tenured management, and its respective investment teams will continue to employ the disciplined investment philosophies that they have delivered since inception.”

So there you have it, Owl Rock is focused on lending money to middle and upper-middle market businesses, which is a pretty wide range of companies that roughly might earn between $50 million in revenue per year to as much as $1 billion. And Dyal is focused on an even more niche area of finance known as general-partner capital solutions, which is a very fancy way of saying that they provide financing to firms that manage private equity funds.

For example, they might purchase a minority stake in a firm that manages private equity funds, giving the firm some of the capital needed to launch a new fund with.

Rather than being investors in the fund, Dyal and now Blue Owl would share in the management fees the fund produces.

Another way to think of the difference between Owl Rock and Dyal is that Owl Rock might lend money to the types of companies that private equity funds invest in, whereas Dyal provides financing for the private equity funds themselves.

The combination of these businesses is how we got Blue Owl Capital, and today, direct lending and general-partner capital solutions remain the focus of the business, alongside investments in triple-net-lease real estate.

That third pillar of the company focusing on real estate came in 2021 when Blue Owl acquired the private real estate firm Oak Street for $950 million.

If you don’t know, triple-net-lease real estate is a form of real estate where the tenant leasing a property agrees to pay for the property taxes, insurance, rent, utilities, and even maintenance of a building, meaning they take on many of the burdens of owning a property while only leasing it.

It’s a common model in commercial real estate, and from Blue Owl’s perspective, they’re basically buying and owning things like office buildings and then negotiating triple-net leases with tenants.

As with any financial services company, there’s a lot going on, and I’ll be the first to say it can get confusing. Blue Owl isn’t a bank, but this is why I typically avoid banks: it gets messy quickly to go through the balance sheet and assets.

I don’t want to be in a situation where I’m trying to understand all of the different loans a bank has made and decide whether high-quality assets back them and whether they’ve been made to creditworthy borrowers.

That’s well above my pay grade and not even completely possible to do for large institutions, so to an extent, you have to go off management’s track record in running the business and industry perceptions.

Ya know, if a financial institution is really highly respected by its peers, and you validate that by talking to other bankers or investors, then that’s a good sign.

As we saw with the 2008 Financial Crisis, when things go wrong in the financial industry, they can go really wrong. And that’s why financial services companies always make me a little uneasy since it’s so hard to know what types of loans and derivatives are truly hidden on their balance sheets.

In 2008, for example, many of the mortgage-backed securities that went bad had stamps of approval from major credit rating agencies, so you would have needed to dig deeply to know otherwise that there were problems beneath the surface, and it would have been even more challenging to figure out the risk exposures that each financial institution was facing.

Blue Owl is not a bank because it does not take deposits and isn’t regulated by the FDIC. They actually probably have a much better business than most banks do, but still, they’re inherently in the business of making an array of investments in a variety of different assets using a mix of their own money, borrowed money, and money that they manage on behalf of clients, which are usually high-net-worth individuals or institutional investors.

And the point is that I don’t exactly hope to vet the quality of their investments individually, but rather, I want to get a general idea of what they’re doing, the results, and decide whether the management teams running the company are the right people to bet on.

So, let’s start there.

[00:11:49] Shawn O’Malley: Each of the three different business units for Blue Owl is independent, so it’s best to look at them individually.

Starting with Dyal Capital, this business was formed by Michael Rees and Sean Ward, who were both formerly at Lehman Brothers, which was one of Wall Street’s most iconic investment banks until it failed in 2008. As I mentioned, they basically focus on acquiring minority interests in some of the world’s best hedge funds and private equity firms, and they’ve even acquired minority stakes in professional sports franchises, too, like the NBA’s Phoenix Suns and Sacramento Kings.

There’s a 2021 article in the Financial Times devoted entirely to Michael Rees actually, so let me just read a few paragraphs from it. It begins by saying the following: “Until Michael Rees became a billionaire this year, he was arguably the most popular man on Wall Street.

Like other successful financiers, Rees works in private equity, an industry with $3tn in unspent capital and a seemingly insatiable appetite for buying houses and hospitals, theme parks and prison payphone systems, genealogy websites, and just about anything else that generates cash. But unlike most of his peers, Rees makes money by buying pieces of the financial industry itself. He has won the trust of dozens of executives, who sold him shares in the closely held investment firms that underpin their personal wealth and have become the most powerful institutions on Wall Street.”

As the article explains, in about a decade, Dyal Capital paid out over $10 billion to purchase stakes in some of the best companies in the financial world, from Silver Lake to Jana Capital.

One investor put it that, quote: “Rees realized, long before anyone else, that alternative investment firms with their resilient cash flows would be particularly attractive for investors in a low interest rate world.”

Rees became a billionaire at 46, after having started Dyal as a fringe experiment at the larger asset manager Neuberger Berman, until, of course, merging Dyal to form Blue Owl in what was one of the biggest ever stock market IPOs of an alternative asset manager in the U.S.

As the Financial Times describes it, quote: “The deal created an all-purpose firm that not only gives top financiers a way to convert their paper fortunes into cash and potentially lower their tax bills, but also provides billions of dollars of debt to finance their buyouts. Yet it has embroiled Rees in a messy falling-out with some of the people he helped make rich.”

So there’s some messy drama surrounding Rees, Blue Owl, and Dyal Capital. Allegations of broken promises ensued, and lawsuits to halt deals highlighted just how tangled things had gotten, and that’s not too surprising considering how disruptive Dyal and now Blue Owl have been to the status quo.

In short, Rees saw that many hedge fund and private equity managers were among America’s wealthiest people in terms of assets, but they weren’t always flush with the cash needed to pay for their often extravagant lifestyles. These fund managers often benefit from something known as carried interest, where they basically get a share of the fund’s profits after a certain benchmark, like, say, 20% of additional profits for anything beyond an 8% return.

But in hedge funds and private equity, those payouts aren’t immediate, and this is how Rees and Dyal Capital got their roots in general-partner capital solutions. He saw an opportunity to essentially give these investment managers early paydays, helping with their need for cash now while carried interest payouts loom on the horizon.

The plan was, simply put, to amass a portfolio of stakes in private equity firms that entitled them to the fees generated by their investment funds. For the Wall Street executives who might sell a portion of their business to Rees and Dyal Capital, the FT reports that they liked the chance to quickly access cash but also to replace their income streams with one-off capital gains from selling part of their business, which would be taxed at a much lower rate.

Again, the FT captures the story perfectly, saying: “the Dyal founders, who had made themselves rich and popular on Wall Street by paying top dollar for slices of other people’s empires, wanted to sell a slice of their own after annual fee income had quadrupled in just four years to $320 million in 2019.”

And that’s how we got the spac that produced Blue Owl Capital in 2020.

Where things got messy was that Dyal had previously invested $500 million in Owl Rock, which if you’ll recall, was the other half of the business that merged through the spac to form Blue Owl.

So, even though the investors in some of Dyal’s funds were still waiting to cash out, Rees and Ward had already done so with the spac merger. Private credit firms like Sixth Street and Golub Capital, which had received investments from Dyal, felt that it was a betrayal for one of their shareholders to merge with Owl Rock, which was one of their largest competitors.

I’m kind of going down the rabbit hole because I find it interesting, but I do think it’s helpful to understand the context within which Blue Owl was created. To be honest, I’m not sure whether this all fairs well or poorly for Blue Owl today. You can probably make a case either way.

Ultimately, the courts sided with Dyal, and the merger was obviously allowed to go through, and to this day, Michael Rees still oversees the renamed version of Dyal Capital within Blue Owl.

He made headlines recently by trying to engineer a multi-way merger of the private equity companies that Dyal and Blue Owl have taken stakes in, hoping to combine them into an alternative asset management giant that could list publicly, which would give Blue Owl a chance to sell out of their stakes in firms like Vista Equity Partners, Silver Lake, Platinum Equity, and other high-profile private capital investors.

From Rees and Blue Owl’s perspective, I suspect they see this as a valuable way to cash-in on their own ownership of these firms, but it is interesting to me because it seems that consolidating them together would form a formidable rival in the alternative asset management industry. Just thinking out loud here, but since these firms are mostly focused on various niches in private equity, whereas Blue Owl tends to own these firms themselves or finance their private-equity buyouts, maybe they don’t see this as truly creating a competitor for their AUM.

[00:18:13] Shawn O’Malley: And from there, that brings us to Oak Street, another of the three pillars behind Blue Owl that I mentioned earlier is focused triple-net-leases in real estate. Before merging with Blue Owl, Oak Street was founded in 2009 and is still led today by its co-founder Marc Zahr. Zahr is another executive who knows his way around Wall Street quite well after also serving as Vice president of American Realty Capital, working as a bond trader at TM Associates, and then working at Merrill Lynch before that.

One of Oak Street’s biggest assets is a 58-story, $1.2 billion skyscraper in Calgary known as The Bow that’s the third tallest building in Canada, so it’s a pretty famous landmark and actually ranked as one of the top 10 architectural projects in the world in 2012

Oak Street’s bread and butter, though, is triple-net-leases, but specifically, what they have made a living doing is buying properties like office buildings or warehouses from businesses and then leasing the property right back to them. This basically frees up cash for companies that have a lot of assets tied up in their real estate while allowing them to operate in the same properties without any hiccups.

I can see how it would make a ton of sense for companies who don’t want to take on the burden of having large real estate assets on their balance sheet, and in this way, they get paid cash, which they can use for other purposes while nothing operationally changes except they now make lease payments to the Blue Owl subsidiary Oak Street.

[00:19:42] Shawn O’Malley: So that’s Oak Street, and the third remaining pillar of Blue Owl is Owl Rock, founded by Douglas Ostrover, who is now the CEO at Blue Owl, overseeing all three parts of the company.

Owl Rock was launched in 2016, and it has a really cool origin story. Ostrover is likable and he did an interview on the Capital Allocators podcast back in 2021 that does a great job explaining what led to Owl Rock and then later Blue Owl.

Again, Ostrover is another heavy hitter on Wall Street who I think is widely respected, and I say that because he was able to convince a number of higher-ups with some of the best jobs on Wall Street at places like Goldman Sachs and Morgan Stanley to come join him in this new start-up that he wanted to bootstrap off the ground.

And the insight for starting Owl Rock came from his time as a senior managing director at BlackStone, where he worked closely with the CEO, Stephen Schwarzman. While he was there, he noticed that direct lending was this fast-growing asset class that university endowments and other institutional investors wanted to allocate money toward, and yet, there were some real gaps in the types of companies that could get financing in this way.

For context, the largest companies across corporate America can go out and issue bonds that are underwritten by investment banks and sold to a bunch of big money managers for funding, but if you’re some lightbulb manufacturing company that does $70 to $100 million a year in revenue, you might be too large to get a meaningfully-sized loan from a local bank but not big enough to access the corporate bond market.

As a result, these types of companies might rely on syndicated loans, where a group of banks will all contribute to a loan since none of them individually want to take on the risks of a large loan to a single company. The problem is that you could have essentially dozens of different lenders to work with on one loan, and that would have been a nightmare during Covid.

Your manufacturing business might have been temporarily shut down due to Covid lockdowns, and while you’re desperately trying to negotiate some relief on your loan payments and get new terms for the deal, you might be working with ten different banks or with the institutional investors they sold the loans to, and that can get very complicated very quickly.

But with Owl Rock, Ostrover wanted to target these larger companies directly, giving them loans from basically a single lender, hence why it’s called direct lending. Instead of working with a bunch of different banks to renegotiate loan terms during the pandemic, you’d be working with just one counterparty in Owl Rock, who could probably be more flexible or at least make the negotiation process much simpler.

So with Ostrover’s connections, Owl Rock was able to quickly raise billions of dollars and launch its direct lending business, filling a niche with companies that were usually too big for individual bank loans or too big to work with typical direct lenders while being too small for corporate bond markets and not wanting the hassle of syndicated loans.

Owl Rock had a tremendous amount of success with this and has avoided taking losses by focusing on companies in industries with very little change, like certain types of software and healthcare, where they felt confident they knew what these businesses would look like in five years and knew that they would probably be repaid in full.

[00:23:06] Shawn O’Malley: So, I went on these asides about Dyal, Oak Street, and Owl Rock to highlight the core parts of the business that have all been merged together with Blue Owl and also to spotlight that the founders of these firms have stayed on to lead these subsidiaries from within Blue Owl, and I mostly see that as a strong indication of the high-quality types of leaders at the company as well the amount of talent they’ve correspondingly attracted at lower-level positions.

Let’s pull it all together a bit now and look at Blue Owl’s business as it stands in March 2025.

The direct-lending business, formerly known as Owl Rock, has almost $130 billion in assets under management, while the GP Strategic Capital business, formerly known as Dyal, has roughly $62 billion in assets under management, and the Oak Street real estate subsidiary has around $44 billion in assets under management.

That adds up to over $230 billion in total assets under management, but Blue Owl doesn’t earn management fees from all of that.

It varies for each unit, but altogether, Blue Owl has more than $150 billion in fee-earning assets currently under management, and as of September 30th, the company had another $21.7 billion in cash that was yet to be deployed that will generate over $260 million a year in fee revenue once allocated. And then there’s still a $50-60 billion that Blue Owl doesn’t earn any fees on. Some of this is actually investments from the company’s own employees and executives into their own funds, so they aren’t charged fees on those amounts, but mostly, this is borrowed money used as leverage in some of their investment funds, which isn’t held at the parent company level.

So fees are only charged on capital committed by investors into the investment funds that Blue Owl manages, and if they borrow some additional money to use in their strategies, they’re not going to charge their investors fees for that.

But since Blue Owl became a public company, its management fee revenues have increased by more than 200%, and management fees are up 25% in the last year, thanks to raising new funds from investors, acquiring other asset managers, and deploying capital that was previously held in cash.

What stands out to me the most is that out of the $154 billion of assets it manages earnings fees, 91% of those funds are considered permanent capital, where investors in these vehicles cannot make redemptions and try to withdraw their money.

Meaning, if we multiply 154 billion by 91%, this implies that the company has $140 billion worth of permanent capital that it will earn fees on indefinitely, and that strikes me as being very valuable.

[00:25:49] Shawn O’Malley: When I say permanent capital, it’s important to understand what I mean. There’s sort of a spectrum of capital permanency in investment products. ETFs, for example, are the opposite of permanent capital — they trade all-day on stock exchanges, and money can freely flow in and out of them for the most part.

Then there are alternative asset funds for accredited investors like private equity, private credit, private real estate, and hedge funds. These can all be structured differently, but they tend to all have some sort of defined lifespan or timeline for being able to withdrawal your money after a lock-up.

So, a private equity fund might raise capital commitments, go out and look for private companies to invest in, and then call capital from their investors to go make the investments, with a goal of later selling those businesses again in 5 to 10 years and returning the money back to the investors in their fund, who are also known as limited partners.

Limited partners in a private equity fund like this are expecting to tie up their money for at least five or more years, so from an asset management perspective, this is much longer term than an ETF but also not quite permanent capital, because the capital will eventually be taken out of the fund and returned to investors in full.

Truly permanent capital in public markets would be something like a closed-end mutual fund, which unlike normal mutual funds and ETFs, don’t accept new inflows of cash nor allow outflows. Meaning, the managers of a closed-end fund raise capital upfront and can allocate it toward investments indefinitely without fear of their investors abandoning them. This is not as ideal for the investors in these funds, but is pretty attractive from the perspective of the asset management companies managing them, since they can charge the same management fee every year on the same base of assets without worrying about that capital fleeing. That obviously makes their business much steadier.

Investors essentially handed them money in return for shares in the fund with no expectation of ever explicitly being paid back.

If that sounds wonky, I’d say that this is basically the same thing that happens with public companies. Investors commit capital to a business during its IPO, receive shares of equity in exchange, and hope that the shares will eventually be worth more when they resell them or hope that they can collect enough dividends to more than repay their initial investment, but they don’t expect to have the company be liquidated and all of their capital returned at some point like with the typical private equity fund.

They’re accepting that their capital has been permanently tied up in the business and are hoping management will be good stewards of that capital.

Warren Buffett appreciated this as much as anyone, and that’s why he closed down his investment partnership, where his limited partners could flee in a downturn and request to withdrawal their money at inopportune moments. Trying to manage a long-term portfolio where your investors could demand their money back at any moment is a tough way to do business, and you could say that’s what drew Buffett to ultimately acquire Berkshire and use it as a holding company to allocate capital through.

As the controlling shareholder, no one could force him to sell any of Berkshire’s assets or distribute its cash unless he wanted to do so. The company’s capital was truly permanent for him, giving him complete discretion to allocate it with a long-term perspective.

I could talk about Buffett all day, but my point is to illustrate how some forms of capital are more permanent than others, and that can be very consequential for the managers of that capital. There’s a balance between what’s most ideal for investors, in terms of maximum liquidity as with ETFs, and what’s best for the folks trying to invest that capital on longer time horizons as with alternative asset funds, closed-end funds, or like Buffett did with Berkshire as a permanent capital holding company.

[00:29:29] Shawn O’Malley: So, back to Blue Owl and their claim of having 91% of their assets under management as permanent capital. Using the company’s own language, they define permanent capital as the, quote: “AUM in products that have an indefinite term and do not have a requirement to exit investments and return the proceeds to investors after a prescribed period of time.”

For example, I’m sure there’s a bunch of nuance in how each of their private credit funds are individually structured, but generally, these have multi-year capital commitments and might even be evergreen in the sense that Blue Owl may offer quarterly redemptions but most investors will prefer to keep their capital in the fund indefinitely assuming it’s performing well. So, the capital is longer-term and not as liquid as an ETF, but it’s not completely permanent either because there would still be a chance to eventually withdrawal funds quarterly.

In its some of its real estate funds, there’s a similar grey area, where funds that won’t be liquidated for five years or longer are considered long-dated and thus functionally permanent, even though that’s not exactly the case.

But Blue Owl also oversees a number of Business Development Companies, which to make things even more confusing, are sort of like publicly-traded versions of private equity and private credit firms. They’re a type of closed-end investment fund that primarily invests in small-to-medium sized businesses and must distribute 90% of their income to shareholders. While they must distribute their income, their asset base is permanent.

I say all this because, if I were to try and value the different piles of assets that Blue Owl manages, I’d want to use a higher discount rate for AUM that is less permanent, like with some of its real estate funds, to reflect that this comes with a bit less certainty than the business development companies, where we know the capital is fully locked-up and will continue to generate steady management fees indefinitely.

So, the degree of permanency varies across Blue Owl’s different investment vehicles.

As far as it goes in the world of asset management, Blue Owl has a very high-quality base of mostly permanent, or at least long-term capital to generate fees on, and that’s what has attracted me to learning more about the company.

I should say that, specifically, my friend Chris Panagiotu put the company on my radar since he runs a financial advisory business and invests chunks of his client’s assets in Blue Owl’s funds. He understands Blue Owl pretty well, so he was a huge help in researching this episode.

And this ties into something we’ve talked about before but that is the importance of using the scuttlebutt approach to investing, where instead of just reading analysis online or trusting the company at their word, you go out and talk to real people who have worked for the company or for competitors, used its products, or for some other reason have hands-on insights into the value they add and how they’re perceived.

Chris was one of those scuttlebutt contacts for me, and just hearing how and why he might consider putting client assets into different Blue Owl funds was immensely useful in contextualizing the company’s role in the asset management ecosystem.

[00:32:23] Shawn O’Malley: To pivot back toward looking at the quality of Blue Owl’s assets and earnings power, the company has said in financial filings that they have $21.7 billion of undeployed cash that will eventually generate $260 million worth of fees for the company, suggesting that Blue Owl’s average management fee is roughly 1.2%. That soon-to-be-tapped stream of management revenues sounds great, but I could see how this can create some incentives that aren’t necessarily the best for the investors in these funds.

Clearly, they want to the cash to be put toward the most optimal potential investments, and Blue Owl wants this to, but there’s certainly a temptation to allocate that capital as soon as possible so they can start earning fees on it.

Still, AUM only continues to grow as the underlying assets compound in value and as Blue Owl launches new investment products and acquires other asset management firms, too. Most recently, Blue Owl acquired Kuvare Asset Management, an insurance investing specialist that offers annuity products, and Atalaya Capital, a lending firm, which combined added more than $30 billion to Blue Owl’s assets under management.

As the Financial Times puts it, “Blue Owl sees the future as now and wants to win the land rush. The good news for them is that they have shown enough promise to Wall Street to make their stock currency very deployable,” referring to the fact that Blue Owl trades at relatively high valuation ratios and can use that elevated stock price to its advantage when funding acquisitions of AUM with new issuances of its shares.

What stands out to me is the number of different approaches Blue Owl has taken to grow its AUM to establish itself as a major player in this industry. In October, the FT reported that Blue Owl, alongside other private credit players, had purchased billions of dollars of loans for consumers, automobiles, and home equity from fintech businesses like Upstart that had tried to use AI and algorithms to improve the loan-underwriting process but were now basically retreating from certain lending niches.

So, ya know, Blue Owl is making acquisitions of traditional-style asset managers at the parent company level while also buying up loans from struggling fintech businesses in its lending funds. I don’t think anyone could accuse them of not being active.

And in October, Blue Owl acquired IPI Partners for $1 billion, 80% financed by new issuances of its own stock and 20% with cash. IPI, for context, is essentially a real estate investment trust with $10.5 billion in assets under management with a portfolio of 82 U.S.-based data centers.

Each of these acquisitions is turning Blue Owl into an increasingly diversified financial institution, spanning everything from financing infrastructure products and private-equity buyouts to leasing data centers.

At this point, though, I’m worried that they’re trying to grow too fast. It makes me think they’re overpaying for these acquisitions, because if all these smaller asset-management firms were otherwise selling themselves at sweetheart prices, you’d think that the Blackstones or BlackRocks of the world would have already acquired them.

Clearly, Blue Owl is trying to transform itself into a gigantic asset manager like that, and it makes good sense to do so because there are some very attractive economies of scale to asset management.

It doesn’t necessarily take any additional employees or research to run a $10 billion fund relative to a $1 billion fund, yet the management fees are an order of magnitude bigger, because they’re usually a fixed percentage, like 1 or 2%, multiplied by the amount of assets being managed.

As you expand the number of investment products offered and build a name for yourself in the industry, it becomes easier to attract more investors and it builds on itself in a flywheel that should grow profit margins over time as AUM grows faster than costs.

But that assumes that you’re not overpaying for that AUM and excessively diluting shareholders along the way. If you increase your share count by 10% to acquire a firm that will expand your AUM enough to boost earnings by 5%, then in the short-term at least, you’ve worsened results for shareholders because earnings per share would actually decline in that case.

To be clear, I’m speaking hypothetically, but you get the idea, and the question is, in the longer term, when you discount all of the future management fees from that acquired AUM, whether the picture is much better.

[00:36:37] Shawn O’Malley: To invest in Blue Owl today with a long-term view would be to implicitly bet to some extent that the bonanza in private investments can continue.

And on that point, I’m skeptical. We have private investment firms rushing in to take over loans that banks are less keen to make after the Great Financial Crisis, yet companies like Blue Owl are far less closely regulated than banks, so it’s not completely evident to me that this is a good thing for society.

Bloomberg’s Matt Levine explains how this has unfolded. He writes:

Traditional banking involves banks, which are funded with short-term liabilities, aka deposits, making long-term illiquid loans like mortgages and corporate loans. This has obvious risks: The depositors can all ask for their money back at any time, and if they do, the bank won’t have it, since it can’t rapidly turn the long-term loans into cash. Much of the modern banking regulatory system is about mitigating this risk of bank runs, but it still comes up in various forms.

Meanwhile there are other firms that have very long-term liabilities like pension funds. Pension funds tend to have a good sense of how much they will have to pay out each year and a long time horizon.

Once upon a time, he writes, it was sort of hard to turn bonds into cash: They didn’t trade that often, because most bondholders were these long-term investors with long-term liabilities, so they would just buy bonds and hold them to maturity. But now, bonds are actively traded.

Still, those long-term investors with their long-term liabilities exist. An endowment or pension or sovereign wealth fund or 40-year-old saving for retirement really does have some predictable need for cash far in the future.

It turns out that you can often get paid more interest by making private loans that don’t trade than you can by just buying regular traded bonds. So “private credit” developed: Big alternative asset managers take big pots of long-term money from pensions and insurers, and use it to make long-term illiquid loans to companies.

And to some extent private credit firms have been able to out-compete banks to make loans, in part because they have a more sensible business model for making loans: Banks have short-term funding and so sometimes can’t make loans because they or their regulators get nervous, but private credit funds have long-term funding so are free to make loans that banks can’t.

That’s the idea, at least. One important exception, says Levine, is that a lot of private credit firms get leverage from banks — instead of just using their long-term investors’ locked-up money to make loans, they also borrow some money from banks to fund those loans — and thus the risk of bank runs sneaks back into private credit.

[00:39:29] Shawn O’Malley: And I’ll add that, in the meantime, there’s been a larger trend generally to private assets, which are often pitched as offering higher returns with less volatility than public markets. Endowments, pension funds, and many other institutions often grade their performance in an academic way based on the amount of return they achieve per unit of risk taken, where risk is defined as the amount of portfolio variance.

So, they’re trying to get as much return as possible with their investments fluctuating as little as possible, or having positions that offset each other’s ups-and-downs, providing diversification benefits.

This is by no means the best way to think about risk in investing, though. And the reason why ties back to the concept of Mr. Market that Buffett always talks about. If someone came and offered you a different price for your house every day, would it really matter how much those quotes fluctuate? If you’re happy living there, the day-to-day price fluctuations shouldn’t matter. And it’s the same with stocks. Price quotes for stocks can fluctuate wildly throughout a year, but to disciplined long-term investors, that shouldn’t matter and is something to take advantage of.

Not to go on yet another tangent, but the reason these institutional investors love private investments is because they aren’t marked-to-market every day, which from a behavioral finance perspective can make the investments more tolerable to their clients.

If a private equity fund buys some dental practice in Des Moines, there’s no active market for pricing that dental practice daily. The paper value basically stays the same until it’s sold again and revalued, and the private equity fund will make quarterly estimates for how much they think that business they acquired is now worth.

Experts, rather than markets, determine the prices of private-equity-owned companies. Even better, those experts are the PE firms’ employees!

And as such, they can report considerably less volatility than you’d see with any listed stock. But I mean, come on, let’s use some common sense here. Do we really believe that some portfolio of small-town dental practices is more stable, from an operating perspective and in terms of changes in business value, than a handful of public stocks like Apple, just because Apple is traded daily and thus has more visible volatility in its pricing?

The whole thing is a bit silly, and if I hadn’t seen these practices for myself in past jobs and in school, I wouldn’t believe it, but for the most part, what I describe above is not that far from what actually happens.

Yes, there are some truly exceptional venture-capital funds, for example, that are private investments where there are enough relationships and expertise to legitimately generate extremely attractive returns, but this is more the exception than the rule. If you can invest with the Sequoia’s of the world, more power to you, but that’s not representative of the entire asset class.

I’d wager far more private equity, private credit, and private real estate funds are benefiting from creating investment products that institutional managers desire, where they can artificially remove volatility and amplify returns with modest leverage and then pitch that to investors as a better product than what they could get by simply investing in broad index funds.

I find the whole thing a bit distasteful, where, as I said, there are legitimate financial solutions being fulfilled here and actual outperformance being earned, and then in other cases, the whole thing seems like an irrational bonanza where we are asked to believe that, just because something isn’t publicly-traded, it can generate not only consistently better returns but returns that almost never decline in value.

And maybe, 20 years ago, with savvy general partners guiding a private-asset strategy, that would be true. Before trillions of dollars raced into private assets, you could probably find a number of compelling private businesses that, because they weren’t listed publicly, could be purchased on the cheap with a considerable relative discount.

But now, there’s an incredible amount of competition to bid on acquisitions of, or loans to, private companies, and I find it hard to believe there can be so many attractive opportunities in these niches still at attractive prices. I’d imagine there’s been a convergence between business valuations in public and private markets, so much of it now looks more like savvy marketing to me and an excuse for charging dramatically higher fees.

I’m confident plenty of people will have no trouble telling me why it’s not as simple as I make it out to be, but a good rule of thumb, if financial history is any guide, is to be wary of the quote-unquote “next big thing” in finance. And the migration to private assets has been one of the biggest trends in finance of the last 15 years, so that gives me some pause about how sustainable this all is and what’s really brewing beneath the surface.

For goodness sake, the boundary between private and public has become so blurred that there are now private credit ETFs as if that makes any sense. The financial masters of the universe believe that, for some reason, we need to try and cram something that is, by definition, illiquid, into one of the most liquid investment vehicles there is.

That is sort of the canary in the coal mine, and to me, this has all become a bit exhausted. In financial theory, there’s such thing as the illiquidity premium, where harder to access and sell investments should offer higher returns, but if there are quite literally private credit ETFs now, how can we have it both ways?

Either there’s an illiquidity premium or there’s not, and broadly speaking, that illiquidity premium has undoubtedly shrunk in recent years, raising questions about the extent to which these alternative investments can still be marketed to advisors and institutions going forward.

[00:45:28] Shawn O’Malley: To see what’s been happening, you need not look further than the stock charts for some of the largest alternative asset managers. The private equity giant KKR has seen its stock jump by over 400% in the past five years, while Blackstone’s has risen by 25% a year since 2020, and Apollo’s stock has tripled over that same period.

My brain immediately wonders where this money is coming from.

Some University endowments already have more than 50% of their portfolios in illiquid private assets, so it doesn’t surprise me that private asset funds are increasingly targeting everyday-retail investors with ETFs and other contrived investment products because the largest and highest-quality sources of capital have already been mostly tapped.

Again, I’m sure some people who work in investment management or alternative assets will be very unhappy with what I’m saying, but the basic idea here is hard to refute, and that is, as more money flows into private assets, the assets become less private and therefore less special, and in 5 or 10 years from now or sooner, I wouldn’t be surprised if these strategies lose their luster and we see a large rebalancing away from alternative assets.

Looking at private credit in particular, the financial journalist Robert Armstrong writes, “The promise of private credit is that for a loan to a borrower of a given creditworthiness, it can get returns that are either a bit better than, or less volatile than, or at the very least uncorrelated to, other forms of lending such as high-yield corporate bonds.” This possibility might derive from, variously, the fact that some borrowers will pay up to avoid public bond and loan markets; tighter contract terms; tighter bilateral relationships between borrower and lender; or lack of mark-to-market valuation. The hard question, though, is whether “risk-adjusted performance is greater or less than the fees [the] clever, hard-working people” who run private credit funds charge their investors.”

And according to a recent study from researchers at Ohio State University, which I’ll link to in the show notes, any extra returns generated by private credit, which is the largest tranche of Blue Owl’s AUM, are completely offset by the higher fees charged by private credit fund managers.

That doesn’t mean Blue Owl’s funds aren’t performing well, and to be fair, the primary pitch for many private assets is that they’re uncorrelated and therefore offer diversification benefits, not that they always deliver better returns, but still the results of the study and some common sense suggest to me it isn’t all that sustainable for money to keep flowing into these strategies if there aren’t excess returns and if the lack of correlation is a manufactured result of simply not being marked-to-market as frequently.

If there’s a substantial degree of truth to that, a troubling development for alternative asset managers who would be needing to compete for new capital inflows by cutting fees if they can’t deliver the same kind of high returns as in the past, mirroring what we’ve seen in public markets since the 1980s where Vanguard has completely disrupted the world of actively-managed mutual funds with ultra-low-cost passive funds.

For Blue Owl, this is where the question of capital permanency becomes increasingly important. The longer their AUM is locked up, the better it is for their existing business to endure swings in the alternative asset management.

And while Blue Owl doesn’t specifically run private equity funds, you might say that as much as 80% of its business is dependent on private equity, either through their private credit AUM that fund buyouts or their GP Capital Solutions business that buys stake in private equity management firms. It’s fortunes are very closely tied with the bigger picture trends surrounding private asset classes and private equity in particular.

So, I’ve railed against the rise of alternative assets enough, and you might be surprised to hear that I’m not quite ready to disqualify Blue Owl yet.

I want to look closer at its business prospects in particular and valuation.

[00:49:56] Shawn O’Malley: When evaluating asset management businesses, the term “distributable earnings” gets thrown around frequently and is calculated by taking a company’s net income and adjusting it for factors like unrealized gains, deferred taxes, and other non-cash items that may not be readily available for distribution.

Blue Owl’s aim is to payout most of its distributable earnings as dividends, and as such, they targeted 72 cents of dividend payments per share last year, which would be a dividend yield of almost 3% at current prices, and higher when you consider that management has said they intend to grow the dividend each year in-line with their growth in distributable earnings.

Since 2021, Blue Owl’s dividend has grown at an impressive rate of 65% per year, and based on the company’s Q3 earnings call, it should rise another 25% in 2025.

That would bring its expected dividend yield for 2025 to roughly 3.6%. That’s fairly solid, especially for people who are looking for income-generating stocks.

Maybe, though, it’s a good time to mention that Blue Owl has a few different share classess of stock. I will warn you to brace yourself because it gets a bit complicated. No hard feelings if you want to skip a head by two or three minutes, but for those who want to get into the nitty gritty, here we go.

[00:51:04] Shawn O’Malley: The Class A shares are traded publicly, whereas the Class B, class C, and Class D shares do not trade publicly. The class D shares hold 80% of the company’s voting power for a period of time until converting into shares of Class A stock, and for now, while class B shares would also have more voting power, there are none outstanding.

The Class C shares are a remnant of the company’s IPO, where the investment firm Neuberger Berman received a stake in Blue Owl for selling its interest in Michael Rees’s Dyal Capital.

So far, so good, nothing too crazy.

This split structure where certain share classes have more voting power is common in companies where the founders want to retain significant control over the company’s strategic direction while still accessing public capital markets through sales of shares that still have an economic interest in the company but have reduced voting power, which in Blue Owl’s case is the Class A shares.

Alphabet has a similar share-class structure, and it’s not a deal breaker for me but it is not something I always love to see, either. It gives founders and insiders more power over the company than they would have simply based on their economic interest in it. This just makes it all the more important to nail down your perceptions of management because if the management team isn’t as high-quality or honest as you’d hope, the stakes are even higher.

Unfortunately, this is not where the capital structure conversation ends. There’s more complexity to be had. Blue Owl conducts business through a combination of Operating Partnerships, of which its publicly-traded A shares have a 39% interest in an entity known as the Blue Owl Operating Partnership, and that stake is defined in terms of quote-unquote “units.” The class A shares directly correspond to this 39% interest and are exchangeable one-to-one with units in the partnership. So, if you hold one A share in Blue Owl, that’s equal to one unit in the Blue Owl Operating Partnership.

The other 61% of the Blue Owl Operating Partnership is split between so-called Common Units and Incentive Units. With the common units, depending on who owns them, they can either convert to class A or class B shares, which cancels out a corresponding number of class C or class D shares.

And the incentive units are what they sound like, they can be awarded to employees and management if certain performance targets are met and eventually convert to shares of stock.

It is a really confusing thing to look at initially, and honestly, my head was spinning the first time I tried to understand it. I legitimately had regrets about trying to cover this company, but I’m glad that I powered through and that you’ve stuck with me, because it’s important to be able to understand a wide range of businesses if we’re going to look for the best returns available in markets.

The different units and share classes should all or mostly convert to class A shares over time, but for the time being and foreseeable future, the structure is wonky.

In short, if you go out and purchase Blue Owl stock, you will be receiving shares of class A stock, which translates currently to a 39% stake in the operating partnership entity, and that stake in the Operating Partnership will increase as the number of class A shares grows over time as, for example, Neuberger Bermann continues to convert their special class C shares into A shares so they can sell them.

If you look up Blue Owl on different financial data sites, you’ll get differing acccunting for its market value. Some places report the equity value of just the A shares, and that gives a market cap of around $14 billion for those shares’ 39% stake in the Blue Owl Operating Partnership.

But if you include the other share classes to get the fully diluted value of the entire enterprise, the share count nearly triples and thus the market cap is estimated at over $38 billion at the time of recording.

Even though the A shares have grown quickly, when you look at the Operating Partnership level and compare with the number of units today versus in 2021, the dilution is much less dramatic than I initially thought at less than 3% per year.

I would say just be mindful of which method you’re looking at, because if you attribute all of the business’s free cash flow to its class A shares, then it looks like the stock is trading at a very attractive price-to-free cash flow of 16, when in reality, you’d have to adjust that to either account for the other share classes or the smaller claim on those free cash flows held by the A shares, but either way, the correct number for the price-to-free cash flow is closer to 40, which doesn’t make the company look screamingly cheap to me.

[00:55:42] Shawn O’Malley: Okay, we made it through the discussion of corporate structure and share classes. Moving on, I’ll say that, to Doug Ostrover’s credit, he has architected a business model that would be any alternative asset manager’s dream.

The model is centered around fee-related earnings, where fee revenues consist almost exclusively of recurring management fees that are particularly valuable due to their stability and predictability. Regardless of performance, the company gets paid.

Even though OWL is much smaller than the biggest companies in the industry, its fee-related earnings margin of 60%+ is second to none.

And as I’ve mentioned, close to 90% of OWL’s AUM that it charges fees on is categorized as permanent. OWL is asset-light to the extreme, too. It’s not like they have to pay for new factories to expand their business. I find that all to be very compelling.

When valuing Blue Owl, it is more informative to look at free cash flows than net income, because its net income reporting is heavily distorted by depreciation, amortization, and stock-based compensation, which are all mostly byproducts of its acquisitions and growth.

Not to say those non-cash charges are completely inconsequential, but they don’t paint a good picture of economic reality as much as cash-based measures of profitability like free cash flow or distributable earnings for an asset management business like Blue Owl.

Financial services firms are notoriously difficult to value with much certainty. As the valuation expert Aswath Damodaran puts it, quote: “With financial service firms, we enter into a Faustian bargain. They tell us very little about the quality of their assets, but we accept that in return for assets being marked to market by accountants who presumably have access to the information that we don’t have. Therefore, estimating cash flows for a financial service firm is difficult to do. So, we trust financial service firms to pay out their cash flows as dividends.”

Thus, Damadoran recommends focusing on the dividends per share a business like this has produced and is likely to produce going forward as the basis for the valuation rather than focusing on GAAP net income. To be clear, he’s primarily referencing banks, but my interpretation of this is that, without being forensic accountants, buying a financial services stock is something of a leap of faith, where you’re putting a considerable amount of trust in management since it’s very challenging to independently verify the quality of their assets.

But this can go quite poorly for even the most sophisticated investors in the world. Warren Buffett was famously burned by Wells Fargo after it was one of his highest conviction bets for years after first investing in 1989 and pouring over $12 billion into purchasing its shares, until mostly bailing on the company in 2021.

If you just look at the stock chart for Wells, it’s not like Buffett lost on the bet over 30 years, but it was a significant laggard that otherwise weighed down returns over the past 15 years. On June 19th, 2009, the stock traded at $24 and 19 cents, and was trading just below $30 per share by the end of 2020.

Wells Fargo has been hit by a host of scandals, lawsuits, and fines that derailed the bank, fundamentally stemming from poor incentive programs for employees, and that wasn’t the first time a bank investment had gone sideways for him, either.

In 1991, he made his now-famous proclamation before Congress as a shareholder in the troubled Soloman Brothers investment bank, saying, “Lose money for the firm, and I will be understanding; lose a shred of reputation for the firm, and I will be ruthless.”

I’m cherry-picking examples here, and Buffett has of course made losing bets in other sectors and also made plenty of winning picks with financial services companies.

His investment in Goldman during the financial crisis is considered one of the best trades of all time, and I use that word “trade” intentionally because it was more of an opportunistic trade than his normal style of owning wonderful businesses for the long-term, but still, financial services businesses are simply more opaque and often more convoluted than your average business, which we’ve seen in action today while trying to understand Blue Owl, and that makes it all the more easy to be blindsided by unforeseen risks.

And that is true for Blue Owl; hence, the focus on, after all is said and done, how much cash the company is paying out to shareholders.

The dividend is a very big part of the story, and management knows that, which is why they continue to set aggressive targets for growing it. In 2022, management committed to $1 of dividends per share by 2025, and now it looks like they’re not going to quite reach that, plus it appears they’ve had to actually take on some debt to finance their dividend distributions in 2024, which is an orange flag for me that would become a red flag if it continues to happen.

[01:00:17] Shawn O’Malley: We’re running out of time to do a deep dive into the valuation, and I’ll go into a little more detail in the newsletter on Blue Owl which you can find a link to in the show notes, but it’s probably not a huge surprise to you that I’m passing on Blue Owl.

I’d guess that there’s a decent chance it proves to be an excellent investment based on Doug Ostrover’s track record, its permanent capital fee structure, and the ongoing expansion of alternative investing, but boy do I not feel like I have my head fully wrapped around this company.

From the Spac to the Operating partnership structure and units and different share classes, to the nuances of its various funds and trying to determine their permanency to bigger questions about whether the trend toward private assets has been a good thing and whether it’s at risk of reversing all give me pause.

Maybe if I was a financial advisor who had experience with working directly with Blue Owl and allocating client assets to their strategies I’d feel more confident about the outlook for the company.

I passed in a similar way when looking at John Deere, and I’d say I have even bigger question marks lingering here. As far as I’m concerned, I’m happy with concluding that Blue Owl is about fairly valued given the quality of its fee structure and prospects for growth at a price-to-free cash flow of 40 and 3% dividend yield.

Blue Owl is not even a company I’ll keep on my watch list just because I don’t have a firm enough price target in mind to know when there’s a true margin of safety in it. I’m glad I studied it to push outside my comfort zone, but doing so doesn’t obligate me to invest accordingly.

With that, as always, I’d like to leave you with a timely quote. This line is often attributed to Benjamin Franklin, and it goes, “An investment in knowledge pays the best interest.” Today, you made an investment in knowledge and learned about not only Blue Owl but also the fast-growing alternative asset industry, and perhaps that will pay dividends for you at some point.

I’ll see you again next week with another business breakdown and potential addition to The Intrinsic Value Portfolio.

[01:02:34] Outro: Thank you for listening to TIP. Make sure to follow The Intrinsic Value Podcast on your favorite podcast app and never miss out on our episodes. To access our show notes and courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decisions, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permissions must be granted before syndication or rebroadcasting.