Pzena Investment Management, Inc.
Q4 2020 Earnings Call Transcript

Published: 3 Feb 2021

[Operator:]

Good morning and welcome to the Pzena Investment Management Inc. Announces Fourth Quarter and Full Year 2020 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Jessica Doran. Please go ahead.

[Jessica Doran:]

Thank you, operator. Good morning and thank you for joining us on the Pzena Investment Management fourth quarter and full year 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.

[Rich Pzena:]

Thanks, Jessica. Everyone asks me the same question these days, so it seems I should start my remarks by trying to address that question. Was the fourth quarter the start of the long-awaited value cycle, or was it just another head fake? The outcome was pretty fantastic for the value style, but so much more for deep value. Most of our strategies outperformed their benchmarks by 10 to 20 percentage points in one quarter. It was the highest alpha-generating quarter in our 25-year history. The truth is, though, I really don't know the answer to that question. And having lived through several cycles I know that I won't really know until it's all become history. Let's consider what we actually know so far. First, value cycles and recessions are highly correlated. We have written extensively about this relationship and the data is compelling. Value rallies generally start shortly after recessions start, because once the recession starts investors start looking forward for signals of the further recovery. This relationship has held in the U.S. for nine of the last nine recessions and that data outside the U.S. is similarly robust. Back end, value stocks actually become momentum stocks when value cycles begin, as the recovery translates into strong earnings growth for these beaten down stocks. Consider the choice investors are being offered today. Buy a portfolio of deep value stocks with two-year forward expected earnings growth rates by the consensus of 23% a year and you can buy that for 11 times earnings or buy a portfolio of the Russell 1000 Growth stocks with two-year forward earnings expected growth of 17% a year and that sells for 27 times earnings.

[Jessica Doran:]

Thank you Rich. To review our financial results for the period, I'll share some of our quarterly results detail. We periodically present both GAAP and as adjusted financial results. We did not adjust results for the fourth quarter or full year of 2020. However, our results for the fourth quarter and full year of 2019 were adjusted to exclude $22.7 million in non-recurring compensation and benefits expenses. For the purpose of this discussion, I will reference the 2019 as adjusted information. We reported diluted earnings of $0.22 per share for the fourth quarter compared to $0.16 last quarter and as adjusted diluted earnings of $0.20 per share for the fourth quarter of last year. Revenues were $39.9 million for the quarter and operating income was $18.2 million. Our operating margin was 45.7% this quarter, compared to 44.1% last quarter and the as adjusted operating margin of 45.5% in the fourth quarter of last year.

[Operator:]

We will now begin the question-and-answer session. Our first question today will come from Sam Sheldon with Punch & Associates. Please go ahead.

[Sam Sheldon:]

Good morning, Rich and Jessica. Rich, you spoke about the strong investment performance in the fourth quarter with plenty of opportunities in the deep value corner of the market. Can you flesh out these opportunities a little bit more? I guess, what sectors are you spending the most time researching and investing in today?

[Rich Pzena:]

Yeah. I mean for the most part, our portfolios are pretty well stable and not changing very dramatically. Remember, a lot of this performance in the fourth quarter came from the fact that these same stocks all had been killed in the previous 12 months, leading into the pandemic and through the pandemic. So, our exposure continues to be skewed towards financial services, energy, consumer cyclicals and industrial cyclicals, with fairly light exposures in consumer staples, real estate and -- mostly and electric utilities.

[Sam Sheldon:]

Okay. How would you characterize the current environment for value manager searches? And has there been, any noticeable changes to RFP activity with values broad performance and your record alpha in the fourth quarter?

[Rich Pzena:]

I would say there is a big increase very, very noticeable in the -- I'll call it, pre-search activity phase. So for example, we did a webcast to potential clients and prospects and existing clients in a week or two ago. And those are getting five to 10 times the volume of attendees than we had been getting for the past few years. So, while I would tell you that our pipeline is fine and it's stable and client is -- and I don't mean to sound bad by the word fine. There's -- the search activity continues to be kind of around the pace that it's been at maybe a little uptick is all I can say. But, the pre-search activity volume was pretty strong.

[Sam Sheldon:]

Got it, okay. Can you give us some updates?

[Rich Pzena:]

I'm sorry. I was just going to add to that that, if you look at prior cycles, it takes probably a good year for you to get into the positive side of the value cycle before you see strong movements in cash flows. At least, that's been the observation I would make from history. So, we'll see if that's the same this time. And obviously, we're very early in this.

[Sam Sheldon:]

Sure. That makes sense. Okay. Maybe you could update us specifically on the sub-advisory business. I guess what is the sentiment there? And is there any large relationships up for renewal on the horizon?

[Rich Pzena:]

As you maybe aware, the Sub-Advisory businesses are always up for renewal. There's -- we have a -- generally have an initial term and then it's just reviewable at will by our partners. So I would tell you that the cycle of renewing is not something that we are concerned about. There's been some increase in activity in Sub-Advisory from the standpoint that -- I mean, it's hard to characterize it as trends, but I would tell you we had some very positive rebalancing that happened during the pandemic. And now, we had a big account win during the year, where we established a very new sub-advisory relationship. And we're involved in discussions about incremental sub-advisory relationships going forward. But I would -- so I would say, renewal isn't the issue. The issue for us is, will any of this -- these existing relationships start allocating more towards us as the value cycle, as they recognize their lack of -- or too low of a level of exposure to value. So that I think will happen that some of the conversations are going on and then there's the -- looking for new sub-advisory relationships. I think you know that we like this business a lot. And the partners that we've had in sub-advisory have tended to be very, very long lived. And mostly because we do what we say we're going to do. And from everything I can tell, the relationships continue to be strong. So I think there's upside going forward, but I hope that gives you a flavor.

[Sam Sheldon:]

Sure. That's helpful. Maybe you could walk us through your philosophy around the special year-end dividend and buybacks and how that philosophy might have changed over time?

[Rick Pzena:]

The philosophy really hasn't changed at all. We've tried to use -- to pay out between 60% and 70% of our earnings as a dividend. And then kind of reserved the rest for stock buyback. And this year is no different than that. Obviously we had a down year. And as you know we pay our dividend. Since the vagaries of the market are very difficult to predict, we've operated for over a decade. It's probably -- for over a decade with a modest quarterly dividend followed by a year-end dividend. That's pretty much just a calculation based on the historical profitability which was down last year because as you know we went through a big dip even though our assets under management ended the year at their high. We were at the bottom, it was substantially lower. So our revenues were lower this year and our earnings were lower and that's what led to the dividend. But philosophically that's no different. We've tended to try to be smart about timing of stock repurchases by buying when there's softness in our share price. And for the most part we've accomplished that. We've acquired shares at reasonably attractive prices over time. We hope to continue doing that. And we hope to deploy the excess cash that we have to buyback stock. We do it in a fashion that is cognizant of the volume of our trading activity. So you can't turn it on and off in rapid strokes as you might imagine. But given those constraints, we want to take advantage of softness and try to redeploy as much of our capital as possible to offset dilution that comes from our share issuances under our employee compensation programs.

[Sam Sheldon:]

Okay. Maybe last from me. Your cash and investment balance continues to grow. Could you update us on capital allocation priorities? And maybe what your growth initiatives are that you have in place at the business today?

[Rick Pzena:]

Yes. You have to remember about the seasonality of our cash. I mean our cash is sort of at its high at the end of the year and then there are substantial cash requirements in the first quarter because we pay our bonuses and we pay our year-end distribution. So mostly, we manage to the minimum cash balance which occurs in March or April every year. And we try to have a modest cushion. So when you see where we are at the low where there's not -- you wouldn't think of there being a whole lot of excess cash. So the cash that we have on our balance sheet is mostly temporary. And so it's mostly focused on -- in short-term investments that are not risky. The only money that we put at risk some of it is seeding new products and strategies and that we will continue to do. And some of it is to fund our employees deferred compensation program, which allows our employees to allocate their deferred comp to our own investment strategies. And then we take those funds and actually invested in those investment strategies. So it has some impact on our quarterly earnings performance. It had a favorable one this quarter. But the strategy continues to be primarily to increase the distribution of our existing products to incubate new products that we think might have interesting -- interest in the future. And that's pretty much what we're doing.

[Sam Sheldon:]

Okay. Thank you for taking my questions.

[Rich Pzena:]

Of course.

[Operator:]

Our next question will come from Tom Brownel with Rocket Point Advisors . Tom, you might be muted on your end.

[Unidentified Analyst:]

Hi, good morning. I apologize, you are correct. I was muted. And just to be clear, it's Tom Brownel with Rock Point Advisors. Rocket Point might sound better and actually might be a great name for us at some point. But for the time being we are just Rock Point Advisors. We will say Rocket Point. Thanks for taking the question. If I could ask you to circle back to the sales and marketing initiatives. I was -- so this might be slightly repetitive, but encouraged by your comment that you were encouraged by your pipeline. And I was curious to hear you say that it usually takes about a year for the interest and value mandates to sort of gain traction. I'd be curious to know what you think of this being the start date in this cycle of when that might have started. Secondly, interested to hear about the participation in your webcast. I guess my question is, is that primarily coming from the consultant space or are those actual members in the investment management community that are participating in those webcasts. And if depending on the answer to that question what are you hearing from the consultant space in terms of interest in deep value strategies? And then lastly can you just comment quickly on the -- whether there's any change in the sort of geographically where the interest might be coming from and whether you're seeing greater and/or less interest in deep value strategies domestically, or is that coming from abroad? As I think I'm aware you have built out some of your sales and marketing efforts internationally. So thanks.

[Rich Pzena:]

Okay. Hopefully, I'll hit all these. If I didn't, you'll remind me. Most people are dating the start of the value cycle to October 1. You can be cuter than that if you want. And if you -- and we can date it back to the actual bottom of the market in March of last year. But I would say that there was from March 23 which was -- which would have been our bottom the October 1. There was a little bit of -- we kept up with the market. We were a little ahead, I wouldn't call that of dramatic value cycle. So the fourth quarter is a dramatic value cycle or at least a dramatic value performance. We hope it turns into a cycle. So I think October 1 would be my guess of where that starting point would be. The increase in interest is actually in a number of areas, but the one webcast I was specifically referring to have a log of financial intermediaries on. These are people that are advising clients. They're not consultants in the institutional consulting community, but they were on as well. The -- but the big bulk were on intermediaries. These are brokers that are probably answering their own clients' questions about value and are trying to be educated on that. We do see consultants and institutions looking more closely. We see it in conversations. I'm going to use that same word I used before, pre-search activity, conference calls. The consultants are -- we're doing educational conference calls for broad swaths of consultants who are engaged in the same kind of questions with their clients about should I change my investment allocation given how well growth has done and given maybe that this is the beginning. So -- and say it's kind of across the board. And you're right to say that most of the people that we're talking to are intermediaries rather than the ultimate investment decision-maker, but my sense is that this is getting communicated on onward. And there's enough of those direct investors that it's encouraging. They're also asking -- or existing clients are asking for more engagement with their boards and committees than we've had lately. So, all of those things are the things that give me -- have made -- we made the statement that pre-search activity is getting pretty interesting. Now, where is it coming from? It's everywhere. I don't think that there's a geographic bias. I probably can look at data and see if that's the case, but this is my gut instinct from the conversations I've had over the last few months that it's pretty much across the board.

[Unidentified Analyst:]

Great. Thank you.

[Rich Pzena:]

Did I get every one of your questions?

[Unidentified Analyst:]

You nailed it. Thank you.

[Operator:]

There being no further questions at this time, I would like to turn it back to Jessica Doran who has an e-mail question.

[Jessica Doran:]

Thank you, operator. I will read a question from an investor that we received via e-mail this morning. This is a question for Rich who is operator trying to get back on the line right now. So, if you could keep an eye out for that as I read the question. We'll just give Rich a moment to get on and respond. So, the question that came in is that -- is as follows. The markets are very worrying lately. From observing large-scale runaway valuations like Tesla, Bitcoin, and GameStop it makes me think of stories that I read from the late 2020s and dotcom bubble. While I understand it's impossible to predict when or what might happen, I'm wondering your assessment of the greater risks that might affect Pzena's assets under management i.e. in your view, is there large-scale debt finance speculation or other risks that could cause significant and permanent capital loss in the market. Further, how do you assess the potential impact of these risks on the assets you manage? And what are your client hesitations on how Pzena's assets are positioned to weather the coming years?

[Rich Pzena:]

Okay, thanks. I apologize, that I got disconnected for a quick second. But, the -- I'll use the word the craziness in the market, has very little impact on us, because we just don't have any exposure to any of these kinds of companies. And we don't have exposure to the high-flying growth stocks that are traditional things that people have invested in. And certainly the items that have caused the market to have these giant dislocations where you stare in amazement that you could have the size and magnitude that you've had. We're not in those. I wish, I could tell you that we own some in advance and we benefited from what happens is when the market wild like this, and volatility gets introduced to the marketplace, it actually creates opportunity for us. And by having a very, very disciplined approach to thinking about valuation and to assessing valuation, we can exploit when the market goes crazy in one way or another, by buying things that get punitively priced and lightening up, if and when we have something that would run. Now does this cause our clients to worry about their investment overall in equities. I'm sure it does. Do I think that it's likely to have much impact on us? I really don't. Because one thing that we've succeeded at over 25 years of being in business is, making sure, that our clients understand exactly what it is that we do. So there are -- they understand and we've been repetitive over and over and over because most of our clients particularly your money which aspect of equities, do you want to put your money in? And give it this kind of stable, steady operator, executing the same strategy year-over-year. I think we instill some of the that would exempt us from this kind of fear, that it would impact our business. And the only thing I can point to, is what happened during , because we were having a lot of these same discussions at the end of 1999 and early 2000, when we would stare at amazement, so I can't believe that's going on in the marketplace. And when it unwound, we actually had the five best years of flows into our business. And good investment performance, because the stocks that we owned, attracted capital, as people withdrew capital, in companies with market values many, many, many times the size of ours. And people just buy and sell it a long time. And we try to take advantage of that. And I know it was a red question. And I don't know if I addressed it well enough, but hopefully you can hear my sentiment.

[Operator:]

This will conclude our question-and-answer session. And at this point, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.