Waddell & Reed Financial Inc
Q1 2020 Earnings Call Transcript

Published: 28 Apr 2020

[Operator:]

Good morning, and welcome to the Waddell & Reed First Quarter 2020 Earnings Conference Call. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Mike Daley, Vice President, Investor Relations. Please go ahead.

[Michael Daley:]

Thank you. On behalf of our management team, I would like to welcome you to our quarterly earnings conference call. Joining me on our call today are Phil Sanders, our CEO; Ben Clouse, our CFO; Brent Bloss, our President; Dan Hanson, our CIO; Shawn Mihal, President of our Retail Wealth Management business, Waddell & Reed Inc.; and Amy Scupham, President of Ivy Distributors, Inc.Before we begin, I would like to remind you that some of our comments and responses may include forward-looking statements and non-GAAP financial measures. While we believe these forward-looking statements to be reasonable based on information that is currently available to us, actual results could materially differ from those expressed or implied due to a number of factors that we reference in our public filings with the SEC. We assume no duty to update any forward-looking statements. Materials relevant to today's call, including a copy of the press release that contains a description of these non-GAAP financial measures and a reconciliation to GAAP and supplemental schedules have been posted on the Investor Relations section of our website at ir.waddell.com.I would now like to turn the call over to Phil.

[Philip Sanders:]

Thanks, Mike. Good morning, everyone, and thanks for joining us. Before we get into the more detailed financial discussion, I want to take a moment to address the extraordinary environment we and the world are currently navigating. The COVID-19 pandemic has caused one of the most rapid and dramatic global economic downturns in history. We may not fully realize the totality of the tragic human consequences for several months. The U.S. stock markets dropped approximately 35% from peak in February to trough in late March.Global economic activity had a full stop around the world as countries and businesses implemented plans to isolate and protect their citizens and employees. Remarkably, within about 30 days, we moved from a relatively strong domestic economy with financial market indexes heading record highs to a global recession. Amid the unprecedented uncertainty and volatility, our company proactively implemented a comprehensive business continuity plan that allowed us to effectively respond to the crisis while maintaining the safety of our employees, clients, independent advisers and stakeholders in the communities where we live and work. We adapted quickly, and by late March, 98% of our workforce was working remotely with negligible downtime.I'll let Brent give highlights of our preparation and response activities in just a moment. I think it's important to note here as well that despite the circumstances and challenges, we remain positioned to execute on our long-term strategic plan. Our steady and proactive response has allowed our asset management and wealth management businesses to maintain continuity of service and the access that our clients need and expect.In short, we are actively managing through this acute global disruption while remaining focused on our long-term growth and competitive position. We maintain a strong financial profile with significant liquidity. In addition to a high level of cash reserves and the significant investment portfolio, the firm operates with a low level of debt. Our exceptionally strong balance sheet allows us to continue to execute our long-term growth strategies while retaining our focus on controlling expenses. Periods of volatility and dislocation may generate additional opportunities or growth accelerators that require a nimble approach, and we remain prepared to respond. As such, the tenants of our long-term strategy remain at the center of our executional approach, as we continue to drive the transformation of our wealth management business to realize its full value and growth potential, as well as continue the strong tradition of Ivy as an institutional caliber asset manager. While the COVID-19 pandemic continues to impact the world, and some say it may forever change certain elements of our society, we steadily look ahead as we plan for a return to more normal circumstances. I'll let Brent take a moment to relay some of the details around our preparation, planning and response to the pandemic. Brent?

[Brent Bloss:]

Thanks, Phil, and good morning, everyone. As Phil noted, the extraordinary environment required us to implement business continuity plans in all aspects of our company. Importantly, our overall strategic approach has been proactive and focused on leading for the benefit of all our stakeholders, our clients, independent advisers, employees, shareholders and community. We believe a holistic approach like this will enable us to navigate these unique times in the best way possible and allow us to come out of this current situation in a stronger position as a company. We started transitioning to a work-from-home environment early in March and have been in lockstep with the CDC and recommendations from local authorities on safe practices throughout this process. We are operating efficiently and continue to provide all investment and wealth management support services remotely. The shift to a work-from-home environment has not altered the comprehensive capability of our investment team or the distribution and service components of our work.Early in the quarter, we quickly stood up an enterprise preparedness team and a COVID-19 steering committee to assess developments and determine the best actions to address business continuity. These teams continue to meet on an ongoing basis. Consistent with the guidance of governmental and public health officials, we have adopted interim business practices, including restricting business travel requiring all meetings to take place via remote access tools, adopting safety protocols to limit potential exposure, adopting social distancing practices, implementing a clearly defined approval process for reentry to any worksite, advising personnel on preventative measures and offering remote collaboration and productivity tools and training resources.In addition, we continue to monitor, enhance our system capabilities to our remote workforce to function efficiently and we have continued our educational and monitoring practices to ensure there are no compromises to confidentiality, privacy and cybersecurity requirements. Given our preparedness, we do not expect any significant impact to our investing, trading, client servicing or reporting functions. The Ivy Investment Management team transitioned seamlessly and was 100% remote working as of March 16. Our investment teams have a strong heritage of active collaboration, and we've been pleased with our team's transition to a virtual environment while maintaining that collaborative spirit. They continue to conduct their daily morning meeting remotely and meet with company management teams in a virtual setting as well. Our distribution operations are largely remote workers throughout the year, and they have not missed a beat during this transition.Our investment management, distribution and marketing teams have partnered to remain actively connected with our clients during these volatile times, delivering ongoing investment insight updates. Within our wealth management business, the majority of independent advisers are working from temporary locations. We are demonstrating our differentiated service and support model by continuing regular communications with our independent advisers as well as delivering over 160 additional adviser and client-focused resources to help navigate these unique times.For independent advisers, we delivered operations assistance for temporary office closures, remote work and business processing. In addition, we've rolled out blogs and webinars around market and industry developments, the CARES Act and practice development. We are also offering client-focused resources such as customizable e-mail and social media messaging as well as supporting client outreach and financial planning for market volatility. With respect to our commitment to our employees and local community, we have not initiated any layoffs, furloughs or reduced hours. In fact, as we implemented our business continuity plans, we have intentionally maintained continuity in our pay practices for all our employees based upon their regular work schedule, paid spot bonuses to certain employees, implemented a temporary hourly wage increase to designated client service personnel on both our asset management and wealth management operations, increased certain benefit recoveries for specific COVID-19-related treatments through May and have increased our philanthropic support for local organizations to help support the COVID-19 responses in our community.In summary, I'm extremely proud of the way our entire company has responded to these unprecedented circumstances. There were certainly challenges along the way, but these learnings have helped improve our continuity process going forward, and we are confident in our continued ability to do the right thing for our employees, clients, independent advisers, shareholders and our local communities.

[Philip Sanders:]

Thanks, Brent. Our teams have done a tremendous -- have done tremendous work to ensure our business continues to operate seamlessly. Let me now provide a few highlights of our asset management and wealth management businesses before I turn it over to Ben to discuss our financial results. With the recent -- while the recent environment has required a significant amount of operational change in a short amount of time, over the last 2 years, we have been evolving this business more holistically and ensuring we have a solid foundation to grow from in the future. The overall enterprise platform and business model is distinct in the industry due to the combination of a highly capable, active fundamental research based asset manager and a reinvigorated wealth manager operating with a fully open architecture, with both operations supported by enterprise-wide shared services groups. This unique enterprise model enables deeper client relationships in both operations, while financially leveraging shared services functions and platforms across the enterprise.Having a fully open architecture model for wealth management enables asset retention over time and enhanced adviser recruiting and broader acquisition opportunities. Through a lot of hard work and investment, we've meaningfully increased our institutional caliber investment and distribution capabilities for Ivy Investments as well. We are already seeing evidence of progress across the enterprise and feel strongly that our strategic positioning, our robust capital position, and most importantly, the resilience of our people positions us well for growth in the future.Now turning to investment performance. We were pleased to see performance trends improving across the trailing 1, 3 and 5-year periods, as measured by the percentage of funds ranked in the top half of their respective Morningstar universes, led by improvements in our small and mid-cap franchises. Performance, as measured by the percentage of assets, was mixed as 1-year records improved, while 3- and 5-year performance declined slightly.Broadly speaking, we have seen active managers perform slightly better than benchmarks during this period of volatility, and we see our franchise delivering improved relative peer group performance in many of our key strategies. As an example, in the U.S. large-cap growth category, 64% of actively managed funds outperformed benchmarks and our Ivy large-cap growth strategy delivered top quartile results, adding to a long-term track record of value creation for clients. This fund has been featured by Barron's as a top sustainable fund for 3 consecutive years. And we see the current market environment as providing continued opportunities for our active fundamental investment approach. We continue to focus on delivering long-term success to our clients through our fundamental research and insights as we have through many market cycles.Flows across the industry shifted sharply during the quarter as investors move significant amounts of money to the sidelines, reversing the prior trend of strong inflows into fixed income products. For Ivy Investments, it is notable that while redemptions increased compared to the prior year first quarter, they actually improved compared to the fourth quarter. And overall, the magnitude of the flows impact at this point has been less significant than the broader market volatility might suggest. From a sales perspective, we saw an improvement, both compared to last year and compared to the fourth quarter of 2019. While there is certainly some seasonality in the first quarter, we were pleased to see sales increase, especially in light of the broader market disruptions and the fact that we implemented a new sales coverage model only 18 months ago.The modest increase in sales is encouraging as we look to the future, with the diversification of sales coming from multiple channels and client types and an increased breadth of investment strategies, including positive flows in our large-cap value franchise. We have seen an improvement in April flows to date with continued sales momentum and a moderation of redemptions. Additionally, within our wealth management business, both sales and redemptions improved compared to last year. Historically, this part of our business tends to be more resilient during periods of volatility, and the work we've done in transitioning the business model has certainly helped these dynamics.Our adviser network continues to stabilize, and we moved closer to the inflection point of adviser growth this quarter with some recruiting successes. Most notably, we added 10 experienced advisers to our network this quarter. Our differentiated service and support model combined with our technology package and full product suite are clearly resonating with these newly added advisers as well as other advisers in our recruiting pipeline.We also continued to see adviser productivity trend upward versus the prior quarter. On the technology front, progress continues on the remaining components of our wealth management business administration program, including enhanced reporting, improved data analytics and a simplified business processing model. During the first quarter, we completed a pilot launch of the new Salesforce integrated data repository, allowing seamless access to data and reports across the business. We will introduce the integrated data repository, WaddellONE source, to the full network of advisers beginning in the second quarter. These are certainly challenging times, but I feel confident that our company is prepared to weather the short-term turbulence, and we have a lot to be excited about as we start to see some of the early results from our strategic actions emerge.The power of our business model is in its combination of asset and wealth management and the synergies that it drives. And we're looking forward to generating growth across both businesses.I'll now turn it over to Ben to go over the financials.

[Benjamin Clouse:]

Thank you, Phil, and good morning, everyone. As you saw in our release, we reported net income of $22 million or $0.32 per share this quarter. Given that the market volatility occurred later in the quarter, average assets and revenues were not as significantly impacted as the outlook for the remainder of the year, which I will cover shortly. While operating income for the quarter was largely inside of our expectations, we did record $11 million in unrealized losses on our investment portfolio compared to unrealized gains at year-end.In addition, the quarter included additional tax expense of $1.9 million, which increased our reported effective tax rate. Wealth management assets under administration ended the quarter at $51.8 billion and decreased 14% compared to the prior quarter. While average assets under administration decreased only 1% over the same period. While absolute asset levels decreased from the market losses, net new advisory assets grew once again this quarter, and redemptions improved slightly as well. Ivy assets under management ended the quarter at $56 billion, a decrease of 20% from the prior quarter, while average assets under management of $66.1 billion were down 4%. Phil covered the details on flows, but clearly, the asset declines will impact our projected revenues for the remainder of the year.Turning now to the financial results. Given these unprecedented times, I'm going to provide some additional color around our balance sheet position before covering the income statement. We ended the quarter with cash and investment balances of $766 million, with the decrease primarily attributable to declines in our investment portfolio and incremental share repurchases. Within that combined total, our cash balance increased modestly from last quarter due to an increase in swap collateral and investment maturities, partially offset by share repurchases and dividends. Investment balances decreased approximately $83 million due to $56 million of unrealized losses on our seed portfolio and $27 million in investment maturities that we redeployed into share repurchases during the first quarter.During the quarter, we returned capital of $71 million to shareholders through dividends and share repurchases. We repurchased 5.5% of our outstanding shares during the quarter, and over the trailing 12 months, we've repurchased over 14% of our outstanding shares. Our investment balance is comprised of a seed capital portfolio totaling $293 million, and our corporate investment portfolio totaling $312 million as of quarter end. A reminder that the seed capital is part of our strategic product incubation and development process, which is, of course, key to our asset management business. We have a conservative hedging program with the majority of the seed portfolio hedged, which partially offset the unrealized losses I mentioned previously. As for the corporate investment portfolio, it is comprised entirely of investment-grade corporate bonds, commercial paper, and U.S. treasuries, with an average issuance size of $5 million and a duration of 1.5 years.We continue to believe our balance sheet strength without any significant leverage is a key differentiator in this industry, especially in the current environment, which affords us the financial flexibility to take advantage of dislocations and other opportunities these markets bring.Now turning to the income statement. Total revenue for the quarter was $263.7 million and decreased 2% compared to the prior quarter. The majority of the sequential quarter revenue decrease occurred in March as asset levels decreased sharply, impacting investment management fees and shareholder service fees. There was also 1 less day in the quarter. The management fee rate actually improved to 64 basis points due to lower fund fee waivers and a favorable mix shift between our institutional and retail products. We did add some new fee waivers on our large-cap growth and core bond products during the period which were effective April 1. We expect these fee reductions to have a $0.01 to $0.02 annualized impact on earnings per share and position these products for distribution opportunities in 2 large asset categories where we have competitive products.Underwriting and distribution revenues were actually slightly higher as over half of our U&D revenues are now comprised of advisory products, which are billed based on beginning-of-month assets so they were not impacted by the March market downturn. Operating expenses totaled $224 million and decreased $16.9 million compared to the prior quarter. However, the prior quarter included a $12.8 million asset impairment charge. The remaining decrease was due to lower compensation and lower G&A expenses. Compensation was lower due to a slight decline in headcount and lower incentives despite the resetting of tax limits and an annual merit increase.G&A decreased across a number of categories, most notably due to meetings and travel shifting to virtual formats. In addition, there was a shift in transfer agency transactional processing costs from the technology line. In light of the market uncertainty caused by the COVID-19 pandemic, we expect our 2020 controllable expenses to be below our prior guidance. We have been modeling various management actions and the related financial scenarios for the remainder of the year. These actions include assessing controllable expenses for savings opportunities, evaluating all ongoing projects for strategic alignment and effectiveness of the project teams, consultants and contractors and evaluating our open positions.We will continue to prudently manage our expenses, but I want to be clear, we will continue to take a long-term view. Our decisions will focus on those actions that we believe best enable long-term success and sustainability, especially as it relates to those projects that we believe will drive future organic and inorganic growth. Our response will be determined by the magnitude and timing of asset levels in the balance of 2020. Should market performance decline further, we're prepared to take additional actions as necessary, while maintaining our long-term focus and doing the right thing for all of our stakeholders.Finally, the effective income tax rate was 32% for the quarter. But as I mentioned, it included additional tax expense items of $1.9 million. Without those items, the tax rate was 25.8%. We expect the tax rate to remain higher due to an unfavorable relationship between nondeductible items and pretax income, excluding the impact of any additional nonrecurring or discrete items. In addition, based on current share prices, we do expect an additional tax charge in the second quarter for the shortfall from vesting of restricted shares of approximately $1.5 million.Overall, as Phil and Brent mentioned, we are leading this company for the benefit of all of our key stakeholders. We believe that will enable the best success over time. For shareholders, specifically, as you have heard, we continue to utilize our strong balance sheet and ample liquidity to invest in key growth opportunities, which we believe will deliver long-term shareholder value. Operator, we would now like to open the call for questions.

[Operator:]

[Operator Instructions]. Our first question comes from Glenn Schorr with Evercore.

[Glenn Schorr:]

So curious -- when you talked about growth accelerants that you're thinking about in your prepared remarks, I'm curious if there are -- if that's talking about new products that are in the pre-pipeline, new investments on distribution? I wonder if you could just unpack that a little bit? I find that interesting.

[Philip Sanders:]

Okay. Glenn, this is Phil. I think primarily what we're seeing is, we've talked in the past about our balance sheet and liquidity to be a real differentiator in this marketplace. And I see -- I think when we see market dislocations, we want to be poised to be opportunistic, whether it's on the asset management side of our company or the wealth management side. So thinking primarily in terms of acquisition opportunities or abilities to accelerate investments or it could be in new product development areas as well. So it really encompasses a little bit of all of the above. It speaks to being opportunistic at a time when maybe some others are kind of on their heels and things are a little dicey. We have a conservative balance sheet, lots of liquidity and really the opportunity to take advantage of opportunities wherever we see them.

[Glenn Schorr:]

Okay. And maybe just a follow-up on your fee waiver comments. You've done some things like that in the past as to basically get below the peer meeting or be more competitive to help drive growth. I'm assuming that this is the case again, but I'm wondering if you could talk about how much of a reduction and how that feedback works. Does that come to you from the retail channels? Do you go out -- seek it out for the best-performing funds? Just curious on how that works.

[Philip Sanders:]

Sure. Amy, do you want to take that one?

[Amy Scupham:]

Sure. Glenn, thanks for the question. Yes. So when we are evaluating our fees, it's a piece of our continued effort to really drive the competitiveness of our products. So we're looking at it from a few different standpoints. But as it specifically relates to the fee reductions that we did in mid-2018 and then these 2 fee reductions as well, we take a look at our competitors in the marketplace. We look at who's winning and where their fees are versus their assets under management and the strategy. And then we also really take a look at what the median of the below-average category on the Morningstar peer group is. And so we take all of those things, combine them together with what we feel like the opportunity is out in the marketplace, and we take that suggestion to our executive team and Board for approval.

[Glenn Schorr:]

How much was the reduction in those products, this go around?

[Amy Scupham:]

There was a 9 basis point expense ratio reduction on security and core bond in the I share classes -- I and N share classes. And then I believe it was only around 4 basis points in large-cap growth because that was also part of the original reduction in mid-July.

[Glenn Schorr:]

Awesome.

[Amy Scupham:]

And that's from the I and N shares. Yes.

[Philip Sanders:]

Glenn, I think Ben wanted to add one thing to your prior question. Go ahead.

[Benjamin Clouse:]

Thank you, Phil. I just wanted to add to Phil's remarks, Glenn, that we're really thinking about that in terms of organic and inorganic growth. Organically, as we think about our wealth manager, we're continuing to invest in recruiting opportunities, which you heard us mention and Shawn could provide additional color on. Also, we are continuing very aggressively our technology efforts in that line of business and beginning to stand up some of the pieces. As you heard in our remarks, that will continue through this year. And then the other piece would be, inorganically, we are obviously continuing to look at the marketplace, as you heard Phil say in his comments about opportunities that may arise and opportunities for us to use our capital for growth.

[Operator:]

The next question is from Dan Fannon with Jefferies.

[Daniel Fannon:]

Just wanted to follow-up on the expense commentary. You talked about coming in below your previous guidance. I was wondering if you could be a bit more specific in terms of what you think the new range is or how we think about the run rate kind of going into next quarter in terms of those controllable expenses?

[Philip Sanders:]

Okay. Ben, do you want to take that?

[Benjamin Clouse:]

Sure. Dan, we're obviously constantly assessing our expense base and looking at the ways we do business, and we're going to continue to be prudent as we think about that. And you've seen that we've taken a number of actions over the last couple of years. As I mentioned in my prior answer, we don't intend to interrupt the strategic progress that we have underway, in particular, in some of those items that I mentioned. Generally, if we -- as I think about our expense base, the magnitude and timing of asset levels in the balance of the year are going to determine ultimately the magnitude of actions we will take. As I think about the composition of our cost base, compensation, G&A and marketing are certainly the most variable. I don't think you'll see us make a lot of movement in technology as that's where a lot of that strategic spending is that I referred to. As it relates to the rest of the year, some items were just naturally lower in Q1, such as our equity and deferred comp plans that have a mark-to-market component. We also have been very judicious in regard to filling vacancies and thinking about that on a case-by-case basis. But again, continuing to invest in talent in those areas that we think it's important to move our strategy forward.

[Daniel Fannon:]

Okay. And then just a follow-up question around the balance sheet and the dividend. You guys have obviously highlighted the strength in the liquidity that, that provides in terms of flexibility. But thinking about the dividend at these levels and your cash flow, how committed, I guess, to the dividend are you, assuming markets are worse, taking a little bit down? And how willing would you be to pay that dividend out of excess cash versus ongoing cash flow from the business?

[Philip Sanders:]

Well, maybe -- this is Phil, and I'll start with a high level comment, and I'll let Ben follow-up. I think we -- a few years ago when we adjusted our capital return program, we thought through this quite extensively about how we wanted to proceed, and we feel pretty comfortable with respect to the level of the dividend at this point. There's quite a difference between the cash flows that we generate versus reported net income. And at this point, we feel very comfortable with the current level of dividend, the sustainability of that. Maybe, Ben, I'll let you elaborate a little bit if you want to add something there.

[Benjamin Clouse:]

Sure. Thank you, Phil. Yes, I would. Just to remind you, as Phil said, it was 2017 fourth quarter, we moderated our dividend level and adjusted our share buyback program at that time to provide much more flexibility in our capital allocation structure. And since that time, you've seen us return a significant amount of capital to shareholders through continuing the dividend, obviously, as well as doing share buybacks at or actually beyond the prior dividend level when you add those components together. We're going to continue to be opportunistic with buybacks, but we can obviously take advantage of that flexibility that I mentioned and move that up or down based on other needs we might have for capital, whether that's M&A opportunities on the market or other strategic investments like we were talking about earlier. And then just to reiterate Phil's other point, we do have cash flow beyond the pure net income level, which gives us some additional room there as well.

[Operator:]

The next question is from Patrick Davitt with Autonomous Research.

[Patrick Davitt:]

You hinted on this in the prepared remarks. But when you kind of think about where AUM ended 1Q, the waivers that came off in 1Q plus the waivers that came on in 2Q, could you give us a little bit more specificity on what you think the run rate revenue level is versus 1Q kind of at the beginning of 2Q?

[Philip Sanders:]

Ben, do you want to take that one?

[Benjamin Clouse:]

Sure. Patrick, as I mentioned, the waivers coming on, we think, are in a range of $0.01 to $0.02 impact, and we believe -- just adding to Amy's earlier comments on the market, we believe those are both product categories where we have some distribution opportunity. Again, our strategy on thinking about pricing is to continue to work on making sure our products are well positioned in the market and that pricing is not an inhibitor, as Amy's team goes to work on distribution. In regard to waivers coming off, that was more a timing issue related to asset composition and movement within our portfolio versus a deliberate action or expiration there, Patrick.

[Patrick Davitt:]

So taking it all together, I guess the question is really like what should we -- where should we think about kind of the baseline for where your total run rate revenue level is versus 1Q right now?

[Benjamin Clouse:]

Yes. Taking it all together, I don't expect a significant change in the fee rate. Obviously, assets are -- have moved and are moving. But our effective fee rate, I don't anticipate a significant change there.

[Patrick Davitt:]

So just kind of run the AUM through. Okay.

[Benjamin Clouse:]

Yes. With the impact I mentioned on the new waivers, again, $0.01 to $0.02.

[Operator:]

The next question is from Mike Carrier with Bank of America.

[Michael Carrier:]

First question, just on the expenses, and being realized it's a volatile backdrop, but can you provide maybe some color on the controllable expense level ahead and either maybe like a flat market backdrop or an environment where we're up or down 10%, I guess, just any color to gauge the flexibility on that base, which I think previously was somewhere in like the low 400s?

[Philip Sanders:]

Ben, do you want to take that one?

[Benjamin Clouse:]

Sure. Mike, you are correct. Our prior guidance was in a range of $420 million to $425 million for that controllable expense base. We came in first quarter at a level of $97 million, so significantly below. As I mentioned, our ultimate response here will be determined by what asset levels look like in the balance of the year, in regard to our expenditure level. The additional color I could give you maybe would be, as we think about our strategic project spend, I do believe that will -- our intention is for that to continue in the balance of the year. And I believe, absent other factors, that would actually drive that controllable rate up slightly in the subsequent quarters. But we've not yet finalized our intentions on what we will do in regard to other controllable expenses. The extreme amount of volatility that we saw in the latter half of March and early April have made that quite a challenge, as you can imagine, for us and others as well to ultimately formulate our plans.

[Michael Carrier:]

Got it. And then just one more follow-up on the fee waivers, and not the fee waivers in April going forward, but more just in the quarter, some of those fee waivers decreasing. Is that, I guess, significant amount? Meaning, if I look at the fee rate and -- like how much these fee waivers can contribute either an increase or decrease in a given quarter? I guess, I'm just trying to kind of gauge or understand what can like shift that around or move things around from quarter-to-quarter?

[Philip Sanders:]

Dan, you want to -- anything to add there?

[Daniel Hanson:]

I would add just one thing which is the primary driver is product composition, and that, I think, was the primary driver in the sequential quarter. So both -- as assets have obviously moved around in regard to where investors are going and also we experienced some shifts in the composition of our assets between institutional and retail assets, which will also impact that rate a bit. Again, the primary driver, in particular, for the quarter was not actions we had taken, but is far more weighted toward composition of the AUM base within our product set.

[Operator:]

The next question is from Kenneth Lee with RBC.

[Kenneth Lee:]

Just one. You mentioned the cash and liquid securities on balance sheet of 776 -- $766 million and as well the latest seed capital. Just wondering, what's your best sense of the current excess capital or deployable cash on the balance sheet, if you were to exclude working capital needs as well as the seed capital?

[Philip Sanders:]

Ben, you want to address that?

[Benjamin Clouse:]

Sure. I would be happy to go. Kenneth, as I think I've mentioned before, our primary needs for working capital or -- is our seed portfolio in the asset management business. We do not maintain or have a need to maintain significant regulatory capital or anything of that nature. In the wealth management business, it's quite minimal. So our working capital needs would simply be running the business. And then our seed portfolio, I don't anticipate we will have significant changes in the seed portfolio in the near term. We do continue to assess that as products make their way into the marketplace. And then we always have opportunities that we are evaluating to pull seed capital out once a product becomes mature and has enough of a base to begin to fully function on its own. We are certainly cognizant of not impacting products or impacting clients as we think about that seed capital. So we're cognizant of those factors. But in the near term, I don't believe we'll see significant changes in that seed capital portfolio. The balance of our capital then will be utilized for growth opportunities and then, of course, thinking about shareholder return, as I talked about in the way of dividends and continued buybacks as well as the potential for inorganic opportunities that may present themselves in the marketplace.

[Kenneth Lee:]

And just one follow-up, if I may. Just in terms of the -- just want to focus on the continued improvement within the adviser productivity metrics, within wealth management. Is this still being driven by the retention and recruitment of higher producing advisers? Or are there any other factors that's driving that continued productivity improvement?

[Philip Sanders:]

Okay. Shawn, do you want to address that question?

[Shawn Mihal:]

Yes, sure. Kenneth, Shawn Mihal. Yes, primarily, this has really been driven off of that retention of those more highly productive advisers as well as our scope and change of recruiting focus on those more experienced advisers. So as we have been gathering momentum around our recruiting efforts, we have been targeting average overall productivity in that $400,000 range with respect to the advisers that we've been onboarding. So I think that's primarily the combination drivers behind that.

[Operator:]

The next question is from Robert Lee with KBW.

[Robert Lee:]

I guess my first question would be on -- within wealth management, can you update us if you look at kind of sales across the platform? What proportion of that, whether it's fee-based products or otherwise or is actually flowing into a Waddell-managed product as opposed to a third-party strategy?

[Philip Sanders:]

Okay. So maybe, Shawn, you want to address that first, from your perspective, and then maybe Amy might add on from kind of the Ivy perspective as well.

[Shawn Mihal:]

Yes. Shawn again. Yes, we are watching the overall concentration ratios of our -- primarily, when we look at this, it's on the advisory side of the programs where most flows are actively going today. So we have our non-advisory business and advisory business. We're continuing to see the positive flows move into that advisory business. In general, we're still continuing to see a little bit of reduction in the overall concentration ratio of affiliated funds with inside of our totality of the wealth management business. The overall ratio ended at about 64.3%. Most of this is being driven by those ongoing flows going into a broader scope of products. And as we look at our advisory programs and the overall assets inside those programs, from our open architecture programs, we're seeing about 10% overall of affiliated assets inside those programs too. Our mutual fund type programs and advisory that we're seeing overall concentration ratio is about 20% of those assets inside those programs. So that's about the ranges we're seeing on the advisory side of concentration of flows around that assets of about 10% to 20% depending on the type of program.

[Robert Lee:]

Okay. Great. And then -- sorry, go ahead.

[Philip Sanders:]

I don't know, Amy, do you want to add something out to that?

[Amy Scupham:]

Robert, I was just going to add, kind of at a higher level, we have a channel of sales and service individuals that focus on our Waddell & Reed adviser team. And we have seen our net outflows for the quarter were right around $1 billion out of that channel. And that's down from an average of $1.2 billion to $1.3 billion net out last year. So we're -- we continue to see a nice stabilization, both of sales and redemptions from Waddell.

[Robert Lee:]

Okay. Great. And maybe as a follow-up to that, maybe, I mean, this is for you too. I'm not sure. But the -- as you look to the -- I guess, your unaffiliated channel, and I know you've made some strategic pivots there to -- in segments that you're targeting. So number one, can you update us on some of those segments? And given kind of at least the asset scale there, be it at $20 billion in unaffiliated, I mean, are there certain -- I mean, do you feel like maybe it's the wirehouses or whatnot that may be, at this point, some would subscale for some channels? Or just kind of update us on kind of the third-party strategy and where you see the opportunity?

[Amy Scupham:]

Yes. Sure. Robert, I'll go ahead and add...

[Philip Sanders:]

Yes. Amy, do you want to take that?

[Amy Scupham:]

Yes. Yes. I will add to that. So just as a reminder, and we walked through this probably about 1.5 years ago. But we divided our distribution sales force into 2 primary channels, one which we are -- which we refer to as our professional buyer or institutional channel and the other is the national channel. In the national channel, that's where we focus on our broker-dealer distribution partners, the wirehouses, the independents and Waddell & Reed. And then in the professional buyer, we have insurance and retirement group. We have our RIA team, and then we have our institutional teams.So when I think about how we're seeing traction, one of the reasons, Robert, that we structured ourselves that way was because of what we saw going on in the marketplace where there's much more of an institutional type of buying process that's coming from everywhere, regardless of what channel it is. And so as I look at the quarter and start to see some of the incremental improvements, I'm seeing it in really kind of 4 different areas. There's getting placement on platforms, there's being upgraded on platforms to either the select or recommended list. There's having those institutional opportunities, and that could be an institutional, like the standard institutional client that we all know of, be it endowment foundation, public plan, corporate plan or it can also be where consultants have overlaid the more retailer third-party intermediary part of the marketplace.And we are starting to see traction in all of those places. It's still early in our new sales strategy, but we're really starting to see our pipeline and wins picking up across channel. I think the other thing that I would say is, in May of last year, you'll recall we introduced a series of model delivery portfolios. We thought it would be something around a 9 to 18 months conversation and beginning to tick on replacement, and we have recently signed a contract on our first large opportunity in that space. So those are nondiscretionary assets, but -- so assets, nonetheless, and a big win for us in the distribution channel. So I think with that, I'll pause, and I'll see if Dan Hanson, our CIO, has anything he'd like to add.

[Daniel Hanson:]

Well, I think just in general -- thanks, Amy. Just to build on the comment about, I think, traction we're feeling. It's all about the core of what we are, Ivy is a platform for quality growth, Ivy is a platform for small-cap and global. These are key strengths that really -- is our heritage and also our strength. And we think it's playing to where the market is going to go. If you look at where the puck is going in terms of active management, it's picking their spots and we're seeing it -- we want to be tentative and realize the market can change quickly. But in the first quarter, we saw 59% of large-cap U.S. managers across the board outperformed in what was the worst quarter, I think, on the book. So you've got the best quarter for active managers in a dozen years, which aligns pretty well with the DNA and core North Star for our franchises, which is around -- not trying to do everything or be everything to everyone, but just that home per active managers who are doing fundamentally deep diligence bottom-up work and picking the spots. That is what -- that is how we define active management in our franchise at Ivy. We think our clients increasingly are getting comfortable with the mix and the role for active managers in a broader portfolio, and we've got our spot in that. So that's the comment I'd make.

[Operator:]

The next question is from Bill Katz with Citigroup.

[William Katz:]

Just coming back to some of the fee cuts that you had mentioned. It seems to be sort of an ongoing pattern as you just sort of look at the market and sort of reset your product line. Where are you today? If you look at maybe your 10 to 15 top-selling funds or largest funds, where are you relative to a benchmark, whether it be median, below median in terms of pricing? And is there any sort of other risk here of sort of residual pricing pressure to try and jump-start flat volumes?

[Philip Sanders:]

This is Phil. Maybe I'll start and I'll turn it over to Amy for some specifics. But just as a high level, Bill, remember, we did a more comprehensive view of our pricing across our product line. I don't remember exactly when it is. Maybe Amy can recall. But it was more extensive and broad-based. And we implemented that, we've kind of cycled through that. And as we move forward, it's going to be, as you described, more ongoing and tactical and product-specific, where we need to be competitive. But it was -- it's something that I think, clearly, we're going to be constantly evaluating. It will probably never end. It's kind of the nature of the industry. But it will be more incremental going forward and product-specific. So Amy, do you want to talk a little bit about kind of where we stand relative to the rankings and how we go about this process and how we think about it?

[Amy Scupham:]

Sure, sure. So Bill, today, we're sitting at about 73% of our assets under management for our funds family is a median or better as it relates to pricing. When we look at our top 10 or what we might refer to as our focus on, 9 out of those 10 funds right now are sitting in that range of that median of the below-average quintile from a Morningstar standpoint. So we're doing pretty well, and the one that isn't sitting right around median, just a little bit more than median. So as Phil said, from the larger fee reduction that we did, I believe it was in July of 2018, effective August of 2018. That's where we've really drilled in and said from a strategic standpoint, where we feel like we have competitive products that we felt like it could get traction today. That's where we made those big moves. And these were a couple of incremental strategic moves. And like Phil said, I do believe that going forward, there'll probably be maybe smaller in nature or more tactical than strategic.

[William Katz:]

Okay. That's helpful. And then just my follow-up is a little bit of a 2-part, so I apologize for that. Just as you think about what's coming in the door versus what's going out the door, how do you think that, that affects the fee rate net of all these product changes? And then secondly, I think you had mentioned that the trends in the wealth management section, I think that's what you're speaking to, had gotten a bit better quarter to date. Just wondering if you could verify that. And then maybe stepping back more broadly, could you talk a little bit about what you're seeing in terms of net flows for the complex in April?

[Philip Sanders:]

Okay. Maybe, Amy, why don't you address the flow issue? And then I don't know if, Ben, you want to think about that fee -- the first part of Bill's question with respect to fees? Or if Amy, you have any thoughts on the differentiation of what's going in and leaving and that type of thing? But maybe I think a flow comment would certainly be helpful.

[Amy Scupham:]

Sure. So as we look into the first quarter and -- I'll address the first quarter first, Bill, and then I'll move a little bit into your question in April. In the first quarter, we saw a very large increase in the breadth of strategies that were winning what we would consider to be a large allocations per our distribution strategy. So we definitely saw less of a concentration in what had formally been our highest selling strategy, the international core strategy. And it has moved across the board. So from small- to large-cap on the growth side. Our small-cap core has seen some nice traction. Mid-cap income opportunities, which is a portfolio that's held a 5-star Morningstar rating for quite some time, continues to flow net positive. And then our emerging market equity continues to have strong performance and good flow patterns as well.So from what's coming in, it's that what's going out tends to be our international core and high income, both of which have suffered a bit of a performance disruption. And so we continue to see outflows in those 2 areas. As we look at April, when we look at a gross sales basis, we're seeing a slight reduction from March, which I would attribute to seasonality more than anything. But I think the more telling point is that we're seeing a fairly substantial reduction in redemptions across the complex. And so -- and that's primarily in that international core and high-income space where we've seen redemptions in those 2 spaces start to slow as well as across our institutional business.

[Philip Sanders:]

Ben, I don't know if there was anything to add on the fee rate or if Amy covered it there? I'm not sure.

[Benjamin Clouse:]

Phil, I think Amy did well. I don't have anything to add.

[Philip Sanders:]

Okay.

[Operator:]

The next question is from Michael Cyprys with Morgan Stanley.

[Michael Cyprys:]

I just wanted to circle back on the controllable expenses that came in around $97 million in the quarter or so. Just curious how we should think about some of the puts and takes as we move into the second quarter here. It sounds like some project spend accelerating through the year, so that arguably drives a little bit of upward pressure. But how much seasonal expenses should we think about coming out as we move into the second quarter? Also, markets have recovered about 11%. So how does that -- how should we think about that driving any sort of upward pressure on expenses here? Maybe you can remind us of the portion of expenses that are market-sensitive and also what portion of the comp line would you describe as variable?

[Philip Sanders:]

Okay. Ben, you want to offer some context around that question?

[Benjamin Clouse:]

Sure. Sure. In regard to the first quarter, we did have some savings versus fourth quarter or some reduction in compensation, as I mentioned. And that was largely driven by lower headcount as well as a little bit of deferral on some open positions as we thought through that. Again, we're not slowing or delaying any strategic hiring, but we're, of course, being very judicious about that. We also saw some impacts already in the first quarter from lower travel expenses as well as lower meeting costs, even some things beginning to move into virtual formats and some planning for some of that into the balance of the year, as we think about a slow ramp-up back to work.In regard to the rest of the year, I think I mentioned earlier, I do expect we'll see some increase in our project spending as some of those items ramp up a bit more fully in the year, and those are really centered around strategic technology projects, in particular, our continued investment in the wealth management platform. And you heard in our prepared remarks some of the rollout of that. In regard to variability, we certainly have -- a big portion of our overall cost base is fixed and flows through the distribution line and varies with asset levels as we are thinking about our business model.As you've heard us say in past quarters, we have done a lot of work to move a number of fixed cost operations into more variable structures, in particular, in the wealth management business, which we believe is more sustainable for the corporation and allows us to be a little bit more flexible. Compensation, as you mentioned, of course, is one item that has some significant flexibility in that, although we certainly will continue to pay our good people as we're, again, taking a long-term view and making sure we can continue to move strategically forward, even through this interruption that we have had.

[Michael Cyprys:]

And just as a follow-up, if I look at the prior guidance on the controllable expenses, the $425 million, I think consensus is around $403 million, so about 4% to 5% below your prior guidance. I guess, do you think that's optimistic or -- that sort of reduction? Or what sort of environment do you think would be needed to see that sort of outcome?

[Benjamin Clouse:]

Yes, I definitely believe we will come in below our prior guidance, which you're correct is in the $420 million to $425 million range based on first quarter at $97 million. Obviously, that demonstrates the start of that trend. And as I said, our ultimate actions will really be determined on what asset levels look like for the balance of the year. We have seen, of course, some recovery of markets in April, and our response will be determined by what that looks like in the rest of the year.

[Operator:]

The next question is a follow-up from Patrick Davitt with Autonomous Research.

[Patrick Davitt:]

I hear the -- thank you for the guidance on kind of how April looks. I think probably not surprising to anyone that it's better than March, but could you frame it maybe relative to January and February?

[Philip Sanders:]

Amy, you want to take that one?

[Amy Scupham:]

Sure. Yes. Relative to January and February, I would say very similar comments. The sales are, depending on which months we're talking about from a growth standpoint, in line, maybe slightly less, and the redemptions just continue to improve. So from a net basis, April is looking better.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Phil Sanders for any closing remarks.

[Philip Sanders:]

Okay. Thank you. Listen, thanks everybody for your interest in dialing in today. Obviously, these are really challenging times. And I just want to say I'm really proud of the organization and appreciate the hard work and everybody -- in terms of how we pulled together and transitioned to kind of this work-from-home environment, really managing the company, balancing the interest of all of our stakeholders, whether it's obviously, clients, advisers, employees, shareholders, communities. It's been certainly challenging times, but I'm really proud of how everybody's pulled together and done their part in terms of coming together and really demonstrating our core values and focusing on the client collaboration and that type of thing. So anyway, it's been challenging, to say the least in a lot of respects, but certainly proud of how everybody's pulled together. So with that, thanks, everybody, for your interest, and look forward to catching up with you in a few months. All right. Thank you very much.

[Operator:]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.