Virtus Investment Partners, Inc.
Q3 2018 Earnings Call Transcript

Published: 26 Oct 2018

[Operator:]

Good morning. My name is Joel, and I will be your conference operator today. I would like to welcome everyone to the Virtus Investment Partners Quarterly Conference Call. The slide presentation for this call is available in the Investor Relations section of the Virtus website, www.virtus.com. This call is also being recorded and will be available for replay on the Virtus website. At this time, all participants are in a listen-only mode. After the speakers' remarks, there will be a question-and-answer period and instructions will follow at that time. I would now turn the conference over to your host, Joe Fazzino.

[Joe Fazzino:]

Thank you, Joel, and good morning, everyone. On behalf of Virtus Investment Partners, I would like to welcome you to the discussion of our operating and financial results for the third quarter of 2018. Before we begin, I direct your attention to the important disclosures on Page two of the slide presentation that accompanies this webcast. Certain matters discussed on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, and as such, are subject to known and unknown risks and uncertainties, including, but not limited to, those factors set forth in today's earnings release and discussed in our annual report on Form 10-K, quarterly report on Form 10-Q and other SEC filings. These risks and uncertainties may cause actual results to differ materially from those discussed in the statements. In addition to results presented on a GAAP basis, Virtus uses certain non-GAAP measures to evaluate its financial results. Our non-GAAP financial measures are not substitutes for GAAP financial results and should be read in conjunction with GAAP results. Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in our earnings press release, which is available on our website. Now I would like to turn the call over to our President and CEO, George Aylward. George?

[George Aylward:]

Thanks Joe and good morning, everyone. I'll start today with an overview of the quarter before turning it over to Mike to provide detail on the financial results. As we began, I'd remind you that our third quarter results include the addition of sustainable growth advisors or SGA which closed on July 1. Looking at the quarter, we believe the results reflect the strength and diversity of our business. In particular, I would note that the results demonstrated continued positive net flows, the favorable shift in our asset mix, a meaningful growth in revenues, earnings and margin, continued strong investment performance and further diversification of our business by product strategy and geography. So turning to assets and flows for the quarter. Despite, will continues to be a challenging environment for active asset managers, we again generated positive organic growth with a favorable mix in flow and assets under management. Long term AUM increased 16% sequentially to 103.9 billion with the addition of assets from SGA, strong market performance and positive net flows. Total assets which include the liquidity strategies ended the period at 105.6 billion. Total sales of 6.3 billion were meaningfully higher than the 4.6 billion in the prior year and divers the very high level of 6.6 billion in the per quarter as increased sales in retail and separate accounts and institutional, where more than offset by decrease in open end funds. Total net flows remain positive at 0.5 billion representing a 2.2% annualized organic growth rate on long term AUM primarily as a result of positive net flows in retail separate accounts and open end funds. Retail separate account not flows were positive 0.4 billion with increased sales in intermediary sold managed accounts and continued positive net flows in the private client business. The positive net flows and open end funds result from continued strong sales in domestic equity including Kayne's small and mid-cap offerings, as well Edinburgh's [ph] consecrated large cap growth problems. In terms of fixed income, excluding rate high income fund contribute positive net flows in the quarter. Institutional had modest net outflows of 01 billion, a stronger sales were offset by higher redemptions. The 1.5 billion of sales in the quarter included a significant contribution from SGA, as well as new mandates that funded two other affiliates. Redemptions were evenly split between outflows on existing and closed accounts and across various strategies at our affiliates. In terms of overseeing in October, which has turned out to be an extremely volatile and challenging month, we have had outflows in our mutual funds, particularly in the first half of the month. Regarding other products institutional, in terms of what we're aware, it's generally looking to be flat on a net flow basis and in structured products, we currently have a CLO in the warehouse space. Moving to the financial results. Operating income as adjusted increase by 28% to 48.2 million and the related margin increase of 38%. The contribution from SGA, as well as higher revenues from organic growth, market appreciation and performance related fees contributed to the increase. Revenues as adjusted increased 16% sequentially primarily due to our investment management fees from higher average assets and fee rate. The increase in the average assets was primarily due to SGA, but also benefited from market appreciation and positive flows. The fee rate increase was due to performance fees and an increased open end fund fee rate that reflected a favorable shift in mix of our assets. Operating expenses as adjusted increased 10% sequentially reflecting higher employment expenses as adjusted due to the addition of SGA and higher profit based variable compensation, partially offset by a 5% decrease in other operating expenses as adjusted. Turning to capital on the balance sheet. As we've demonstrated, our approach to capital management includes balancing our investing in the business, returning to couple shareholders and maintaining an appropriate level of leverage. As we indicated on our last call, with our current level of cash flow, we believe we can address all three priorities based on the facts and circumstances at any given time. This quarter, our main capital usage was closing on our investment and SGA. And then in addition, we used 5 million for share repurchases, announcing 2% increase in our common stock dividend and made 11% million of debt repayment. With the benefits of our enhanced scale, higher margin and increased earnings. We believe we can continue to return capital to shareholders, investing grow and maintain appropriate leverage. With that let me turn it over to Mike. Mike?

[Mike Angerthal:]

Thank you, George, and hello everyone. Before I review the results in detail, let me provide some of the key highlights. In particular, we had meaningful AUM growth as a result of SGA, market appreciation and continued positive flows. Revenue was also higher, reflecting the growth of the business and a more favorable AUM mix. Operating margins increased as a result of the higher revenues and the benefits of scale and the leverage ability of our model. And earnings per share grew significantly from both the prior quarter and the prior year. Importantly, the increase in EPS was primarily the result of organic growth complemented by the earnings contribution from SGA. So let me move to Slide Seven, assets under management. At September 30, long term assets were 103.9 billion, which reflects a sequential quarter increase of 15.7% and an increase of 19.3% from the prior year quarter. The sequential increase included 11.3 billion of assets from SGA as of July 1, as well as market appreciation of 2.5 billion and positive net flows of 0.5 billion. The SGA beginning assets are reflected in the other role and are AUM role forwards with 10.5 billion in institutional and 0.8 billion in retail separate accounts. The change from the prior year also primarily reflects the addition of SGA assets, market appreciation of 6.3 billion and positive net flows of 0.3 billion. As a result of adding SGA's assets, which are primarily institutional, our product mix has become more diversified with institutional comprising 30% of long term AUM at September 30 compared with 22% at June 30. SGA also provides us with more exposure to non-U.S. clients. AUM diversity improved by asset class product type and channel and we expanded our financial supplement disclosure to include additional asset class detail. Two points I would like to highlight. Our domestic equity assets are more diversified by market cap with large nor small caps exceeding 20% of total AUM. And are further diversified among core, growth and value strategies. In addition, emerging market equities are less significant portion and now comprise approximately 7% of long term AUM. As of September 30, 32 retail mutual funds representing 83% of Morningstar rated fund AUM had four or five stars and a total of 53 funds representing 98% of rated retail fund AUM at three four or five stars. Each of the company's five largest mutual funds is a five or four star fund. In addition, 75% of institutional assets were beating their benchmarks on a five year basis as of the end of the third quarter. Turning to Slide Eight asset close. Total sales were 6.3 billion, a decrease of 6% sequentially and higher retail separate account and institutional sales were offset by lower open end fund sales. We generated 0.5 billion of positive net flows in the quarter, reflecting positive net flows in open end funds and retail separate accounts, partially offset by modest net outflows in ETS and institutional. With respect to open end mutual funds, new flows for the quarter were 0.3 billion, representing an annualized organic growth rate of 3.1%. This organic growth rate resulted from strong total sales and included a 34% annualized sales rate for open end funds. Looking at mutual fund flows by asset class, domestic equity funds primarily small and mid-cap strategies at Kayne continued to generate strong inflows with 0.8 billion compared to 1.5 billion in the prior quarter. Kayne's mid-cap core and growth strategy sales were up compared to the prior quarter. And while the small cap strategy sales remained strong, they were down from the elevated levels of the second quarter. International equity funds which include both developed and emerging markets had modest net outflows of 0.1 billion in the quarter, consistent with the prior quarter. Positive net flows of 0.3 billion in the international small cap fund are offset by 0.4 billion of net outflows in the emerging and developed markets large cap funds. Fixed income funds had net outflows of 0.3 billion compared with 0.2 billion in the prior quarter, as 0.2 billion of positive flows in bank loan strategies were offset by modest net outflows in investment grade and short term bond strategies. Regarding flows in other products, retail separate accounts net flows were positive 0.4 billion in the quarter, representing an annualized organic growth rate of 97% as Kayne continued to generate positive net flows in both intermediary sponsored and private client accounts. Institutional flows which can vary greatly, reflected 1.5 billion of inflows including new accounts at new fleet, Kayne and SGA, offset by outflows of 1.6 billion across various strategies. The outflows are evenly split between closed accounts, including a client reallocation to quantitative and passive strategies and existing accounts, primarily sub-advisory fund relationships that have recurring sales and redemptions. It's also worth noting that on a year-to-date basis, total net flows are positive 1.1 billion, reflecting an annualized organic growth rate of 1.6% consistent with the same year a date period in 2017. Turning to Slide Nine. Investment management fees as adjusted of 123.4 million, increased 18.8 million or 18% sequentially, due to higher average assets under management. Our higher average fee rate and 3.6 million are performance related fees. Average long term assets under management increased 15% as a result of the addition of SGA, positive flows and market appreciation during the quarter. The average fee rate on long term assets for the quarter was 47.4 basis points, an increase from 46.7 basis points in the prior quarter. Excluding the 3.6 million of performance related fees, the long term average fee rate was 46 basis points, reflecting the addition of SGA institutional assets, partially offset by a higher open end fund fee rate. With respect to open end funds, the fee rate increased to 54.3 basis points from 51.8 basis points in the second quarter. The increase is a continuation of the trend we have seen over the past several quarters, which is the result of a positive fee rate differential between sales and redemptions. This quarter, the blended fee rate on mutual fund sales was strong at approximately 66 basis points, while the rate on redemptions was approximately 54 basis points. The structured product fee rate of 60 basis points included 2.3 million of a performance related fee on a 2007 vintage CLO that had been previously called. Excluding the impact of the performance related fee, the structured product fee rate was 35.4 basis points consistent with the prior quarter. Institutional fee rate of 31.9 basis points increased modestly from the prior quarter and included a 1.3 million performance related fee that represented the first year of performance measurement for that account. Excluding the performance related fee, which will be measured on a quarterly basis going forward, the institutional fee rate was 30.1 basis points which is a reasonable rate for modeling in the fourth quarter. We do not have performance related fees every quarter, but have them periodically and we are seeing more requests from institutional clients for these types of fee structures. Slide 10 shows the five quarter trend in employment expenses. Total employment expenses as adjusted of 61.7 million increased 15% sequentially from the second quarter. The increase in employment expenses reflects the incremental expenses of as GSA and higher profit based variable compensation. As a percentage of revenues as adjusted, employment expenses were 48.0%, a decline of 50 basis points sequentially. The trend in other operating expenses as adjusted, reflects the timing of product, distribution and operational activities. Other operating expenses as adjusted were 17.4, a decrease of 0.8 million or 5% from the prior quarter, which included our annual equity grants to the Board of Directors of 0.8 million. Excluding the director grants, expenses were flat as the addition of SGA's expenses was offset by lower sales and marketing expenses at declined 0.6 million sequentially. As we look ahead to the fourth quarter with our expectations of higher sales and marketing activities, other operating expenses could move to the higher end of our range of 16.5 million to 18.5 million. Slide 12 illustrates the trend of earnings. Operating income as adjusted of 48.2 million, increased 10.6 million or 28% sequentially and 13 million or 37% from the prior year quarter. Operating margin as adjusted was 38% compared with 34% in both the second quarter and the prior year quarter. Net income as adjusted of $3.64 per diluted share increased $0.67 or 23% from $2.97 per share in the prior quarter. The majority approximately 70% of the $0.67 per share sequential increase is attributable to higher revenues and profitability from organic asset growth with the remainder related to the contribution from SGA. The effective tax rate as adjusted for the quarter was 26.7%, a decline from 28% in the prior quarter. The decrease in the effective tax rate is the result of the impact of the majority ownership structure of the SGA investment on the calculation of tax expense. We believe this quarter's rate is good for modeling going forward. It's important to note that there are two items of economic value that are not included in net income as adjusted. Interest and dividends on CLO and seed investments were 3.4 million or $0.30 on an after tax per share basis in the quarter. Compared with 4.6 million or $0.39 per share in the prior quarter. And intangible tax asset amortization, as a result of acquisitions, including the SGA transaction will provide a cash tax benefit over the next 15 years of approximately 10.5 million per year at current tax rates. Regarding GAAP results, third quarter net income per share was $3.19 compared with $2.75 in the second quarter. Third quarter net of tax GAAP earnings included the following items. $0.35 per share related to a one-time tax benefit, $0.37 per share of acquisition and integration costs, primarily related to costs associated with the closing of the SGA transaction, and $0.49 per share of unrealized losses on investments. Slide 13 shows the trend in our capital position and related liquidity metrics. Working capital at September 30, 2018 128.2 million increased 33.9 million or 36% sequentially, reflecting operating earnings, investments in the business, changes in debt outstanding and return of capital to shareholders. For investment in the business, during the quarter, we closed on the 129.5 million SGA transaction that was financed with 105 million of borrowings and existing balance sheet resources. This increased gross debt to 363.1 million on the July 1 closing date. Gross debt outstanding at September 30 was 351.5 million, as we repaid 11.6 million of debt, representing a 1.6 million scheduled payment and an additional $10 million payment that will be applied toward our annual cash flow suite publication which is due in the first quarter of 2019. As we mentioned on the second quarter call, our working capital includes an estimate of the required debt repayment over the next 12 months. At September 30, our estimate of the excess cash flow suite publication was 17 million down from 33 million at June 30, which had the effect of the increasing working capital by 16 million sequentially. The net leverage ratio was 0.9 times net debt to EBITDA at September 30, an increase from 0.7 times at June 30, primarily reflecting the implemental borrowing related to the SGA transaction. Bank EBITDA for the third quarter was 57 million. Regarding return of capital to shareholders, share repurchases in the quarter totaled 5 million or approximately 38,200 shares of common stock, which represented 0.5% of total outstanding common shares as adjusted. In addition, we announced a $0.10 increase to the common dividend to $0.55 per share. The increase reflects the higher cash flow generation of the business and represents the first increase since we implemented a dividend in 2014. With that, let me turn the call back over to George. George?

[George Aylward:]

Thanks, Mike. Looking ahead, we'll remain confident that the advantages and leverage ability of our multi-boutique model, our diversification of close affiliates, asset classes, channels and products and our strong invest performance position us well for further growth. So with that, we will take your questions. Joel, can you open up the lines, please?

[Operator:]

[Operator Instructions] Our first question comes from Ari Ghosh with Credit Suisse. Your line is now open.

[Ari Ghosh:]

Hey, good morning, everyone.

[George Aylward:]

Good morning, Ari.

[Ari Ghosh:]

On the institutional channel, you mentioned the flows are flattish in early October I believe, so just curious what the dynamics look like over here. The pipeline has been growing quite nicely but also are you seeing a pickup in redemption notices given the market backdrop, just curious how that's playing out there? And then also, if you could give us some color on Kayne Anderson overall performance, I believe the longer term is quite strong but curious the one year on the near term looks like for the overall AUM?

[George Aylward:]

On the first one on the institutional, so we're sort of referring to is what is it that we're sort of aware of here is where what three and a half weeks into October. And as I indicated that's generally looking flattish. And the way I would sort of articulate that is I think a lot of people are just not doing a lot right now, so I wouldn't - because again the month has really been a challenging month. So there's not a lot of activity but we do have sales in the pipeline and we do think there is some other things that could eventually go out and it's trending sort of net. We're still happy with it. As you pointed in the call, having multiple affiliates having sales in a given quarter is a positive momentum for us because we sort of separately have a little bit of some of the smaller legacy business that's just going to run out on a normal basis. So for us, the primary driver is getting the diversity of sales and the growth of the sales where they are. And as you sort of alluded to as we were talking about flows in the quarter for institutional which are again were generally flattish modestly negative. That did include we referred to as you know client reallocation to pass the strategies. And that did impact the couple of our equity strategies. We don't see that necessarily for that situation to be continuing but who knows what institutional investors will do depending on how the rest of the year pans out. And I'm sorry, what was the other part of your question?

[Ari Ghosh:]

And then just on the overall Kayne Anderson performance, because a lot of that - a lot of your flows in the institutional side, SME is driven by Kayne as well. So just curious what the overall - like the nearer term one year looks like for them, across the border with some of your peers you've seen you keep on deterioration given what markets are doing, so was wondering if what their overall performance looks like in the near term?

[George Aylward:]

Yeah, look I mean with Kayne and with their focus on the asset classes in the small caps and the mid-caps, a lot of activity you see related to them will be influenced by how is the market feeling about those market caps. Kayne and - I think why is Kayne is attractive as a manager is a very disciplined approach to quality investing right. So that's the way to think of them. So even in the periods where they have outperformance or underperformance, the people that are attracted to them are people who like companies with very low debts that have you defensible competitive advantages. So actually from what we've seen over the years of, God I think 2002 was when we entered into our relationship with Kayne. Their approach to investing is actually more attractive, the more volatile and the weaker the equity market is because generally their companies lower debt, have much more defensible and competitive advantage, those are the companies they seek to invest in. So - but they will be subject to as we saw in the second quarter where there was a high level of demand in the smaller caps and it'll be interesting to see how the rest of the year shakes out. We've seen an uptick in mid-cap which we think is smart play to this point in the cycle is just the question will be what is - in the next two months in the quarter look like.

[Ari Ghosh:]

Got it. That's helpful. And then just on capital. You continue to buyback a modest amount each quarter but what will it take to get a little more aggressive here. I guess with the deal kind of close behind you now, how you're thinking about buybacks just given the current valuation of the stock and so the free cash flow that you highlighted like could you get a little more aggressive, are you looking to be a little more optimistic given what the markets are doing and the overall sort of valuation spread of it versus the traditional peers?

[George Aylward:]

Yeah. Sure. Great question. And the way I would sort of articulate it, if you look at as historically, we've had periods where the primary focus of our capital has been repurchases, some has been investing in acquisitions and in some it's been launching products. And as I sort of indicate in the prepared remarks, a lot of it depends upon facts and circumstances in the quarter right. So closing on a transaction is a fact and circumstance in a quarter which would cause us to be obviously utilizing cash to complete. But we think is a great acquisition to diversify our asset base, give us more non-U.S. exposure and give us access to a great high conviction growth equity capability. But every quarter is different. So we do consider all the factors including how our stock is trading relative to what we think is reasonable and the peers. And the whole point of us having flexibility in our capital structure is so we can take advantage of opportunities and one quarter it might be a transaction and then one quarter in might be as we've done in the past very aggressive stock repurchases. So we're pleased at the strength of our balance sheet in terms of what we have available proceeding cash flow allows us to prioritize things differently. So I would really look at it as it's something we toggle back and forth between depending upon different things. And our stock price is here, our stock prices last quarter is different than that has been in the first three weeks of this month. So that's something we're very confident about.

[Ari Ghosh:]

Got it. Thank you.

[Operator:]

Thank you. Our next question comes from Michael Cyprys from Morgan Stanley. Your line is now open.

[Michael Cyprys:]

Hey, good morning. Thanks for taking the question. Just wanted to talk a little bit about the seed book and the investment portfolio that you have on the balance sheet. If you could just update us on where those stand, I think you had some amount on that in the presentation, if you could just talk a little bit about the composition of where they stand today, what the expectation is for that going forward either in terms of redeploying, returning to shareholders and how much would you say is truly access at this point?

[Mike Angerthal:]

Yeah, I'll start on that. Hey, Michael, it's Mike Angerthal. I'll answer in a couple of ways and I think we've talked about our seed capital range between $100 million and $150 million and we've been consistent over the last probably year and a half or so between $100 million and $110 million. So as you know the way we think about those are we're deploying product in there to facilitate organic growth. And I think you're seeing that in products that George alluded to at Kayne Anderson like international small cap and others that have been instrumental to the organic growth. So that's not a part of the balance sheet that really is contributing meaningfully to the return levels that we talked about. That's really the CLO portfolio which is again is like $103 million or $104 million for the quarter and that's really the impetus that drove the $3.6 million of interest and dividend income that we referred to - that as you know we do not include in our non-GAAP measure. So that's something that is included in EBITDA which we highlighted, that was $57 million for the quarter. So it's an important component of generating that cash flow that enables us to execute on some of our capital priorities and George alluded to. So I don't think about those elements as generally part of what we would be using to be opportunistic to do other capital activities. When we look at capital overall, we look at the strength of the $57 million in the quarter where we're generating strong cash flows, enabling us to execute on a meaningful return of capital to shareholders. We've paid had a little debt this quarter just to ensure we have continued operating flexibility. And we have a balance sheet that has working capital to spend level that's generally in line with our range and enables us to withstand shocks in the market that would dealing with now. So I wouldn't look necessarily in our balance sheet assets to be redeployed. I would look to the cash flow they were generating. And those assets are instrumental to the seed for product launches and for the CLO where we generally supporting our fixed income managers for important product launches on the structured product side.

[Michael Cyprys:]

Great. And just on the CLOs, it is becoming a larger portion of your AUM base, real small in the grand scheme of things but are quite significantly over the past couple years. So maybe just curious your thoughts on the overall CLO industry which is also seen a lot of growth but there's also a little bit growing concerns and some pockets around credit quality and use a covenant light provision and some challenge or some funding of CLO equity in the marketplace in the past couple weeks. So just curious what you're seeing today in the marketplace on CLO's thoughts on the ability of source the CLO equity versus that what's on the books in terms of the balance sheet in terms of how are you using and any color around the composition of that CLO that's on the balance sheet in terms of vertical slices versus just the equity?

[Mike Angerthal:]

Yeah, I think I start there are a couple of points on that. It's Mike Angerthal. Our CLO exposure, our balance sheet exposure has been reduced this year and we were beneficiary of the changes in the risk retention rules. So we're pleased with that. As looking to that product and asset under management basis, as George alluded to, our sites affiliate has a product in the warehouse currently. They are a seasoned issuer going back probably over a decade with 15 years lead by George and his team. They have a product it in the warehouse phase and they also have third party equity and that is generally been a long term sponsor to them in launching products. I will take positions alongside to support and sponsor launches of products, but we have a high degree of confidence in that team. They manage an industry leading bank loan product as well. So they're very in tune with the market. And we have a great degree of confidence in their ability to navigate through these kind of choppy markets. And certainly the CLO market will go through ups and flows but they are and that there are significant participant in there, we have a great degree of confidence in that. Newfleet also has done CLOs in the past. But right now there, they refinanced a transaction this year but there's nothing currently in the warehouse on the Newfleet side.

[George Aylward:]

Yeah, just on CLO, just in particular, again there I think you sort of alluded to, you know a little bit of coverage about trying to make some kind of an analogous connection to curve light CLOs and high risk non-paper mortgages that were used to create CDOs, the CBOs that imploded during the financial crisis. And I don't think it's probably fair to make penology because there's a lot of differences in terms of the structural differences that have been put in place on those products and the credit quality. So it's - I'm always surprised that the only thing they are focusing on is curve light as opposed to the caliber and the quality of the underwriting that's being done and many of those companies like ourselves which are strong companies even if we're below investment grade and then the structural enhancement that are in those products. And we had CLOs from the pre-financial crisis that made it through the financial crisis. And size being a new addition to our family is a very experienced seasoned issuer. So I'm surprised, I think people make an over analogy to the mortgage back security issues that occurred in the financial crisis.

[Michael Cyprys:]

And just a quick follow-up on that point. The balance sheet position of the CLOs, is that all equity and to what extent is there any sort of use or balance sheet rescue around the warehousing base and the construction of the CLOs?

[Mike Angerthal:]

The $103 million is generally first loss equity, we exited some of the debt tranches where we held vertical slices earlier in the year. As for the warehouse phase, we have capital investment in that. We do expect it to securitize and based on the market conditions our expectation would be over the next 3 to 6 months or so. But our exposure there's like $7.5 million. So we made that investment earlier this year.

[Michael Cyprys:]

Great. Thanks so much.

[Mike Angerthal:]

Sure. Thank you.

[Operator:]

Thank you. Our next question comes from Alex Blostein with Goldman Sachs. Your line is now open.

[Alex Blostein:]

Hi, good morning, guys. First question is just a follow-up to your earlier discussion around flows, so far on October, do you guys highlighted the open end channel was up, you are seeing some challenges I think public that it would show something in the $500 million of outpost range and a lot of it is coming from Kayne. So, maybe comment a little bit on where the strength and flows we see from Kayne over the last couple years? What type of strategies or what type of accounts that go into and how should we think about the stickiness of the money that went into that product over the last few years given sort of the near term turbulence in the markets?

[George Aylward:]

Well a couple things. So for October, so we sort of alluding to is that, so for October which has just been really an awful month, that we have negative flows. It was probably the first half of the - particularly the first half of the year - first half of the month. And I sort of give attribution in a couple of categories. One is just the general nature of a volatile scary month does cause investors to hesitate. So I think we're seeing some impact on that on the sales side. I think we specifically and again also in the first half of the month had some using reallocation. And then also you deal with asset classes and how in favor out of favor they are. And if you saw a little bit of activity in small cap, some of that could be attributable to how did somebody feel about small caps in terms of where we are in the mortgage cycle and advance of mid-term elections. With the way - there if you're asking specifically about Kayne and I spoke a little bit earlier about why you would invest with Kayne. And it again is because you want to have investments in companies of higher - generally higher quality and generally have less debt and less exposure. So you'll be attracted to those in certain markets and not in others. Those where the assets are placed. There is both the retail separate accounts as well as the mutual funds. And while some of those were in the same firms, generally - sometimes see different behavior in terms of people in separately - retail separate accounts versus funds. Funds generally are more volatile more in and out then you generally see in separately managed accounts. And then I think as you know we also did for two of those strategies have some communications regarding soft closes on some of those products, which was does always create a little bit of confident you get around that period of time. But what I would really say and I've seen you and others refer to it, it's hard for me to really reach too much, three and a half weeks into October which is ended up as a historically is the most volatile market. So that would really be the characterization that helps.

[Alex Blostein:]

Got it. Yeah. That's helpful. And then second question I was hoping you guys could expand on your earlier comments around changes you're seeing in the institutional up that for performances fee structures. So maybe talk a little bit about which type of product, what's typical arrangement between just kind of base fee versus performance fee and broader thoughts on whether or not you expect to adopt more of those structures and how that could impact your fee rate in the institutional business?

[Mike Angerthal:]

Yeah, and you're right. It's hybrid type of structure that we're seeing and we saw at one of our affiliates tells one of their clients implemented this type of fee structure, where you have a base fee and there's a percentage on a relative analysis of performance versus benchmark. And then we've seen in the RFP process, these type of similar structures where they will generally have a base fee component and a measurement again sort of a relative benchmark. We actually saw that on one of the mandates that we discussed that got funded at one of our affiliates this quarter. So we're seeing it more and more from institutional clients to generally align interests with the portfolio manager and the outcome from the clients. So it's something we're monitoring it's still less than 3% of our total revenues in this period something if it becomes a more meaningful, we will provide more transparency around it. And I think one of the important things to note on the $1.3 million that we recognize this quarter, it was for a full one year period, so I would expect it to be at the level going forward, but it obviously will vary based on performance relative to the benchmark and other factors, but it is something we're seeing a bit more of it.

[Alex Blostein:]

Yeah, and the structure makes a lot of sense. What's the typical delta between I guess in terms of you guys seeing in terms of a kind of reset based fee versus the all end fee prior to the change, I am just trying to get a flavor for the magnitude of base fee change extra formal fees?

[Mike Angerthal:]

It's hard, it will vary depending on its asset class again we only have couple of them. So in some period the net outcome will be higher, in some period it will be lower than what the base fee was. It's hard to characterize that specifically.

[Alex Blostein:]

Okay. Understood. And the last just going clean up question. So Mike you guys talked about, I see interest in dividend of $0.30 this quarter not being capturing in your adjusted earnings and then you also get a tax yield you know back in the envelop looks like that's almost 20% of your kind of reported adjusted earnings number, any thoughts about shifting the reporting network to incorporate these items you know similar to I guess a lot of the peers in the space for you guys. And then with respect to the $0.30 specifically, I think you mentioned it's down sequentially, what is the reason for the decline and its $0.30 in kind of interest dividend income a decent run rate here?

[Mike Angerthal:]

Yes, it's good question and I'll just ballpark, I mean the contribution for the balance sheet, investments has increased significantly and we had an earlier question on that specifically the makeup of the changed materially when we did the Ridgeworth transaction because of the more meaningful CLO business. So we haven't updated our metric since the transaction and something we're spending a lot of time internally looking at. So certainly from the balance sheet investments, investors look at the cash flow generation of companies like ours and we are spiking out the cash component of that, so it is consistent with what we think investors should be looking at and do look at in evaluating how to value firms like ours. So we are looking carefully at that. Any time we change our performance metric, we want to be measured in evident context of what's going on. So we do that very thoughtfully, but it is something under evaluation especially as it relates to the interest in dividend income. On the tax side, that's a little more difficult, if there's variances you know in practice where some bring their cash tax rate or estimate their cash tax rate. We try and point investors to the balance sheet and look at the deferred tax asset on there and then we highlight the benefit will have on the tax shield so to speak which provides as we said $10.5 million over 15 years and we've seen investors look at that on a net present value basis to try and describe value to that. And you're absolutely right, we're seeing that are at a level that's somewhat meaningful, very meaningful when you're looking at current stock prices and we talk about an MPV basis. So we'll continue to provide transparency on that we'll evaluate it in context of the metric, I'm not as far advanced on that one in metric as I am on the first item.

[George Aylward:]

Yeah, bottom line is on that those are two items of true economic value that truly create value either create cash or shield cash outflows for us and reason might highlight it and we always highlight it is to do what you're doing which is try to how to think about it because again those are earning streams that people should be describing some form of valuation to.

[Mike Angerthal:]

And then your second point Alex, we had a decline of a little over $1 million quarter-over-quarter on the interest in dividend income. And that's generally due to lower distributions from the CLO investments. Again as I alluded to that's the majority of the contribution there. And CLO investments on the equity tranche as you probably know don't have coupons that coupon rates or yield associated with them, so they could vary to period-to-period. What we've talked about and what we've seen is generally over an annual period a yield in the range of like 6.5% on the balance sheet. So when we think about it we look at it more over an annual period and that has been sort of a general context stuff of the level we've seen.

[Alex Blostein:]

Great. Thanks for answering all my questions.

[Operator:]

Thank you. Our next question comes from Jeremy Campbell with Barclays. Your line is now open.

[Jeremy Campbell:]

Hey, thanks, guys. Most of it have been answered but just one kind of clean up question here. I think for some your peers, I think the rough relationship between incentive revenue is like 30% of that gets to kind of given back through the comp line. Is that really kind of the applicable ratio I've heard is, so I think your call I think $3.5 billion of incentive base revenue, does that mean 1.5 to 2 was the contributor to increasing comp?

[Mike Angerthal:]

Yeah, I mean we typically don't share affiliate level information on what ratio is. I think a better way to look at is on the employment expense line, we highlighted it came in at the low end of that range this quarter at 48% and that - as you know there are incentive compensation elements to those fees and it does impact the employment ratio. George?

[George Aylward:]

Yeah again, we don't give you no detail into the breakdown of all of that. There's so many things that come together in the creation of the sharing in affiliate comp plan that to give them a piece because doesn't really give a lot.

[Jeremy Campbell:]

Yeah, I'm just sort of trying like is lopping off that extra piece of the fee rate side for the modeling go forward for what you guys talked about earlier, I just want to make sure that we're also thinking about the expense right way to?

[Mike Angerthal:]

Yeah, and you may want to do just that the incremental margin you talked about a 50%, it's just all is being equal, a good way to think about it.

[Jeremy Campbell:]

Got it. Great. Thanks guys.

[Mike Angerthal:]

Thank you.

[Operator:]

Thank you. Our next question comes from Michael Carrier with Bank of America Merrill Lynch. Your line is now open.

[Michael Carrier:]

Hi, thanks, guys. Just one for me. Just given what we've seen over the past few quarters in terms of the flow strength and then you mentioned in October and obviously the shifting dynamics kind of in the market. Just wanted to get your guy's sense when you think of the product line up, the distribution in the sales teams in an environment where maybe some of the small caps are soft closes, maybe is a little bit more interest on the value side. When you think about the products you guys have, what are the ones that would potentially start to stand out kind of in a shifting backdrop over the next 12 to 24 months?

[George Aylward:]

Yeah, I mean it's a great question but the big unknown is really where is the market go and where do investor preferences go, right. And generally a lot of our strategies are more overweight to slightly more defensive or higher quality types of approaches. I definitely think you know there is a scenario where there's a movement from growth to value. Again we have value capability, so that could be something that could be become more interesting for people. The market is volatile, I would think people would want to be more quality oriented types of strategies rather than high obtain strategies. We generally don't have a lot of our assets in those types of capabilities. And then the real question is really what's happening with interest rates and where people how they want to access fixed income. And in terms of looking at yield and right now we sort of pointed out that the high income fund is in positive flow. So that's right now is attractive but are people going to be taking a different look at things like investment grade. So the bottom line is the reason that we try to have a variety in a diversity of different managers and capabilities is hopefully that when one is out of favor, the other one is in favor, right. So if growth is out of favor and values in favor, we can play that. And if spread to fixed income is out of favor and high quality sleep at night investment grade is back in favor, we can play that as well. So we do sort of think through that so in terms of our product suite that we that we can sort of have attractive offerings in different market cycles. I mean the whole point for us is to try to avoid that fees and family concept, which sometimes means that things blend out a little bit, but it's good to have the flexibility. So it'll be interesting to see I think the market will probably decide after the midterm elections in later in the year what it wants to be in 2019.

[Michael Carrier:]

Okay. Thanks a lot.

[George Aylward:]

Thank you.

[Operator:]

Thank you. This concludes our question-and-answer session. I'd now like to turn the conference back over to Mr. Aylward.

[George Aylward:]

Great, thank you. And I just want to thank everyone for joining us today. And as we always do, I would encourage you to give the call if you have any other further questions. Thanks and have a great weekend.

[Operator:]

That concludes today's teleconference. Thank you for participating. You may now disconnect.