Sculptor Capital Management, Inc.
Q4 2015 Earnings Call Transcript

Published: 11 Feb 2016

[Operator:]

Good morning, everyone, and welcome to the Och-Ziff Capital Management Group's 2015 Fourth Quarter Full Year Earnings Conference Call. My name is Jenna, and I will be your operator for today. [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, Jenna. Good morning, everybody. 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 2014 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 these 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. With that, I will now turn the call over to Dan.

[Dan Och:]

Thanks, Tina. Good morning, everyone. As you all know 2015 was a difficult year for equity and credit markets globally and 2016 gotten off to an extremely challenging start in global markets and in the industry. We have experienced periods like this in the past and while they can be difficult in the short-term, we believe, they ultimately play to our strengths. We are well positioned to manage market uncertainty. Dynamic capital allocation has always been a cornerstone of much of our business and it will be critical in this environment. Our focus remains on identifying investments in situations that we believe can perform regardless of market direction. Volatility creates opportunity for us. Investors turn to our firm in turbulent times for a number of reasons, our risk management, our reputation for outperformance in choppy markets and our focus on capital preservation. I feel good to know we have expertise in either storm as we saw in energy, in credit or in Asia this past year. Let me quickly recap our performance in 2015, begin with our multi-strategy funds. The OZ Master Fund generated gross return of 1.6% and a net return of minus 38 basis points. On a gross basis, merger arbitrage in the U.S. and long-short equity in Asia generated the strongest returns within the portfolio and our credit strategies in aggregate produced a slightly positive return. Long-short equity in the U.S. had the weakest performance as our long positions underperformed, while our short positions performed strongly. Since we are modestly not long in this area of the portfolio, this dynamic adversely affected our returns. Our Europe and Asia multi-strategy funds had strong performance years in 2015, with our Asia fund generating a gross return of 13.8% and a net return of 9.6%, and our Europe fund, a gross return of 8.9% and a net return of 5.8%. While our regional strategies comprise a small portion of our multi-strategy assets, they were important contributors to the performance of the Master Fund and on demonstrated the strength of the investing teams we have in these geographies. In opportunist to credit, OZ-CO our global credit opportunities fund generated a modest loss on a gross to net basis last year. We have been reducing risk in the portfolio giving us significant buying power to put to work in the coming months. As the credit markets become more and more dislocated, the forward opportunity set becomes extremely interesting to us as distressed investors. Our closed-end opportunistic funds continued to successfully harvest investment despite difficult market last year, reflecting the success we have achieved in investing across a range of credit assets. As of year-end, these funds had since inception gross IRRs of 17% to 24% and gross MOIC of 1.4 to 2.1 times. In real estate, we are taking the same highly selective and measured approach to deploying capital in our third opportunistic funds that we did in our first two funds. We have committed approximately 25% of funds to-date and continue to be vigilant about finding the right opportunities given market volatility and where we are in the real estate cycle. Our first two real estate funds continue to return capital LPs, although we remain extremely disciplined in our approach to the timing of realizing investments. We are very pleased with the performance of these funds. As of year-end, our first fund had since inception gross IRR of 25% and a gross MOIC of two times. Our second fund has since inception gross IRR of 35% and a gross MOIC of 1.7 times. In terms of our more recent initiatives, our dedicated equity funds generate an average net return of over 4% on approximately $1 billion of capital last year, due to an overweight allocation to European and Asian equities. We are pleased with this performance, especially since 2015 was a difficult year for many long-short equity funds, particularly those with an event-driven orientation. As we turn 2016, the environment clearly requires caution. That said, we are opportunistic investors, with deep expertise across a number of asset classes and geographies. This gives us a significant competitive advantage in capitalizing on the types of market dislocations that are currently taking place. There are three areas in particular that we believe will be sources of interesting investment opportunities in the coming months, credit, merger arbitrage and energy. Each of these areas will also create new opportunities in equities, particularly on event-driven side. In credit, we believe the opportunities set is evolving rapidly. There are definitive signs of distress and dislocation in some parts of the global credit market, including U.S. high-yield, emerging markets, energy and commodities. We are closely watching to see if these areas become a reinforcing cycle or broader risk aversion that creates new investment opportunities. We expect volatility to continue as market participants navigate the growing uncertainty and stress in the credit markets, could have a widespread impact on broader market in the coming months. This is an interesting dynamic for us, because we have such a strong investment team with expertise in so many areas of the credit markets. This positions us to capitalize on a broad universe of opportunities, not only in credit, but in many other areas as well. For the same technical and structural reasons that will potentially create significant opportunities in credit, merger arbitrage has become very attractive and we see a number of merger situations where spreads are particularly wide. Our capital attribution in the strategy in the Master Fund doubled to 12% in the fourth quarter of last year, the highest it has been since 2007. In energy, we continue to believe the dislocation in the North American private energy sector is creating a number of compelling investment opportunities across the capital structure, including credit, equity and private investments. In the currently depressed commodity environment, there is greater need than ever for access to external capital. We believe the expertise of our energy private equity team will enable us to capitalize on those opportunities and create significant value. As I mentioned, the evolution in all these areas creates opportunities in equities. We own many ventured investments that we believe remain fundamentally undervalued and we have conviction that these positions will perform in the future. In addition, our investment teams are working hard on many situations that we believe have reached interesting price levels. Now, turning to our assets under management, we entered 2015 with $45.5 billion in AUM, a 4% decline from the prior year, because of net outflows of approximately $1.2 billion, distribution of about $900 million and just a small amount of capital appreciation. As of February 1st, we had $43.7 billion in AUM. We saw $4.7 billion in net outflows from our multi-strategy funds in 2015 and another $1.2 billion so far in the first quarter of this year. These net outflows were primarily from the Master Fund as market volatility and challenging market conditions for the industry overall negatively affected our flows. As always, there are many reasons that factor into allocation decisions by our LPs. Some of the larger ones include reducing exposures to the hedge fund industry and we are balancing to maintain asset allocations or to achieve different return and risk profiles. Uncertainty stemming from the FCPA investigation has also had some impact on investment decisions by certain LPs. On the credit side, we saw $3.2 billion of net inflows through a combination of new capital commitments to opportunistic funds and CLO issuance last year. Over 60% of the $1.1 billion net inflow on the opportunistic side reflected a five-year capital commitment. Our closed-end opportunistic funds returned about $730 million last year due to realizations. Diversification clearly strengthened our business in 2015, as client interest in inflows to newer products offset some of the outflows we saw on the multi-strategy side. Although markets have been volatile, we remained focused on our strategy to grow and diversify by introducing new products, where we have track record and can address investor demand. Last year, we initiated a number of new products in real estate credit, European performing credit and in the space [ph]. These are in addition to announcing a partnership with NorthStar Asset Management, to develop closed-end credit funds. We anticipate that each of these will show asset growth this year as we start building them to scale. As we look ahead to what will likely continue to be a volatile year, we see considerable opportunity for experienced managers with sufficient capital and deep investment expertise. In challenging markets, LPC asset managers who can offer exactly what we have, a track record of excellent performance, a diverse array of products, a strong global franchise and a robust infrastructure. It is this combined offering that enables us to take advantage of opportunities across markets and I believe this agility will be crucial in 2016. With that, let me turn the call over to Joel, who will take you through our financial results.

[Joel Frank:]

Thanks, Dan. This morning we reported 2015 full-year distributable earnings of $252 million or $0.49 per adjust Class A share. This amount reflects a fourth-quarter loss of $36 million or negative $0.07 per adjust Class A share. We will not pay a dividend this quarter. 2015 full year revenues were $849 million, 30% lower year-over-year. While management fees were essentially unchanged at $642 million, our incentive income declined 63% to $205 million. Although the Master Fund represented the majority of the incentive income we earned in 2015, the mix of our incentive is diversifying as we grow our credit, real estate and other platforms. Collectively, these platforms generated approximately 30% of our total incentive last year. Our credit funds, including our CLOs and our real estate funds, can earn incentive at the end of a longer-term lap or after the investment period of the fund that they are in has been completed. We anticipate that contribution to incentive will continue to increase and be substantial, but recognition will be over time as we build these platforms to scale. Full-year operating expenses were $504 million or 4% increase over the prior year. Of this amount, comp and benefits expense was $303 million, 16% lower than the prior year. Salaries and benefits expense increased by 10% as their headcount grew by a comparable percentage while cash bonuses expense declined 26% as a result of the decline in our incentive income. The ratio of cash bonuses to total annual revenue was 22%. This level of bonuses was driver of our fourth quarter loss. We take a long-term view to building our business and our competitive positioning. Our employees are essential to that. We believe that we have the strongest, deepest bench of talent than we have had not had since the firm's inception. This is true across the Board, from investment professionals to our fund client relations team to our global infrastructure teams. While the level of cash bonuses reflected the substantial decline in their incentive income last year, it also reflected the need to maintain a sufficiently competitive compensation structure so that we can continue to attract and retain top talent. Non-comp expenses were $201 million, 60% higher than the prior year. This increase was primarily due to higher legal fees related to our ongoing FCPA investigation and the full-year effective higher interest expense in the bonds we issued in late 2014. Our full-year effective tax rate was 27%, which reflected the lower level of incentive income we earned relative to the management fees. We believe our 2016 effective tax rate will be in the range of 25% to 30%. For the first quarter this year, we estimate the ratio of our operating expenses to management fees will be in the range of 56% to 60%. For salaries and benefits, we estimate that ratio will be 20% to 22%, and non-comp expenses will be 36% to 38%. We anticipate that there will be some normalization of our non-comp expenses from the fourth quarter levels once the investigation is resolved. However, the exact timing and magnitude of this normalization is difficult to predict. While it is certainly still our hope the investigation is concluded by the middle of this year, we may see some heightened level of legal expenses for a period of time after that. Additionally, we continue to make investments in our infrastructure to position our business for future growth. In 2015, we paid out 82% of our annual distributable earnings in the form of dividends. As we think about 2016, we do not anticipate any change in our policy of paying out substantially all of our distributable earnings. However, as always, we will evaluate the use of earnings with a view to optimizing total return to our shareholders. Before closing, let me just add that we know the investigation has raised questions and created uncertainty, unfortunately, because it is ongoing, we cannot provide any further information at this point or speculate on the potential outcomes. We recognize that this is not ideal, but we want to assure you that we will provide further details when we can. We know that the resolution of this issue as is important to you as it is to us. In closing, although 2015 was a challenging year for us and for many in the industry, the fundamentals of our business are very strong. We are an alternative asset manager with an exceptional long-term performance track record. We have made great progress in diversifying our business and taking advantage of our competitive strengths in the markets for multi-strategy, credit, real estate and energy products. We have an extraordinary talented team in place across our business and we are well-positioned to capitalize on numerous opportunities that we globally. We believe that over the long-term, the combination of these elements will deliver superior value to our LPs, shareholders and employees. With that will now take your questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Mike Carrier, Bank of America Merrill Lynch. Please proceed.

[Mike Needham:]

Hi. Good morning, guys. This is Mike Needham in for Mike Carrier. Just first, you mentioned a few reasons for the outflows and multi-strat, reducing exposures, reallocating and then the FCPA investigation. I guess, how do you think about market share in the product? Do you think people still like the multi-strategy broadly and which of those factors they mentioned do you think has been most important for clients?

[Dan Och:]

We absolutely feel good about market share and about going forward prospects, the multi-strategy fund has a very long-term track record. The team is stronger than it has ever been, the depth of our resources are stronger than they have better been. You have to remember that our strategic plan to become a multi-product alternative asset manager provides substantial benefit to multi-strategy fund investors. We have got a much larger and we are global credit team. Our private real estate and private energy teams are very relevant to the investing in those areas and multi-strategy investors benefit from that, so we have been through tough periods in markets and the industry before. We have been doing it for 22 years. Most to you went through this with us in 2008, and you know that during these difficult periods, it just seems difficult, but if we continue to do what we have always done and continue to do a little things that strengthen the firm and provide clarity and confidence to investors, it has always led to substantial growth and higher market share and we are confident that will be the case again.

[Joel Frank:]

Yes. I think just to add to that, Dan's points are all akin. I think it is important to understand, certainly multi-strat is an important product and one opportunity, but because of our expertise and diversification all our products, we give people the ability to invest in different exposures and different structures, so that it is not just the multi-strat. However, I think, across the Board, because of the value and the expertise that we have - we not only in the past offered a lot to people, but we have a lot more to offer now.

[Mike Needham:]

Okay. Thanks. Then could you just walk through the bonus expense decision for 4Q and just balancing or retaining people versus the weaker performance in the year and the negative [ph]. Thanks.

[Dan Och:]

Yes. Look, our view in terms of resources is not obviously continuity in the business. We have the deepest and strongest bench of employees we have ever had. We think the highest quality employees, and although we did adjust bonuses down, we felt there was a certain level of that we had to pay people in order to be competitive and to compensate them properly and we thought the use of resources to do that was in the best interest of all our investors, LPs and our public investors as well.

[Mike Needham:]

Okay. Thanks for taking my questions.

[Operator:]

Thank you. The next question comes from the line of Bill Katz from Citi. Please proceed.

[Bill Katz:]

Okay. Thanks. Good morning everyone. Just a couple of questions, I guess. The first one on the Master Fund, certainly appreciate your strategic position, but the flow story there continues to be disappointing. What incremental strategy can you do to possibly offset some of the runoff to try and drive growth and here I am thinking about your thoughts on pricing, new distribution opportunity set or maybe something that you might thinking about try and grow this part of the business again.

[Dan Och:]

We have been focused on new distribution opportunities. I mean, we talked about the fact that private banks were one of those initiatives going back several years ago, we have other strategic initiatives in place. No discussions or considerations are on pricing. We do not think that is the relevant issue at all.

[Bill Katz:]

Then I know you are not going to talk about the investigation itself, but Joel, I am sort of curious, you mentioned that you expect these, the non-comp numbers, which I think were a lot higher. Do you anticipate even from here, so lingering on the other side of this? Could you talk a little bit about why that might be? Is there some kind of structural change that might be coming here or is it just sort of some built in overhead that just takes time to sort of work itself off the system once you get on the other side of any kind of resolution?

[Dan Och:]

Yes. I think it is more of a latter than the - a meaning that. Obviously, there are legal expenses related to the actual investigation. Then as you go through the process of settlement and everything else, my expectations would be there is going to be some elevated level of expense beyond that. That is why the best thing I can do for you is give as much information as I can and as much guidance as I can as we go through the process and as the process finalizes and moves forward.

[Bill Katz:]

Just last one. Thanks for taking all these notes, because [ph] everybody. The tax rate is that just an earnings mix issue, sort of where you are right now on performance year-to-date and sort of thinking about management fee versus incentive income?

[Dan Och:]

If you are talking about the projection for 2016, yes. For 2015, obviously, it is the result of the mix of income and how it flows through the model as you already understand.

[Bill Katz:]

All right, thank you guys.

[Operator:]

Thank you. The next question comes from the line of Patrick Davitt from Autonomous. Please proceed. You are live in the call.

[Patrick Davitt:]

Hi. Good morning. Thanks for taking the question. You mentioned that 30% of incentive is coming from the more closed-end strategy. I know it is difficult, but if you think about the seasoning of those positions and how do you cover broad idea from where we are sitting now, particularly after the sell-off, we have had. Do you feel like that could be about the same this year, higher or lower, are you even willing to go there?

[Dan Och:]

Look, I think you are making the right point. It is hard to tell, because it all does depend on market conditions and opportunities. Obviously, we are going to try to realize whatever sell-off and realize whatever incentive we can over time. Very hard to predict, again, it is going to depend on the markets and opportunities, but obviously we have a focus on generating and spending from those investments and will do them as soon as we can.

[Patrick Davitt:]

Okay. Then do you have visibility on a tax-related incentive distribution in the first quarter?

[Dan Och:]

I am sorry. Could you repeat that? I did not hear you?

[Patrick Davitt:]

Yes. Do you have visibility on a tax-related income of distribution in the first quarter?

[Dan Och:]

None.

[Patrick Davitt:]

Okay.

[Operator:]

Thank you. Our next question comes from Gerald O'Hara from Jefferies. Please proceed.

[Gerald O'Hara:]

Great. Thanks. Just a couple of from us, I guess, to start increasingly we have been hearing about sovereign wealth funds needs to raise liquidity given the energy backdrop and what not. Can you perhaps provide a sense of how discussions have been tracking with respect to allocations or potential implications going forward with respect to that?

[Dan Och:]

Look no major implications in terms of what you have been reading about other funds. We do not have those issues and generally I do not have big exposure to sovereign wealth funds. Although, where we do have conversations with sovereign wealth funds, they have generally have been positive.

[Gerald O'Hara:]

Fair enough. Then I guess one for Joel. With respect to the balance sheet, can you size what amount of the cash on the balance sheet is basically free and clear or not subject to kind of regulatory holding or what have you?

[Joel Frank:]

Well, look, we are very little in terms of the regulatory holding. We do not have the big balance sheet. Obviously, there is a small amount of cash that we have retained for even new products and general corporate purposes, but it is not material at this point in time.

[Gerald O'Hara:]

Then just one last one, can you remind us any specific kind of covenants or maturity on outstanding debt that is coming up in the near-term or might be coming up.

[Joel Frank:]

No. There are no covenants.

[Gerald O'Hara:]

Okay. Thank you.

[Operator:]

Thank you. The next question comes from the line of Robert Lee, KBW. Please proceed.

[Robert Lee:]

Thank you, good morning. Just going maybe back to the fund raising, I am just curious - I mean, in looking through some of the tables, I was curious where you with maybe raising some closed-end opportunistic funds. I mean, I think, the last credit fund you had it is probably a couple of years old, but I mean closed-end fund kind of a couple of years old at this point, so could you maybe talk about some of the capital raising initiatives underway and kind of closed-end structures. Then I think in the past memory serves me you had talk about - and maybe there was some real estate debt or energy kind of opportunity, so kind of curious where some of those initiatives stand?

[Dan Och:]

Sure. I mean, we have talked about some of them. We talked about the NorthStar closed-end funds. We have talked about our real estate credit fund, but I think the point you highlight is very important. We do not have a proven track record. We went out in 2010-2011. We went and told investors, do not invest in optimistic credit yet, then when we thought it was time, we went to them, we told them it is time and here it is how we think we should invest and where you think we should invest? We very successfully compounded returns on that capital and then have returned large amounts of capital to them, so we think we are one of a small number of branded alternative managers who have shown the ability to tell people when not to invest when to invest, made money for them and then returned the capital to them when it was the right time. As we now see the opportunities develop in the credit markets, we think there will be a lot more for us to do, we think we will have a lot credibility. As we commented during the call, approximately $700 million of the recent commitments we got were a five-year commitment in the credit space, so we see a lot of growth the potential for us in that area.

[Robert Lee:]

Okay. Great. That is all I had. Thank you.

[Dan Och:]

Thank you.

[Operator:]

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

[Will Cuddy:]

Good morning. This is Will Cuddy standing in for Ken. Thank you for taking our questions. You had mentioned launching new products, what type of investors are you targeting for these new products, particularly with NorthStar, I am thinking?

[Dan Och:]

Well, we talked about our growth opportunities. One of them is the potential for not only these to penetrate our current investor base and cross-sell new products to our current investors, but to expand our investor base and our distribution potential, so we are focused on doing that. We are focused on doing that through products such as the NorthStar closed-end fund and other potential distribution relationships, [ph] and others. We are focused on doing that by taking our new product areas they developed make sure we are sure that they have the investor relations and client service capabilities that they need, so we think that broad opportunities exist. One thing that we do want to make sure to point out, there has been some discussion about the loss this quarter and about the decision on the bonus side in terms of the employees. Over the last five years, we think we have been very successful on our strategic plan to move from being a leading multi-strategy hedge fund manager to being a leading multi-strategy alternative asset manager. You have seen that in terms of $12 billion in credit assets and $16 billion in long-term assets and what we have done in real estate and what we have planned in energy et cetera. We have got over 650 people at the firm now. We believe we have the pieces in place to be substantially larger in many asset classes and to be substantially larger as the firm. While the decision this quarter was difficult, we believe it is the right long-term decision for the firm and we feel very good moving forward.

[Joel Frank:]

I will add to what Dan has said, in relation to what we are doing with NorthStar. We already have a great exposure into private banks, but in the retail space that is where NorthStar closed-end fund and so on help, so when you talk about different distribution channels and going different levels of investors increasing our retail exposure increasing our exposure to other types of investors will generate normally from products such as what we are doing with NorthStar.

[Robert Lee:]

Great. That is helpful. Then to kind of chime into that, so there is a - best interest proposals that things are likely in view by the office of management and budget. Do you see risk from that - if it comes out in a similar firm to what the most recent proposal was?

[Dan Och:]

Look, I do not necessary see there is risk. I think it may change the types of funds and opportunities that we will pursues an example with NorthStar, but that is I think also going to be because there are other ways of doing this, well I do not see there is risk. I see there is just an adjustment, the types of opportunities and structures we may pursue.

[Robert Lee:]

Okay. Thank you for taking our questions.

[Operator:]

Thank you. That concludes the questions-and-answers session today. I will now turn the call over to Ms. Madon.

[Tina Madon:]

Thanks, Jenna. Thank you everyone for joining us today and for your interest in Och-Ziff. If you have any questions, please do not hesitate to call me at 212-719-7381. Media inquiries should be directed Joe Snodgrass at 212-887-4821.