Waddell & Reed Financial Inc
Q2 2020 Earnings Call Transcript

Published: 28 Jul 2020

[Conference CallParticipants:]

Glenn Schorr - Evercore ISI Daniel Fannon - Jefferies Michael Carrier - Bank of America Merrill Lynch William Katz - Citigroup Michael Cyprys - Morgan Stanley Robert Lee - KBW

[Operator:]

Good morning, and welcome to the Waddell & Reed Financial Second Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mike Daley, Vice President, and 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; Brent Bloss, our President; Ben Clouse, our CFO; Dan Hanson, our CIO; Shawn Mihal, President of our 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 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:]

Good morning, and thanks for joining us. The second quarter brought our country, the economy and the stock markets on an unusual journey as we started the period in the depths of a dramatic downturn amid the global pandemic. Despite the ongoing health pandemic, social unrest in the US, and economic uncertainty throughout the period, the US stock market returned one of the strongest quarters since 1998. Thanks in part to a broad and rapid central bank policy stimulus; investors have generally recovered much of what was lost to the downturn earlier this year. Historically, typical market recovery from a recession has taken two to three years or more. This recovery to date tests progress quickly although its sustainability remains in question. Enthusiasm about a gradual reopening of the economy has been muted by ongoing uncertainty regarding the resurgence of public health risks in more parts of the country. And a concern that Q3 and Q4 could be more challenging from a public health perspective. Broadly, the financial markets remain strong. While concern about another downturn remains, we do expect to see continued market leadership from companies with high quality business models, which have delivered more consistent results. We believe this type of market environment is well suited for the IB approach to active investing, where we invest based on fundamentals, business models, management, leadership and valuation. At the same time, within our wealth management business, our affiliated advisors focus on delivering disciplined financial advice and long-term personal financial planning is as valuable as ever helping clients achieve their financial goals. For our enterprises as the whole across the changing circumstances, our shift to a remote work environment has not altered the comprehensive capability of our teams, or the quality of service we are delivering to clients and our wealth management affiliated advisors. Our COVID-19 steering committee and enterprise preparedness teams continue to meet regularly to effectively navigate these unique times and evaluate options for returning safely to the workplace over time. As we mentioned on the last earnings call, we have taken a holistic approach to managing through this environment with all stakeholders in mind, our clients, affiliated advisors, employees, shareholders and our community. Regardless of circumstances or environment, we are committed to steadily executing on our long-term vision and growth strategy. As a reminder, that strategy consists of six key strategic enablers. Competitive products and pricing, continued focus on strong core processes and performance metrics, the ability to leverage technology and analytics as a strategic asset across the organization, having a growth culture in a more agile organization, sharpening our brand awareness in the marketplace and finally, effectively allocating capital to internal investment initiatives, as well as taking advantage of potential dislocations and acquisition opportunities in the asset management and wealth management industries. I'd like to highlight some of the major steps we took over the quarter on these key focus areas. Within products and pricing, we supported clients by introducing new products in both businesses. In our asset management business, we introduced two additional strategies in our model delivery format, bringing our total offering to nine. These strategies are available in third party retail separately managed accounts and unified managed accounts. We believe the opportunity in this space going forward is strong, as wealth managers and financial professionals increasingly turned to model delivery because it provides them greater flexibility and vehicles as they provide financial plans for their clients. 76% of our assets under management are now priced at or below their respective peer medium after the fee reductions that went into effect this quarter, on our core bonds and large cap growth products, as well as finalizing the closure of certain legacy unused share classes. In our wealth management business, we introduced the high network suite of products and services designed to meet the needs of more affluent clients while enabling affiliate advisors to offer a holistic, flexible approach to complex financial situations. We also introduced new separately managed account strategies in partnership with a range of institutional money managers, allowing affiliated advisors to offer the direct ownership, structure transparency, ex-strategy options and other benefits of SMEs to clients who may benefit. Within technology and analytics, we have filled the newly created position of Chief Analytics Officer. This role will spearhead our efforts across the enterprise focused on our enterprise wide data analytics and artificial intelligence initiatives. We have also continued with our wealth management and asset management technology platform initiatives, with the goal of improving our affiliated advisor and client experiences, enhancing sales enablement, and improving internal operations. Lastly, we implemented additional digital and technology capabilities for employees throughout the quarter for continued operational productivity and efficiency, while we navigate to work from home environment. We also made progress enhancing core processes and operating performance during the quarter. In our asset management, and in our asset manager, we strengthened our institutional distribution model by launching new technology to create a more seamless client experience to support our continued progress and reducing AUM redemptions. In our wealth manager, we implemented a remote recruiting process that allowed us to maintain advisor recruiting activities despite the challenges associated with COVID-19. We expect these innovations will benefit our recruiting efforts even in a more normal environment. As we are able to leverage technology to more nimbly and quickly evaluate candidates in our strong pipeline. Our entire wealth management team also did an extraordinary job of converting our annual vision conference to a virtual format under challenging circumstances. Our annual conference has been part of our culture for more than 50 consecutive years. And we did not want to let this year's plans for shared content and experiences be diminished due to the pandemic. Our team was able to quickly pivot to leverage technology enabled solutions and create an interactive virtual two-day experience that was attended by nearly 1,500 advisors, partners and home office staff. In an effort to further drive our growth culture into organizational agility, we took additional actions to advance our diversity and inclusion initiatives. We have made great strides to ensure we have a true culture of belonging within our organization. However, especially with recent events across the country over the past few months, we also know that we as a society and industry and a company needs to do more moving forward. Additional actions and steps we have recently completed and or announced include conducting additional all employee learning session, called days of understanding, focused on racial diversity and justice. These sessions include guest speakers from our local communities. Also beginning in 2021, we will observe June 10 each year as a paid company holiday. This will provide our employees the [Tech Difficulty]

[Operator:]

Pardon me. This is conference operator. We appear to have lost Mr. Sanders location, if someone else would like to pick up or I can put the call back on hold, your choice. Okay, we'll put the call back on hold, until Mr. Sanders dials back in. One moment, please.

[Ben Clouse:]

I’ll continue on. It's Ben. You bet. Apologize for the interruption, everyone. I'll pick up where Phil left off and hopefully, he will join us. As we progress into 2020 and 2021, we will hire two newly created roles entirely dedicated to diversity and inclusion. First, the Head of Diversity and Inclusion responsible for developing and delivering on the next evolution of our comprehensive diversity and inclusion strategy, that is aligned with our purpose, vision, mission, values and business goals, across the organization. The second role will focus on diversity outreach and sourcing, they will work across the organization to enhance our community and industry diversity outreach and sourcing efforts, including the diversity of candidate pools for employment and affiliated advisers, as well as minority and women-owned vendors and business partners. In addition to the COVID-19 related donations we made earlier this year, we have recently provided support to organizations to help focus on racial justice and diversity and better support our local underserved communities. With respect to brand, we have launched a full brand review that will include all three of our brands across the enterprise. This is a multiyear effort and we launched the first phase of this initiative in the second quarter and are partnering with a premier well-respected global brand agency on this phase of the project. Lastly, in terms of capital allocation, our balance sheet enables us to maintain a regular capital return to shareholders by way of dividends and share buybacks, while also positioning us to pursue and finance strategic M&A, if opportunities arise. In support of these efforts, we announced during the quarter that we have filled a newly created position of Vice President, Acquisition Strategy and Integration. We have been clear that inorganic growth is a key component of our strategy and this position will play a vital role as we continually evaluate acquisition opportunities across wealth management and asset management. All of this progress highlights just some of the ongoing work we are continuing to deliver on our long-term vision and growth strategy. We continue to see evidence of progress across the enterprise and believe that our strategic positioning, our robust capital position and most importantly, the resilience and adaptability of our people positions us well for growth in the future. Turning to a few details within both our asset management and wealth management businesses now. Ivy Investments net flows improved this quarter, aided by meaningfully lower redemptions against our $2 billion in gross sales. In fact, redemptions improved 24% compared to the first quarter and 19% compared to the same quarter in 2019. Sales continue to be strong in our Mid-Cap suite, with both strategies in net positive flow for the quarter. While short term performance has improved. We continue to see outflows in our international core strategy. Our distribution teams are working well remotely and continue to make traction across channels since we realign the structure of our sales teams. We continue to focus on providing our clients with high quality service that meets their unique needs, as well as highlight and provide access to our intellectual capital while keeping the safety and wellness of our employees and clients as our top priority. Turning to investment performance, second quarter of this year was one of the best quarters for U.S. equities since 1998. The catalyst for the strong quarter was the resurgence and risk appetite in the market following the securities purchase programs announced by the Fed, March 23, which marked the bottom in the first quarter sell off. Equity markets in particular are driven by low quality factors which over the long term have proven to be detrimental to compounded returns. Our commitment to institutional caliber processes means that while we are mindful of short-term market dynamics, we remain focused on the long term and maintain discipline and consistency in volatile times such as we have seen in the first half of the year. While absolute returns were strong, active managers generally did not keep pace with benchmarks in the second quarter. We maintain strong long term, relative performance across our quality-oriented growth franchises owing to our long-term commitment to finding and investing in companies with differentiated long-term growth prospects. Our international core equity strategy, which as we have previously noted, has been challenged by negative flows, has more recently seen its relative value discipline results in improved investment performance. We continue to focus on delivering long term success and communicate our discipline to our clients through our fundamental research and insights, as we have through many market cycles. As we consistently enhance our institutional caliber investment and distribution capabilities, our near-term focus will be on driving sales across a wide breadth of distribution opportunities, while sustaining long term performance improvement. Turning to the wealth management business, it has held true to form this year as a consistent and stable aspect of our enterprise that individuals, families and businesses continue to find value in personal financial planning guidance from professional advisors. As we've shared in the past, the wealth management business is a key driver to our long-term vision and growth strategy. We've seen strong advisor recruiting results this year. And we think our differentiated service and support model, combined with our technology package and full product suite are resonating with these newly added advisors, as well as other advisors in our recruiting pipeline. We also have been pleased to see continued strong growth in advisory assets with the sixth straight quarter of positive net advisory flows. The fact that these inflows occurred despite a challenging market backdrop, illustrates the wealth managers ability to capture assets through market cycles. On the technology front, we further expanded WaddellONE centralized digital data platform by introducing a comprehensive, web based and cloud accessible integrated database, along with a digital repository of processes, procedures and other information, both of which are now available to all affiliated financial advisors. Now, I'll turn to financial results. We reported net income of $25 million, or $0.38 per share, compared to $22 million, or $0.32 per share in the prior quarter. As was expected, revenues dropped due to the sharp decrease in asset levels as we headed into the second quarter. Lower operating expenses partially offset the lower revenues and were $7.9 million better, while investment income improved to $22.9 million due to unrealized investment gains on our corporate and seed investment portfolios, a lot of our hedging strategy. Wealth Management assets under administration ended the quarter at $59 billion and increased 14% compared to the prior quarter, primarily due to the market rebound. Net new assets improved compared to the first quarter partially from stronger advisory sales, as well as lower brokerage account redemptions. As you saw in the release, we've updated our definition of net new assets to include dividends and interest, which aligns with how others in the industry report this metric versus including it in market action. We have included a schedule, presenting the historical data on our IR website. So, you can see the impact of this change. Notwithstanding the updated net new assets definition, this quarter continued a multi quarter growth trend in net new advisory assets with 3.3% annualized growth and an all-time high balance of $27.2 billion in advisory assets at quarter end. Our progress transforming the wealth management business continued in the quarter. And we were pleased to have another 11 advisors affiliate with the firm. As you know, we just recently reinvigorated active recruiting efforts, and we've been pleased with the progress thus far in the year, despite the challenges that remote recruiting brings. Since the beginning of the year, 21 advisors have affiliated with what Waddell & Reed with combined prior firm assets under administration totaling over $1.4 billion. This strong recruiting combined with continued low attrition resulted in the adviser count inflecting modestly this quarter and stabilizing at 1,317 affiliated Advisors and Associates at June 30th. Advisor productivity remained consistent as well, at an average of over 460,000 in total gross revenue. We believe our differentiated service and support model combined with our technology package and full product suite are resonating with these newly added advisors, advisors in our recruiting pipeline and our legacy advisors. Ivy investments under management ended the quarter at $65 billion, an increase of 16% from the prior quarter, while average assets under management of $61.7 billion or down 7%. I would only add to the to the detail on flows earlier in the call that we've been encouraged with the steady continuous improvement in flows and while it's still early, the potential of our redefined sales strategy has thus far proven worthwhile. Turning to the financial results, total revenue for the quarter was $240 million and decreased compared to the prior quarter, primarily due to the lower asset levels. Investment management fees were also lower due to a lower effective management fee rate resulting from mix shifts, as well as the targeted fee reductions implemented in the quarter on our large cap growth and core bond products. U&D fees were lower as well due to lower advisory fees and service and distribution fees due to lower asset levels. In addition, sales commissions were lower $5.7 million as a result of reduced sales activity across insurance product lines. Operating expenses totaled $216.4 million and decrease $7.9 million compared to the prior quarter. Distribution costs were lower $12.2 million due to the lower revenues, while controllable costs increased $4.9 million due to higher compensation, G&A and technology costs. Compensation increased as a result of the mark-to-market increases on equity compensation and our deferred compensation plan, both due to the market rebound. G&A expenses were higher $1.9 million as we redeployed travel and entertainment savings into strategic initiatives across the organization. Technology costs also increased due to new software solutions deployed during the year. While we did take several incremental actions to reduce control expenses through the first six months of the year. We were clear in our last earnings call that we would continue to take a long-term view and invest in the areas we think will allow us to come out of the pandemic in a strong position and drive our long-term growth strategy. While we will continue to closely monitor expenses for opportunities to drive additional efficiencies, we do expect the controllable expense run rate to return to our prior guidance range of $105 million to $160 million per quarter for the remainder of this year, primarily related to continued strategic project investments, but of course subject to the broader market environment. The effective income tax rate was 25.3% for the quarter, and was lower due to volatility of forecasted earnings, despite including discrete tax expense of $1.3 million related to shortfalls from the vesting of restricted shares. Based on current asset levels and the resulting forecast, we expect the tax rate to be at the high end of our prior guidance range of 24% to 26% for the balance of the year. Cash and investment balances increased modestly compared to the prior quarter due to unrealized gains on the investment portfolio, as well as operating cash flows, which were partially offset by share repurchases and dividends. We continue to be pleased with the strength of the balance sheet as we execute on our organic growth plans while maintaining the flexibility to pursue inorganic opportunities, all while maintaining an active shareholder capital return program. Finally, we completed the settlement of our pension plan which removes $194 million gross liability from the firm. We viewed this action as a win for both the company from a reduced cost of record keeping and compliance perspective, as well as for participants who are able to access their balances and direct them in accordance with their overall retirement plans. We still maintain a competitive defined contribution plan, which we enhanced as part of this transition to include a discretionary company contribution component, in addition to the matching component. Operator, we would now like to open a call for questions and I'm told that Phil has rejoined us.

[Operator:]

[Operator Instructions] The first question is from Glenn Schorr with Evercore. Please go ahead.

[GlennSchorr:]

Thank you very much. I appreciate it. Okay, so I want to ask a question on your hiring of executive on the M&A front. We've seen a little bit of a pickup in activity lately in the industry. So, curious what you're seeing overall. And then for you, with the balance sheet stronger, I'm curious on how you balance the healthy tension of wanting to probably buy something that's in favor, higher fees and inflowing but the higher valuations that come with that and your willingness to do so in this marketplace? Thanks.

[PhilipSanders:]

Okay. Thanks, Glen. This was Phil, my apologies for dropping off earlier. And thanks to Ben for taking over. I guess this is highlights the challenges of working from home at different times. But I'd say, maybe I'll start and Ben, I don't know if you want to add on this. I think as the market has rebounded, there's been a little bit more activity in terms of it's buying a little bit. And obviously, this we've made no secret of the fact that over time, as we've kind of transformed the business model, along with our strong capital position, we have the ability to jumpstart our growth through acquisition opportunities or in strategic investments and that type of thing. I think, as you said, it will be I think, on the asset manager side, it would likely be more specific with specific strategies are relatively focused areas that can augment existing string or broaden our portfolio, as you said, either uncorrelated asset classes that we don't currently provide or excel, I think within the fixed income area, that's not been a huge area of expertise for our company. Historically, we've been more equity minded. So, I think there are opportunities on the margin to be active there. I do think acquisitions in the asset management area do present some specific challenges with respect to culture and, integration and we want to certainly be mindful of that. I would also say that this kind of wealth management side, I think that is also an area that we're very interested in, we've made significant progress in transforming the business model within our wealth management, transition to an open architecture platform. As you've seen in the recent results, we've now really made a significant improvement with respect to stabilizing the advisor count, we're optimistic then we can grow that business going forward. So, there are opportunities to scale that part of our company as well, which I think would be a long-term stabilizer to the overall business model. And then finally, I would just say, obviously, share buybacks remain an area of focus as well, and we can be opportunistic there. So I'd say in this environment, it's a good asset, we have real strength in our balance sheet and our financial profile, and it provides us a lot of opportunity to be flexible and take advantage of potential dislocations in this industry. So might stop there. Ben, I don't know if there's anything else you want to add, in terms of how we see that.

[BenClouse:]

I think that was well said, Phil. I would add one thing, which is we're very pleased to have Charles join us, who will be focused in particular on M&A opportunities. And his addition as well as that focus is part of our continued strategic plan like we have laid out. So we're just marching toward in that respect.

[PhilipSanders:]

Okay, Ben, I think you wanted to make one point.

[BenClouse:]

Yes, I'll just add a point, Glenn. And Glenn, you rightly point out there areas in the market that are hot; they're going to trade at higher valuations. The equally interesting part of that equation is there are other areas of the market where the market has a less demanding view of it because in some cases potentially a short-term dislocation and challenges and what not. And that can very well be an opportunity. So the attitude we take is, is there a strategic fit with our investment capability within the asset management, M&A, rubric. Does it advance our core like who we are as Ivy, as fundamental active investors, as an institutional caliber platform? Can we complement and advance that core identity through our inorganic levers? And if so, valuation clearly is a part of all that, which is our hot areas in the market. There are areas to add value by taking a longer view.

[Operator:]

The next question is from Dan Fannon with Jefferies and Company. Please go ahead.

[DanielFannon:]

Thanks. Just wanted to talk about the advisor backlog and kind of the outlook for advisory growth. And if you could just talk about where that sits today. And I know you mentioned recruiting is getting a little bit easier, but also you talk about the typical profile of the advisor that's coming on your platform year-to-date with 21 new advisors you've added.

[PhilipSanders:]

Sure, Shawn, do you want to take that one?

[ShawnMihal:]

Yes. Thanks, Phil. And Dan thanks for your question. We're continuing to see even in the midst of the COVID-19 impacts in the pandemic and having to do some alternate type approaches with regard to recruiting virtually, we're still seeing a strong pipeline that's coming through the organization. We're actually and we look at the overall backgrounds, I mean the typical profile. Our average recruiting has been right about that 400,000. And we take the 21 advisers for the 2020-year average for it to be about 390,000. So consistent with that target that we laid out there, we're trying to recruit towards that more high producing type advisor targeting around 400,000 in production. With that, we're seeing a relatively diverse background coming from a variety of different firms, independence banks, some warehouse, as well as the RIA channel. So a relatively diverse group that's coming into the organization, but consistent with what our value proposition has been, which has been focused on the build out of our competitive technology package. But more about the overarching support model that we've been providing to our advisors with detailed practice development services, advanced sales, diamond service support, things of that nature that have really driven the experience with those advisors. So we're seeing quite a bit of background there that's driving that competitiveness around a multitude of different aspects of advisors that are coming into the organization. Again, the pipeline is remaining strong for us and we've seen five advisors on board in the month of July here with bringing in assets in that range of about $1.5 million trailing TGR, total gross revenue. So, the pipeline is remaining active and we're working through some of the complexities related to the COVID-19 pandemic.

[Operator:]

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

[MichaelCarrier:]

Hi, good morning and thanks for taking the questions. Maybe firstly, just on the net flows, sort of the unaffiliated your channel, you guys saw a good improvement so that we can see the trend in terms of the low redemptions is still there were fairly steady. But anything particular driving that just in terms of like certain products or certain platforms, you noticed like a significant change. Obviously, the industry trends got better. But just wanted to see if there was anything specific for Waddell?

[PhilipSanders:]

Amy, do you want to touch on that?

[AmyScupham:]

Yes. Good morning. Good morning, everybody. And thanks Mike for the question. I would say you're right the industry flows just generally got better, especially as it related to redemptions. But when we look at it product by product, with the Phil mentioned in his scripts of the improving short-term performance of international core with it, with the relative value strategy coming back in favor, and we saw some decreased redemptions in that strategy. That was a big driver, but we really thought across the board and more heavily in the strategy is where we focus our sales efforts. So, it really was across the board but led by international core.

[MichaelCarrier:]

Okay, and just quick follow-up, it's on the fee rate. You guys mentioned the price changes. And for everyone in the mix this quarter, it created a lot of volatility. I don't know if you can parse that out in terms of the impact, but just trying to get a sense of, what's more normal, just given the pretty significant move in the quarter?

[PhilipSanders:]

I don't know, but Ben do you want to take that?

[BenClouse:]

Sure. I wasn't sure I would be happy. Yes, a piece of that of course were the new fee waivers that we added on large cap growth and core bond. And again, we expect those to have an annualized impact of $0.01 to $0.02. So, of course the quarter was proportional piece of those. The other thing going on there was mix in particular ICE or International Core Equity flows, as Amy alluded, that shifted our fee rate a little bit. And then we are, as are many others, making up some of the rate on money markets just due to the low rate environment that also had a very small impact in the quarter.

[Operator:]

The next question is from Bill Katz with Citigroup. Please go ahead.

[WilliamKatz:]

Okay. Thank you very much for taking the questions. So just coming back to your distribution margin a little bit. Appreciate its price and moving parts in their quarter-on-quarter, but it does look like it sort of squeezed down a little bit in terms of profitability. Could you talk a little bit about what might be driving that as any sort of unusual items and there's that sort of a right way to be thinking about looking ahead?

[PhilipSanders:]

Okay, Ben do you want to take a crack at that.

[BenClouse:]

Yes, I think. Good morning, Bill. I think part of that, of course, were lower asset levels in particular starting at the beginning of the period, which probably had the most significant impact on both wealth and asset management. As a reminder, most of our advisory assets in the wealth business are billed at the first of the month based on asset levels. And so some of that is just the way the calculations work and movement, of course, during the quarter was quite significant and as you all know. We also had a little bit of a decline in sales in insurance products, again, in the wealth business that we mentioned in our comments that we're contributing to that.

[WilliamKatz:]

Okay, that's helpful. And then just as I think about the pipeline, you'd mentioned, it's pretty good. When you -- could you talk a little bit about which segments within the wealth management business, you're really seeing the greatest opportunity set right now?

[PhilipSanders:]

Okay, Bill, are you referencing potential M&A opportunities and/or that type of thing?

[WilliamKatz:]

Well, sure, it was actually more of an organic argument, but I didn't want to double down on the organic question. But if you want to answer it that way, too, I'd be sitting open to your views.

[PhilipSanders:]

Yes. Well, Shawn, why don't you talk about what you're seeing in terms of on the recruiting front and the opportunities to add to our advisor count over time?

[ShawnMihal:]

Yes. Hey, good morning, Bill. Yes, the pipeline we've been working is been relatively fluid for us. We look really across the segment. Most predominantly, it's the other independent channel so other independent firms where we're seeing most inflows of advisors coming into what on reorganization. And I think what's resonating there is really the overarching package that we've assembled here competitive technology payout grids, overarching product and open architecture development on our advisory programs that we've been working on for the past several quarters. But it's really resonating around additional support models with advanced sales support through our well solutions group. The materiality of our practice development team as well as field support that we have embedded out there. We've done a lot over the course of 2020 to still maintain service levels and support models in light of COVID-19, and evaluating the situation and doing a variety of different type, virtual opportunities, including the migration of our in-person conference, to a virtual based conference that had a lot of success associated with that. So, all those things are resonating with advisors and promoting that opportunity to organically grow the organization. With obviously seeing the inflection point, modestly here this past quarter with an uptick in advisor headcount just a modest uptick, but it's the first headcount increase since the fourth quarter of 2015. So, a lot of the work that's been done over the last several quarters and couple years to really drive to the competitive, so the firm is resonating. And what we're seeing from those other independent firms is either coming from larger firms where the support isn't as robust with regard to that more dedicated type of support that I mentioned through the various different personnel services, where we can't compete, obviously, the technology and, and payout grids and things like that, but really giving that to those advisors that are not getting that type of support of larger firms, or at this lower, smaller firms having the opportunity to provide those overarching competitive packages with the support programs that I mentioned, is really what's driving that and maybe I'll refer back over to Phil and Ben on the inorganic M&A, side.

[PhilipSanders:]

Okay, thanks, Shawn. Ben, did you want to make a point there?

[BenClouse:]

Yes, Bill. I would add to Shawn's comments just from a product perspective in addition to the points Shawn made in regard to advisors, we're certainly focused on our advisory suite of products, which as you know we've expanded and grown and as you heard in the comments we're very pleased with the asset growth there. On the M&A side just adding to Phil's earlier comments in the wealth business; it's really about driving more scale. So, we believe we have a best-in-class grid. We are in the process of building out our technology to also be best in class and have made a huge amount of progress there. But believe we now have the infrastructure in place to support greater scale, more advisors with the platform that we've put together.

[WilliamKatz:]

Great, it's helpful, I know violating the code here, but kind of have to squeeze one more question in. Just appreciate that your flows have gotten better sequentially, but we look month-to-month, like June was a little bit of a step back month on the retail side. Can you maybe talk a little bit of what might have happened there despite sort of very elevated retail engagement just more broadly, and then how things were going in July?

[PhilipSanders:]

Amy, do you want to take that?

[AmyScupham:]

Sure. Yes. So, Bill, yes, we did see a little bit of a setback in June, it was actually more of an increase in redemptions in that month than it was a decrease in sales. When you look at July, you're seeing, I guess, trends on par with June, maybe slightly better due to better redemptions. But I think what we're seeing is a little bit of seasonality. Just going into the summer time month, second quarter is generally, one of our -- one of our second-best quarters of the year. And so the third is typically the worst. So, we're seeing a little bit of seasonality. And then we've also seen that return to fixed income, heavy fixed income flow, especially across the intermediary marketplace. And then I would say, just to add a little bit more to that Bill, for some context, when you look across our institutional channel, as we know, it's a lumpy channel that can have big inflow, big outflow, we've had two consecutive quarters of no clients, no client losses, and continue to see the pipeline growing there. And I think that's an important point to make. Because from a long-term flow perspective, you have a lot of institutional overlay in the intermediary and retail marketplace. And we've had some positive markers of success with some of those gatekeepers on that side of the business, and during the quarter had two semi-finals and one final presentation. So, definitely progress on that side of the business as well, which will help the overall flow profile.

[Operator:]

The next question is from Michael Cyprys with Morgan Stanley. Please go ahead.

[MichaelCyprys:]

Hey, good morning. Thanks for taking the question. Just wanted to ask about profitability about 10% operating margin in the quarter here down from around 15% or so, where I think you've been operating for a number of quarters, arguably this current quarter impacted by the lower average AUM level. So I guess is there a minimum level of profitability that you're kind of keeping in mind here that you're managing the business to, and if it floors, if you will, and if it falls below which you'd consider more strategic changes. So just curious how you're thinking about that? And as you look out over the next couple of years, what's the right level of operating margin or pretax margin for Waddell over the next couple of years? How are you thinking about that?

[PhilipSanders:]

Okay. Ben, do you want to address that? Is Ben on the line? Let's see here. Maybe I'll just at a high level, Michael, I'd say, I think with respect to the short term volatility and profitability, I would say, I think we are pretty clear, we’re managing the company for the longer term and the strength of the balance sheet and the financials allow us to kind of make the strategic investments we need to do to kind of get us where we need to be over the long term. So we're not going to overreact to short term volatility in the market. And a lot of, as you've pointed out, a lot of that profitability metric was influenced by asset levels and that type of thing. But as we move forward, we think that will operate over time. We have a long-term opportunity here in terms of strengthening the profitability and the wealth management aspect of our business and we'll get to more competitive levels with respect to the enterprise over time. Let me see if Ben is back on. Ben, are you back on? No. I think he is trying to get back on, Michael, so maybe we'll go to next question and have him circle back and when he reconnects, so we can come back to that question.

[MichaelCyprys:]

Yes, sure. And I'm happy to follow up offline as well. Maybe just a quick follow up on some of the retail distribution initiative, some of the new vehicles that you are bringing to the marketplace on SMA model delivery. Just curious how you're thinking about the opportunity set there, how much is that contributing, would you say today to AUM and flows and as you look out, what are sort of the next things on your to do list there?

[PhilipSanders:]

Sure. No, go ahead Amy.

[AmyScupham:]

Yes. So as it relates to the model delivery or SMA portfolios today, it's contributing very little to the overall flow in AUM picture. You'll recall that we launched the first seven model delivery portfolios last May. So just a little bit over a year ago, we've seen some pretty good progress on the RIA side of the business in getting a couple of additional model placements and opportunities which have a huge opportunity to drive flows. So I'll give an example. One of the contracts that we signed last quarter is on a model provider that has over a 100 bank trusts that utilize that platform. So the ability to drive flow that direction is going to be fairly substantial. The work that we're still in the midst of is working with our broker dealer distribution partners for placement there. And the point of that is to be able to offer the flexibility of vehicles to their advisor basis based on whatever program they might be in and model delivery is certainly one of those, especially when you look across the domestic equity asset class. I think from a product development standpoint, we focus in; we're kind of focused in a couple of areas. Certainly, we're taking a look at the ETF structures, whether it's fully transparent or semi-transparent, it's still a discussion and a decision for us to make. But making sure that we're paying attention to the newer vehicles out there in the marketplace that might be garnering flow. And then when you partner that with potential -- our current active capabilities that we have incubator portfolios or potential acquisition or talent addition and other spaces could certainly add ability for us to launch a series of ETFs as well.

[PhilipSanders:]

Mike. We do have Ben back on the line. So, I might just add, asked him to add any perspective with respect to your question and the short-term different profitability given the market sell-off.

[BenClouse:]

Good morning. Sorry about that, Michael. Back to technical difficulty. I apologize. I didn't hear the answer I would just give here would be my context. As a reminder, we operate two lines of business asset management and wealth. So, of course, you're looking at a blended margin. As we've talked about before, we have a number of initiatives that we're pursuing to drive margin improvement. I don't think we clearly have any particular floor and as we talked about in the first quarter, we identified a number of savings initiatives or things to enhance the margin. But at the same time, we're very much focused on the long term and investments we continue to make in our business. And we are very much aligned as a management team and with our board on that. So, I apologize if that's duplicative, but hopefully that that helps.

[Operator:]

The next question is from Robert Lee with KBW. Please go ahead.

[RobertLee:]

Hi, good morning. Thanks for taking my question. I guess my first question is some of the comments around expense and the guided, the controllable expense guidance in the next couple quarters, just trying to get a feel for if we think beyond the next couple of quarters into next year. Now understanding that you're in the process of moving headquarters obviously, even investments to make. So is there any piece of that you feel like spend, technology spent or otherwise that we maybe start to see ease or follow up as we kind of move into to 2021 at this point, or are you there? Or is this really kind of is right now kind of making a good run rate and kind of normal inflation growth right here?

[PhilipSanders:]

Okay, thanks for the question Robert. Ben, do you want to address that?

[BenClouse:]

Yes. Good morning, Robert. Obviously, the farther out, we look, the less precise we can be. I agree with your premise that inflation is a good proxy for expense growth. Of course, we will continue to look to offset that through efficiency efforts. In regard to the technology spend, I referenced in the investments we're making there that will continue into '21, at least for the first part of '21. And in particular to our wealth management business. Some of those technology investments are in areas of workflow and on-boarding and things we're doing to drive a better adviser and client experience that will result in some efficiencies ultimately, once fully implemented. I would also remind you of our ongoing real estate transition, which we will largely have concluded by the end of this year that will also drive some margin improvement for us into 2021.

[RobertLee:]

Okay, great and maybe as a follow up just in the wealth management business. Can you may be update us on how Waddell products are faring kind of in sales and so for example our observation kind of seems like retention rates are pretty sales in there here maybe sales in the wealth management channel of Ivy products has moderated or so you are seeing just even existing advisors just allocate more and more fine budget there to third party products and you bring in a new advisor, what's kind of your expectation over time as relates to their ability to sell more Waddell product deal that is kind of your breakeven now?

[PhilipSanders:]

Yes. Shawn, do you want to take a crack at that one?

[ShawnMihal:]

Yes, I'll maybe start off and certainly Ben, and or others Amy may want to comment as well. We look at this with regard to just inside the wealth management business, our overall ratio of affiliated funds was at about 64.8%, and the prior quarter was about 64.3%. So not much changed between the quarters. But when we look back a little further, the ratios at this time last year was about 67.6%. So what we're really seeing is with regard to new sales going forward as we've opened the architecture is that new sales are going into a broader product set. So with existing advisors, legacy advisors, as well as new advisors that are joining the organization having broader products that means that sales are going to a broader space of opportunities there. So, we do look at reasonably what those expectations are for sales affiliated funds going forward. But we know that those sales are going to on new sales spaces continue to reduce in some regard with regard to the open architecture of the platform. So, on that wealth management side, we do expect to see that rates continue to shift. As we've seen here over the course of the last year, just based on primarily new sales going forward, there likely will be some minor migration of assets that we've seen over the course of the last time here. But at least new sales going forward to broader products that will lead to a more dispersion in that affiliated fun product mix. And I might just turn it over to Ben or to Amy to talk about the Ivy side.

[AmyScupham:]

Hi, this is Amy. I'll go ahead and make a couple of comments here. Yes, I would agree with everything that Shawn said as the advisors is within the wealth manager have more selection across their advisory platform. In particular, we have a range of market share depending on which products that they're using. And so, I would expect to see a continued mix shifts of less unaffiliated or more unaffiliated funds being utilized inside of that base. However, as the wealth manager continues to grow and recruit new advisors, potential acquisitions, we do have the ability to compete inside of that advisor base as well. My expectation would be, that we would that it looks very similar to what does in our unaffiliated partners where you're more competitive products can bring in up to 10% to 15% market share in a fully open architecture, and it would move down from there. So, it would just really be dependent on which product they're using inside of the wealth manager, and then the competitiveness of our individual strategies within that.

[BenClouse:]

One last point, I would add on that which we've seen a bit of already but certainly over the longer term, our wealth management business provides greater balance and stability to our overall firm revenue as those assets are more resilient during periods of volatility and the work we've done in transitioning the business model and wealth has certainly helped those dynamics. So that's another aspect of that as well.

[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. Appreciate everybody joining us. And my apologies again for the technical difficulties at the start of the call. But as you can see, we've undergone quite a bit of a business model transformation over the last couple of years, but given our strong capital position; really feel comfortable with the state of the world these days with respect to our model and how it's evolved. And our ability to invest in continuing to build out our institutional caliber asset manager, as well as now be positioned to really grow the wealth manager over time and the power of that business model through the combination of both an asset manager and a wealth manager supported by shared services functions really is quite unique in the industry and one that gives us a lot of confidence in terms of our ability to grow in the future. So with that, I will conclude and just again, thanks everybody, and have a great day. Thank you.

[Operator:]

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