AllianceBernstein Holding L.P.
Q2 2015 Earnings Call Transcript

Published: 30 Jul 2015

[Operator:]

Thank you for standing by. And welcome to the AB Second Quarter 2015 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, the Director of Investor Relations for AB, Ms. Andrea Prochniak. Please go ahead.

[Andrea Prochniak:]

Thank you, Chris. Good morning, and welcome to our second quarter 2015 earnings review. This conference call is being webcast and accompanied by a slide presentation that's posted in 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 1 of the presentation. You can also find our Safe Harbor language in the MD&A of our second quarter 2015 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're also live tweeting today's earnings call. You can follow us on Twitter using our handle @AB_insights. Now, I'll turn the call over to Peter.

[Peter Kraus:]

Thanks, Andrea. Good morning everyone, and thanks for joining us today. I am going to start with a firm-wide overview on Slide 3. Our second quarter gross sales of $24.8 billion were up 5% in the same prior year period and up 27% sequentially. Sales include the $10 billion customized retirement strategies for CRS mandate that funded in April. Net inflows of $2.3 declined by about $6 billion year-over-year and by nearly $4 billion sequentially. As we reported in June AUM release two large institutional redemptions in June set us back for the quarter. Quarter end AUM of $485 billion was up 1% versus the second quarter of 2014 and flat sequentially. Average AUM of nearly $493 billion was up more then $28 billion or 6% year-on-year and more then $11 billion or 2% sequentially. On Slide 4 you can see our quarterly flow trends across channels. Firmwide net flows were positive for the second quarter straight, and for four out of the past five quarters. And our year-to-date net inflows of $8.2 billion are more then double last year’s first half inflows of $3.9 billion. Institutional net inflows of $3.5 billion offset net outflows of $900 billion from the retail and $400 million from the private wealth channels. In private wealth, we usually see a spike in tax related account withdrawals in the second quarter. Its worth noting, that this quarters net outflows were lowest for a second quarter since 2010. Now let's look at investment performance, beginning with fixed income on Slide 5. In many respects, fixed income investors reacted to the events in China and Greece and talk of rising US rates, in much the same way they did during the volatility taper tantrum, in May of 2013. That affected our flows and performance during that quarter. Yet from a longer term, we either maintained or improved our very strong track records. At quarter end, our percentage of assets and out performing services were 87% for the one year period, 90% for the three year, 94% for the five year. Top quartile performance for the three and five year periods, include U.S. High Yield and European High Yield. We gained even more ground in equity investment performance across time periods during the quarter. Now I am on slide six. At quarter end 87% of our qualifying equity assets were an out performing services for the one period, 85% for the three year, and 66% for the five year. That compares with 63%, 52%and 42% respectively one year ago. Improvement has been both absolute and relative to peers and spread among our long standing and newer services. Today, 20 of our equity services are ranked top cortile for the three period, compared to 9 at this time last year and more than half them a 11 services are ranked top decile up from just 2 last year. As we've maintained, build, restored our track records across a broad set of equity and fixed income services, we've seen the positive effects in the diversity of our pipeline and gross sales and the strength of our relationships with clients and with consultants. That’s clear from our institutional channel highlights which are on slide 7. Starting with the chart top left, even after the large CRS funding we finished the quarter with a robust $5.3 billion pipeline, significant adds, include emerging market debt U.S. High Yield, U.S. Investment Grade debt and U.S. and global concentrated growth equities. That’s the table at the bottom left. In terms of gross sales, we've seen recent success with Canadian fixed income, our Real Estate Fund II and of course CRS. These services drove sequential and year-on-year gross sales increases in multi assets and alternative products. Our overall RFP activity is also higher year-to-date which bodes well for future sales. We've seen year-to-date increases in equity and multi asset RFPs with particular strength in areas like emerging, concentrated and global core equities and retirement space. And consultant advocacy is also the strongest its been years in North America one, 10 different consulting firms have included us in 34 searches for 19 different products so far in the first half of 2015. And leading global consultants have recently awarded their highest ratings to our global core, emerging consumer and next 50 frontier equity strategies and by ratings to global concentrated growth and commercial real estate debt. We've demonstrated consultants and clients that we've earned more at best and we're getting them. Now, let's look at the activity in our retail channel during the quarter. And I am on Slide 8. As you can see from the left hand side of this slide, industry wide mutual fund flows and those trends have been challenged so far this year in our two largest markets, the US and Asia, ex-Japan. In the US, total industry active equity mutual fund flows reversed from positive $47 billion in the first half of 2014 to negative $30 billion so far in 2015. After a strong first quarter bond fund flows plunged in the second quarter most notably in June when the industry sustained a $11 billion in net outflows. As a result, year-to-date industrywide bond fund flows of $32 billion are down $20 billion or more than 38% for the 2014s first half. In the Asia, ex-Japan region bond fund sales, global high yield in particular have fallen sharply in both absolute terms and as a percentage of total industrywide sales. As equity fund sales have grown, you can see that in the chart at the bottom left. Bond fund sales which peaked at more than two thirds of the total industry sales in 2012, climbed from 35% of total sales in 2104 to 26 for '15 through that. We don’t have June data, but I imagine that share is even lower now. And within that category global high yield is dropped from a peak of 20% to 15 in '13 and '14 and to just 8% on the total so far this year. The same time, industry wide equity funds have been gaining momentum in the region accounting for 60% of total industry sales so far this year, double the share for 2012. We have been seeing sales from [indiscernible] scenarios, the local launch of our global high yield fund in Taiwan raised $200 million during the quarter, pushing our total onshore Taiwan AUM pass the $3 billion mark. In equities Japan has been a bring spot for us in Asia, three of our equity funds, US Large Cap growth, Global Core, Concentrated US growth our top five sellers there year-to-date. So although we still have the ways to go, we're making progress in capturing some of the regional flows that are shifting to equities. And while our overall retail gross sales have been muted our gross redemptions and redemption rate have declined, that’s a chart at top right. So like many others in the industry today are challenges with sales, not with redemptions. We're capturing new client’s inflows in private wealth management as well, now I am on slide 9. Three years we focused on two things in this business, improving the investment performance of our fully integrated offering, particularly in equities and introducing creative and relevant new services that attract a broader audience. US strategic equities featured at the top left of this chart is a perfect example of innovating to improve investment performance. This three year old multi style or cap service which is designed to seek reliable returns in any market has outperformed for the year-to-date one year and three year periods, it ranks top decile for year-to-date and one year and top third for three year. Dynamic asset allocations or DAA are risk management tool designed to smooth ride for clients portfolios, while preserving returns it just celebrated its fifth anniversary in the second quarter. In that time, DAA is been able to reduce volatility and client portfolios with conservative, moderate or more aggressive risk profiles by anywhere from 5% to 6% with absolutely no impact on returns. That’s particularly reassuring to our clients in any environment and including the current one. Our suite of targeted services represents another way we're aiming to anticipate and meet the evolving needs of our private clients. Together these services have gathered more then $2.6 billion in committed capital of which $880 million are as yet unfunded. And our asset gathering momentum is increasing. The four targeted services we've introduced since the beginning of 2014 account for half the total and just 36% of these commitments have been called. These new offerings have made us more relevant to a broader slot of the wealth management market than ever before. So far this year, we've seen a 23% increase in new private wealth client relationships compared to the first half of 2014 and one in five of these new relationships come to a targeted services dialogue. Relationships with targeted services clients have increased 70% year-to-date compared to last years first half. Our success with building and strengthening client relations is coming through in our advisory productivity as well, which up 15% among principals and pre-principals. As periods high momentum is strong in this business and it’s really great to see. A wrap of business highlights with Bernstein Research Services on Slide 10. Revenues for the quarter were up 3% for the second quarter of 2014, but down 3% from this years first quarter. You can see from the chart at the bottom left the trading volumes were flat to down both sequentially and year-on-year in both the US and Europe, while sequential growth in Asia was still very strong at 34% it was about half to 67% year-on-year increase. Between muted trading volumes and pricing pressure in the US, regulatory development regarding payment for research and unbundling in Europe and fierce competition for talent in Asia, differentiated research is more important than ever these days in winning and retaining institutional clients around the world. And this is where Bernstein Research has always excelled. Each year a well known independent research firm surveys portfolio managers to rank research providers and in 2015 results for the US and Europe are in. Once again, Bernstein Research took the top spot in highest quality US equity research product, greatest knowledge of companies and industries and quality of analyst service in each case for 12 years or more. We also ranked number one in greatest knowledge of companies and industries in Europe for the fifth consecutive year for every year we've been included in the survey. Across sectors and markets clients choose Bernstein Research first for our unique insights and unviable industry perspectives. That’s more than differentiated, it’s outstanding. As always, I'll close with a recap of the progress we're making on our long-term strategy to deliver for our clients. That’s on slide 11. In the second quarter we not only maintained our long-term investment performance premiums at fixed income during extremely volatile times. We significantly improved upon our equity track records. That’s helping us build attraction with different clients and consultants all over the world. At quarter end our diverse $5.3 billion pipeline at a higher fee rate than our two year average. Innovative newer offerings with higher fees are exceeding our expectations like real estate fund II, which closed during the quarter with total commitments of $1.2 billion, sooner than anticipated and at a target. And finally, we keep making progress with our financials. AB again achieved year-on-year growth in adjusted revenues, operating income and operating margin in the second quarter and an incremental margin of nearly 50%. There is no doubt the operating environment became more challenging in the second quarter and that continues so far in the third. But that just makes the accomplishment of the talented committed relentless folks here at AB that much more impressive, could be proud of the people here and work they are all doing each day to keep our clients and of tomorrow. Now, I'll turn it over to John for discussion of the quarter’s financials.

[John Weisenseel:]

Thanks you, Peter. As always our remarks today will focus primarily on our adjusted results. You can find our standard GAAP reporting, as well as the reconciliation of GAAP to adjusted results in this presentation appendix, our press release and our 10-Q. Let's start with the highlights on Slide 13. By every measure, our adjusted second quarter results improved meaningfully versus the same prior year period. Second quarter revenues of $657 million were up 4%. Operating income of $158 million was up 10%. Our margin increased $110 basis points to 24.1% and we earned and we’ll distribute to our unitholders $0.48 per unit compared to last year's second quarter adjusted EPU of $0.45. In addition, our revenue and operating income both increased 4% from this years first quarter. I’ll get into these in more detail as I note the key items from our adjusted income statement on Slide 14. I'll start with the talk with base fees which increased 5% year-on-year and 2% sequentially as a result of higher average AUM across all three of our distribution channels, institutional, retail and private wealth. Performance fees of $14 million were down from $20 million in the second quarter of 2014, this included $7 million related a liquidation in that quarter of the AB recovery assets or ABRA fund. The current quarters performance fees included $8 million on our Luxembourg registered Select Absolute Alpha fund. We recognize performance fees on services as revenues at the conclusion of their calculation periods and its equity launched shot fund has an annual calculation period ending in May. Bernstein Research service revenues were up 3% versus the second quarter of 2014 as a result of higher client activity in both the U.S. and Asia which offset declines in Europe and declined 3% sequentially due to lower activity in the U.S. and Europe. Investment gains of $5 million compared to losses of $3 million in the second quarter of 2014 and nothing in the first quarter this year. Included in these numbers were seed capital gains in the current quarter compared to losses in the prior year’s quarter and lower gains in the first quarter this year. As a reminder, investment gains and losses includes seed investments, our 10% interest in venture capital fund and our broker dealer investments. We had $498 million in seed capital investments at quarter end, the majority of which is hedged. Seed decreased $13 million from the first quarter as seed capital returns exceeded new fundings. Finally, total net revenues were up year-on-year and sequentially as a result of higher base fees from the higher average AUM I mentioned earlier. Moving to adjusted expenses, I’ll begin with compensation and benefits. As you know, we accrue total compensation, excluding other employment cost such as recruitment and training as a percentage of adjusted revenues. In the second quarter of this year, we accrued compensation of 50% ratio inline with the same prior year quarter and the first quarter this year. Total compensation and benefits expense increased both year-on-year and sequentially largely inline with the increase in our net revenues. Second quarter promotion and servicing expenses increased slightly year-on-year. The 11% sequential increase is due higher marketing cost and seasonal T&E. The higher marketing spend is attributed to our semi annual strategic decisions conference hosted by Bernstein Research, annual buy side Asia Investment Forum and higher marketing campaigns spend for our US and Asia retail businesses. In Asia we launched campaigns for our Asia ex-Japan and emerging markets both the asset strategies, as well as our successful onshore global high yield fund launch in Taiwan. G&A expenses decreased 2% versus the second quarter of 2014, as a result of lower professional fees and occupancy expenses which offset higher technology expenses. G&A was essentially flat for the first quarter. All-in-all, our total operating expenses of $499 million increased 3% year-on-year and 4% sequentially. Operating income of $158 million for the quarter was up 10% from the prior year, and 4% from the first quarter as revenue growth outpaced expense growth. Our operating margin of 24.1% for the quarter was up 110 basis points from the second quarter of 2014, reflecting the operating leverage we achieved in our business and a 49% incremental margin we produced. Our year-to-date incremental margin is 51%. Finally, the second quarter effective tax rate of 5.6% for AllianceBernstein L.P. compares with 4.9% in the second quarter 2014 and 6.8% in the first quarter this year and reflects the adjustment of our year-to-date tax provision for our anticipated current full year 2015 effective tax rate range.. These points are all highlighted on the next slide of this presentation as well. And with that, Peter, Jim and I are pleased to answer your questions.

[Operator:]

[Operator Instructions] Your first question is from Bill Katz with Citi. Your line is open.

[Bill Katz:]

Okay, excuse me. Thank you. And good morning and appreciate you taking my questions. Announced in the press release that headcount looks like it rose pretty meaningfully sequentially. Can you talk a little bit about where you are hiring and what the implications might be for margins?

[Peter Kraus:]

Yes. The increase sequentially is largely due to college hires that we have that start in June, and almost, the overwhelming majority of the headcount increases is just what would you expect from seasonal hiring.

[John Weisenseel:]

Bill, this is John. I would just add too, in the first quarter we were basically flat as far as the headcount.

[Bill Katz:]

Are these – just a follow up to that, are these transitioned temporary employees or are these full time employees?

[Peter Kraus:]

No, these are full time junior people that we have coming off of campus. They are really spread across our entire business and its type of thing that you see this time a year.

[Bill Katz:]

Okay. And my follow up question is a two parter. So I apologize that you mentioned that but. On the institutional side, could you talk little bit about what drove determinations and then more broadly what you're seeing in terms of appetite. And then I think on your summary slide which you didn’t cover you mentioned a few more retail funds will gain sort of a two year time line – anniversary, excuse me, by the end of this year? What kind of sales are beginning to spin on that as well?

[Peter Kraus:]

Well, let me talk about both of those things. On the institutional terms, this quarter we said we had some large lumpy redemptions in June, which we don’t expect are reoccurring. Of course, we could have another large redemption, but that’s as you say unusual and not an expected event. Most of the – if you look at the actual redemptions, in gross redemptions in institutions what you find is the large percentage of them I think two thirds is really rebalancing. And so that’s more of what's going on inside of a clients portfolio and it reflects to some extent equity out performance and it reflects to some extent, they are persisting rebalancing away from that as those assets outperformed. In terms of what we expect going forward, we mentioned the significant increase in RFP activity and consultant support and that makes us feel confident over time about being able to win more in the institutional space across a broader set of services. If you take a look at the performance, in particular in equities, it’s just nothing to argue with. In fact, there is a lot to be celebratory about, not only is the relative performance terrific, but the competitive performance is also terrific. So if in fact performance, biggest assets, if in fact that occurs, I think we're in a pretty good spot. With regards to retail, we're fighting like everybody else, some reasonably significant negative retail trends in the active equity space, particularly in the US. In international, the flow trends have been more positive, but that’s a place we have the shortest or the smallest line up of strong funds. So in global, in US where we have the most strength that’s where the flows have been challenging in the United States, but in Asia they have been positive for us. So I think we don’t know what's going to happen in the United States. We don’t know where that trend goes. But certainly if the Asian trend continues that we'll bode reasonably well for retail.

[John Weisenseel:]

Bill, and in terms of the two specific redemptions that we talked about, one was a transitional situation where we knew it was transitional. We knew the client was going eventually bring that money in house and they did. And the second was driven by a decision on the part of client to reallocate their asset allocation and in fact we were awarded, a mandate in another asset class. So which hasn’t funded yet, which is not yet funded.

[Bill Katz:]

Okay. Thank you very much.

[Operator:]

Your next question is from Michael Kim with Sandler O'Neill. Your line is open.

[Michael Kim:]

Hey, guys. Good morning. First, maybe just a follow up on the performance, on the equity side, if I look at the slide in the appendix that shows the performance versus benchmarks, just more strategies are out performing across all time period. So I know you highlighted the pick up in searches more recently, but can you just sort of maybe contrast that tailwind with some of the headwinds that you continue to face around rebalancing like you mentioned earlier and or the shift to passive. So just trying to get a sense or prospects in terms of those was two dynamics?

[Peter Kraus:]

So I think there is three things to consider, you mentioned two of them. There is persistent rebalancing, i.e., large institutions are not increasing their risk. They are rebalancing their risk positions to be consistent. Two is there is move from active to passive which is pretty clear in the numbers in the second quarter. And there is a regency of our strong performance, meaning in the last quarter performance really turned up and it didn’t just turn up in one year, its really affected the one, three, five and in some cases 10 year numbers. So there is some regency to the strength of the numbers in the US equities space and in the global equity space. That regency has to play through the process of consults recommending us RFPs happening, institutions making decisions and even in the retail space a financial advisor is becoming aware of the services of the large Weyerhaeuser and/or RIAs creating recommended list, putting us in portfolios or in model portfolios. And some of those things are happening as we reported, and that’s all pretty recent. So I think the headwind against all of that is of course what happens in the active equity channel. And for example we have a lot of very strong services in US active equity and US active equity flows this quarter were negative $46 billion. So if we became positive $46 billion, which I am not predicting, but if it did, that would be a really big deal for us. But negative $46 billion is obviously challenging to grow assets in that environment. Does that give you little more?

[Michael Kim:]

Yes. That’s helpful. I appreciate the color there. And then just as a follow up, maybe a question for John. Just wondering how your are thinking about the trajectory for expense growth, particularly assuming that the broader markets remain more volatile, just curious where they might be some flexibility to maybe dial back on some discretionary spending?

[John Weisenseel:]

Sure. I think if you look at our non-comp expense to start with on both the promotion servicing side and the G&A, we've been in very tight type ranges and you saw a bit of a sequential pop up in promotion servicing this quarter, but again its just really seasonal, seasonal item. So I think as far as what we'd expect going forward from both, promotion servicing and G&A is to just kind of stay in the ranges that we've been in. We're not – we've basically taken a fine line as far as cuts, so I wouldn’t expect anymore there, it’s just we're in a containment type of mode. As well as, as we add more assets and produce more revenues we don’t need to add to those expense lines going forward. So we'll see that leverage, as we way year-over-year with the 49% incremental margin, those non-comp expenses were fairly flat and the revenue went up and most of it tolerate to the bottom line.

[Jim Gingrich:]

So, Michael, Andrea pointed to me that I gave you a bad industry number, I said minus $46 billion for US active equity, it’s actually minus $82 billion. I would have taken minus 46 outer and better.

[Peter Kraus:]

The only thing I would add to John's comments, on the – because as he indicated we're obviously trying to keep a tight range on non-compensation expenses. In terms of the business more broadly, we're not running at quarter-to-quarter, we've made strategic decisions about where we want to invest. I think we've indicated that our expectation would be that if we can drive growth in those investments, deliver what we expect them to deliver we will also see operating leverage in the compensation line over time. But we've also made commitments and those – our commitments to those strategies is not going to fluctuate from quarter-to-quarter.

[Michael Kim:]

Got it. Thanks for taking my questions.

[Operator:]

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

[Michael Carrier:]

Thanks, guys. Just on the Asia ex-Japan market, you gave some good stats there, just in terms of some shifting trends. I just wanted to get an update, from you guys just in terms of how you're positioned. Obviously the equity performance improving and it should help just given the trends that you're seeing. I just wanted to get some sense in terms of products, where you're seeing the sales. And on the redemption side, it doesn’t seem like that’s been a big issue, but just wanted to get an update on that region, just given the trends that highlighted?

[John Weisenseel:]

So I think broadly we've been saying in that region for last nine months or so, that there is been a shift away from the bond funds, given the concern about rising rates. And in some instances what's more concerned about credit, to multi assets and services and equities. And that trend might basically continue. The thing that’s kind of interesting is the percentage to which the bond funds and the uncertainty [Technical Difficulty] is resolved around rising rates, it certainly seems as their 30 percentages will grow. I am not suggesting they are going to back to their high point, but they are just unstable at the level that they are at. So I would predict which is of course a bad thing to do, but I would predict that there would be some balance inflows going forward that bond flows will probably grow at the expense of this equity multi asset space. And where in equities money goes, I think we probably continue to see a trend balance between multi assets and global equities and maybe a little bit in US and if that sort of depends upon how those markets – those specific markets behave going forward.

[Michael Carrier:]

Okay. That’s helpful. And then just a follow up, John just on – I guess two points that you just highlighted. I think it’s like the second quarter now in a row where you're seeing that roughly 50% incremental margin, so just wanted to get a sense on your comfort in that type of incremental operating leverage? And then the headcount you guys mentioned there was some seasonality there, just wanted to get an update on how you're thinking about just the share creep and whether that’s new hires or just annual grants versus the level buybacks and I know over time you guys try to manage that. But just given that the buybacks were tick down this quarter?

[John Weisenseel:]

Sure. So I'll start with the first one, Michael, as far as the operating leverage, again, if revenues continue to increase, AUM continues to increase, aspirationally I think the 49%, 50% incremental margin would be our objectives. Obviously though we need the help on the revenue side because as I mentioned earlier to Michael, as far as the non-comp expenses, there is really no further cutting to be done there. We're pretty much in a containment mode and don’t need to add to those expense as revenues increase. As far as the second item is, as far as the headcount, again, these were kind of I think what you saw here was pretty much a seasonal add, a lot with the younger new hires, don’t really expect that to have any material type of effect, as far as our share based compensation. And so over the longer haul as we've said before our objective is to actually buyback shares to offset some of the equity that were giving out in share based compensation. We've been fairly quite I'd say at the last year or two compared to where we've been previously, and that’s because if we go back and you look at the period 2000 to 2014 we were very, very aggressive there in terms of buying back. I think we bought back more than 7.5 million shares in the open market that we actually issued in share based comp and we were able to do it at very, very low market prices, if you remember the stock back in 2012 it was down $14.11 a share. So we have pre-funded a lot of the share based comp, but over time you'll see us go into the market and on a opportunistic basis and continue to work towards offsetting some of the grants that we do in the future.

[Michael Carrier:]

Okay. Thanks a lot.

[Operator:]

Your next question is from Ryan Sullivan with Credit Suisse. Your line is open.

[Ryan Sullivan:]

Great. Thanks a lot. Good morning and congrats on the positive flows guys. Can you just give us little color on the conversations you're having with institutional investors regarding issue of rising rates? And how you guys are thinking about this in the context of the $146 billion in fixed income assets in channel? Thanks.

[John Weisenseel:]

Sure, Ryan. So clearly not just institutions, but retail, home offices are concerned about rising rates. What we said to people in those conversations is well, let's look at the evidence of what happens when rates rise. First of all usually when rates are rising, rates can rise precipitously but if they rise, I won't say gradually, but persistently overt time yes, you do in fact loose some capital gains because your existing assets that don’t convert to cash are at lower yields than the market yield. But fixed income portfolios actually generate a lot of cash and you reinvest at a higher yield along that time period. And over time even a rising yield environment fixed income actually produces a reasonable return. There is also a number of studies in the high yield market that suggest that over time, again, over time 7, 10, 15 years high yield returns are actually pretty addict to falling rates and flat rates. So I think what we're engaged in right now is uncertainty about the impact of rising rates given how low they are, uncertainty about the timing of rates actually moving and uncertainty about the speed at which they will move. And that’s a little bit unusual in a tightening cycle, given where we're starting from. And so I think it’s starting from position, and the length of time at which been it basically zero rates, its having a affect on peoples concerns about what will happen in the market place. Having said that, I think investors are figuring out how to position their portfolios for that market place for that opportunity and they are more than likely willing to continue invest as rates rise, but probably that doesn’t happen. And so, the moment that rates actually start to move.

[Ryan Sullivan:]

Okay. Great. And then just to go back to the discussion of institutional interest in the equity strategies and I know their performance is driving a lot of the interest right now and it’s a big tailwind for you guys. But how often is active share coming up in the discussions here, I mean, based on recent conversations is it as important as the improving performance trends in the community?

[John Weisenseel:]

Well, we would certainly like active share to come up all the time because we have a very large portfolio of managers that have higher active share portfolios, and we believe that that is the right way to think about active equity. In fact, we recently put something out that says exactly that, that in fact, you have to think not just about performance, but you have think about capacity of the manager and the constraints on capacity and you have to think about how conviction is expressed in the portfolio and higher the conviction, the better the capacity constraints, the more persistent the out performance can be. So we actually engender those conversations for the institutions and for sure institutions are beginning to have that discussion as well. You also see it in the retail channel. Now the margin, could the great stock of investments or great stock of dollars are invested with many, many managers, many large cap managers that don’t have that high active share and aren’t that capacity constraint. And so there has to be a shift over time, and of course a lot of money is to move to passive, which in a way has no active share. And it’s simply one manager, and that feels like that’s a challenging place to be.

[Ryan Sullivan:]

Great. Thanks a lot.

[Operator:]

Your next question is from Greggory Warren with Morningstar. Your line is open.

[Greggory Warren:]

Yes. Thanks for taking my question guys. And when we think about where sales are on the fixed income side, I'm just kind of wondering, the Fed's been out there saying they're likely to raise rates this year before the end of the year. The impetus is probably greater because next year's an election year, and generally the Fed doesn't like to get in the middle of an election year cycle. But there's definitely some concerns on the other side between the Greek debt crisis and then concerns about China slowing from a growth perspective. And you just have to wonder, are institutional investors looking at the scenario and saying, well, in second quarter 2012, when the Fed started talking up rising interest rates, we all shifted our focus, we pulled money out, we reallocated. Is it just a concern that maybe there's some fatigue there. They're concerned about if is the fed really going to do this, and if we move, are we making the wrong move, or we're going to be negatively correlated to US interest rates for another couple of years and nothing really moving.

[John Weisenseel:]

I think you're getting at the point I was trying to make, which is, in this cycle I think there is less willingness from the part of the investors to predict what the Feds move will be and more money will move when the Fed actually makes a decision.

[Greggory Warren:]

Right, right. We've always kind of taken the point that when we went through that cycle in 2012, a lot of investors, especially in the institutional side, made bigger adjustments to make their portfolios pretty much neutral to rising rates, or to take advantage of rising rates and it didn't really materialize. But we're just wondering, as we move forward here, do you think it's just going to be a bigger headwind, then, as long as there's uncertainty as far as sales go?

[John Weisenseel:]

Yes. It certainly appears to us that the lower sales and the lower percentage of sales in retail, institution is different, but certainly in retail is affected by this uncertainty of when rates will actually move and what the Fed will do. The institutional market place I think is much longer term, and much more persistent about their exposure to – their exposure to fixed income generally. But I am sure even in that space incremental dollars are being held back until there is clarity around that.

[Greggory Warren:]

Okay. And then just real quick, then. If you look at, say, what Black Rock's had over the last couple quarters here, especially on the ETF side, do you think people are just parking capital in ETFs because there's more liquidity there and it's just a quicker place to put it, as opposed to making a longer-term commitments to mandates?

[John Weisenseel:]

Well, Greg, I don’t know, I think that a valid speculation. We don’t know until we ask the people and we obviously can't ask them.

[Greggory Warren:]

Right.

[John Weisenseel:]

I do think that this whole – the whole movement to passive, whether it’s an ETF or a mutual fund is a large question that hangs over the investment landscape right now. And its so far has been compelling, because beta has been attractive and you haven’t given up much in a way of Alfa, and if you were up 15% a year, whether you were up 17% I mean, not have mattered, in a market that’s up less than3%, if you are up 5% it would matter. So investors are going to have to decide whether they want to hold passive portfolios in place of some money that would be an active management and I think that rational person is going to look to see if there are managers that are performing, that are persistent and what the characteristics of this managers are and that money is going to move.

[Greggory Warren:]

Okay. Well, thanks for the color guys.

[Operator:]

Your next question is from Alex Blostein with Goldman Sachs. Your line is open.

[Alex Blostein:]

Great. Thanks. Good morning, everyone. Peter question for you since you mentioned unbundling, just curious to hear where are those conversations, what kind of the timing the latest degrees you guys are hearing from the regulators. And what are the chances do you think that that might spill into US?

[Peter Kraus:]

I think there is no chance that it will from a regulatory point of views go into the US. I don’t think the US was going to change its regulations. Practically speaking however, a behavior of buy side firms will be different, some may choose to be consistent across the globe, some may not. So we'll have to wait and see what that brings. In the European theater right now, whether the regulations – first of all the regulations are not finalized as you know, where they are come out, I don’t have any greater insights then we did on the last call which our best information is that there is going to requirements of to unbundled, but research can be paid for, its just going to have to be paid for with a check as opposed to commissions and we already know that.

[Alex Blostein:]

Got it. And just a follow up I guess on fixed income, I guess. When you take a step back, you guys obviously had tremendous success in that area for the last couple years. When you think through the type of clients that are in these strategies today -- and I know it's hard to generalize. But when we think about the stickiness of these assets, what would you is the number one concern for potential pickup in redemptions? Would it be the level of interest rates? Would it be widening credit spreads? Just kind of thinking through the type of client base that you guys have accumulated over the last couple of years.

[Peter Kraus:]

I mean, I think if we really underperformed, that’s going to affect redemptions. I think if we continue our performance we're not going to see an increase in redemptions. What we're seeing is a lack of sales. And I think that’s the major issues. It’s really – its sales actively, its not redemptions.

[Alex Blostein:]

Right. Understood. Great, thanks so much.

[Operator:]

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

[Robert Lee:]

Great. And thanks for taking my questions. I had a question on private client. In the slide, you mentioned that I guess it looked like a 23% increase in I guess clients year over year. I'm just kind of curious, is there, in your experience, is there a lag between when you start growing your client base and then assets follow? Or is that kind of already -- does that increase in the number of relationships already being reflected in the sales levels in private client?

[Peter Kraus:]

There is definitely a lag Robert. We talked a little bit about headcount, part of the increase in headcount at least over the last few years has been a clear attempt to grow the private client, financial advisory number and it usually takes three, maybe four years for a financial advisor to become productive at a attractive level, both to the advisor and to the firm. And of course there is always a failure rate, included in that process. So we're beginning to see productive advisors come online and that’s whey we're seeing more advance and that’s why we're seeing more success and that’s why the business is growing in terms of its diversity. Still that out run is redemptions, which are persistent because people spend money. Although the redemption of clients, the termination of clients is at a low level and has been at low level now for last 18 months to 2 years. So we expected in the next 2 years we're going to see a significant change, positive change in the business because of performance, proper product, adding financial advisors, those advisors are becoming productive and just our persistency of being able to convince people to become part of our world. And the fact that redemption activity has been low historically, relative to history. So the dynamics look good, but it takes time for that to actually play out and that time is usually measured not quarters but years.

[Robert Lee:]

As a follow up, is there usually little seasonality in redemptions and private clients around Q2, I don’t if it’s maybe driven by tax season or something, is that kind of normal?

[Peter Kraus:]

Yes. And as we said, we had a very low redemption level this quarter which included April, just everybody's favorable month for cash outflows.

[Robert Lee:]

And maybe just one last question, sticking with private client, I mean, just your thoughts on I mean, it hasn’t past yet or didn’t put in place yet. But do you anticipate if the DOL rule kind of went into effect as currently proposed, that would have much impact on your private client business?

[Peter Kraus:]

I don’t think it will have an impact on the asset gathering business. We have some of our assets that are in retirement accounts that would be affected. It’s hard to predict what that impact would be, but it doesn’t look like it’s significant.

[Robert Lee:]

Okay. Great. Thanks for taking my questions this morning.

[Operator:]

[Operator Instructions] Your next question is from Surinder Thind with Jefferies. Your line is open.

[Surinder Thind:]

Hi. Good morning, gentlemen. Just wanted to touch base on kind of liquidity in the fixed income markets, a lot continues to be written about it in dealer inventories. Just any evolving thoughts that you might have or perhaps where they might be misunderstanding. It seems like their opposing views are emerging on that topic?

[Peter Kraus:]

I don’t think we've shifted our view. I think we still feel liquidity is constraint in the fixed income market. We are continued to be concerned and vigilant, I guess best way to say this vigilant about liquidity, available liquidity in the portfolios to service potential redemptions that could come as rates rise and investors react. So and I still think that if you look at the price behavior of ETS in the high yield space or some of the specialized credit spaces, it certainly looks as if there is not a lot of liquidity in trying to meet redemptions in those spaces and price action in the cash world also looks as if there is no increase in liquidity in that space. So I am not sure what the opposing point of view is, because I can't really see an argument that, oh no, we're really all wrong, there is a lot more liquidity in the fixed income markets than we think. I think there is no evidence to that effect.

[Surinder Thind:]

Okay. Fair enough. That’s helpful. That’s it from me.

[Operator:]

Your next question is from Bill Katz with Citi. Your line is open.

[Bill Katz:]

Yes. Just to follow ups. I was wondering if you comment on any development you might be having with the initiative in your time of business with Morningstar. And then separately it seems like a lot of debate this morning is on how volumes are going to hold up here, given the uncertainty about rates. What's your appetite to give up a little bit margin for growth along those lines?

[Peter Kraus:]

So on the Morningstar question we're continuing to have accelerating momentum in the Morningstar target date product. I think when we first talked about it, we had zero assets, we don’t have assets. We have success. There are numerous clients that are talking to us. We've had from the outset a lot of interest in it, as a unique service and differentiating service, that continues. Certainly the DOL resolution will impact the speed at which it grows, either it will continue its current speed or accelerate, I don’t think it decelerates on anything that comes out of the DOL. So for right now, we still feel pretty good and excited about what we've got there. Performance in that product actually ticked up a bit this quarter as well, I think its relative performance was in the top cortile and some cases top decile for the quarter. So performance is adequate. The product is pretty attractive to people who are looking at it and we're having success converting people. So give me your rising rate question again, I am not sure I got it.

[Bill Katz:]

Well, as I listen to the Q&A this morning, I think the concern is that rising rates is in and of itself bad for AB. So I am sort of curios while I view that, I am curious you have very strong incremental margin goals, will you be willing to give up some of that incremental margin to be maybe accelerate the marketing spend to capitalize in some good underlying underperformance? And then it would drive more volume.

[Peter Kraus:]

Yes. Fair play. And I know understand. I do think that the stock price seems to have been affected by announcements of competitors about their flow of funds in the emerging market debt space and in the Asian debt space, as well as just industry data that we've mentioned. I think that as opposed to 2012, the impact on AB in this ground has been less, not positive, still negative, but it’s been less, and it’s been less pronounced. As to whether we'd spend money on marketing, I don’t think we're thinking about sacrificing our margins, but we're also not thinking about being parsimonious, it’s spending marketing dollars against very successful strategies. I think we have ramped that up. We are ready, we're very focused on it and if that resulted in some incremental margin reduction we wouldn’t stop spending the money. But we didn’t say, well let's comprise the margin and spend more money, we didn’t have that exclusive discussion, we just said we've got a number of services here that are attractive, they are attractive now, they are competitive around the world, let's put effort behind that and make it work.

[John Weisenseel:]

And Bill, this is John. Just to add to Peter's comment, this quarter we had very successful onshore launch in Taiwan of our global high yield product and we set marketing dollars to market that. And that’s reflected in the quarter’s numbers and it’s also reflected in the year-over-year incremental margin of 49%. So back to Peter's point, where we see the return on investment we'll spend the dollars.

[Peter Kraus:]

Yes. And that’s a good point John, and that goes directly to your point in rising rate question, because we did that in the debt world and in Asia.

[Bill Katz:]

Okay. Can I ask one more, while I have you guys. Thanks for your patience. In private client you mentioned this is sort of best second quarter you've about half a decade. Is there a way to frame out how much you think you lost in terms of seasonal tax-related attrition to look at maybe the core trend underneath that, if that's possible? I'm curious, would you have been positive in the quarter absent that? Because we are seeing some very good growth so some of the other asset gatherers, like a Raymond James or Schwab, et cetera. So I'm curious if you're starting to participate in that more broadly.

[Peter Kraus:]

Bill, I don’t think that that – that we have visibility into what is driving a particular clients with withdrawal, we just know that in the quarter that is something that we inevitably have to deal with and the numbers kind of speak for themselves. So in terms of what this quarter was versus a recent history.

[John Weisenseel:]

Got it. I think just to step back a bit, what happens in any quarter in the private client businesses, they are both terminations and cash flow, and the taxes issue is a cash flow issue its not termination issue, so the point on terminating account to pay their taxes is taking money out. So if you exclude that of course that would have an impact on the numbers but that’s just not realistic because obviously it happens every year. I think what you're trying to get at is, is there really underlying momentum in the business and we are trying to give you some facts to share that we believe there is in activity, in new products, in performance and trying to express some degree of confidence that that’s going to continue.

[Bill Katz:]

Okay. Thanks for taking my questions today.

[Operator:]

Your next question is from Ryan Sullivan with Credit Suisse. Your line is open.

[Ryan Sullivan:]

Hey. Thanks for taking my call. I appreciate it. Just in light of the spike in market volatility since the end of June, can you just give us some initial color on how this has impacted the different businesses maybe, and maybe an indication of how flows are starting to trend Q to date. Thank you.

[John Weisenseel:]

Sure. Given you what you said about the market, we don’t really anticipate having any different impact in the retail space, retail flows we don’t have the industry numbers. But it looks like industry numbers would follow reasonably consistently with they have been, it could trend differently, but that – given your comment about markets that so what we would expect. Institutionally, as we said that the June had some very lumpy things in it which we don’t expect to continue and we'll see how the institutional market plays out. We will release numbers in two weeks.

[Ryan Sullivan:]

Thanks a lot.

[Operator:]

I am showing no further questions at this time. We’ll turn the call back over to Ms. Prochniak for closing remarks.

[Andrea Prochniak:]

Thanks everyone for participating in our conference call this morning. Investor Relations is available for the rest of the day if you have any follow up. Thanks so much.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.