Manning & Napier, Inc.
Q3 2017 Earnings Call Transcript

Published: 2 Nov 2017

[Operator:]

Good evening. My name is Jacob and I will be your conference operator today. At this time, I would like to welcome everyone to the Manning & Napier Third Quarter 2017 Earnings Teleconference. Our hosts for today’s call are Scott Williams, Director of Financial Reporting; Richard Yates, Chief Legal Officer; and Paul Battaglia, Vice President of Finance. Today’s call is being recorded and will be available for replay beginning at 8

[Scott Williams:]

Thank you, Jacob. And thank you, everyone, for joining us today to discuss Manning & Napier’s third quarter 2017 results. Before we begin, I would like to remind everyone that certain statements made during this call not based on historical facts, including any statements relating to financial guidance, maybe deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Because these forward-looking statements involve known and unknown risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements. Manning & Napier assumes no obligation or responsibility to update any forward-looking statement. During this call, some comments may include references to non-GAAP financial measures. Full-GAAP reconciliations can be found in our earnings release and related SEC filings. With that, allow me to introduce our, Chief Legal Officer, Richard Yates. Richard?

[Richard Yates:]

Thank you, Scott. Good afternoon and thank you all for joining us. For today's call, I'll provide a business update for the third quarter before turning the call over to Paul, who'll provide details on our flows and financials, after which we'll open up the call for your questions. The current bull market continued during the third quarter despite a tumultuous political landscape and natural disasters dominating the news cycle. The stock market continues to set all-time highs, volatility remains at historic lows, and interest rates remain low despite two rate increases from the Fed earlier this year and a potential third rate hike before the end of the year. Although we try not to focus too much on short-term results, we have been encouraged with the returns we have earned for our clients in 2017 in this challenging environment for active managers. In the third quarter, we maintained or extended our relative out-performance across several of our key products in part due to our portfolio positioning during the fourth quarter of 2016. At that time, we used the post election volatility as an opportunity to increase our exposure to health care, technology and other growth stocks, while other investors added cyclicals, financials or value stocks based on their expectation of the U.S. economic growth would be off to the races. Our positioning proved correct as the rotation of value sectors at the end of 2016 was driven by post election optimism regarding legislative changes in tax reform that have not yet materialized. Whereas growth sectors have significantly outperformed this year. Our clients benefited from our willingness to stick with our investment disciplines, though out of favor at the time rather than position the portfolio and stocks where our analysis concluded that the price was not supported by the underlying fundamentals. Looking at some of the specific products of focus this year, we're pleased with the strong performance of our Rainier International Discovery Fund, which we adopted on to our platform during the third quarter. International Discovery is now rated five stars by Morningstar, ranked sixth amongst its peer group year-to-date, outperforming the All-World ex-US Small-Cap Index by a 1,000 basis points year-to-date, and has a compelling risk-adjusted return characteristics. We remain optimistic about the products distribution opportunities, particularly in the institutional adviser space, it has a strong pipeline across its vehicles. Our Disciplined Value Fund returned 4.9% during the third quarter, outperforming the Russell 1000 Value Index, the fund is outperformed by over 500 basis points year-to-date and for trailing one-year and three-year periods. Year-to-date, this fund ranks in the top decile of its peer group, which only further supports our decision this year to create a collective trust version. While we are pleased with the short-term performance and distribution opportunities for these newer products, we continue to work through longer-term performance challenges across much of our traditional products set that we've addressed previously. That said, we have an opportunity to improve our three-year performance numbers over the next several quarters by replacing periods of underperformance from the fourth quarter of 2014 and the first half of 2015 with better performance. If we are able to effectively execute our investment disciplines, some of the performance headwinds that we've experienced recently could start to ease later next year. Turning now to distribution. A recurring theme in our conversations with clients, advisers and prospects is the concern about the length of the bull market and high valuations. Simply put, clients are asking when will the bull market end and how market end and how we're preparing for this. And these conversations were able to stress the proven benefits of active management across market cycles, and in particular the importance of active investing as a risk management tool in the current environment as valuation remains elevated and the risk of investor complacency continues to exist. Starting every September, we host our annual cycle of client seminars throughout the country, giving our clients another opportunity to interact directly with our sales team, product managers, portfolio strategists and other members of the management team. Client feedback from these seminars has been very positive. Clients are pleased with our performance so far in 2017, and our active management message resonated with clients and prospects alike. Our clients have been very engaged throughout these meetings regarding their portfolio and the firm as a whole, and clients have reiterated that they appreciate the depth of our team and our commitment toward retaining our key employees. This feedback, combined with our strong short-term performance and improved returns across much of our products set, has energized our sales force in the conversations with clients and prospects, and reflects how impactful our traditional high-touch service approach is. I'll now address some of the broader initiatives we have been working on to help us gather and retain client assets. While these assets have not yet driven meaningful inflows, they represent growing areas of strategic focus and we are deploying resources accordingly. We believe that this will further expand our value-added service offerings and help maintain deep client relationships over multiple market cycles. We continue to pursue our custom solution offering, which is a consultative advisory service where we can tailor an investment portfolio among proprietary and non-proprietary investments like ETFs, to meet a client's investment objectives and cash flow needs. We've been test marketing our custom solution with our regional sales force, targeting small and mid-sized institutions or high-net-worth families. Year-to-date, we've won mandates, including our largest separate account close in 2017 across the firm. Going forward, we are focused on building out our non-proprietary capabilities to enable a fully customizable solution. As we state in our prior calls, we're restructuring fees across our fund-to-product set to be more competitive with our peer group. This effort has three components

[Paul Battaglia:]

Thanks, Richard. Good afternoon, and thank you for joining us today. I'll provide an update on our third quarter results before opening the call up to your questions. Starting with assets under management and net client cash flows. AUM decreased from $27.1 billion as of June 30 to $26.5 billion at the end of the third quarter. The 2% decrease was the result of $1.5 billion in net client outflows being partially offset by $1 billion of market appreciation. When compared to September 30, 2016, AUM decreased by $8.3 billion or 24%. As of September 30, our blended assets strategies made up 62% of our AUM or $16.4 billion. Our various U.S. and non-U. S. equity strategies represent 33% of our total assets, with the remaining 5% invested in our fixed-income products. On prior calls, we have discussed the termination notices we have received earlier this year from certain institutional relationships, which we originally estimated to represent approximately $4 billion of outflows in 2017. As an update, the majority of these outflows have now taken place and are reflected in our year-to-date results. We estimate the remaining $500 million of outflows from these relationships to be completed during the fourth quarter. Our trailing 12 month separate account retention rate currently stands at 82% and was 89% for the third quarter. Not get reflected in the September 30 results however, is the planned sale of the Rainier U.S. product set to Hennessy Advisors, which we are targeting to complete during the fourth quarter. Rainier U.S. products currently represent approximately $400 million of AUM that will transition away as part of the transaction. To wrap up AUM, with the remaining redemptions in the Hennessy transaction still to be completed, it is our expectation that AUM will again decrease during the fourth quarter, though the rate of decrease is slowing compared to prior quarters. Moving to the third quarter financial results. We reported revenue of $48.8 million for the quarter, down 5% from revenue of $51.5 million reported last quarter. Our overall revenue margin continues to remain steady at 72 basis points for the quarter. Operating expenses were $37.1 million in the quarter and were generally flat compared to the second quarter, but down $4.5 million from the third quarter of 2016. The majority of the decrease was attributable to compensation-related costs, which has decreased in conjunction with AUM, revenue and workforce reductions. Compensation and related costs were $22.3 million for the quarter, unchanged sequentially, but down by $2.3 million compared to last year at this time. Despite the decrease, compensation as a percentage of revenue has increased to 46%. There are a couple of factors here to consider

[Operator:]

The floor is now open for questions. [Operator Instructions] Thank you. Our first question is from Robert Lee with KBW.

[Robert Lee:]

Thanks. Good afternoon. Thanks for taking my questions. Maybe to start with this – is it possible to quantify the impact of some of your product fee changes, I mean, if given what asset levels are today, what the revenue impacts would be and how we should expect that kind of phase in over the coming year?

[Paul Battaglia:]

Yes. Hi, Robert, it's Paul. I think the easiest way for me to answer the question is to, sort of, put it in the context of a run rate. So the changes are going to leg in. Some of them have already taken place and there are still some more slated for the first quarter of next year. When all is set and done, it will depend on the mix of – the product mix – the client mix at the time the changes occur, but we figure it could be 5 to 8 basis points on fund in collective assets from the revenue side. And then you'll have an offsetting expense reduction that will be more in the range of 3 to 5 basis points. And again, I can't narrow it down more than that right now. Just given a lot of it will depend on the mix of AUM and the level of AUM when we get into the first quarter of next year, but you'll see a revenue reduction and then a partially offsetting reduction in distribution expenses.

[Robert Lee:]

Okay.

[Paul Battaglia:]

And just to – I guess so – just to level set that I guess, we're talking about the fund in collective assets, which I think right now make up about a third of the total assets. So you want to make sure that you don't apply that to the full – the mix of business, but just on the funds in collectives.

[Robert Lee:]

Fair enough. And then just maybe as a follow-up, I think you kind of touched on this a little bit. With some of the products you're seeing the better performance. Can you talk about where you – maybe up – where you feel the best potential would be to kind of leverage some of those? I think you kind of suggested maybe it's through your regional distribution in separate accounts, but do you see much opportunity in more traditional intermediary channels or is it – is that really, kind of, the main place where you'd see any, at least in near term, benefit?

[Paul Battaglia:]

So I think there's opportunities on both sides. I think Richard made some specific remarks around the Rainier Fund, which I think has some institutional and adviser appeal. Some of the other strategies that we've been focused on, Disciplined Value, Strategic Income, the actively-managed ETF, I think those kind of cross distribution channels as well. And the nice thing there is that they are available in almost all of the different vehicles that we have. We've also seen some good activity with the high-yield bond fund. Again, that's a 40-act fund, but we have a lot of different fixed income, separate account strategies as well. So I think the direct regional side has been where we've had a lot of traction during 2017. And the custom solution that we referred to was through the direct regional sales force, but I think that as we think about both channels in the different vehicles that we have the products available in, there is pipeline activity, sort of, across all the channels.

[Robert Lee:]

Great. Thanks for taking my questions.

[Operator:]

[Operator Instructions] And your last question comes from Ken Worthington with the JPMorgan.

[Jenny Ni:]

Hi. Good evening. This is Jenny Ni filling for Ken. Thanks for taking our questions. In the call you mentioned you're evaluating your seed products and strategies. I'm just wondering from which investments are the $8.9 million redemptions from? If it is okay to disclose. And it will be a great if you could provide more color on what is your strategy going forward? Thanks a lot.

[Paul Battaglia:]

Yes, thanks for your question. As we think of products seeding, this is a speculative exercise for us. A lot of it is anticipating where the market's going to go, and having products that are complementary to the skills that you already have, and to be able to leverage those skills with new products that will reach out to new clients that you may not already have. So in terms of what the portfolio looks like today and what we're thinking about in the near-term, I'd say that the Disciplined Value Strategy, it's been an interesting one for us in that there's a lot of different flavors or different varieties of that that we can use off of the same engine to be able to attract new clients. So I think in terms of where we are in the short term or in the near term, Disciplined Value, Global Equity, fixed-income products are a lot of what's in there right now. And in some of the things that I'd say we've moved away from. In some cases, you have success stories where a product has gained traction and gained scale to the point that we don't need to seed it any longer, and some of the products that we're talking about today with investors, including our managed-DTF, Strategic Income, Disciplined Value, these were all seed products a few years ago that have gone across the go-line from a distribution perspective that we're now able to go out and talk with clients about. So as we look ahead, I think – I go back to that, sort of, core philosophy of what do we do well, are there varieties that we can add to that or new strategies that we can see that leverage the skills we already have to be able to reach new clients going forward.

[Richard Yates:]

Jenny, Richard here. The only thing I'll add to it is that there's a certain cyclicality to the portfolio size. So as we ramped up a more intentional product seed strategy three, four, five years ago that we're now in the window of recycling the non-performing or underperforming and we're launching as Paul is mentioning. So I think there is a natural cadence to the portfolio size that we're seeing now in terms of some retrenchment as we retool to go back into some more R&D and other product types.

[Jenny Ni:]

Thanks a lot. Thanks for the color there.

[Operator:]

And we do have a follow-up question from the line of Robert Lee with KBW.

[Robert Lee:]

Thanks, again. I just have a simple modeling question really. Just curious what is the revenue you're generating, say, in the last quarter from non-advisory services some – for some of the other things you do? Just trying to get a sense of – from modeling perspectives, management fees versus other incomes, so to speak.

[Paul Battaglia:]

Yes, sure. So I don't have that in front of me, but I can certainly get back to you. I – we only show one line of revenue right now. It is still not a material part of the business by any stretch. So – but I can give you the details following the call, and I think that would be the easiest way to handle it.

[Robert Lee:]

Okay, thanks.

[Operator:]

Thank you. This does conclude today's conference call. Please disconnect your lines at this time, and have a wonderful day.