Sculptor Capital Management, Inc.
Q1 2016 Earnings Call Transcript

Published: 3 May 2016

[Operator:]

Good morning, everyone, and welcome to the Och-Ziff Capital Management Group's 2016 First Quarter Earnings Conference Call. My name is Gemma, and I will be your operator for today. At this time, all participants are in listen only mode. [Operator Instructions] I would now like to turn the call over to Tina Madon, Head of Investor Relations at Och-Ziff. Please proceed.

[Tina Madon:]

Thanks, Gemma. Good morning, everybody and welcome to our call. Joining me are Dan Och, our Chairman and CEO; and Joel Frank, our CFO. As a reminder, today's call may include forward-looking statements, many of which are inherently uncertain and outside of our control. Och-Ziff's actual results may differ, possibly materially, from those indicated in these forward-looking statements. Please see our 2015 Annual Report and the press release we issued earlier today for a description of the risk factors that could affect our financial results and our business and other matters related to the forward-looking statements. The Company does not undertake any obligation to update publicly any forward-looking statements. During today's call, we will be referring to economic income, distributable earnings and other financial measures that are not prepared in accordance with U.S. GAAP. Information about and reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are available in our earnings release, which is posted on our website. No statements made during this call should be construed as an offer to purchase shares of the Company or an interest in any Och-Ziff fund or any other entity. Before we get started, I know you have questions about the status of the FCPA investigation. Joel will update you in his remarks and provide as much information as he can at this point. With that said, because we have entered into discussions with the government about resolution of this matter, we won't be able to take any questions on it today. We understand that reaching a settlement is as important to you as it is to us and we're doing everything we can to get closer as expeditiously as we can and in the best way possible for the business. With that, let me now turn the call over to Dan.

[Daniel Och:]

Thanks, Tina. Good morning, everyone. As you all know, global financial markets were volatile during the first quarter. The sharp declines experienced early on were to varying degrees of cross markets we grouped towards the end of the quarter. However, that recovery was not uniform with equity market performance diverging substantially between major markets. The S&P 500 ended the quarter posting a modest gain while the major indices in Europe, Japan and China experienced substantial declines. Credit markets were also challenging early in the quarter in liquidity conditions and a lack of market conviction contributed to volatility in securities prices that we believe was disproportionate to fundamental considerations. However in March the credit markets found renewed footing with positive performance from many corporate and securitized credit assets, constructed developments in the energy markets and additional monetary stimulus from the ECB contributed to an improvement in overall credit market sentiment. There is no question that recent market conditions have been challenging particularly in equities. Although we have certainly seen periods like this in the past, the magnitude and duration of this one has been unexpected. We believe that our proven investment process, our global presence, our diversified product platform and our willingness to change and adapt to markets will deliver attractive results for investors in our funds and our firm over time. With that, let me recap our performance beginning with our multi-strategy funds. Our returns which is stronger than many in the industry, but we can do better in absolute terms. Overall we believe that the current opportunity set will reward caution and excessive risk-taking in this environment can lead to dramatic underperformance. As a result, we have position our multi-strategy funds to control risk and take advantage of dislocations as they arise. The OZ Master Fund generated gross return of minus 3% and a net return of minus 3.4% through March 31. In the month of April our estimated net return was plus 53 basis points reflecting a solid month of performance. Through the end of the first quarter, losses in equities more than offset gains in our credit strategies and in convertible and derivative arbitrage on a gross basis, while our core approach and philosophy and long/short equity is unchanged, we always look for ways in which we can improve our investment process and continue to manage the portfolio dynamically. In light of acute volatility and consistent with our goal of preserving investor capital we reduced gross exposures across the portfolio especially in the U.S. early in the quarter. We continued to balance concerns over the near-term environment against what we believe our highly attractive investments on both the long and short sides. We firmly believe that focusing on return generation through disciplined security selection will yield strong results over time. Merger Arbitrage continues to perform well and this opportunity set remains attractive. Recent developments in this area serve as a solid reminder of the merit of deep analysis and selectivity. Merger arbitrage became a popular strategy at the end of 2015 as deal spreads widened. While we agreed with this view directionally, we made highly selective investments in individual positions rather than taking on a broad basket of yield spreads. Turning to credit, we were particularly active during the quarter opportunistically adding to existing exposures and initiating certain new positions. In addition, we trimmed exposure to specific assets we believe to be fully valued as markets rebounded and buyers returned. In opportunistic credit our Global Credit Opportunities Fund has generated strong gains year-to-date and we continue to see significant opportunity in this space. Our closed end opportunistic credit funds continue to successfully harvest investment taking advantage of improved credit market conditions. In institutional credit strategies our performance credit platform, we are generating top quartile performance in our CLO business. Our performance and the quality of our products are differentiating us in creating additional opportunities. We anticipate that we will continue to grow this business in the U.S. and enter the European CLO market over the course of the year. In real estate we remain cautious and disappointed in our approach to deploying capital in our third opportunistic fund given current valuations in major markets and property types. We continue to find interesting opportunities in both traditional and nontraditional real estate in both debt and equity. Our ability to analyze investments across a broad spectrum of real estate assets is central to the success we have achieved in delivering leading returns in our real estate funds. Now turning to assets under management. As of May 1, our AUM totaled $42 billion. Year-to-date we've had net outflows of approximately $2.5 billion, distributions of $254 million and depreciation of $751 million. The net outflows were primarily from the OZ Master Fund reflecting both cyclical and idiosyncratic headwinds. The first quarter was challenging for the hedge fund industry. During the quarter the industry experienced its worst net outflows since the second quarter of 2009 as weak performance and volatile market conditions caused investors to reduce their exposure to the industry. Additionally, as we said on our last call, some other identifiable factors affecting flows were investors rebalancing to maintain asset allocations or to achieve different risk return profiles and an uncertainty related to the FCPA investigation. It goes without saying that this is a challenging environment for all investors and many are struggling to generate returns. We believe we are well-positioned to meet these challenges. We don't believe it is appropriate to make strong directional calls on asset classes. As we see it, this is an environment in which disciplined security selection will be the major driver of performance. Today our investment teams are more capable and our senior leadership is broader and deeper than at any time in our history. We believe this depth of talent combined with our rigorous risk management, our proven investment process, and our ability to quickly address shifts in volatile markets will enable us to continue to generate attractive returns over time. With that, let me now turn the call over to Joel who will take you through our financial results.

[Joel Frank:]

Thanks, Dan. This morning we reported distributable earnings loss of $143 million for the first quarter or $0.27 per adjusted Class A share. This loss reflects the $200 million reserve that we have established in anticipation of a monetary settlement associated with our FCPA investigation. Excluding the effect of the reserve our distributable earnings were $57 million or $0.11 per share. Now for a quick recap of our economic income results excluding the reserve. Our economic income revenues were $176 million, 24% lower year-over-year with the majority of the decrease resulting from lower incentive income. Management fees were $144 million 12% lower as our average AUM decline. Our average management fee was also lower reflecting the change in our asset mix. Incentive income was $31 million generated primarily by tax distributions on the incentive income that has been accrued on longer-term assets. These distributions are taken at year-end and in the first quarter of each year. Our operating expenses totaled $91 million for the quarter increasing 23% year-over-year. Top end benefits were 34 million essentially unchanged. Non-comp expenses were $57 million reflecting an increase of $17 million or 42% due mostly to higher legal expenses related to our ongoing FCPA investigation. Again, excluding the reserve, our effective tax rate was 32% and we anticipate that our tax rate will be 30% to 35% in the second quarter based on our estimate of our full year economics for 2016. We expect that the ratio of our operating expenses to management fees will be in the range of 60% to 64% in the second quarter. Of that range we expect that salaries and benefits will be 21% to 23% and non-comp ratio will be 39% to 41%. Now for an update on the investigation. Since our last call we have entered into discussions with the government and we are moving forward towards the resolution of this matter. As I mentioned earlier, we establish a $200 million reserve this quarter. We believe it is probable that the final amount of the monetary settlement will be greater than the reserve, but at this point in time we're unable to reasonably estimate what that amount would be. In order to meet any final monetary settlement we have retained the entire amount of our distributable earnings this quarter and we drew $120 million on our revolver at the end of last month. When we have further clarity on the final settlement figure we will assess any additional sources of capital that may be needed. While we remain hopeful that this matter can be resolved by midyear, pinpointing the exact time of a resolution is difficult. It is possible that the timetable may take longer than we hope. We are doing everything we can to bring the process to close in the best way possible for the business, our shareholders, our LPs and our employees. With that we will now take your questions. Again as Tina mentioned, we won't be able take questions related to the investigation, but we are happy to answer any other questions you have.

[Operator:]

[Operator Instructions] Your first question comes from Bill Katz from Citi. Please go ahead.

[Bill Katz:]

Okay, thanks very much. I appreciate taking the questions. So first question is Joel maybe yourself, I think your non-comp guidance is a little bit higher than what you had sort of guided to last quarter for this quarter, I was just very curious if you could talk about maybe some of the drivers behind that and then if you look into the second half of the year how you might see that ratio trending?

[Joel Frank:]

Most of the drivers really related to the legal expense related to the FCPA investigation is really the big driver in terms of increases and I can't project, but I will give you guidance each quarter in order to help you model what's going to happen going forward.

[Bill Katz:]

Okay and then Dan, for yourself perhaps, some of your reading different sort of views on hedge fund allocations and pricing dynamics overall a bunch of very large LPs have sort of come out and said that the two and twenty [ph] mile is no longer alive if you will. So can you talk a little about your separating away from, I know you can't speak to what's in the investigation, but could you talk a little bit more about what you are seeing here in teams of cyclical versus secular growth for the hedge fund business and how you sort of see the long term impact if at all on pricing?

[Daniel Och:]

Now, we're not seeing any changes or discussions about changes in terms of pricing. I think about five or six years ago we were a leader in the concept of for those institutions who are willing to commit larger amounts for longer some level of flexibility on the management fee, no change on the incentive and those structures remains in place as they have been for years and we're seeing no changes or discussions on that front. In terms of the industry overall, look we really prefer to focus on object [ph] our view is that historically by adding value, by generating returns, by giving investors the opportunities to do what they want to do for their portfolios, we have generated growth. We are confident that our multi-strategy fund will continue to do that going forward and we are also a strong believer that the new products that we have developed still have a lot of runway in front of them.

[Bill Katz:]

Okay just one last followup and thanks for taking my questions. As I look at your slide that sort of carries forth in the end of the year to now in terms of gross inflows and what have you. If I look at the non-multi-strategy portfolio it is still relatively nominal in the grand scheme of things. Some of it appears of putting up some very strong organic growth trends in these related buckets. What strategies do you see has the most near-term opportunity for growth away from the multi-strategy side?

[Daniel Och:]

Well, the two areas that we're most focused on are our credit and real estate. So on the credit side, you look at our opportunistic credit funds which have a long track record of extremely good performance both in terms of executing when there were things to do, and at least is important for institutions to tell them when there are not thing to do. If you look at our global credit fund, performance not only was strong through the cycles but continues to be strong this year. And on the institutional liquid side we mentioned that our CLO performance not forget offset to a lot of things well here but performance will always be at the top of that list. And the fact that our CLOs over a multiyear period are performing at the top of this sector, winning is important both to the growth there and to the European business that we mentioned we expect to roll out some time later this year.

[Bill Katz:]

Okay, thank you.

[Operator:]

Thank you. Your next question comes from the line of Dan Fannon - Jefferies. Please proceed.

[Gerald O'Hara:]

Great, thanks for taking my questions. This is actually Gerald O'Hara sitting in for Dan this morning. Joel, in the past you have mentioned or indicated there might be a bit of a trailer I suppose with respect to some of the legal fees on the expense side. Is there any potential update there or additional clarity given today's announcement?

[Joel Frank:]

No, not at this point. I've really said more than I can already say and in terms of expenses I'll give you guidance going forward.

[Gerald O'Hara:]

Okay, fair enough, thanks. And maybe one for you Dan as well, you mentioned sort of next opportunity with respect to European CLO market. Perhaps you could give us a little bit of color as to how the demand trends or opportunity set might differ there versus the U.S. side of the equation? Thank you.

[Daniel Och:]

Well there are some – the basic business is very similar in terms of what we're trying to accomplish, have a look at assets and liabilities, generating performance and how to structure the product. There are some technical differences which we think create advantages for larger firms such as ours that have scale. But most importantly, about five years ago we launched the CLO business and we've got about $7 billion in assets under management. We've got top quartile performance and our goal is going to be to do something similar in Europe.

[Gerald O'Hara:]

Great, thank you.

[Daniel Och:]

Thank you.

[Operator:]

Thank you. The next question comes from the line of Ken Worthington at JPMorgan. Please proceed.

[Ken Worthington:]

Hi good morning. I was hoping if you could talk about the fundraising pipeline outside of the multi-strategy area, I am looking mostly for color on sort of close in the credit funds, energy, the BDC or maybe even any other areas that seem poised to potentially raise money this year? Thanks.

[Daniel Och:]

So look, because we’re in fundraising in a lot of these new products, we can’t talk about specifics. But those opportunities are there and we’re focused on all the products that you've mentioned and obviously if there is more opportunity to do other things, we will do that as well.

[Ken Worthington:]

If you kind of hit the targets that you’re looking to make about how much gross do you think you could raise this year, again if all went according to plan?

[Daniel Och:]

I can’t project. Like I said, these are in fundraising, it’s not something that we could do at this point, but obviously when we can we will give you information.

[Ken Worthington:]

Steve Cohen [ph] expressed concern this morning about the challenge in finding talent in the hedge fund industry. How are you guys finding the hiring process as you continue to grow and expand?

[Daniel Och:]

Well we think finding talent has been, finding, training and retaining talent has been a core part of Och-Ziff since inception 22 years ago. So the base the construct is the same as it’s always been; figure out the best sources of talent and make sure that people internally feel this is the best place to be. Our best advocates are the people who are here that want to stay here, that can demonstrate that they made the right decision coming here and tell people on the outside why they should be here as well. So the core principles are the same, the tactics as with every part of the business become different as we evolve and as the business evolves. But we continue to focus. We have a human capital organization at the front. We have a human capital committee that focuses on how to keep expanding. We are constantly looking at the best sources of talent for each of the different areas of the business and then the key is a mentoring and training process for people when they get here, even senior people, so that we can incorporate them into the team and have them to develop even further. So I would echo that, of course it is challenging. It has always been challenging. I think focusing on our people and the internal culture has always been important at Och-Ziff and remains a competitive advantage.

[Joel Frank:]

And I will add to that, we have a lot to offer here. Obviously as the diversified manager there is lots to learn, there is a lot of interconnectivity between the asset classes and it’s a group effort. So there are different aspects that you get to see at Och-Ziff that you might not elsewhere. So it’s a cultural thing, but it is also how we are restructuring on the opportunities that we offer.

[Ken Worthington:]

Okay and then lastly on the reserve, I believe the reserve needs to be probable and estimable. If you think it’s going to be higher than the $200 million why didn’t you reserve a higher number?

[Joel Frank:]

Look, I’m sorry Ken, I can’t say more than I’ve already said.

[Ken Worthington:]

Okay, thank you very much.

[Operator:]

Thank you. And the next question comes from Michael Carrier, Bank of America. Please proceed.

[Mike Needham:]

Hey good morning, this is Mike Needham in for Mike Carrier. Just kind of a two part question on flows and the outlook. The fee rate ticked down again decently in the quarter 134 to 131. Was it just the mixed shift given the outflows from the master fund products and should we, I guess looking at fund flows 2Q we can expect that pressure is going to continue? And then the second part, in the schedule you gave pensions are 35% of your AUM versus 33% last quarter. So I guess is it fair to imply that the pensions aren’t driving your recent outflows. Thanks.

[Joel Frank:]

So let me take the first part of your question on that. Say look diversification of our business has created a broader asset mix with varying fee structures. The diversification allows us to offer additional opportunities for investors and generates growth within the business and it will generate growth. I mean all of the multi-strategy assets have reduced over the last 12 months which obviously has an effect on the mix in our average management fee, we are confident we are going to have growth in all areas over time. In terms of the percentages, I mean obviously that in exchanges as investors come in and come out you are going to see that in the exchange. I wouldn’t conclude any specific thing on any individual sector. It is a broad - when people take distributions that is a broad based thing. Obviously most of it’s in the multi-strategy, but I wouldn’t make a conclusion on slight changes in the numbers.

[Mike Needham:]

Okay, thanks. I think last quarter you alluded to earlier in the call you gave us three reasons clients maybe seeing some increased outflows from clients, you think in 1Q is it more environment driven given the outflows for the industry or just kind of those same factors are in play? Thanks.

[Joel Frank:]

Same factors are in play.

[Mike Needham:]

Okay, thanks.

[Operator:]

That concludes the question-and-answer session today. I will now turn the call over to Ms. Madon.

[Tina Madon:]

Thanks Gemma. Thank you everyone for joining us today and for your interest in Och-Ziff. If you have questions, please don’t hesitate to contact me at 212-719-7381 and media inquiries should be directed to Joe Snodgrass at 212-887-4821.

[Operator:]

Thank you for your participation in today conference. This concludes the presentation. You may now disconnect. Good day.