Pzena Investment Management, Inc.
Q1 2020 Earnings Call Transcript

Published: 22 Apr 2020

[Operator:]

Hello. And welcome to the Pzena Investment Management Results for the First Quarter of 2020 Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note today's event is being recorded.I would now like to turn the conference over to Jessica Doran. Ms Doran, please go ahead.

[Jessica Doran:]

Thank you, operator. Good morning and thank you for joining us on the Pzena Investment Management first quarter 2020 earnings call. I am Jessica Doran, Chief Financial Officer. With me today is our Chief Executive Officer and Co-Chief Investment Officer, Rich Pzena.Our earnings press release contains the financial tables for the period we will be discussing. If you do not have a copy, it can be obtained in the Investor Relations section on our website at www.pzena.com. Replays of this call will be available for the next two weeks on our website.Before we start, we need to remind you that today’s call may contain forward-looking statements and projections. We ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from today’s comments. Please note we do not undertake to update such information to reflect the impact of circumstances or events going forward. In addition, please be advised that due to prohibitions on selective disclosures, we do not, as a matter of policy, disclose material that is not public information on our conference calls.Now, let me turn the call over to Rich who will discuss our current view of the investing environment.

[Rich Pzena:]

Thanks Jessica. I want to start my remarks with an observation I never thought I would make in my lifetime. The daily volatility of the average stock at the end of March was as high as it was during the Great Depression in 1929. The wild swings that we experienced for a sign of total uncertainty plus or minus 7%, 8%, 9% in a day for individual stocks. It's a world where greed and fear are on steroids. It means investors just don't have a clue. Imagine a regular person trying to hit pitches thrown by a major league pitcher. If swings would be wild and only randomly would they even touch the ball. Investing is not about wild swings and value investing is about taking advantage of those that are swinging as if their eyes are closed.Investors today are all asking one primary question. How long will this economic crisis last? Are we in the next great depression? Let's consider both possible answers. The bear case says we are in the early stages of the decline. We just don't know how bad it will get and for how long it will go on. The bull case says this is a virus, definitely temporary and while we don't know the exact timing or path, the recovery will come and it will ultimately last. Of course, we don't know which scenario will play out. So in the meantime what do we do? The broad market response as usual during a crisis has been to flee, lead to safety. Today that means, mostly means government bonds. And if one must be exposed to equities then flee to what has already worked and that means run away from value.Compare this environment to what actually happened during the depression. If an investor had bought the broad market index after the November 1929 crash associated with peak involved market volatility that investor would have lost almost 18% in the next year. An investor who bought a basket of the deepest value stocks at the same time would have fared worse losing almost 34%. I think that's where the opportunity is created. Most people are unable to stay the course, but if the investor out of five year horizon the results were far different. The broad market investor would have lost 10% per year, while the value investor earned a positive 10% per year. And if this period turns out to be not depression like, well, that's easy. In almost every period where volatility eased value outperformed the market. That's because uncertainty eased and uncertainty is not healthy for the valuation of cyclical stocks.One last point as a comparison of the two environments, I think, it is worthwhile to remember that government policy today is the polar opposite of the policy followed during the Great Depression. But Herbert Huber Fed tightened; today central banks around the world have been doing everything in their power to stave off and extended downturn. At it's trough in March, the S&P 500 and the MSCI All Country indices that each fallen by about 34%. By the way that decline is not all that different from what happened at the start of the Great Depression. Our deep value portfolios fell further as the market punished businesses already out of favor. This has created value opportunities that rival any in modern history and for companies with strong financial capacity to survive and thrive beyond the crisis.For example, our largest holding General Electric is nearly 80% off its three-year high. GE has more than $50 billion in cash and short-term borrowing availability. With GE's most profitable business, the aviation segment nearly shut down; there is enough liquidity for a multi-year downturn at current sales levels. And at roughly 5x our estimate of GE's normal earnings, we believe it is well worth being patient. Just a word or two about our business. While our earnings were zero this quarter due primarily to the losses in our investment portfolios and the fact that up until mid quarter, we were executing a growth strategy, we still managed to earn a 32% operating margin. The good news is that we finished the quarter with approximately $200 million in net positive flows, not a big positive but positive nonetheless.The flows came across client types and needless to say we are encouraged by our clients' ongoing commitment to us and to our disciplined execution of our value strategy. I look forward to answering your questions and I will now turn the call back over to Jessica.

[Jessica Doran:]

Thank you, Rich. Our earnings release discloses both GAAP and as adjusted financial results. We did not make any adjustments to our results during the first quarter of 2020 or 2019. However, our comparative results for the fourth quarter of last year adjust for certain non-recurring compensation and benefits expenses. As Rich mentioned, we recorded diluted earnings of $0.00 per share for the first quarter compared to as adjusted diluted earnings of $0.20 per share last quarter and $0.17 per shares for the first quarter of last year.Revenues were $34.7 million for the quarter and operating income was $11.1 million. Our operating margin was 32.1% this quarter, decreasing from as adjusted 45.5% last quarter and from 43.3% in the first quarter of last year. Taking a closer look at our assets under management, we ended the quarter at $26.8 billion, down 35% from last quarter, which ended at $41.2 billion and down 27.8% from the first quarter of last year, which ended at $37.1 billion. The decrease in assets under management from the fourth quarter of last year was driven by market appreciation of $14.6 billion, partially offset by net inflows of $0.2 billion. The decrease in the first quarter of last year reflects $10.8 billion in market depreciation, partially offset by net inflows of $0.5 billion.At March 31st, 2020, our assets under management consisted of $10.8 billion in separately managed accounts. $14.3 billion in sub-advised accounts and $1.7 billion in Pzena fund compared to last quarter at the center management across all channels decreased. For separately managed accounts reflecting $5.7 billion in market depreciation, partially offset by $0.1 billion in net inflows. Sub-advised accounts reflecting $8.1 billion in markets appreciation and assets in Pzena fund to $0.8 billion in markets depreciation partially offset by $0.1 billion in net inflows. Average assets under management for the first quarter of 2020 were $35.4 billion, a decrease of 7.1% from last quarter and thus 1.9% from the first quarter of last year.Revenues decreased 9.8% from last quarter and 7.3% from the first quarter of last year. The decreases from last quarter in the first quarter of last year reflect decreases in average assets under management and weighted average fee rate. The decrease from the first quarter of last year primarily reflects the decrease in average assets under management. During the quarter, we did not recognize any performance fees similar to last quarter and compared to $0.4 million recognized in the first quarter of last year.Our weighted average fee rate was 39.1 basis points for the quarter compared to 40.4 basis points last quarter and 41.4 basis points for the first quarter of last year. Asset mix and the impact of swings and performance fees and fulcrum fees are all contributors to changes in our overall weighted average fee rate. Our weighted average fee rates for separately managed accounts was 52.6 basis points for the quarter compared to 54.1 basis points the last quarter and 55 basis points for the first quarter of last year. The decrease from the fourth and first quarters of 2019 reflects the shift in assets just towards strategies that typically carry lower fee rate.Our weighted average fee rate for sub-advised accounts was 26.6 basis points for the quarter compared to 27.3 basis points last quarter and 29.5 basis points for the first quarter of last year. The weighted average fee rate for the quarter reflects the reduction in the base fees of certain accounts related to the fulcrum fee arrangements of one client relationships. These fee arrangements require a reduction in the base fee if the investment strategy underperformed its relevant benchmark or allows our performance fee if a strategy outperform its benchmark.During the first quarter of 2020, fourth quarter of 2019 and first quarter of 2019, we recognized $1 million, $0.8 million and $0.2 million reduction in base fees respectively related to this client relationship. These fees are calculated quarterly and compare relative performance over a three-year measurement period. For the expense of three year performance records of these accounts fluctuates relative to their relevant benchmark. The amount of base fees recognized may vary.Our weighted average fee rates for Pzena funds were 62.5 basis points for the quarter decreasing from 69 basis points last quarter and from 67.9 basis points for the first quarter of last year. The decrease from the fourth and first quarters of 2019 reflects an increase in fund expense cap reimbursements recognized during the first quarter of 2020, which are presented net against revenue. The remainder of the decrease from the fourth and first quarters of 2019 reflects the shift in asset towards products that generally carry lower fee rates.Total operating expenses were $23.6 million for the first quarter of 2020, decreasing from $43.7 million for the fourth quarter of 2019 and increasing from $21.2 for the first quarter of 2019. The decrease from the fourth quarter of 2019 reflects the absence of a one-time expense related to the issuance of certain unit based awards and a reduction in the cost related to employee departures offset by headcount growth. The increase from the first quarter of 2019 reflects an increase in headcount growth and the cost of employee departures offset by a decrease in the bonus accrual.Other expense was $9 million for the quarter as Rich mentioned driven primarily by the performance of our investments. The effective rates for our unincorporated and other business taxes was 29.9% this quarter compared to 3.3% last quarter and 3.9% in the first quarter of last year. The fluctuation in these effective rates reflects the impact of permanently non deductible expenses, as well as unrealized losses. We expect the effective rate associated would be unincorporated and other business taxes of our operating company to be between 3% and 5% on an ongoing basis.Our effective rate for our corporate income taxes ex-UBT and other business taxes reflected 100% this quarter compared to our effective tax rate of 27.6% last quarter and 30.6% for the first quarter of last year. The fluctuation in these effective rates reflects the impact of permanent differences and the revaluation of deferred taxes. We expect this rate excluding these items to be between 23% and 25% on an ongoing basis. The allocation to the non-public members of our operating companies was approximately 77.1 % of the operating companies net income for the first quarter of 2020, compared to 74.6% last quarter and 74.1% for the first quarter of last year. The variance in these percentages is the result of changes in our ownership interest in the operating company.During the quarter through our stock buyback program, we repurchased and retired approximately 919,000 shares of Class A common stock and Class B units for $6.2 million. At March 31st, there was approximately $12.6 million remaining in the repurchase program. In spite of the markets decline, we have ample resources to continue operating unaffected. We ended the quarter with $20.5 million in cash and cash equivalents, as well as $7.1 million in short term investments. We declared a $0.03 per share quarterly dividends last night.Thank you for joining us. We'd now be happy to take any questions.

[Operator:]

[Operator Instructions]The first question comes from Sam Sheldon with Punch.

[SamSheldon:]

Hi. Rich and Jessica. Thanks for taking my questions. Rich, maybe if you could start with what sectors are most attractive to you and deep value today? And maybe if you could give your thoughts on investing in the energy space today as well?

[RichPzena:]

Sure. Well, energy is up there on the list, but I would also say almost everything cyclical where the enterprise is not threatened by the decline in revenues associated with the economic calendar. So that would include industrial cyclicals, consumer cyclicals, financial dividends and that's the range. Energy is an interesting area generally speaking because the companies that don't have that, the declines in energy prices even though they're substantial generally won't lead to negative cash flows because the companies have the ability to shut down their capital spending. And so the, even at fairly low oil prices only stresses that will come, pertinent stresses that will come or companies that are of substantial leverage. So we've been buying in energy and energy service where we fought that despite very, very weak current results, there was enough financial resources to make it through.And we expect that the supply response will be big. The demand response came first obviously from the shutdown of the global economies and the supply response is now happening. And so when things do recover which they will, there's only the time that's unknown. The oil price almost has to return the levels that will cause investment to reemerge and therefore these companies given how much they've fallen or selling at incredibly attractive prices.

[SamSheldon:]

Great. Maybe on the on the client side, can you talk about how your existing clients are reacting to the current environment and conversations that you're having with them? And are you sensing a change in interest about value investing in the last two months during conversations with institutions?

[RichPzena:]

I would say that the investing -- the investors are reacting as in about as vertical ways we can hope for. They understand what we do and what they signed up for broadly speaking. Nobody is happy with the results. Obviously, we're not happy with the results, but the results are not out of line with what they would have expected given the environment. And so the general reaction has been to rebalance towards us. So a lot of the flows that happened to us during the quarter happened in the last few weeks of the quarter as valuations really got low. And we saw our clients doing what we would hope they would do, which is reallocate towards us and rebalance their portfolios as we became lower percentage because of the markets moves.I would say more of the flows that we've seen have come from existing accounts other than new accounts. So to say that there's a big change out there in the marketplace of people suddenly embracing value. I don't think I would say that. I would say that we're having lots and lots of conversations with clients prospects and consultants and those what is being explored is this such an incredible time that you have almost no choice but to try and put money to work in these kinds of companies. And but that doesn't mean they're making that decision. I would say our pipeline is good. It continues to be good. There are actually finals that are going on. There are actually clients and prospect presentations to say that they sense a major shift, no, but certainly a lot of interest.

[SamSheldon:]

Okay. Great. My last question and I'll let somebody else on but on the mutual fund business, it's obviously been an area of investment for you guys in recent years. Can you talk about how that business has performed versus your expectations over the last two years? And how close is it to breakeven today?

[RichPzena:]

It's very, I'm going to give you wishy-washy answer but if you look purely at the mutual fund business and didn't count the sub-advisory relationships that we've won as a result of our outreach efforts you would say it's not breakeven. It's a little breakeven. We were into it with expectations that we will be beyond breakeven by now. Of course, the performance hasn't helped and it's anti value environment for a firm that's extremely deep value. It is not very conducive to growing a mutual fund business. So the question is do you let it to keep going until conditions are better, which has been our instinct. Having said that the accounts that we've won as the result of our calling on intermediaries that haven't gone into our fund, where we've still managed the money as a sub-advisor or in some other fashion way, way more than pay for the costs that we expended on this, into a bigger reason to the change the strategy.We're going to what a period of good performance, looks and garner assets during a period of good performance then hopefully that then will has been proven to be right. And if it turns out that we can't then we'll figure out what to do at that point.End of Q&A

[Operator:]

Thank you. And that concludes a question-and-answer session as well as the conference. Thank you for attending today's presentation. You may now disconnect your lines.