Waddell & Reed Financial Inc
Q3 2015 Earnings Call Transcript

Published: 27 Oct 2015

[Operator:]

Good morning and welcome to the Waddell & Reed Third Quarter 2015 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mr. Hank Herrmann, Chairman and Chief Executive Officer. Please go ahead.

[Henry John Herrmann:]

Thank you. Good morning. With me today are Mike Avery, President; Tom Butch, Chief Marketing Officer; Brent Bloss, our Chief Financial Officer; Phil Sanders, our Chief Investment Officer; and Nicole Russell, our VP of Investor Relations. Nicole, would you read the forward-looking statements, please?

[Nicole McIntosh-Russell:]

During this call, some of our comments and responses will include forward-looking statements. While we believe these 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, including, but not limited to, those we reference in our public filing with the Securities and Exchange Commission. We assume no duty to update any forward-looking statements Materials relevant to today's call, including a copy of today's press release as well as supplemental schedules, have been posted on our website at waddell.com under the Corporate tab.

[Henry John Herrmann:]

Thank you, Nicole and good morning, again, everyone. I would like to begin my prepared remarks by addressing what I know is top of mind with investors, that is slow trends, weakened sales, underperformance in certain investment strategies and their combined impact on our business. I'd also like to go a bit beyond these factors, and address what I believe to be, underlying strengths in our business. And actions we are taking to adapt to changing product environment and stay competitive. And finally, I'll touch on capital management. First things first, unfortunately, asset strategy outflows re-accelerated in the third quarter, after having moderated through the first and second quarters. The fund's performance continues to lag its peer group and benchmarks on a year-to-date bases. Moreover, flow into the world allocation category has decelerated meaningfully in the recent past. While outflows appear to have slowed in October, we cannot say with certainty, when asset strategy outflows will decrease materially or ultimately end. But, at this point, it is unlikely we will see a drastic improvement in the short term. Performance will, of course, be one factor and capital gain related to selling in the fourth quarter maybe another. On the other hand, the high income strategy has seen a slowing in net outflows. September outflows of $119 million were the second lowest monthly level of the year and outflows have moderated more in October. If this trend holds, one of the important overhangs in net flows would be eliminated. Listen, the side flows here are more about overall sentiment on high yield, as opposed to the portfolio's performance itself. Extra asset strategy and high income, our retail channels have combined net outflows of $220 million during the third quarter. This is especially noteworthy during the period of intense headwinds for active management. In August alone, the top 50 active managers had net outflows of basically $60 billion. We recognize that it's, in a sense, convenient to look at our flows exclusive – our two largest strategies, while our optimism for the future rests on the breadth and quality of our product line and distribution models. In addition to our flexible and high income mandates, we have franchise strategies that is strategies over $5 billion or more, in science and tech, mid-cap growth, large cap growth and in international core equity. Even as we have grown these franchise products, we have accelerated our launch of new funds both in categories we have investment expertise and in categories where we do not, but have crafted strategic relationships. In the past few years, we have partnered with global leaders in their asset classes. LaSalle Investment Management for global real estate. Pictet for emerging market and absolute return or debt and Apollo for non-traditional credit. These funds augment our existing core line-up and help us respond to ongoing movement in investor sentiment. We believe all will be important in time. In addition, we have committed to the ETMF structure and we'll stand ready to move into that product structure aggressively upon its adoption by distributors. We're diverse not only in product, but in distribution. Our advisor channel is a very strong revenue generator and it continues to enjoy industry low redemption rates. Technology and processing upgrades underway will further strengthen our competitiveness in that channel. Despite recent specific headwinds – excuse me – despite recent product specific headwinds, we remain important and well known in the wholesale channel and many of our funds featured on distributors' recommended lists. Further, the institutional channel continues to provide opportunities to take our investment capability beyond the retail environment and often in the strategy used, maybe out of favoring (00

[Operator:]

We will now begin the question and answer session. The first question comes from Michael Carrier with Bank of America, Merrill Lynch. Please go ahead.

[Michael R. Carrier:]

Thanks guys. First question, maybe just on the shorter term, like the one year performance, just given some of the pressure, and in the third quarter just given the amount of volatility that we saw in some of the markets, just wanted to get an update on how you guys are positioned just in terms of where you see opportunities? But then just from an exposure standpoint, overall for Waddell, how much exposure is there to commodities, emerging markets and obviously it was a pressure in the third quarter, but we'll see longer term, but just wanted to get an update on that side.

[Henry John Herrmann:]

Well, several different people in the room could answer and all three would be different answers. So maybe what I'll do is keep the investment guys out and let the marketing guy start.

[Thomas W. Butch:]

I think that's equitable, personally. This is Tom. Michael, relative to sort of positioning and things that are working in the marketplace, as Hank indicated in his opening remarks, international core equity continues to drive flows. Fortuitously, if you look at actively managed categories, it remains steadfastly near the top in terms of net inflows and so there is good harmony between our having a very good product in that space and that space remaining of great interest relative to active. We're having good inflows in our balanced product and then more niche-y kinds of flows in things like European opportunities. We have opportunities beyond that, that are starting to really come to the floor in things like global real estate, which heretofore has not been a category where active was winning flows, but has been in the recent past and we have funds that are maturing in that category and give us good opportunity. Further, Hank mentioned the fact that working with the Apollo group, we have two new funds that we're taking to market and there seems to be a good bit of interest, both among our wholesalers, the advisors with whom they interact and the firms with which we interact, as you likely know. It takes some time to get new funds on platforms. In fact, it takes little longer than it did in the past. And so, we haven't materially penetrated the largest platforms yet, but we're confident that, that will begin to unfold before the end of the year and into the first quarter, but those distribution environments, where it is offered, have received it very favorably today. And so I think, it is those products and our energy product is another one that seems to be garnering a good bit of interest. One of the interesting things Hank also mentioned in his opening remarks was the span of offerings we have on preferred or recommended list. This year alone, we've seen good new opportunities across the whole span of products, and so I think it furthers his comments relative to the fact that there is good breadth, good interest, good opportunity that transcends some headwinds in our largest products.

[Henry John Herrmann:]

Mike, this is Hank back. I'm not quite sure I completely understood your question, so I'm going to answer something perhaps you didn't ask, but I apologize. It will be brief. Just looking at a year-to-date bases and looking at Lipper rankings, relative performance is pretty good in a lot of places and not as good as we'd like in a couple. When you look at the volatility that occurred in the third quarter, you touched on a couple of things that maybe played a role, I would just like to point out that in our emerging portfolios, in our natural resources portfolios and in our energy portfolios, all those categories just happen to be, on a year-to-date bases, ranked pretty high, above top third and so I just think that's an interesting comment on the overall structure of where we are. I'd also mention that in high yield category, our energy exposure has been in low single digits, I don't think – maybe 6% or 7% for quite a long time. So even in high yield fund, our relative performance has been pretty good despite the outflows. I don't know, if that was a question you were raising but I thought, I should address it.

[Michael R. Carrier:]

Yeah. No, that's helpful. And then just as a follow-up, Brent, just two small things, just the non-op – the C losses seemed a little bit – more, I don't know, visible versus like the past. So, just wanted to get update, maybe like the seed portfolio size versus the past, and maybe, it's just the product categories, meaning, more in Asia emerging markets, commodities, and so that's exacerbated it. And then you gave a little bit of the expense guidance and, obviously, this quarter, expenses were well controlled. Just wanted to get an outlook, particularly around 2016 on where your thoughts are, just given some of the outflows and, I guess, assuming, I guess, a stable market?

[Brent K. Bloss:]

Yeah, Michael, first on the – I apologize for my voice this morning. But on the seed investments, those have ramped up over time, and just given the new products that we've put in place and so currently, right now, we have close to, I believe, a $160 million in seed investments. And you're right, during the quarter, we did see a lot of – a lot of those are an emerging market type products, where we did see the downturn hurt us in September. And as Mike – or as Hank mentioned in his remarks, a lot of those losses have already been recovered here in October, so on that front. And then as Hank also mentioned in his remarks that we're aware of the revenue base being lower and margins under pressure. At this point, we don't see ourselves overreacting, but again we understand that there is pressure where everything's on the table as it relates to expenses right now, were going through our annual budgeting process and so we're looking at everything very closely, and we'll look to align with that revenue base where it makes sense and doesn't hamper our future growth. We planned to keep our head count intact and we've been, throughout this year, managing that very closely. So, not a lot of additions there. So, all that's on the table. I'll have more information for you in the fourth quarter as we move through our budgeting process. So, we're definitely looking to make some cuts where we can find things that, again, not hamper our future growth.

[Michael R. Carrier:]

Okay. Thanks a lot.

[Operator:]

The next question comes from Dan Fannon with Jefferies. Please go ahead.

[Daniel Thomas Fannon:]

Thanks. I guess starting with the institutional kind of pipeline in business, you've had the outflow that you called out for the quarter. Just wanted to get an update on kind of potentially other strategies that might be able to fall victim to kind of the smart beta re-allocation and also kind of what is in the Asset Strategy Fund that is left that is institutional?

[Thomas W. Butch:]

This is Tom again. So during the quarter, the – as Hank indicated, it was – and you reiterated, it was substantially a result of the movement away from a quarter of smart beta strategy. Whether we have further vulnerability to that is sort of a great unknown. Those things happen from time-to-time and it goes the other way from time-to-time as well. We do have some wins that have yet to be funded here in the quarter and as Hank indicated to-date, the quarter is also positive. Your second question relates to the asset strategy portfolio in the...

[Brent K. Bloss:]

Institutional.

[Thomas W. Butch:]

...institutional.

[Brent K. Bloss:]

...it is just over $2.7 billion.

[Thomas W. Butch:]

And that account has been with us for some time. At one point, it was quite a bit larger than that. We have been notified by that account of its intent to recommend to its board a redemption of most of those assets sometime in the middle of next year. We obviously don't want to get in front of the board to which that will be recommended, but we have had that notification from staff.

[Daniel Thomas Fannon:]

Okay. And then a follow up just on capital return, Hank, I guess I would like to get your characterization of this level of buybacks that we saw in the third quarter, the dollar amount is still below most of the – I think three or the four quarters from last year, your cash balances still remain well above historical levels. And so wondering if a special dividend is also still a potential opportunity or obviously you raise your dividend which is consistent with historical patterns, but curious as to kind of the outlook and how we can think about the rest of capital return?

[Henry John Herrmann:]

Well, I think we've been buying stock down pretty steadily here and my view is there's still more opportunities given how depressed the stock is. But other than that, I don't care to be specific. In the case of a special dividend, it's not something that the board is currently considering.

[Daniel Thomas Fannon:]

Great. Thank you.

[Operator:]

The next question comes from Glenn Schorr with Evercore. Please go ahead.

[Glenn Paul Schorr:]

Hi. Thanks very much. I'm just curious and maybe it's – each one is different, but you mentioned the potential redemption in middle of next year on the asset strategy money, which is a nice long lead time. I'm curious if the timing of the notification on the billion institutional account this quarter going into smart beta and if there's any norm in between or is kind of episodic?

[Henry John Herrmann:]

Glenn, it's Hank. I'm not really sure what you're asking. Try me again, I apologize.

[Glenn Paul Schorr:]

My bad. I'm curious if there's any normality towards the timing of large institutional flows? Did it let you know, like this asset strategy won six months in advance.

[Thomas W. Butch:]

There tends to be a great deal of variability in that fund.

[Glenn Paul Schorr:]

Okay. Maybe a follow-up on the expense side. With comp down 13 in the quarter and G&A down 9, I guess on the comp side, some of that could just be year-to-date accrual catch-ups for changes in the environment. I guess what I'm looking for is the jumping-off point going forward, even if we were just talking about fourth quarter at the start. I know markets have gotten better, but are these good comp and G&A numbers to build from?

[Brent K. Bloss:]

Yeah. Glenn, I think, it will depend on where performance ends up in the fourth quarter, but we're looking at a range of 47 to 52 on the comp side in the fourth quarter. And again that will depend on where performance falls out during that period of time.

[Glenn Paul Schorr:]

And just G&A, that was helpful.

[Brent K. Bloss:]

On the G&A side, we'll look at probably a $25 million to $28 million range there. In the current quarter, we had – although lower level of IT spend than we had guided in the past, we expect that to pick up a bit in the fourth quarter.

[Glenn Paul Schorr:]

Got it, okay. And then in the text, last one from me is, you noted the higher level of front-load variable annuity sales commissions. Is that in your own channel? Is that where all your variable annuity sales take place?

[Brent K. Bloss:]

Yes, they all take place in the Advisor channel.

[Glenn Paul Schorr:]

And is that just a product that's growing business and a little bit more Advisors, or is there a little bit of a shift towards client preference there?

[Thomas W. Butch:]

I'd say, it's more of the former than the latter, Glenn. The other thing is that the suitability requirements around variable annuities are extraordinary and it's taken us sometime to systematize our review of those in a way that fulfills all the requirements without being unduly owners to our advisors, and I think that's starting to reflect as well. When you look at retirement solutions, our view in that channel is that perhaps that's an underappreciated one. The other thing I would say, though it's not specific to your question is though we offer annuity products only through our proprietary distribution, we of course sell our VIP series of funds through others distribution and that's been a growing part of the overall mutual fund mix relative to variable annuities.

[Glenn Paul Schorr:]

Okay, I appreciate that. Thank you.

[Operator:]

The next question comes from Michael Kim with Sandler O'Neill. Please go ahead.

[Michael S. Kim:]

Hey, guys. Good morning, so first, just doing some quick math, coming up with roughly a $1 billion of outflows quarter to-date based on the $112 billion real time AUM you mentioned. So first, just any comments on our math. And then I know you mentioned slowing outflows across Asset Strategy and then High Income in October, so beyond that, any color on some of the puts and takes thus far this quarter.

[Brent K. Bloss:]

Probably a little bit lower than your number, and I don't remember specifically saying lower outflows out of Asset Strategy. Off the top of my head, I'm not sure exactly I'm looking at, Tom.

[Thomas W. Butch:]

Asset Strategy specific, let me look at that, I apologize I don't have that right here...

[Brent K. Bloss:]

I think what I've – what I've said, I believe, was the performance was quite good so far, relatively, in October, and relative ranking has improved a lot and that sort of thing. But I don't remember talking about flows specifically.

[Thomas W. Butch:]

Yeah Asset Strategy in October appears to have been abated somewhat though as Hank said, future outlook in the near term is still a little bit unclear. I think maybe another way to think of it, Mike, is that if you look at the three channels at the moment, it would suggest that the net flow situation would improve in October versus September in all three of them with Institutional being positive and lesser net outflows in the other two. That's maybe the simplest way to look at it and we'll retreat on the Asset Strategy number and get certitude around that.

[Michael S. Kim:]

Okay. Fair enough. I appreciate the color. And then just to come back to the institutional channel excluding the billion dollar loss, looks like there were still some bit of residual outflows across the channel. So just wondering if you could maybe sort of talk about some of the dynamics and sort of the outlook going forward.

[Thomas W. Butch:]

Yeah, I think one of the things that's happened in the channel is that, it has become modestly less lumpy, though certainly that wasn't in place so much in the third quarter. What you're seeing at work there, for example, is the aforementioned asset strategy account is a daily valued account and the outflows of it show in the institutional channel, so that's one thing that we saw during the quarter. But the overwhelming majority was in the redemption that we already talked about. There wasn't a lot of other stuff shaping the quarter. Relative to the future, I did mention some unfunded wins. Activity continues to be centered around, principally, our core equity and large-cap growth products. If you look at search activity, it's likely that as the year moves forward, we will look at an overall search activity fairly consistent with the prior year. Again, one of the emphases that draws into play a broader span of strategies is greater emphasis on the insurance marketplace, which among other sub-advisory opportunities allows us to take more strategies into a sub-advised context. But again, it is our core large-cap growth, mid-cap growth, and to a lesser extent international core equity products that have substantially driven recent search activity.

[Michael S. Kim:]

Great. Okay. That's helpful. Thanks for taking my questions.

[Operator:]

The next question comes from Craig Siegenthaler with Credit Suisse. Please go ahead. Craig Siegenthaler - Credit Suisse Securities (USA) LLC (Broker) Thanks, good morning.

[Henry John Herrmann:]

Good morning. Craig Siegenthaler - Credit Suisse Securities (USA) LLC (Broker) If a larger financial services firm was interested in acquiring Waddell, can you remind us how you would handle this process?

[Henry John Herrmann:]

Are you offering a bid, Craig? Craig Siegenthaler - Credit Suisse Securities (USA) LLC (Broker) Yep. I got one right here.

[Henry John Herrmann:]

I don't think I've ever discussed the way you just structured that question. But if you're wondering what happens from a procedural perspective, if someone came to us and made some sort of an offer, all things being equal, we would reflect that to the board and have a discussion about it and how it laid relative to prospects we would expect standing on our own. Craig Siegenthaler - Credit Suisse Securities (USA) LLC (Broker) Got it. And then I think one – right now, Waddell & Reed is overweight U.S. clients versus global clients. And part of the world that's growing quicker, if you look at flows, is Europe and potentially longer term Asia. And I'm just wondering if you thought about – if you looked over maybe the Dai-ichi/Janus relationship which looks like its bearing some fruit in Japan, any sort of situation like that which could help grow your business internationally?

[Henry John Herrmann:]

With no specificity, but certainly those sorts of things occur to us; we do recognize that it would be better if we had more distribution in other areas of the world. Obviously, we're very domestically oriented and it's also, I think, true that foreign economies, broadly speaking, are interested in finding ways to participate in the U.S. investment environment. I say that with the exception, of course, recently of the changes that are going on in the Middle East. Craig Siegenthaler - Credit Suisse Securities (USA) LLC (Broker) Got it. All right. Great. Thanks for taking my questions.

[Operator:]

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

[Robert Lee:]

Thanks. Good morning, everyone. Bunch of my questions were asked, but I guess one question I had was in the Advisor channel. Is it – Tom, is it possible to get maybe a little bit more color; you kind of talked about VA sales being up. If I look at the gross sales in that channel, kind of getting a better feel for the breakdown, how much of that is coming from – came from VA? How much of that kind of came from your fee-based platforms versus, say, more traditional one-off fund sales – trying to get a feel for the mix.

[Thomas W. Butch:]

Sure. About 65% of the sales and about 47% of the revenues came from fee-based sales. That's the single largest dynamic that I think is in play, not only here, but at most broker-dealers. We still do sizable transactional business, obviously, but the fee-based model has substantially taken hold. I think that's the single largest trend. If you look at the variable annuity piece of that, it's not particularly material to the overall construct of the channel in terms of flows.

[Robert Lee:]

Okay. And maybe just a follow-up question, I mean, I'm just curious with some of the expanded product line, particularly where you've partnered with, whether it's LaSalle or Apollo or I guess Pictet were the three, you mentioned. Can you maybe update us on where you feel like those stand with – are you seeing much traction with those or is it just too early maybe particularly with the Apollo strategies to – you're still working to get them on platforms; just kind of curious how that process was going?

[Thomas W. Butch:]

Taking the three in order, Pictet – we came to market with an emerging market local currency product from Pictet at what has proven to be an inopportune time. We don't try to time entry of new products into the market, but certainly that's been an asset class which has been under extraordinary pressure. If you look at its Lipper rankings though relative to the peer group, and Lipper in that category is lot more relevant because Morningstar includes the hard currency funds and the locals together. It's building a good track record for when it becomes more opportunistic. So flows into that have been minimal. The two global real estate funds together have about $100 million in assets. They're starting to hit advisor's and firm's screens a little bit. They're still maturing as I said, and the sales environment for global real estate has become considerably more hospitable recently. So we expect good and important things out of those. And just to reiterate, the Apollo, we have about, since they were launched October 1st, there's been about $15 million that has gone into them; that includes transfers and sales. And substantially, probably, I would say substantially from the Waddell & Reed broker dealer, because, again, it takes some time to get those placed. I will say that the feedback we've gotten from our firms, from our wholesalers and from their advisors has been quite constructive. So we're hopeful that those gain traction just as soon as we get them on platforms later this and early next year. And again, these are products that augment the core skills that we bring to market as an investment manager, in no sense are a replacement for them, but enable us to perhaps expand our conversations and the span of things that we do. And all of those relationships, I would say, we hope not to be sort of single product relationships, but more strategic in nature over time.

[Robert Lee:]

Okay, great. And maybe just one last question and, obviously, the DOL hasn't come out with their final proposals, but at least it feels like, at least to me, things are kind of marching in that – in some direction, that they'll come out with something. So, as you think about that, how are you – are there any steps you could start to take or how are you thinking about things you may have to – whether it's compliance or something, beef up with your Advisor channel. Do you feel, given what you know today that you're pretty well set with most of your infrastructure that you would need to put in place or have in place?

[Thomas W. Butch:]

Let me answer it a couple of ways. The late September letter by 96 House Democrats and the subsequent and highly unpredictable move for the Republicans to follow right in with the larger voice, has, I think, given some pause to the situation and even statements from officials seem to suggest a slowing in greater consideration. I guess our view would fall in line with the SSIs around issues like complexity, additional standards, potential reduction in access among low and middle comp – middle income investors and, especially, the best interest contract and what that sort of implies. And so there seems to be a period of just digestion and consideration, whether that results in material changes, it's hard to say. And now, on to your real question, yes, we have a task force, which has been meeting internally on this and I guess the shorter story is yes, we feel, we would be operationally able to handle the changes that, to this point, have been suggested. We, like other broker-dealers, have opined on this subject, certainly believe there to be a lot of complexity in doing so, and like all other broker-dealers, they are digesting it and hope that this period of – if not greater consideration leads to some simplifying of what's been put forward.

[Robert Lee:]

Great. That was helpful. Thanks for taking my questions.

[Operator:]

The next question comes from Chris Shutler with William Blair. Please go ahead.

[Chris C. Shutler:]

Hi, guys. Good morning.

[Henry John Herrmann:]

Good morning, Chris.

[Chris C. Shutler:]

You talked about all expenses being on the table, Brent. Maybe just help us think through what the big spending items are that you're considering, maybe what could be deferred and then on the advisor platform, which I know you guys are working on it, what's the timeline on that project?

[Brent K. Bloss:]

Well some of the major expenses that will be on the table, obviously, are our advertising budgets, our sponsorships and other things, that we'll have to take a close look at, as well as looking at – our compensation structures and other things internally, as we move forward. On the advisor channel technology, we will look to pull that into our normal IT budget for next year, we're coming off of a huge lift in IT over the last couple of years, it'll probably push into the first quarter. There's still some items that need to be, to manage there. But we think, we can manage through this advisor channel upgrades within our normal budget and, hopefully, see even some reductions in IT spend as we move into 2016.

[Chris C. Shutler:]

Okay, thanks. And then on asset strategy, just one quick question there. I'm just wondering, has there been any change in the – in terms of your discussions with distributors, in terms of platforms that strategy is on or recommended list that it's on? Thanks.

[Thomas W. Butch:]

There have been some yes – there is a pending redemption from one broker dealer in November that we have been apprised of. It's nowhere near the magnitude of the other one we discussed. The fund, like many funds which underperformed for some period of time, is on a span of watch list. All that means for the moment is that, it gets greater due diligence scrutiny for some period of time.

[Chris C. Shutler:]

All right. Thank you.

[Operator:]

The next question comes from Bill Katz with Citi. Please go ahead.

[William Raymond Katz:]

Okay and thanks very much for taking the questions. Just a few to wrap up. Can you talk a little bit about the fee rate dynamics, what might be coming in terms of net new business versus some of the anticipated attrition? Would you anticipate that, that rate will blend lower or is it more of a push?

[Brent K. Bloss:]

Bill are you talking institutional or overall?

[William Raymond Katz:]

I'm talking about overall, Brent.

[Henry John Herrmann:]

Well I would expect the rate to move somewhat higher. Given the asset strategy attrition, I wouldn't think it would go a lot higher but it certainly won't move lower.

[William Raymond Katz:]

Okay. And then just to clarify. I apologize, I joined a touch late, some problems at our end. You've mentioned there's a $2.7 billion notification for the next year. Is there any change – if that's right, just let me know, and then is there chance to recapture that elsewhere in the firm and some other mandates?

[Thomas W. Butch:]

Yes. That was mentioned, Bill. I think the number, just updating, I think, more recently, is close to the $2.5 billion.

[Brent K. Bloss:]

Well we have over – what I meant to say or what I should have said more clearly is the question that was how much money does that strategy have in institutional accounts? And the answer is over $2.7 billion. We haven't talked about the clients, specifically, nor the amount given that, that's a pending decision by that client's board, which will not even be taken under consideration until December. If the board agrees with the staff recommendation, redemption would be May 1st, I believe.

[Thomas W. Butch:]

Yeah. And to further clarify that, that whole amount – the largest part of that amount is at risk, it may not be the total amount. And again from Mike's point, and as I mentioned earlier, we don't want to front run the board but did want to make you aware that, that notification has taken place. Whether we can recapture it in other strategies? Certainly, we hope so. We detail as best we can the pipeline for the institutional business and the opportunities that we see. That's a sizable – obviously, a sizable account and recouping it one fell swoop is less likely than recouping it through a span of wins and a span of products.

[William Raymond Katz:]

Okay. And then the – thank you for that. And then in terms of what you mentioned, in terms of the broker dealer. Can you size the AUM that might be at risk on that particular platform?

[Henry John Herrmann:]

Say again, Bill. I'm sorry, I didn't understand.

[William Raymond Katz:]

I apologize. I think you mentioned that you have another pending notification on one broker dealer redemption in the Asset Strategy Fund. I'm sort of curious, if you could size what that exposure might be?

[Thomas W. Butch:]

Yeah, it's roughly $125 million.

[William Raymond Katz:]

Okay. So stepping back, in the Asset Strategy Fund, I think you have a couple of billion dollars in private investments, and if my reading of the rule is right, that only account for about 15% of the fund. If you were to be in a situation where the fund would have shrink toward that level, how do you handle that private investment in terms of if it were to go north of 15%, is there any flexibility around that ratio and would you be forced to liquidate? What's the timeline against that?

[Brent K. Bloss:]

Well, Bill your interpretation is correct. Under – as a 40 – 1940 Act Company under SEC rules, there is a limit that you can buy up to, but not above 15% of AUMs. Our interpretation of the rules would be in the case of a catastrophic decline in AUMs and our exposure to private investments would rise above 15%. We are not compelled to sell those, although we'll probably get a lot of questions about what our exit strategy is, but it certainly would prohibit us from adding to our private investments.

[William Raymond Katz:]

Okay. Just stepping back, I recognize the third quarter was very difficult for everybody, but your gross sales number was down pretty substantially both quarter-to-quarter and year-on-year. How do you toggle between tactically some weak, but maybe improving investment performance to cut back on spend and trying to percolate the gross sales. What's the strategy from here to try and drive the nets a bit better?

[Thomas W. Butch:]

Well strategy as always is to align our best opportunities with what the marketplace is seeking from us. As I articulated earlier, there are span of products we have that are working and others that – part of the question on our newer stuff are coming into maturity and I don't – there's no single solution to reigniting sales of the magnitude that have dissipated as a result of the two largest products having slowed as substantially as they have. That said, the rolling net sales of our high income product, the rolling net outflows are at their lowest level in a long, long time and, as Hank said, that's likely to dissipate materially, where we reignite growth is a function of three things. The products we have that are performing, the categories that are working best in the marketplace and the percentage of those categories, sales that go to active. So it's really a rather simple sounding, but very complicated process of matching opportunity to what we have to serve it.

[William Raymond Katz:]

Okay.

[Thomas W. Butch:]

And again, I would point out that, again, across our product line, though overwhelmed to a certain extent by what's happened in Asset Strategy. A lot of good things are happening in terms of recommended list placements of the span of products and the new opportunities that we continue to see.

[William Raymond Katz:]

Okay just one last one. Thanks for your patience with all my questions this morning. Within the Advisor channel, can you give us an update of how much was proprietary Waddell product versus third party sales this quarter?

[Thomas W. Butch:]

I have in terms of AUM right at my finger tips and let me give you that one, while Nicole searches for the sales piece. The AUA in the channel at present is just south of $48 billion and the proprietary piece of that is about $42 billion. The sales as you know tend to be in the 90 percentage range under normal circumstances and Nicole will continue to look for that number and I suspect it will be somewhere near that range.

[William Raymond Katz:]

Okay. That's very helpful. Thank you so much.

[Operator:]

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

[Michael J. Cyprys:]

Hey, good morning. Thanks for taking the question. Just first on the seed investments, given some of the volatility in that line, just curious what you're latest thinking on – is on hedging, that sort of risk on a go-forward basis?

[Henry John Herrmann:]

Yeah it's – it's certainly something we've – we've been looking at, although I will point out, in the past, we've had a large capital loss carry-forward, that we've been – bringing down over time, so the seed investments are really our only alternative for managing that capital loss carry-forward at the current time and again, we've been pretty successful at bringing that down over time. We did have a bump in the road here in the third quarter as I said, most of – most of those losses have been recovered today, but it's certainly on our mind about putting an overlay on this at some point, once we get pass managing this capital loss carry-forward.

[Michael J. Cyprys:]

Got it. Okay. That's helpful. And then just on the investment spend, just – can you give an update on your plans for technology upgrades in your Advisor channel, something you mentioned earlier, just what are you considering there in terms of potential upgrades at this point and how should we think about the timeframe and cost around that and does the DOL fiduciary role accelerate any of that?

[Thomas W. Butch:]

To a certain extent, it's not accelerable, if that's a word. There's a lot of sort of decommissioning that has to take place and changing the frontend of the broker dealer is no simple task. We've not announced publicly any of the vendors with whom we've been working, but suffice it to say, we're moving from – seeking to move from a paper-intensive, transfer-agency-centric environment to sort of a full electronic, substantially paperless environment. We have selected a couple of the vendors for the first part of that process. As to timeline, it's lengthy, but we're going to do it in stages. And I would expect suspect that, that will be somewhere between an 18 months and two year process.

[Henry John Herrmann:]

But the cost associated with that platform, if anything, it will be minimal in 2016 because it will be backend loaded and some of that cost will be capital.

[Michael J. Cyprys:]

When you say backend loaded. Does that mean it's going to go into 2017 as well?

[Henry John Herrmann:]

Yes I believe that by the time it's operational, most of the cost will show up in 2017.

[Michael J. Cyprys:]

Got it, okay. Thanks.

[Operator:]

The next question comes from Eric Berg with RBC. Please go ahead. Mr. Berg, your line is open. Please go ahead. Is it possible your phone is muted?

[Eric N. Berg:]

Could you hear me now?

[Operator:]

There you are. Go ahead, sir.

[Eric N. Berg:]

Thank you very much. Sorry for the delay; my line was muted. As you think about the gross sales in the Wholesale channel in the September quarter, what portion of them were other than Asset Strategy? Was it essentially all the sales or are you enjoying some gross sales in Asset Strategy?

[Thomas W. Butch:]

First, we're having gross sales in Asset Strategy, Eric. The – as a matter of fact, on a gross sales basis, Asset Strategy still remains an important part of that quotient. It was about 13% of sales in the quarter.

[Eric N. Berg:]

And while I know you can't get into that heads of, and understand the motivation of financial advisors everywhere, what's your best sense as to – just your best sense from conversations as to why the flow situation did deteriorate in the September quarter versus that in the June quarter? Was it a performance issue or is it something else that reignited the outflows? Thank you.

[Thomas W. Butch:]

I think Hank referred in his opening market – opening remarks, to the confluence of two things. One is that the performance was under pressure, but concurrently the category was under pressure. I think I said before when asked about sort of the forward look of things and where we would seek to find opportunity, there are a lot of factors at work and investor preference, in my experience, is moving more quickly than ever before in the World Allocation category, which is how Morningstar categorizes it at least, and you in the past have noted the disparate peer groups between Morningstar and Lipper. But in the World Allocation category, that category in September was not – was in very substantial outflow of $2.4 billion and that continuef the trend of that category being under some degree of pressure. So you've got sort of the joint headwinds of performance versus peers being under some pressure and the category itself being similarly pressured and that I think was at – was what was at work.

[Eric N. Berg:]

And Hank if I could finish my questions by asking a general question and direct it to you personally. If you were to characterize where Waddell is in terms of a turnaround, and maybe you want to challenge that word turnaround. But if you're comfortable with that word turnaround, would you say you are at the beginning, before the middle, just after the middle, kind of like a U-trajectory, before the bottom of U, at the bottom of the U or getting towards the end? Where in that process is the company?

[Henry John Herrmann:]

Turnaround. I got struggling immediately with turnaround.

[Eric N. Berg:]

Okay. That's why I said, if you don't like that word, what – you can use a different one.

[Henry John Herrmann:]

I don't have a better one. I didn't say I didn't like it, I said I was struggling with it. In the end, you can't sell out of an empty barrel and for just you and I that means we got to get our performance headed in the right direction. Be a little bit heuristic or some other fancy term if I were to suggest to you in the environment where the volatility is at the level that we're experiencing and sector rotation and whipsawing is a common practice, that I am highly confident that we will turnaround performance in the next week. I can't say anything like that, and I'm sure you understand that. However, there are no broken bones here in the investment process in – amongst our very talented group of people. And you know that we have a long record of doing pretty good. But, you may remember that a man from La Mancha, the commentary is there is no man for all seasons. And if you've been a portfolio manager, as I have been a portfolio manager, every once in a while it ain't your season, to use kind of crafted language. And we're struggling with a little of that. On the other hand, I think that the staff is very dedicated to working hard, pulling on the wagon and working our way out of some of the performance shortfalls we've had. So, no matter what I say, everybody in the PM Group is well aware that, performance, particularly in the environment we're in now with passive having the influence it is, that performance is critically important and if you don't deliver, you get diluted, marginalized. And we've got a lot of very senior people around; we've been through ups and downs and are very focused on getting things headed in the right direction. And I hope that was responsive with, at least in part, in the question. In the way you characterize it, I'd say we're earlier rather than later.

[Eric N. Berg:]

Thank you for answering.

[Operator:]

The next question comes from Mac Sykes with Gabelli. Please go ahead.

[Macrae Sykes:]

Good morning and thank you for taking my questions. Hank, just a follow-up in your past comment; given some of the challenges, IAS (57

[Thomas W. Butch:]

This is Tom, and Mike may want also to comment on this, because he and his team are tireless in working with the wholesaling team, and facing off with the financial advisors of our firm and the market, generally, doing conference calls more regularly I think than most PMs in the marketplace and trying to keep people apprised, the whole universe, our wholesalers, proprietary advisors and many advisors who use this product. I think the effort around this fund has been transparent and unrelenting throughout this downturn, much as it was when the fund was gathering assets at a very rapid clip. Mike, I don't know if you wanted to say any more than that?

[Mike L. Avery:]

Well, I guess I would say that as Tom mentioned, we've spent quite a bit of time, as we're happy to do, with clients, advisors, institutional accounts either in person or in conference calls, walking them though the last 18 months, 24 months. And when an investment neither meets people's expectations nor is consistent with past exceptional performance, they rightly ask the questions, what is changed, should I stay with Asset Strategy? And those questions are certainly appropriate. When we – for those that we were able to talk to or allow us to talk to them, we remind them that the team has been managing their money since 1997, during that time, five-year rolling return performance met or exceeded a comparable five-year rolling return for the S&P 500 through the end of 2012, it's not easy and during that period, we more than met most people's expectations. The focus has been and this a question, I believe, Eric raised, the focus has been on 2014 specifically, given the extreme underperformance relative to the S&P and a period in which we had a member of the team leave, who was my partner at that time. And those two things together create a perfect storm that raises the consciousness of people who have become, again, somewhat used to, if you will, exceptional performance and are also told that when a PM leaves, no matter what the circumstances, to be wary. And as we've been able to sit down with people and explain our approach and that the approach hasn't changed, our philosophy, our objective, our approach, our benchmark, our time horizon has been very consistent and well articulated for an 18-year period of time and when you walk through 2014 in which case, what I think people forget after a period of time again, when they enjoy good returns is that we're humans and we're prone to making bad judgments or shoot ourselves in the foot relating to specific investments in a discrete time period and in 2014, decisions that we made in years prior came back to – even though they were helpful prior to 2014, came back to haunt our clients in 2014. The first six months of 2015 were pretty good. We were doing, as well, are better than the S&P 500. The peak in the markets began – began to rollover, I would say, mid-June and accelerated in earnest in August and into September, were particularly painful given our exposure to global markets during that period, China in particular led the charge, if you will, with regards to questioning not only the expected growth rate for China, but also the impact on global growth and particularly, difficult period that happens at the end – at the end of this quarter. October has been much better, we performed about in line with the S&P up about 500 basis points in the month of October so far, October is obviously not over, but so far, our performance has been pretty good and it's certainly been good relative to our competitors. With the exits of my partner in 2014, I'm very happy that we now have a much stronger team than we had before. We've increased the experience, we increased the proven track record, stock picking skills, if you will, the ability to work with younger members of our research staff has increased dramatically and it's early days for the new team, but I'm very optimistic that this is the team that will continue to generate the returns that our shareholders will expect based on our view of the world looking forward.

[Macrae Sykes:]

Great. Thanks Mike. And just one other quick accounting question, excluding the NOL will it be normalized tax rate for the confirm?

[Mike L. Avery:]

It's about $37.5 million.

[Macrae Sykes:]

Great. Thank you very much.

[Operator:]

The next question comes from Patrick Davitt with Autonomous. Please go ahead.

[Patrick Davitt:]

Hi, good morning. Thanks. My question is just is an extension of all the discussion you just gave around the thought process at Asset Strategy and – if we're going on about a year now since the rolling one year performance really kind of collapsed relative to the group. At what point do you revaluate the strategy, if at all, if this kind of continues to drag out for another year for instance?

[Mike L. Avery:]

Well, that's a good question, Patrick. It's a question that you ask yourself anytime you get into a difficult market environment. We're not, as Hank pointed out earlier, we all have been doing this for a very long time. The Asset Strategy Fund has gone through different – has gone through a number of periods of economic market turmoil, people forget but when we started in early 1997, we were thrown quickly into the throws of the Asian financial crisis, long term capital management. We were thrown and not too long after that had to navigate the TMT cycle prior to 2000, the recession that followed in 2001, the question that we successfully answered where would growth come from after 2002? The global financial crisis in 2008 and period of underperformance, which I would attribute as the bump not a derailment. I don't think you throw out a long successful approach based on one very short time period. But you're right, I mean it certainly requires – our approach is all focused on the art of discerning human behavior and that requires looking forward, not looking back as quantitative methods are based upon. And most of the time, we do a good job at that, sometimes we're going to get that wrong quite frankly and sometimes where – all of our stock picks are not right. I mean I wish every investment we made was a homerun, but it's just – that's why you have a diversified portfolio that doesn't work out that way. So I don't think that there's anything that we would change, it's certainly makes you think harder about the lessons learned from your past mistakes and you apply that to your view of the world as you look ahead.

[Patrick Davitt:]

Okay. That' s all. And then I guess, the other side of the question, I guess then is those clients sort of been around since 1997, is how much patience do they have?

[Mike L. Avery:]

Well, the ones that have been around since 1997, they have a lot of patience.

[Patrick Davitt:]

Yeah. Obviously.

[Mike L. Avery:]

That's not the group that where we have issues with the – if people – humans are humans, and they never ask me when they should come in or leave or the reasons they should have in their heads, when they make an investment. And what we've tried to tell people if they ask is that if you are a short term momentum trader then, please, don't come into this fund. It's the wrong one for you. When you have an open platform that allows anybody to subscribe sometimes you get people like that and in a period like 2014 and early 2015, that group is going to be the first to flee because, again, they're short term oriented. The people that are very happy with us are the ones that have been in for a long period of time. The people that go back to 1997, we are getting into a maturity of those clients, as they get close to moving on to the next chapter in what is appropriate for their investment portfolio, meaning I've had people call after being in the fund for 10 years and be very appreciative of what we were able to do for them, but have moved on to a more conservative investment that's based on income generation, which is the right thing for them to do. So if we're doing the right thing over a long period of time, you should have some natural transition to a different investment portfolio that's income oriented. And when you get into a bump, you're going to scare out the short term trading group, which is fine with us, it's not the group that's appropriate for this type of strategy to begin with.

[Patrick Davitt:]

Very helpful. Thanks.

[Operator:]

As our allotted time for questions has run out. This concludes our question-and-answer session. I would like to turn the conference back over to Hank Herrmann for any closing remarks.

[Thomas W. Butch:]

This is Tom. I have one quick clean up on Mike's question. You asked about Asset Strategy, September versus October, plus minus billions outflows September if you extrapolate the experience to-date in October somewhere around $840 million outflow. Percent of proprietary, Nicole will get back to you on that one. I just didn't want to leave that hanging, sorry.

[Henry John Herrmann:]

That's the end of our remarks. We appreciate your time and look forward to talking to you next quarter. Please take care.

[Operator:]

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