Manning & Napier, Inc.
Q3 2014 Earnings Call Transcript

Published: 30 Oct 2014

[Operator:]

Good morning. My name is Jackie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Manning & Napier Third Quarter 2014 Earnings Teleconference. Our hosts for today’s call are Patrick Cunningham, Chief Executive Officer; James Mikolaichik, Chief Financial Officer; and Paul Battaglia, Director of Financial. Today’s call is being recorded and will be available for replay beginning at 10

[Paul Battaglia:]

Thank you, Jackie, and thank you everyone for joining us today to discuss Manning & Napier’s third quarter 2014 results. Before we begin, I’d like to remind everyone that certain statements made during this call, which are not based on historical facts, including any statements relating to financial guidance, may be deemed to 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 statements. With that, allow me to introduce our Chief Executive Officer, Patrick Cunningham. Patrick?

[Patrick Cunningham:]

Thank you, Paul. Good morning and thank you all for joining us. As usual, I'll make some opening remarks before turning the call over to Jim Mikolaichik, our CFO. Jim will then take you through the key financial highlights and when Jim is done, we'll then open the call to Q& A. The third quarter of 2014 saw a return of volatility to the stock markets due largely to rising concerns about future global growth. We can grow our forecast and develop here and speculations about the federal reserves planned for monetary policy that to increase in uncertainty that impacted market returns. In the end, US tax managed a modest positive return for the quarter, but those returns were biased towards a small group of large capitalization stocks. For the 12 months ending September 30, the average return of an equally rated index of the largest 20 stocks in the Russell 3000 was positive 17.7%. However, the majority of companies in the index performed far worst than the small group of the largest companies. Specifically 68% of index constituents underperformed the 20 largest holdings with an average return of negative 6.7% over the period. This highlights hat returns were biased towards a small handful of larger capitalization stocks. In this type of environment the index becomes hard to beat for active managers. The life time in the markets illustrated this degree of bias was in late 2011 when over 70% of the stocks in the Russell 3000 lagged the returns of the largest constituents. Prior to that, was during the financial crisis in 2007 and 2008 and during the technology growth [ph] of 1998 and 1999 when more then 90% of the stocks in the index were laggards. In each of these periods Manning & Napier's excess returns relative to the market were either highly diminished or in fact negative. It is not surprised us to see difficult relative comparisons in these type of environments given our high active share approach which causes us to look different in the benchmark more often then not. With over 40 years of history we know that these types of environments are a requisite for strong out performance periods that ultimately drive long-term results. Regarding our lifecycle strategies, which currently account for approximately half of our total assets under management, these strategies had a difficult time our performing their benchmarks in this last quarter. However, they exhibit strong absolute and relative returns over 3, 5, 10 year and full market cycle periods through the end of September. For example, each of our targeted collective investment trusts maintain peer ratings in the top cortile of higher over the last 12 months above median for the last 5 years and in the top decile over the 10 year and market cycle time periods. Some of these strategies date back to the 1970s and represent over 25 billion of our assets with both institutional and individual clients across separate accounts, mutual funds and collective trust vehicles. Our loan opportunities funds which is our non-US equity strategy and our equity series which is our US equity strategy also trail their benchmarks in the third quarter given the overall impairment, but continue to maintain strong value added track records over the last 10 years in the current stock market cycle. Once again, the history of these strategies illustrates that short term underperformance is not uncommon and has been part of the building blocks of each strategies long-term out performance. Often these deviations in performance occurred when our perspective on current opportunities in the market differs from consensus or from the factors that are driving the markets. During the third quarter, in addition to the disadvantage of our all-cap approach and our large cap biased environment, returns were also impacted by our distinctly different opinion and positioning in the energy sector. As of September 30, our Equity Series had a 3.8% higher allocation to the energy sector than the S&P 500, while our World Opportunities Series had a 5.9% higher allocation then its benchmark. As you know, the price of oil declined roughly 20% during the third quarter of 2014 on global growth fears. All commodities were hurt, but energy was the worst performing sector in both the US and foreign [ph] markets loosing approximately 8% and 10% respectively. Our overweight is based on a different perspective with respect to the global supply of oil which we believe to be tightened in the markets consensus and our view today’s oil prices are artificially more and more global investment to boost supplies inevitable, when this occurs our holdings in this sector which are largely represented by the oil services companies that stand to benefit from capital investment should be rewarded. With our question the increase in market volatility and our relative results during the third quarter will require a higher service levels to ensure that we are providing our clients with the appropriate perspective. We are making our overviews available to them in person, on our website, and in writing in these communications our message is focused on our differentiated positioning. Also, we are using the opportunity to garner additional assets by focusing on the fact that in our past short periods of underperformance have typically been followed by periods of meaningful out performance. Before I turn the call over to Jim to talk in detail about our flows and financials, let me touch briefly on our fewer other topics. First, our new business generation remained strong. We are seeing gross in flows of more than $7 billion so far this year and that's an improvement from this time last year. In particular, we continue to see strong interest in our lifecycle strategies across client types. The strong rankings I mentioned for these products should bode well for our recent efforts to enhance our distribution in the defined contribution market, including our dedicated DCIO wholesaling force and the addition of managed futures as a key risk management tool and a differentiator in our lifecycle strategies. In addition, we recently passed a 3 year mark for our global quality equity strategy which has current performance advantage of 275 basis points per year relative to its benchmarks since inception. Our emerging markets equity mutual fund will also reach a 3 year track record in November of this year and is currently outperforming its benchmark since inception by more than 300 basis points per year. And with that as a background, I'll now pass the call over to Jim to discuss our financials.

[James Mikolaichik:]

Thank you, Patrick and thank you everyone for joining us today. Hopefully, you have had an opportunity to review our earnings results, which were released yesterday after market close. And as Patrick, mentioned. I'll take you through the financial highlights before opening the call to Q&A. As in prior quarters, some of my comments will include references to non-GAAP financial measures, but full GAAP reconciliations can be found in our earnings release and related SEC filings. Looking at net client cash flows and assets under management, we ended the third quarter with $51.1 billion in Assets Under Management or AUM, a decrease of $3 billion or 5% on a sequential basis. $2.6 billion of the decrease was attributable to market depreciation based on blended investment performance of negative 4.8% for the quarter, with the remaining decrease in AUM due to net client outflows. When compared to the third quarter of 2013, AUM has increased by $2 billion or 4%. And as of September 30, 2014 the composition of our client assets by investment vehicle was 52% in separate accounts and 48% in mutual funds and collective investment trusts. By portfolio, 50% of our total client assets were invested in blended assets portfolios or lifecycle products, 48% invested in a variety of equity strategies and the remaining 2% in fixed income portfolios. In the third quarter, we experienced net client outflows of approximately $360 million, with $2.2 billion of client inflows, offset by $2.6 billion of client outflows. Our mutual fund and collective trust products had net outflows of approximately $205 million, which consisted of $1.4 billion of gross client inflows, offset by $1.6 billion of outflows. And defined contribution continues to be a driver of net client inflows for us as demonstrated by the positive flows of $123 million into our lifecycle products for the quarter and nearly $700 million of inflows year-to-date through September. In our separate accounts, gross client inflows of approximately $830 million were offset by $980 million of outflows, resulting in net client outflows of approximately $150 million for the quarter and our year-to-date retention rate for separate accounts stands at 93%. As of September last year, we had net client outflows of $1.9 billion with $6.5 billion of gross inflows offset by $8.4 billion of gross outflows. And as of September 30, 2014, we have seen improving trends with inflows of $7.2 billion and outflows of $7.8 billion, resulting in approximately $630 million of net client outflows year-to-date. Transitioning to our financial results for the third quarter, we reported revenue of $104.8 million for the quarter, an increase of 11% from $94.6 million reported in the third quarter of 2013 and up 1% from revenue of $103.9 million last quarter. The changes in revenue were generally consistent with changes in average assets under management which increased by 10% from the third quarter of 2013 and remained unchanged since last quarter. And revenue margins also remained the same at 78 basis points for each of the respective periods. Operating expenses were $59.9 million in the quarter, an $8.1 million increase compared to the third quarter of 2013 and a decrease of $1.5 million compared to the previous quarter. Compensation and related costs for the quarter decreased by $2.2 million to $30.7 million as a result of reduced incentive compensation caused by negative market returns and relative underperformance during the period. However, the $30.7 million of compensation for the quarter represents a 15% increase over compensation of $26.7 million reported this time last year on the cumulative impact of absolute relative investment performance over the two plus years leading up to the third quarter of 2014. Distribution, servicing and custody expenses, including sub-transfer agencies and 12b-1 expenses associated with our mutual fund and collected trust offerings have remained unchanged compared to last quarter and have increased by 14% over the third quarter of 2013, which is consistent with the changes in our average mutual fund and collective trust assets which were unchanged since last quarter but increased by 14% since last year. And other operating costs were $9.4 million and increased by 800,000 or 9% compared to last quarter and by $1.7 million or 22% compared to the third quarter last year. And for the quarter other operating costs were 9% of revenue which is inline with prior periods. And we had non-operating loss of $1.2 million for the quarter resulting from investments in product seeding. And as a result, we reported economic income for the quarter of $43.6 million, a 1% increase over both last quarter and the third quarter of 2013, and economic net income was $26.9 million or $0.31 per adjusted share. We reported economic net income per adjusted share of $0.30 for both the second quarter of 2014 and the third quarter of 2013. With that, I'll summarize our results for the first nine months of the year. Revenues were $307.1 million, which were 11% ahead of last year. Operating expenses were $177.6 million, an 18% increase over last year. And our revenue growth has been attributable to increased assets under management resulting from high client retention, and blended investment performance of 1.7%, with revenue margins of 78 basis points, consistent with historical periods. Year-to-date, economic income is $131.7 million, up 3% from $127.4 million reported this time last year and our economic income margin is 42.9% for the nine months ended September 30, 2014 compared to 45.8% this time last year. The decrease in economic income margin is primarily attributable to the increase in compensation and related costs, and more specifically the amounts earned by our research team during the first half of 2014 based on results through June 30. And the economic net income per adjusted share is $0.92 for the nine months ended September 30, 2014 compared to $0.88 per adjusted share last year. Before closing, I'll point out a few other items. As a reminder, our management team continues to own approximately 16% of our business and a portion of that ownership is subject to individual vesting requirement through the end of the year. As a result, we are continuing to record non-cash compensation expenses. Those expenses are variable in nature subject to the underlying vesting criteria, and the market value of our public stock. And with respect to the balance sheet, we continue to maintain a debt free capital structure, with a cash balance of $119 million and have $29 million invested in new product concepts as of September 30. And as you are aware, Manning & Napier group distributed $31.3 million in cash to its members for the quarter. This distribution resulted in a quarterly dividend of $0.16 per share, which is consistent with quarterly dividend we have provided to shareholders in prior periods. In addition, yesterday the board of directors approved a quarterly distribution for Manning & Napier group of $46.3 million, which includes a quarterly distribution of $31.3 million and a special one-time distribution of $15 million. In conjunction with this distribution the board of directors declared a dividend of $0.24 per share to the class A shareholders consisting of a quarterly dividend of $0.16 per share and a special one-time dividend of $0.08 per share. That concludes the formal remarks and I'll now turn the call back over to the operator and we look forward to your questions. Operator?

[Operator:]

(Operator instructions). Our first question comes from the line of Adam Beatty with Bank of America Merrill Lynch

[Adam Beatty:]

Thank you and good morning. Just a question around your balance and Target Date Funds. Could you talk a little bit about the asset allocation process, you know, with interest rate potentially rising, I think some folks are concerned about you know, the fixed income portion of Target Date Funds, kind of taking a hit, you know, without folks necessarily realizing that exposure. How do you go about allocating the assets within the fund? I am familiar with your stock that you processed. But in terms of asset allocation, you know, and maybe what the parameters are around that for your Target Date Fund? Thanks.

[Patrick Cunningham:]

Sure. This is Patrick. I'll talk first about the general asset allocation strategies that we've used for 40 plus years and then I will talk specifically about your question regarding interest rates. The – as you know, in our lifecycle and our multi-asset class strategies, we don’t have a static allocation between – those are top down group, it says okay, we should be 20% non-US equities, 40% US equities, 30% high yield. It doesn’t work that way. We are just much more of a bottom of process. So, if we can find stocks that meet one of our three stocks selection strategies, one the profile which is a growth company there is a hurdle rate which is cyclical industry that’s going through a downturn in the consolidation, which by the way is the strategy we use for the energy sector and have used multiple times for multiple industries, but that’s – the strategy we are using for that sector. And then the bankable deal strategy, which is a deep value strategy. So our analysis are 40 plus, bottom up, stock picking professionals, looking for stocks that meet one of the strategies and then we subject to a rigorous pricing discipline. We want a buy a company below its fair value and sell it when it reaches its fair value. If we cannot find companies that meet that criteria as is the case towards the end of the bull market, stocks in the portfolio will hit their sell price, but we can't find anything to replace it and as a result the asset allocation ratchets down to the low end of the range. And what we call our Pro Blen Extended Term which is our most popular risk based strategy and it’s also the same strategy that’s used in our Target Date Funds. The range is between 35% and 75% in equities. So we can – we call that the glide range in our Target Date Funds, but once again it’s not a top down call relative to the general asset allocation between stocks and bonds. So, if we can find stocks in their criteria we'll allow the portfolio to have a greater percentage of the assets. In fixed income we will – we'll manage the duration of the fixed income in all times and manage the mix between corporate’s, mortgage-backed or treasuries depending upon real rates return and where we see the greatest value. All that said, as I mentioned before with rates that is you know, very, very low at this point in time. There is no – you know, we don’t have the same ability to use asset allocation, particularly the bond as the same kind of protection that we could in the past. 2007, 10 year treasuries were in the 5.5% range and that the only asset class that sort saved view during that financial crisis were treasuries. They dropped to two and three quarters 2.5% and all other corporate bonds, high yield bonds, mortgage-backed equities you name it across the boards suffered and suffered significantly and it was those long bonds that in particular that protected you and have your return of over 20% over that downturn of the market. Where our rates really are now which is little over 2%, we don’t believe that rates are going to down to zero at this point in time. So if you don’t have that same ability to cushion what do you do. That was one of the reasons why we acquired 2100 Xenon and now many approve [ph] Xenon because their strategies to manage futures have a very strong track record of protecting when interest rates are going up and when you have inflation in the environment. So those are – that is – that was a top down call, meaning we said this something that we are going to and we don’t have, it’s a relatively small allocation and is based upon US fixed income. But it is one of the tools and the risk management tools that we have in place in the event that interest rates start to rise and or we see inflation back in the picture. And that was a long response to relatively short question, but I hope I answered it.

[Adam Beatty:]

Thank you. Its great color on the process and also Xenon deal helpful. One other question, your discussion of energy stocks, how should we think about kind of hedging, do you ever – would you ever hedge your positions, you know against say the price oil or currency or what have you or is your philosophy really that that’s part of the exposure that you're seeking?

[Patrick Cunningham:]

It’s the latter. That’s part of the exposure that we are seeking. We typically do not use those types of hedges certainly within our –in our lifecycle portfolios, but that’s not say we wouldn’t. It just to say we haven’t historically.

[Adam Beatty:]

Thanks. And just one final, thanks for taking all my questions. In terms of you know, you mentioned 2011 and how it was kind of a similar environment to right now and hit performance a little bit. At this point, in terms of rolling that out of 3 year records bodes for the purposes of measuring fund performance, but also for the purposes of your compensation system. Where are you, have you, has that already rolled off, is it just about to, what's the timing around that, just broadly?

[Patrick Cunningham:]

It rolls off as of the end of September. So it was the September of 2011 which was a similar time period and relative underperformance. And you know, we were encouraged through the end of June because things were you know, it looked like things were running on all cylinders. And this quarter we had a similar bias towards large capitalization and that was one contributing factor. But the thing that you know, replaced 2011 with another quarter of underperformance, in fact, the underperformance is comparable, its slightly worst, was the fact that the concerns about the price of oil have an impact in our energy stocks.

[Adam Beatty:]

Got it. Thank you. That’s all I had this morning. Thanks very much.

[Patrick Cunningham:]

Okay.

[Operator:]

(Operator instructions) Our next question comes from the line Michael Kim with Sandler O’Neill.

[Michael Kim:]

Hey, guys. Good morning. So first maybe a bigger picture question, just sounds like institutional investors continue to reallocate away from actively managed large cap equity strategies which were the dovetails with some of your comments about performance earlier. So, just curious to get your take on sort of this shift in terms of whether you think this is more of a secular versus cyclical trend and then what the implications might be not just for your business, but just the industry more broadly, assuming a more permanent shift away from these types of strategies?

[Patrick Cunningham:]

Yes. Good morning, Michael. The – we think there is some cyclicality to it. It seems that passive strategies always become more popular of course at the end of overall market. And so there is cyclical aspect to. When you go through significant downturn and people realize that you could get protected if you had active management, then active management once again, you know, it'd be versus to a certain extent. But we believe that there is a secular trend going on as well. Part of the reason is the general downward pressure on fees, as part of the – as part of guidance in terms of looking at QDIAs, the regulatory authorities saying pay close attention to fees. So, we think the advisor channel continues to use more passive strategies, including ETFs and passive mutual fund strategies. When you have a low return environment and low growth environment, you know, there was a day when advisors were using vehicles that charged 2%, they were getting anywhere from 50 to 75 basis points as part of their advisor fee, now, in a low growth environment, the slow market environment that’s not the case. So I think the advisor channel in particular is – and that’s a secular trend. So we've seen big organizations like CalPERS announced that they were going – go into index there, traditional equity strategies. But we continue to believe that if you are a truly an active manager which we are, and its evidence by the quarter, its evidence by the weightings that we have in portfolios. We overweight or underweight pretty dramatically depending upon where those strategies drive us, those bottom of fundamental strategies that we've used by our team and the team that is in place now is a same team that was with us in 2000 when the tech bubble occurred in 2007, 2008, we have a very stable research team. That’s the same – we believe active management, there is a place and there will be a place for it and the – and once again those who are more what we call you know, index huggers or closet indexers, the ones who are trying to just beat the index by a few basis points each quarter, we think they are much more susceptible to being replaced by a passive strategy.

[Michael Kim:]

Got it. That’s helpful. And then maybe in terms of the mutual fund channel, just sounds like contributions from DC plans remain pretty, pretty steady. So just wondering if you could talk a bit more about sort of the underlying mix of the assets in terms of platforms or retirement accounts versus more discretionary retail accounts if you will?

[Patrick Cunningham:]

Sure. We are – our life style which are risk based and life cycle funds which are targeted funds are on virtually of all of the major platforms out there. There is – I can't think of one certainly for the vast majority of the assets that are being kept by administrators and record keepers, our funds are available on those platforms. And that represents the majority of the assets in our life style and life cycle funds from the retirement space. We don’t break it out specifically between retail, meaning individuals going into those accounts versus the – those in a non-qualified plan environment versus those who are in qualified plan environment. But those – for the funds, mutual funds in particular what you asked about which are and also for our collective trust which are used by some of the larger institutional plans, the majority assets are qualified.

[James Mikolaichik:]

And across the board I'd say to the middle of the year we had good flows into – I'd say really most products, both equity, the single strategy products, as well as the multi-asset class and you heard my remarks on the DC side that Patrick has touched on. We've had good strength on DC side, the 700 million into the life cycle and life style funds, specifically and that’s attributed mostly to the funds and collectors. And the equity strategies remain strong through the middle of the year, but we have a little bit of pressure maybe on the non-US equity with some recent underperformance where we've seen little bit of out flow in the world opportunity and overseas fund which are the same strategy just two different share classes. So – and then rounding it out on the US and fix side, they are not much of story either way relatively flat there.

[Michael Kim:]

Got it. And then just to follow up with you Jim, any updates on RSU grants. I think last quarter you talked about maybe some additional grants to come in the back half of the year. So just curious where you stand in terms of this years awards?

[James Mikolaichik:]

Nothing more specific at the moment. We still had as you know I think about 5 or 600,000 RSUs that were in that initial computation that we are going through a more deliver process as we got to the end of the year with respect to those grants. But no additional information right now and you know as we get to the end of the fourth quarter, we'll see to where we stand, as well as we hit the beginning of the next year.

[Michael Kim:]

Okay. Thanks, for taking my questions.

[James Mikolaichik:]

Thank you.

[Operator:]

Our next question comes from the line of Steven Schwartz with Raymond James.

[Steven Schwartz:]

Hey, good morning, everybody. A couple, but I want to start off with something that maybe a little strength having to do it, DC. The US Treasury has approved the use of annuity products in target date. I am wondering if that matters to you at all one way or another?

[James Mikolaichik:]

It make sense, I know it’s recent and it’s within the last couple of weeks that that has – I believe been approved. We have – we think conceptually that annuities, either annuity wrapper around a target date fund or a risk based fund or incorporating annuities into it is – that’s a good thing. We've been evaluating that for many years. So its something that we have done research on and talked to a variety of third party companies about how because we're not a insurance company as you know, but how we might partner with some insurance companies to provide those types of capabilities either around or within our funds. But we don’t have any specific plans on doing that right now.

[Steven Schwartz:]

Okay. All right. And then I am just – Patrick, if I may just, I now you're formerly a marketing guy. The global quality in emerging markets and good numbers over the three years, how – what's the process now of getting them out? You know, on to a…

[Patrick Cunningham:]

Well, we think it’s…

[Steven Schwartz:]

Platforms and get investments in there?

[Patrick Cunningham:]

Yes, we have been working on that in anticipation of this for you know, more then a – I'd say year or more. The – so we have teams that work on the various platforms and are responsible for the various platforms and their job is to make sure that all of our offerings are available working on that for some time. I would say more importantly in terms of the shorter term flows, we've also been doing a fairly significant internal programs and launches and training and you know, refining clever material and presentation materials and all the internal training necessary, so that our institutional representatives or what we call our multi-state who deal with the largest institutional prospects and clients, as well as our regional reps who are – deal more and with the middle market, they are fully on to go out and not only sell those two products, but we also have the you know, our fixed income with what's happening with some of our larger competitors in that space. That we believe there is opportunities in fixed income, as well we have good very long and strong track records of duration management, sector management, issue management where our high yield fund is also very competitive. So we believe that we have a robust distribution for us that has a variety of track records and products that it can actively attract assets with them.

[Steven Schwartz:]

Okay. And the large institutional side Patrick, do you need the one big client in order to I guess, justifying and put the – and make sure that this is okay to use, does it work like that at all?

[Patrick Cunningham:]

I mean, they like to see that, that they don’t represent 90% of their assets…

[Steven Schwartz:]

Sure.

[Patrick Cunningham:]

Of course, right, you know, and we have – so it grows you tend to get the larger and larger pieces, but I don’t know what that, I don’t have the AUM in front me.

[James Mikolaichik:]

Do you have the AUM in those funds?

[Paul Battaglia:]

I mean, the global product has several hundred million and I think the emerging markets is you know, probably out near I'd say 50 to a…

[James Mikolaichik:]

Over a hundred million…

[Paul Battaglia:]

Hundred, yes.

[Patrick Cunningham:]

Over hundred million. So, I mean, we think they will you know, it will be the smaller and middle size pieces that will get that to the point where its you know up above the $0.5 billion. And of course with the emerging market there is so – there is not a lot of – those fill up quickly, right. You get up to $4 billion, $5 billion and they reach capacity quickly. So I think there is real need in the market place and they will tend to be more liberal in terms of what they're going to do in allocating as a percent of adjusting assets.

[Steven Schwartz:]

Okay. All right. That’s what I had. Thank you, guys.

[Patrick Cunningham:]

Thank you.

[Operator:]

And there appear just to be no further questions at this time. I'd like to thank everyone for joining today's conference call. You may now disconnect your lines at this time. And have a wonderful day.

[Patrick Cunningham:]

Thank you.