AllianceBernstein Holding L.P.
Q2 2016 Earnings Call Transcript

Published: 30 Jul 2016

[Operator:]

Thank you for standing by and welcome to the AB Second Quarter 2016 Earnings Review. At this time, all participants are in a listen-only mode. After the remarks, there will be a question-and-answer session and I will give you instructions on how to ask questions at that time. As a reminder, this conference is being recorded and will be available for replay for one week. I would now like to turn the conference over to the host for this call, Director of Investor Relations for AB, Ms. Andrea Prochniak. Please go ahead.

[Andrea Prochniak:]

Thank you, Stephanie. Hello and welcome to our second-quarter 2016 earnings review. This conference call is being webcast and accompanied by a slide presentation that's posted to the Investor Relations section of our website www.abglobal.com. Peter Kraus, our Chairman and CEO; John Weisenseel, our CFO; and Jim Gingrich, our COO, will present our financial results and take questions after our prepared remarks. Some of the information we present today is forward-looking and subject to certain SEC rules and regulations regarding disclosure. So I'd like to point out the Safe Harbor language on Slide 2 of our presentation. You can also find our Safe Harbor language in the MD&A of our second quarter 2016 Form 10-Q, which we filed this morning. Under Regulation FD, management may only address questions of a material nature from the investment community in a public forum, so please ask all such questions during this call. We are also live tweeting today's earnings call. You can follow us on Twitter using our handle @AB_insights. Now I will turn it over to Peter.

[Peter Kraus:]

Thanks, Andrea. Good morning, everyone and thanks for joining us on what is a busy reporting day. Let's get started with a firmwide overview, which is on Slide 3. AB attracted $3.5 billion in net inflows in the quarter, our second straight positive quarter. Net flows were up nearly 60% sequentially and positive in all of the client channels. Gross sales of $18.4 billion rose 19% sequentially, but were lower year on year due to the $10 billion customized retirement solution, or CRS funding we had in last year's second quarter. We ended the quarter with AUM of $490 billion, up from both prior comparable periods with both markets and flows contributing. Average AUM was up 4% sequentially and down 2% year on year. Let's take a closer look at the quarter's flow trends, and that we can do on Slide 4. On a firmwide basis, gross sales increased for the third quarter straight to $18.4 billion. As you can see from the chart at the top left, year-to-date net inflows were $5.7 billion and all three of our client channels played a positive part. Institutional gross sales of $5.2 billion increased 16% from the first quarter and were up slightly from the second quarter of 2015 if you exclude the $10 billion CRS mandate we funded that quarter. Net inflows totaled $1 billion. Most of the sequential increase in redemptions can be traced to one large termination. In retail, both gross sales and net flows rebounded from the first quarter. Resurgent demand from both Asian and U.S. retail investors for fixed income products drove gross sales up by 40% sequentially. That resulted in a swing to positive net flows of $2.3 billion. Private wealth net flows of $200 million stayed in positive territory in the second quarter, even with our usual tax season redemption pressure. This is our first net flow positive second quarter for the business, that is for the private client business, since 2007. There are two AUM changes of note we wanted to highlight. First, as we announced in our June AUM release, our 529 College Bound Fund relationship with the State of Rhode Island has officially ended and all of the assets have now left our complex. About $150 million left during the second quarter, $100 million from retail and $50 million from private wealth. The rest, which is $6.7 billion, left in the early part of July with $6.3 billion out of retail and $400 million leaving private wealth. Second, as you know, we acquired the SunAmerica Alternative Investment Group from AIG in 2010. As part of this transaction, we agreed to manage a large percentage of AIG's institutional alternative assets for a low fee. Recently, AIG publicly announced it would significantly reduce its hedge fund exposure and begin managing its remaining alternative assets in-house. These redemptions have begun and will ultimately total approximately $7 billion. We expect them to be completed by quarter-end. Now let's move on to Slide 5, our fixed income investment performance. Continued strong performance in the second quarter, particularly in the services designed to reduce risk, allowed us to maintain our strong track records. Overall, our percentage of fixed income assets and outperforming services ranged from 85% to 90% for the one, three, and five-year periods. Moving to equity investment performance, which is on Slide 6, we did lose some ground in our one and three-year numbers for outperforming assets, mostly due to challenged performance in our style-based portfolios this year. Some notable outperformance in the table on the right include U.S. large cap growth, which ranks top decile for three and five-year periods, emerging market growth top decile for three- year and top quartile for five-year. In our strategic core services, which are designed to capture the upside of the market while providing downside protection, all four of them U.S., global, international and emerging market are outperforming benchmarks by a very wide margin and rank top decile among peers for the three years. Turning to our client channels, let's start with institutional on Slide 7. In our second consecutive quarter of net inflows, client activity was dominated by active fixed income, particularly U.S. investment-grade debt where we had several large fundings. As I mentioned earlier, the sequential increase in gross redemptions came largely from one significant termination. We continue to maintain a healthy pipeline of active services, just above $6 billion, and we are encouraged by what we see coming in. Strategic core equities represented the largest addition to our pipeline during the quarter, two mandates totaling $600 million. That's a clear sign that clients are noticing the downside protection capabilities of these services. Multi-manager target date was another significant addition to our pipeline. We signed our first institutional Collective Investment Trust, or CIT, client for the multi-manager target date series we launched with Mercer in 2015. That's a pretty nice vote of confidence as we look to grow this business. Those are just two of our diverse pipeline adds. As you can see from the pie at the bottom right, new additions during the quarter were split nearly 50

[John Weisenseel:]

Thank you, Peter. Let's start with the GAAP income statement on Slide 13. Second quarter GAAP net revenues of $726 million decreased 8% from the prior year period. Operating income of $143 million decreased 13% and the 19% operating margin was 100 basis points lower. GAAP EPU of $0.41 compared to $0.48 in the second quarter of 2015. Going forward, I will focus primarily on our adjusted results. As a reminder, we provide these non-GAAP measures in addition to and not as substitutes for our GAAP results. We base our distribution to unitholders upon our adjusted results, which remove the effect of certain items that are not considered part of our core operating business. You can find our standard GAAP reporting and a reconciliation of GAAP to adjusted results in our presentation's Appendix, press release, and 10-Q. Our adjusted financial highlights are included on Slide 14. Second quarter adjusted net revenues of $604 million and operating income of $135 million decreased year on year, but increased sequentially. Our margin of 22.3% was down versus the prior year, but was essentially flat to the first quarter. Lower base and performance fees were the primary year-on-year driver of the decline in our financial results. Higher base fees drove the sequential improvement. We earned and will distribute to our unitholders $0.40 per unit compared to $0.48 in last year's second quarter. We delve into these items in more detail on our adjusted income statement on Slide 15. Beginning with revenues, total net revenues of $604 million decreased 8% year on year, but increased 2% sequentially. Base fees decreased 5% year on year as a result of lower average AUM and portfolio fee rate realization across the retail and institutional distribution channels. Base fees declined more in percentage terms than average AUM reflecting a mix shift from higher to lower fee products. Sequentially, base fees increased 6% due primarily to higher average AUM across all three distribution channels. Performance fees decreased $13 million from the second quarter of 2015 when we earned $8 million on our Luxembourg Registered Select Absolute Alpha Fund. This equity long short fund has an annual fee calculation period ending in May and did not generate any performance fees this year as a result of less favorable market conditions. Bernstein Research Services revenues decreased 6% year on year due to a decline in client activity and lower market levels in Asia and unfavorable foreign exchange translation effects in Europe. The 9% sequential decrease is attributed to decreased client activity in the U.S. and Asia. Moving to adjusted expenses, all-in, our total operating expenses of $469 million decreased 6% year on year, but increased 2% sequentially. Total compensation and benefits expenses decreased year on year in line with our lower revenues but increased sequentially due to higher accruals for incentive compensation. We accrued total compensation, excluding other employment costs such as recruitment and training, as a percentage of adjusted revenues. In the second quarter of this year, we accrued compensation at a 50% ratio, in line with both the same prior year quarter and the first quarter of this year. Second quarter promotion and servicing expenses decreased 10% year on year due to lower T&E and marketing expenses. G&A expenses increased 2% year on year due to higher portfolio servicing expenses and 3% sequentially due to higher professional fees. Less favorable foreign exchange translation also contributed to the increase versus both periods. Operating income of $135 million for the quarter was down 15% from the prior year as revenue declines outpaced expense reductions, but increased 2% from the first quarter driven primarily by higher base fee revenues earned on higher average AUM. Our margin of 22.3% for the quarter was down 180 basis points from the second quarter of 2015, and essentially flat on a sequential basis. In addition, our first quarter adjusted operating income of $135 million was $8 million lower than our GAAP operating income. This was primarily due to the exclusion of the following two items from our adjusted results that are not part of our core or recurring business operations. First, we recorded a $3 million non-cash real estate credit for GAAP reporting to true up our sublease assumptions relating to real estate write-offs recorded in previous periods. Second, we adopted the new consolidation accounting standard for variable interest entities for GAAP reporting effective January 1, 2016. Since the first quarter of this year, we consolidated certain seed investment funds that had not been consolidated previously. Although this increased GAAP operating income by $5 million, it had no effect on net income or EPU. Therefore, we deconsolidated these seed investments for our adjusted reporting, in effect subtracting the $5 million from our adjusted operating income. Both items are included on the GAAP-to-adjusted reconciliation included in this presentation's Appendix. Finally, the second quarter effective tax rate of 7.4% for AllianceBernstein LP compares with 5.5% in the second quarter of 2015 and 5.7% in the first quarter of this year. The year-to-date effective tax rate is 6.5% and reflects a higher percentage of pre-tax income expected to be derived from higher tax foreign jurisdictions. And with that, Peter, Jim and I are pleased to answer your questions.

[Operator:]

[Operator Instructions]. Your first question comes from the line of Bill Katz with Citigroup. Your line is open.

[Bill Katz:]

Okay, thanks good morning everyone. Appreciate to taking the questions. May be I misheard this, or I was just wondering if you could just review the AUM impact from the AIG account loss. I thought I heard $7 billion. If that's the case, can you walk us through what the economic impact might be and are there any other related assets that might be at risk on the other side of this?

[Peter Kraus:]

You didn't mishear it. $7 billion is the AUM impact. The revenue impact though is negligible. It's at a very low fee. You recall that it was part of a transaction and so that describes the situation.

[John Weisenseel:]

And Bill, it's John, I would just add there's no material impact on either revenue or operating income.

[Bill Katz:]

Okay. That's helpful color. And then just a little bit of a technical question; I apologize. But it looks like the AB Holding percentage dropped sequentially. Just a little curious if you could walk us through the dynamics of why that was the case and how we should think about that ownership ratio on a go-forward basis?

[John Weisenseel:]

The ownership ratio is decreasing because of the share buybacks because as we are reducing those shares, AXA's ownership percentage is increasing.

[Peter Kraus:]

Unless AXA sales shares to us privately, the only share count that's going down when we are buying stock is the public share count and so that's why that percentage changes. When we issue shares at the end of the year, you'll see that percentage go up.

[Bill Katz:]

And so is there any reason to think that that number is going to meaningfully change from here on a sort of a year-on-year basis?

[John Weisenseel:]

Well, it's John. I think the ownership percentage of AXA, as you see it now; will be similar to where it's going to be at the end of the year. Keep in mind our share count is down now a little over 3 million units, almost close to 4 million. We typically issue about 4 million units in connection with employee-based comp in December and we expect to continue to buy back in the market during the balance of this year. So I would expect the share counts and the ownership percentage to remain relatively within this range.

[Bill Katz:]

Okay, all right. Thank you.

[Operator:]

Your next question comes from the line of Robert Lee with KBW. Your line is open.

[Robert Lee:]

Thanks. Good morning guys. I guess my first question is in the retail business really around the DOL. One of the impacts from that, I guess, that a lot of peers have talked about is seeing increased demand for in the SMA business. Can you maybe update us on your positioning there? I know in the distant past, that has been a large business for Alliance. I'm not sure where it stands today, so how do you feel about your positioning in the retail world, assuming demand accelerates for the SMA business in retail?

[Peter Kraus:]

I think if the large firms move towards more SMA type accounts, we feel pretty well-positioned for that. As you know, in the tax-aware muni space, that's a huge incentive or a huge opportunity for us and has been growing persistently for almost 18 months. So that's an example of us being able to both pivot and take advantage of that. I also think it will allow for more flexibility on the part of both the large distributor and the asset manager to tailor products that make more sense for the client base.

[Robert Lee:]

Great. And may be as a follow-up, in private wealth, you pointed to the increased FA productivity, clearly better trends there, have some unique and interesting products that you are even introducing. So how do you feel at this point about may be going kind of more on the front burner from a FA recruiting perspective in terms of productivity is up, now maybe starting to add more relationship managers going forward, whether experienced or training, or to train?

[Peter Kraus:]

We have a very diligent and consistent process for acquiring or bringing new people into the firm. We certainly haven't diminished the number and it grows slightly. I have an opinion, or I have a view on that business that it's very hard to actually increase productively the number of people that you hire in that space. There are many, many examples of organizations changing the rate of speed of hire and there it's very difficult to double or materially change the number of people that you hire and then adequately train them, integrate them into the business and make them productive. So our view is that we will create more productivity and more business growth and more momentum if we are persistent and diligent and we have a strong process and we bring good people into the organization.

[Jim Gingrich:]

The other thing I would add is that there really is nothing better for both our clients, the folks in the business, as well as the unitholders, than being able to grow the productivity of our advisors. From a unitholder standpoint, it generates the greatest operating leverage and it's also the best thing for our clients. So, yes, it's something we stay very focused on.

[Peter Kraus:]

You know just another way to think about that, Robert, is that if productivity increases, it's like adding more people?

[Robert Lee:]

Great. Thanks for taking my questions.

[Operator:]

Your next question comes from the line of Michael Carrier with Bank of America Merrill Lynch. Your line is open.

[Michael Carrier:]

Peter, you mentioned a lot of the sales trends and the net flows and anything across channels just looking pretty good relative to the industry. And you gave the AIG color. Just wanted to also get the 529 color, and when you look at kind of the -- those lumpy outflows versus where you are seeing the incoming inflows, how should we be thinking about the fee rate or the revenue production of the asset base?

[Peter Kraus:]

So let me just ask you a question because I'm not quite clear what you would like a response to. Are you asking prospectively what we think is going to happen to fees and flows going forward?

[Michael Carrier:]

Well, it's mostly like when you look at the pipeline and then where you are seeing the improvement on the retail side versus obviously you gave the color on the AIG being insignificant, but then just giving the color similar color on the 529 assets.

[Peter Kraus:]

So the 529 assets are what we said they are, so that's the number. The business is really two different pieces. So in other words, we both manage the assets and also administer the assets, and that is an activity that Rhode Island going forward split. And so we get a fee for managing the assets, which is comparable to what has been publicly discussed by the new manager and then we add an administrative fee on top of that. And the estimated revenues for both of those were around $50 million.

[Michael Carrier:]

Okay. Got it. And then, John, just given the volatility on the research services business, just wanted to understand when you had that and some of the pressures that you are seeing, how much flexibility do you have on the expense base related to that business just given that that was one of the big deltas this quarter?

[John Weisenseel:]

There's not a whole lot of flexibility in terms of the expense base. They've been working very hard in terms of trying to reduce both their clearing costs, as well as some of their execution costs as far as transacting on different platforms, but for the people costs, people cost is obviously still there. So other than that, there's not a lot of flexibility to reduce.

[Peter Kraus:]

But as you know the people costs though, the comp cost is entirely flexible.

[Jim Gingrich:]

As is most of the trading costs.

[Michael Carrier:]

Got it. Okay. Thanks a lot.

[Operator:]

[Operator Instructions]. Your next question comes from the line of Craig Siegenthaler with Credit Suisse. Your line is open.

[Craig Siegenthaler:]

Thanks. Good morning everyone. I just wanted to come back to Slide 8. I really like the chart on the top left here and I don't know if you have the data handy for June or especially July post-Brexit, but I just wanted to see what non-Japan Asian retail fund sales looked like over the past two months.

[John Weisenseel:]

We don't have industry data for June, nor July since it's not over, but, as you can see from our overall flows in the quarter, I think that the trends that we saw in June were similar to what we had seen in April and May.

[Peter Kraus:]

I think if you go back last couple of quarters on the conversations we've had around this, I think we've made the observation that the gross sales numbers were extremely low and that we did not think that that level of sales was sustainable, and I think what you are seeing is that play out here.

[Craig Siegenthaler:]

And just my follow-up here, I don't know if you guys have done any work on the new liquidity risk management proposal from the SEC, but I am assuming you have. Would you think there will be any impact to the investment processes in some of your less liquid credit strategies, especially in the open end mutual fund sleeves in the U.S.?

[Peter Kraus:]

We have looked at the six liquidity requirements. I think those are a little bit too separate questions, although I understand why you are putting them together. So one is a question of disclosure and whether or not that disclosure will actually benefit people reading the disclosure. And I think that there is a little bit of a risk of over-precision by bucketing assets into liquidity categories. In the event of a serious liquidity crisis, the correlation between those categories is likely to break down and many things are likely to be a lot less liquid than you thought they were. So I think there's a -- some caution that we have with regards to the efficacy of that disclosure and the reliance that investors can have in truly distressed situations. As it relates to the management of the funds, I don't think it's going to change the management of the funds because we manage the funds on the basis of exactly that, those stress situations. And however we categorized the assets is not really relevant exactly because what is relevant to us is how we think they are going to behave in a highly distressed condition and then we carry enough liquidity to deal with that problem. So I don't think that the disclosure will have much of an impact on the actual securities that are in the book.

[Craig Siegenthaler:]

Thank you.

[Operator:]

Your next question comes from the line of Surinder Thind with Jefferies. Your line is open.

[Surinder Thind:]

Good morning. Just to start with a question on the DOL. In light of those new rules, just any color or thoughts around the conversations that you might be having with your distribution partners in terms of how their business models might be evolving and how you fit into the picture and may be as the select list gets smaller and those kinds of things?

[Peter Kraus:]

Well, Surinder, I have said publicly that I think there's too many managers in the world, so if they reduce the number of managers, I'm onboard for that. And so I think that that's positive if it goes in that direction. But any more specificity with regards to what the large players are going to do with regards to DOL is unclear. They have not decided. They are working very hard at it. The major distributors of which we are one are trying to stay as close to them as possible. I think one risk for the industry is that each of the major distributors have a slightly different or markedly different plan and that could create more expense and perhaps an inefficient marketplace. And I don't think we know the answer to that until it actually occurs. So I appreciate the question and I wish I could be more effective at answering it, but I just think we don't know yet.

[Surinder Thind:]

That's helpful, but so just to hit upon a point that you made there, so is there the possibility that you potentially see some of the major players going in very different directions in terms of the business models they adopt, which obviously would make it more challenging for you guys to perhaps work through those channels or those partners?

[Peter Kraus:]

We hope that does not happen, but it could happen.

[Surinder Thind:]

Fair enough. And then just a quick question on you touched on this a little bit earlier about just geographic demand and the outlook. Kind of with post-Brexit, are you seeing anything different in Asia in terms of demand versus may be what you are seeing here in the U.S. or even a shift in investor sentiment from maybe favoring one region over another at this point?

[Peter Kraus:]

I think the major effect has been a resurgence of sales in the Asia ex-Japan space. I think that is the major difference. Brexit clearly had a chilling effect on risk-taking in Europe and in trading activity, which was reflected in the Bernstein numbers. I don't think we've seen any material move of flow from Europe to the U.S. One interesting thing to note, which fits a little bit in the Asia ex-Japan story, is the perhaps surprising to some very positive equity returns in emerging markets, at least in the last 12 months. And that may engender some flow into that space going forward because we are still at the end of a period of time of disinvestment in emerging markets and that -- I suspect that that might actually change. That might be six months or nine months out, something that investors or something that observers say, yes, we've really seen a flow change there.

[Surinder Thind:]

Fair enough. Then just one really, really quick question here. Any additional color on -- you said there was one larger mandate in the institutional channel that you lost that was responsible for a significant portion of the gross redemption activity. Was that a rebalancing, something being pulled in-house, or any color there?

[Peter Kraus:]

It was a rebalancing by that client and it was a normal process. We called it out because it was really the one thing that changed the context of those institutional numbers and we wanted you to understand what the real underlying flow trends were.

[Surinder Thind:]

Okay. Thank you. That's it for me.

[Operator:]

Your next question comes from the line of Bill Katz with Citigroup. Your line is open.

[Bill Katz:]

Just a follow-up. Thanks for your patience. So again, I think you said about $50 million of related revenues on the Rhode Island account. That seemed like a high number to me, but I just wanted to clarify that. And then are there any offsets on the expense line against that?

[Peter Kraus:]

Yes. Remember, Bill, that those are two services. There's the investment service and the administrative service. That's why it seems high to you. So if you were taking both Invesco's revenues and Ascensus revenues, which are the two people that Rhode Island hired to replace us that's what you would have to be looking at. And of course, there are lots of expenses that will be removed.

[Bill Katz:]

Is there any way to size the net impact against that?

[Peter Kraus:]

Yes, there is, but we generally don't give you P&Ls for specific activity, so --

[Bill Katz:]

Okay. One last question on this and thanks again. Can I presume that the operating margin on that business is a lot lower than the core business?

[Peter Kraus:]

I don't want to give you information that might end up being challenging for you to use. I think it's fair to say if you look at what you would assume the operating margins are for additional revenues or that we take on, I think if you stick with that, you'll be fine.

[Bill Katz:]

Okay. Thank you very much. Sorry for the minutia.

[Operator:]

There are no further questions. I turn the call back over to Ms. Prochniak.

[Andrea Prochniak:]

Thanks, everybody, for joining us today. I know that you have a lot of companies reporting. I just want you to know that IR is available for any follow-up that you may have. Thanks so much and have a great day.