Pzena Investment Management, Inc.
Q4 2016 Earnings Call Transcript

Published: 8 Feb 2017

[Operator:]

Good morning and welcome to the Pzena Investment Management Reports Results for the Fourth Quarter and Full-Year 2016 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask questions. [Operator Instructions] 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’s fourth quarter 2016 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 periods 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 that 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 materials that is not public information on our conference calls. In a minute, I will turn the call over to Rich, but first, I would like to review some of our financial highlights. We reported non-GAAP diluted EPS of $0.15 per share and $10.5 million in non-GAAP diluted net income. Revenues were $29.1 million for the quarter and operating income was $13.7 million. Now let me turn the call over to Rich, who will discuss our current view of the investing environment.

[Rich Pzena:]

Thank you, Jessica. Just a few short months ago, investors had accepted the paradigm of low interest rates and sluggish economic growth forever. That has been turned on its head with expectations of fiscal stimulus and higher interest rates in the US driving asset prices. The rotation out of bond proxies and stable earners into banks and economically sensitive stocks coincided with the rise in interest rates in early 2016 and accelerated in the third and fourth quarters particularly after the US Election. Our portfolios were well positioned to benefit with most of our strategies beating their benchmarks by between 400 and 700 basis points for the year. [indiscernible] turn in the value cycle, it appears that the cycle in the US turned up in February of 2016 with deep value stocks outperforming the broader market by almost 20% since then. Deep value also outperformed outside of the US during the second half of the year. While it is too soon to say definitively if the value cycle has turned in those regions, we believe the widespreads we are seeing in markets outside the US are similar to what we have seen in the US which is starkly preceded extended periods of deep value outperformance. Now investors are asking did we miss the cycle is it over. Our view is a resoundingly no, only hindsight will tell us the ultimate length and magnitude of the current value cycle but we believe there is much further to go. In order to understand how this value cycle might unfold let's focus on what created it and look at historical data to see how prior value cycles have played out. This current cycle has been very long in the making with years of declining interest rates leaving investors seeking yield and earning stability to the detriment of financial services and other economically sensitive businesses. As a result, valuation spreads widened to levels approaching those we last saw during the Internet bubble beginning to contract only recently on the dramatic shift in investor sentiment. However over the last 50 years, history over the last 50 years has shown that pro-value cycles are typically far longer in duration and greater in cumulative outperformance than the current cycle to-date. Pro-value cycles in the US have lasted 72 on average and generated a 162% cumulative excess returns versus our current cycles of 11 months and 20% cumulative excess return. We believe there is still significant opportunity and longevity to this value cycle. Valuation spreads remain wide throughout the world leaving us with portfolios that are generally characterized by deeply discounted cyclical businesses with sustainable business franchises, strong balance sheets and a demonstrated ability to adapt to a wide range of economic scenarios. More than ever, 2016 demonstrated the importance of being exposed to deeply undervalued securities before the turn in a value cycle. On the business side, 2016 was an exciting year for the firm and we're very encouraged with our business outlook for 2017. Our AUM ended the year at 30 billion. Net flows in the quarter were approximately $300 million but we estimate that gross outflows were inflated somewhat due to client rebalancing resulting from our recent strong investment performance. Still our win rates continue to be high with recent wins ranging across our product suite and large assignments won in the fourth quarter in international ex-US, emerging markets and US large cap. Almost all of our strategies have outperformed their benchmarks over trailing one, three and five year periods. Given that performance historically proceeds fund flows, we are encouraged as we continue to see an increase in interest in our strategies with new opportunities spread throughout the world and across institutional investors, sub advisory relationships, and our intermediary distribution efforts. I would like to thank all of you who took the time to attend our call today and I look forward to answering your questions. I'll now turn the call over the Jessica Doran, our Chief Financial Officer who will provide this quarter's financial update.

[Jessica Doran:]

Thank you, Rich. As I mentioned, we reported non-GAAP diluted earnings of $0.15 per share for the fourth quarter compared to $0.12 per share both last quarter and the fourth quarter of last year. Our non-GAAP income statements adjust for certain valuation allowance and tax receivable agreement item. I'll address the tax-related adjustments at the conclusion of my remarks, but for now I will focus on operating income information. As Rich mentioned, our assets under management ended the quarter at $30 billion, up 9.5% from last quarter which ended at $27.4 billion and 15.4% from the fourth quarter of last year which ended at $26 billion. The increase in assets under management this quarter was driven by market appreciation [ph] [00

[Operator:]

[Operator Instructions] Our first question comes from Ken Worthington of JPMorgan. Please go ahead.

[Ken Worthington:]

Hi. Good morning. Maybe first, can you talk about maybe more fully your conversations with your institutional investors? I think, Rich, you said you saw this quarter some money was taken out, given our performance and I'd say that's sort of the logical initial reaction, but to what extent are you seeing institutional investors kind of buying into or is the pitch resonating with them that it's still very early in the cycle. And I guess in terms of the sub-advise, are you seeing any new interest emerge, given how maybe the deep value cycle appears to have turned?

[Rich Pzena:]

So the conversations, first of all, the conversations with existing clients who have already been invested with us for some time, pretty straightforward, they're very happy with our performance and we would get, we pretty much, you’d get an e-mail the last week of the year saying, please send us 8% of the account. So, the conversations -- usually very little conversation around that. Of course, we call whenever we get one of those and they say they're just rebalancing, because we are out of whack with our asset allocation -- with our strategic asset allocation. A good example of that would be we’re a sub advisor to a closed end fund called the Liberty All-Star fund and we were the best performing manager in that fund. I believe there are five managers in the fund and we're supposed to all be equally weighted. And at the end of the year, they just redistribute it, so we're all equally weighted. And that is how they’ve operated, so we benefit from that, if you want to call it that, when we're underperforming. And we donate when we're outperforming and it tends to be sharper when you've had periods of sharp relative performance. And so there were fairly wide differences amongst managers’ performance during 2016, which I think made this an unusually large number. It's hard to quantify exactly because you don't really know how much is rebalancing and how much is adjusting in the underlying fund size, so you can't come up with a precise number. But that's the conversation that we've had with existing clients, with clients that have been thinking about this for the last 18 months, we've been going around the world pounding the table on this and so the only thing I can observe is we try it, we track the size of search activity that we're involved in and that has picked up fairly significantly during 2016 and that does not guarantee that you're getting the business. And although, we've had some pretty decent win rate, this is why we're optimistic. But for sure, people are wringing their hands and saying, well, with this just a Trump bounce and I have to worry about it going away. So did I miss it? Conversations are real. I mean they're agonizing that anybody would go through when they're making shifts to their portfolio, but I think broadly speaking, because so much of the dialog in the last few years has been moved towards passive and lower volatility and safe and quality that I think people are finding themselves, I don't know, if I want to use the word significantly, but under allocated to the kinds of things we do. So while there's no guarantees in life, I think things look good. On sub-advisory, we funded a fairly decent sub-advisory new relationship in the fourth quarter and it continues to have the daily flows that we've seen in the first year or two of other sub-advisory contracts. So we hope that that continues and we are in conversations for one sizable sub-advisory relationship. But there's no guarantee how that will turn out either.

[Ken Worthington:]

Okay, great. You had mentioned some larger account wins across some various mandates in 4Q, did those happen the funding 4Q or are we still waiting for those for that money to come in ’17?

[Rich Pzena:]

The ones that I mentioned funded in 4Q, we do always have an inventory of funded, one but not funded, which we did have at 12/31, and a lot of that funded in January. So for the most part, I think you're seeing most of that already in the January AUM.

[Ken Worthington:]

Okay. Great. And then you had been finding value in a number of sectors, including banks and energy. Is your opinion that you're still seeing still good value in those areas or are your thoughts evolving as to what areas actually may provide the most value from here as we look out the next couple of years?

[Rich Pzena:]

Well, the biggest change has been the addition of healthcare into the value universe. We've had some pretty sizable contractions in share prices in healthcare as a result of -- really as a result of the election I guess you would say, because of fears that there might be some pressure on drug pricing. So, the generic drug manufacturers, the branded drug manufacturers, the drug distributors have all started to screen up and we're beginning to make some investments in those. Financials still remain the cheapest sector globally in spite of their big run. We still think the risk reward trade-offs are pretty favorable in financials. So we haven't really reduced any of our exposure in financials and we're excited to have another area to be focused on.

[Operator:]

[Operator Instructions] There are no additional questions at this time. This concludes our question-and-answer session. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.