Waddell & Reed Financial Inc
Q1 2013 Earnings Call Transcript

Published: 23 Apr 2013

[Operator:]

Ladies and gentlemen, thank you for standing by. And welcome to the First Quarter 2013 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Hank Herrmann, Chairman and Chief Executive Officer of Waddell & Reed. Please go ahead.

[Henry John Herrmann:]

Thank you, Victoria. Good morning. With me today are Mike Avery, President; Tom Butch, our Chief Marketing Officer; Dan Connealy, our Chief Financial Officer; Mike Strohm, our Chief Operations Officer; and Nicole Russell, our VP of Investor Relations. Nicole, would you reading the forward-looking statements, please?

[Nicole McIntosh:]

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 referenced in our public filings 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. Good morning, again, everyone. The year is off to a good start. Investor appetite for our equity funds returned in January, allowing us to achieve positive flows each month of the quarter. Investors' interest in our fixed income products remains high as well as sales rose 10% sequentially while net flows rose 8%. We believe solid investment performance separates us from other investment choices available to investors. An 8.7% -- at 8.7% for the quarter, our annualized organic growth rate exceed the industry's and is likely to surpass most of our publicly traded peers. Our Wholesale channel saw organic growth of 16%. We believe it's results are an appropriate comparative measure to most of our publicly traded peers and reflects on our continued success in gaining share in this channel. Barron's annual performance review survey again recognized us as one of the best mutual fund families over the last 5 years. This is the fifth year in a row that Ivy or Waddell & Reed Funds claim either the first or second place in this category. On April 1, we launched 2 new funds

[Operator:]

[Operator Instructions] Your first question comes from the line of Cynthia Mayer.

[Cynthia Mayer:]

Just a couple of questions on flows. I think as you mentioned, the asset strategy drove about 33% of the sales, which look like it's more than it has been. I'm wondering if you could give some color on why it popped up and what the contribution was in terms of net flows. And also, it sounds like flows have been fairly steady in April. I'm wondering if you've seen any impact from recent underperformance in asset strategy just within the flow mix.

[Thomas William Butch:]

Starting with the latter part of your question, asset strategy remains positive for the month of April. The overwhelming number of days so far have been positive on a net basis, though at a somewhat lesser -- that at somewhat lesser level than we saw in the first quarter. I'm sorry -- the first part of your question had to do, I think, with investors returning to asset strategy. And I know Mike is on the phone and has spent a lot of time with investors. I would start by saying that the fund's long-term track record and its salience with the advisors and investors continues to position it well when there's a change in sentiment in the marketplace, which clearly we did see in the first quarter, which affected not only asset strategy but a span of our products constructively. And so I think the fact that investors were willing to consider equity-based alternatives at which this fund has been for a while to fixed income, and the fact that the fund has a long-term track record and has a flexibility to move certainly position it well to be a recipient of investor money in the first quarter. We said it again, to the second part of your question, which I think, substantively was, "Has April diminished the enthusiasm for the fund?"And I would just repeat that the fund has been very positive in terms of these sales experience for the month so far.

[Cynthia Mayer:]

Okay, great. And then just 1 more on flows. I noticed the redemption rates are lower in every channel, both sequentially and year-over-year. Are you seeing -- is that a function of people taking more of a wait-and-see attitude, or is it -- what could be driving that?

[Thomas William Butch:]

I think we talked a lot in the last call about the fact that in Q4 there were lots of uncertainties, politically and otherwise, weighing on investors' minds, which may have elevated the prior quarter's rate. And I think maybe we're seeing just a return to some semblance of a more normalized redemption experience generally.

[Operator:]

Our next question comes from the line of Michael Kim.

[Michael S. Kim:]

First, can you just give us an update on the Institutional channel in terms of the pipeline and demand trends? So are you seeing any signs that pension plans might be getting a bit more proactive in terms of rebalancing or replacement activity?

[Thomas William Butch:]

I think generally Hank spoke to the fact that we're continuing to see good interest in a number of our strategies, particularly the core equity strategy. And I'd say that the pipeline in the aggregate remains fertile. We've had a number of final presentations, most of them relating to that strategy here in the first quarter. We had a number in the first quarter and have a number still outstanding in the second. The first quarter did not bear winds, and we're hopeful that will change in the second. So I would say, generally, relative to the appetite for rebalancing, that these equity product -- that equity product and others specifically, continue to gain interest and salience among the consultant community.

[Michael S. Kim:]

Okay. And then maybe just a follow-up on that point. Any update on Pictet, and then more broadly, how you're thinking about maybe further penetrating overseas markets?

[Thomas William Butch:]

Pictet, I don't have that specific number during the quarter, and somebody will look for that. But generally, the Pictet relationship is one where there's greater competition within that asset class than maybe historically has been the case. And more broadly, penetrating offshore opportunities has to do mostly with following our consultants overseas. We've been gaining exposure to opportunity fairly regularly there and would anticipate it's doing the same. I'm now looking at the Pictet in Q1, and we had an outflow of about $50 million.

[Michael S. Kim:]

Okay. And then just finally maybe a question for Dan. Any guidance on comp going forward, just kind of some of the different moving parts as you come out of the quarter? And then also in terms of G&A, just curious, you called out some lower consulting and legal costs in the first quarter. Just wondering how sustainable that run rate is going forward as well?

[Daniel Paul Connealy:]

Well, I think that -- to take G&A first, Mike, the G&A will probably be in the range of $17 million to $18 million in the second quarter. The lower legal expense assisted us in the first quarter. And as far as total compensation, we think that will be probably between $46 million and $47 million in the second quarter. It's always a tough comparison because you restart the taxes in the new year and we have the full effect of all the hiring of the prior year that are in there. But that's our projection at this point.

[Operator:]

Your next question comes from the line of Bill Katz with Citi.

[William R. Katz:]

Just one quickly one on the P&L. The tax rate is a little bit low in the quarter. Can you just talk about the outlook going forward?

[Daniel Paul Connealy:]

Well, that tax rate moves with our investment income. As you know, Bill, we have the NOL from the past sales of subsidiaries so that when we have investment income that's a capital gain, it attracts no taxes. So to the extent that we are able to harvest some of those gains that are in our portfolio, that will make the tax rate a little lower. We really can't predict what we're going to do. We don't know what the market is going to do. And we have to be mindful of the portfolio managers who operate these portfolios. So the normal run rate is still about 37.8%, so the difference you see there is from -- largely just from investments. Once in a while, there can be the close of a tax year or a state tax year that affects it slightly, but that's the main difference.

[William R. Katz:]

How big is the NOL at the end of the quarter?

[Daniel Paul Connealy:]

Well, it's now about $43 million, and I think we pretty much have exhausted all of it, a slight bit of the ACF loss, but now we have, of course, a large one here to work out.

[William R. Katz:]

Okay, that's helpful. And then, just a couple of big picture questions. I apologize, on your commentary on the institutional pipeline, did you say there were a couple of fundings that didn't happen, are going to happen this quarter? Because I guess the bigger question is that you've been pointing to this as an opportunity for a bit of time and this continued to be somewhat uneven from any 1 quarter, then the quarter to the next. So what kind of opportunity set do you see in front of you here?

[Thomas William Butch:]

Bill, just to clarify, no. I did not point to any fundings. What I said was that we had a number of finals presentations in the first quarter that did not yield wins and that we have still a number on the horizon here. So I did not refer specifically to funding.

[William R. Katz:]

I'm sorry. I apologize for misinterpreting.

[Thomas William Butch:]

That's okay. That's clarified.

[William R. Katz:]

[indiscernible] speaking, then, you obviously have a good performance on the retail side. You're doing a nice job in the Wholesale channel. What gets the traction going on the Institutional channel?

[Thomas William Butch:]

I think perseverance and breadth of the offering and relationships with consultants is sort of the triangle. This is a business which we've always told anyone who inquires about it is going to be lumpy relative to the other 2. Certainly, the performance that is translated into sales on the retail side, as in the past, yielded good opportunity on the Institutional side. We have every expectation that will be the case again. It's very heartening to see the number of opportunities into which we are invited, particularly on strategies which a couple of years ago may not have been the case and were not institutional offerings on our part. And so I think on the com we're still very confident and very determined in the Institutional business that we will be successful. But again, it's always going to be lumpier, and we'll have states of opportunity and states of periods where, like in the first quarter, it was a little bit dryer.

[William R. Katz:]

Okay. And my last question, so a 2-part question. In retail, can you point to where you're gaining the share from? And then secondly, on the close end fund, any thoughts on initial sizing? Or is it just the beginning of a number of products that you might be able to leverage?

[Thomas William Butch:]

To answer the second one first. What Hank included in the opening remarks is really all we're able to say about that offering at this point in time, as you would appreciate. And relative to where the flows, I think are coming from, I don't know whether you're referring to product or distributors, so I'll do just a little bit on both. In terms of products, one of the really heartening things is again the breadth of sales being as good as it is. In the top 5 funds, in the quarter, you had asset strategy, obviously flexible mandate, high income, mid-cap growth, and science and technology, obviously, equity portfolio is one of the specialty. And then balance does the top 5 sellers. And so if you look at that basket, it says that we're succeeding across a really, really good span of products. And we always preach internally that breadth equals sustainability. And the breadth just continues to be very encouraging. Relative to the span of distributors, we similarly think that we are well diversified among the important distributors in the business. And some relationships are more mature than others and continue to provide us opportunity to gain share, and some are more at their earlier stages and still very much in a growth phase. So there's a lot of opportunity across the span of distributors. I don't think we're unduly [indiscernible] than any 1 dimension of the distribution world.

[Operator:]

Your next question comes from the line of Jeff Hopson with Stifel Nicolaus.

[J. Jeffrey Hopson:]

So I guess for a time, if you could follow up a little bit on the distribution side. Obviously, you're getting what you had hoped for in terms of diversification. From time to time, you've, I guess, tweaked the compensation of wholesalers, et cetera. Anything new there that you'd be emphasizing to try to get to that desired goal? Are you -- is diversification the driving force in what you're trying to achieve, anything new there? And then any products besides the new ones that you mentioned that you've introduced that perhaps you're emphasizing out in the field. I noticed like global income allocation, not big numbers, but a little bit of pickup of flows. Anything there that could emerge potentially as a fund or product that could be -- could contribute at some point in the future?

[Thomas William Butch:]

There's a certain interrelatedness to your questions. I think, because some of the funds that you're seeing maybe some pickup and are some that we haven't sent it. Per your point, we do at the outset of each year look at the compensation program for wholesalers and determine how we want to utilize the compensation program to support corporate objectives, the largest of which, as you pointed out, is continued diversification and sales. So we're seeing very good pickup in things like our balance fund, which sort of is part of a suite of allocation products, incorporating, of course, asset strategy and as you point out, global income allocation. We did some campaigning around that in the first quarter. If people are stepping back into equity, as a way station between fixed and equity is more allocated product. And so that has been one emphasis, which you picked up on. We've seen good salience for our core equity product, which has done so well institutionally. And now on a retail basis, with investors reacquainting themselves with actively managed equity product, has done well, too. Those are some of the ones I've pointed out. And of course, Science and Technology, which has a terrific track record but had been in a category which really, since the tech level had a lot of forward energy and now appears to is doing very well as well. And those are some of the ones I would point out. Again, I think the underlying point is one that Hank noted in his remarks, which is we have very good breadth and very good performance across that breadth that enables us to create the breadths in the sales that create the sustainability that we're seeking. So if you kind of spin the wheel of where the market goes, which I -- one of the heartening things is I think, over the 10-year life of the Ivy Funds, despite what happened in the market and how it's rotated pretty violently at times across that span, we have had something based on the great work of our investment folks, to take market effectively in any context. And as the market is becoming more supportive of a broad span of asset classes, we're really seeing the benefits of that breadth once again.

[J. Jeffrey Hopson:]

Okay. And if I could follow up, the fact that you're launching a close end high income, does that suggest that there's no concern about capacity or supply or value on the high income side?

[Thomas William Butch:]

We're comfortable in the current context of obviously being able to manage that fund plus the assets in the open end product.

[Operator:]

Your next question comes from the line of Daniel Fannon with Jefferies.

[Daniel Thomas Fannon:]

I'm wondering if there's been any change in the positioning within the funded asset strategy at the start of the year?

[Michael Durwood Strohm:]

Daniel, this is Mike. There has been a little bit of a change since the beginning of the year. At the end of year, we were approximately 85% global equities. We had about 10% of the funding, gold bullion, very little fixed income, and the remainder about 5% of the fund was in cash. Since the beginning of the year, primarily based on the mood of the markets becoming more complacent, what we have done is increased our cash exposure, reduced our global equities to the point where global equities are about 70%, 75% of the fund.

[Daniel Thomas Fannon:]

Okay, great. And then any thought around -- I think you've historically said hedging in the portfolio expenses has been too costly to think about that. Has that changed at all or are you evaluating that again?

[Michael Durwood Strohm:]

Well, we haven't used any derivatives to hedge the portfolio to protect the downside. What we have done a little bit of since the beginning of the year is use derivatives to take long positions by buying calls like putting on quick call spreads. The price of taking a long position using derivatives has cheapened up, if you will, quite a bit. And so we have done a little bit in that regard.

[Daniel Thomas Fannon:]

Okay, that's helpful. And then, I guess, one question just with regards to the U&D, more on the expense side. It seems that we always have a little more variability in that versus your expectations. And one of the comments in the press release said indirect costs were higher due to compensation. Just kind of wondering, first off, is anything that you would flag as kind of one time in the U&D costs outside of just higher sales? Or -- and then maybe flush out the kind of dynamics as we think about that going forward?

[Henry John Herrmann:]

Well, I think it was primarily related to sales. As far as indirect, you do have some compensation increases in there. And you have the payroll taxes starting up and that sort of thing. I don't think there's any one thing that was driving that up other than that.

[Operator:]

Your next question comes from the line of Matt Kelley with Morgan Stanley.

[Matthew Kelley:]

I just wanted to follow up a little bit on asset strategy and get a sense from you guys as to -- I know you have a new opportunities fund within that kind of sleeve, too, and you talked about a balanced fund. I'm just wondering, in your mind, how far along the trend line are we of the growth in this broader class? It seems to me, from talking to retail channels, that they're using asset strategy and other similar funds as the new equity product. I'm just wondering if that's what you guys hear as well and how far along that shift we are?

[Michael Durwood Strohm:]

Well, this is Mike. I'll let others chime in. But my sense of it is I'm now talking to clients today. And our sense is we talk to investors as to how they think about asset strategy. I think what they like is the flexibility offered by our product of this type where we are not constrained to any one asset class, that we can be across a number of different asset classes, including asset classes that they may not be able to participate through some other satisfactory vehicle, whether it's direct ownership or gold bullion, whether it's participation in private equity, private debt, the use of derivatives plus the knowledge that this is a team that thinks about global markets 3 to 5 years out, has always managed to fund that way, and is thinking about the client in the same context about as how we manage our own money. So I think the combination of all of those things continues to make asset strategy attractive for a large group of financial advisors.

[Matthew Kelley:]

Okay. And then just a follow-up on that. What about demand among institutions for the same sort of product? Do you think that, that is something that you could be out in the market selling pretty well for institutional investors as well? And is there any -- within that context, is there any risk of institutions trying to set up indexes to kind of match what you're doing as well?

[Michael Durwood Strohm:]

Well, I think there's -- this is Mike again. I think there is -- sure, I mean, there's that risk, if you will, of people replicating what you do. There's nothing proprietary about what we do, in terms of how we select securities or how we select from different asset classes. And you can -- as you pointed out, you can certainly come up with indices or ETFs that will attempt to mimic different securities or asset classes. But what you can't mimic is the asset allocation decision. And I think that's what the financial advisors that we talk with find of value. I mean, they can replicate what you own, but they can't replicate the decisions that go into when you change what you own.

[Operator:]

Your next question comes from the line of Marc Irizarry with Goldman Sachs.

[Marc S. Irizarry:]

Mike, if we could just follow along those same lines, given some of the volatility that we've seen in commodities and in emerging markets relative to the underperformance of maybe EM versus DM indices and equities? Can you talk about what impact, if at all, that's had in their discussions with clients and the way they are thinking about asset strategy versus maybe more fixed allocation fund strategies?

[Michael Durwood Strohm:]

Well, you're right, Marc. It certainly -- it comes up. As it -- people want to know what you're currently -- any time there's a major change in any asset class, up or down, people naturally want to know what you're thinking, how that's affected what you do, whether you would increase, decrease as a result of some short-term price movements. So it always comes up. I would just say that there is -- we've been actively investing in emerging markets in some form for, let's say, 10 years now. It seems like Marc, every year, there is a growth scare as it pertains to the prospects for the emerging markets, China in particular. We're currently in the -- as you pointed out, in the throes of one now, which was -- it came to a hit, I guess, when China reported their first quarter GDP number of 7.7%, which was below what people expected. It's hard to believe that 7.7% might be viewed as disappointing. But when the world expects 8%, then 7.7% is disappointing. And so you're right, that certainly sends off a round of people speculating or agonizing over whether or not we're in the beginning of a dramatic slowdown in emerging markets. And what we have told clients is that if you think about where growth is coming from globally, if you think about the global companies that are offering goods and services and who they are dedicating those products to in order to -- who they're going to serve, I think as you peel that back with clients, they understand that there is a large demographic that resides in either the ASEAN countries, India, China, Latin America, parts of the Middle East, North Africa, that live in areas that are domestic consumption driven, where prosperity is rising and where you do have an opportunity to see the benefits associated with serving that demographic. And I think that the rates of growth that perhaps people ascribe to China, in particular, are perhaps too high on a sustainable basis. I think many people that we talked do have come to the conclusion in some way that China is a country that's always going to grow at 8% forever. And it's just not a realistic assumption, given it's now the second largest country in the world. And the leadership of that country is trying to move their economy to more of a domestic consumption model, away from a fixed asset investment, away from an export-driven model, towards a domestic consumption driven economy. And if that's the case, then a long-term growth rate, more reasonable, is 5% to 6%. Now having said that, we suspect that for the next 5-year period of time, that you're still likely to see numbers between 7% and 8%, but again, scaling down to a lower, more manageable number. And as you walk through that with clients, I think they have a better appreciation for just how the economic model of China in particular, as well as India, which is very much a domestic consumption driven economy, as well as the ASEAN region, which has a large domestic consumption driven component to it, particularly as it pertains to Indonesia, Singapore and the Philippines, that they appreciate that and perhaps if you assuage some peers associated with that. What you're not asking me about directly is gold, and gold has had a significant pullback certainly. And I think that it's related to a couple of things. To a lesser extent, it's due to Cyprus, perhaps either being encouraged or offer to sell some of their reserves out of their treasury, but part of it is certainly slowdown in China; it concerns about slower growth in developed markets. But I think in addition, the market has a sense of are we at a point where we can expect central bankers, politicians to get engaged in even more aggressive quantitative easing or are we at the point where they're likely to pull back on it. And the -- for some investors in gold, particularly those that have come in the last 2 or 3 years, where they came in after the price of gold reached $1,900 are somewhat dissatisfied with not only their purchase but are anxious about whether or not we're headed towards an increase in real interest rates, if in fact, central bankers are likely to pull back on quantitative easing, which would result in interest rates generally rising and which would result presumably in real interest rates being positive as opposed to being negative that they are today. And people who invest in gold look to that as a barometer in terms of what their expectations should be. Now, if the outlook going forward is that we are at the point where the Federal Reserve, the ECB, the Bank of Japan are going to begin pulling back on quantitative easing, reducing the money supply, reducing the size of their respective balance sheet, then yes, I would worry about being in the positive real interest rate environment. However, what we see is that the opposite is occurring. Bank of Japan is engaged under new leadership in a very aggressive round of quantitative easing. The Federal Reserve has been for sometime, as is the ECB, the European Central Bank, as well as the Bank of England. So I think the emphasis on the part of global bankers, politicians to increase nominal GDP by pressing on the money supply accelerator in order to improve the velocity of money to get nominal GDP to grow is still very strong. And if that's being the case, I think there is a place for gold in the portfolio as a currency. It's the only currency that central bankers, politicians cannot devalue. Other currencies floating around or a note, which is a call on real money, and gold is real money. And so I think as long as we're in the environment that we are, and it looks like we will be for, unfortunately, perhaps a long time, then you want to be an investor in gold. And on the pullback in the Asset Strategy Fund, we actually added to our position.

[Operator:]

Your next question comes from the line of Mac Sykes with Gabelli & Company.

[Macrae Sykes:]

Just looking at the equity appreciation Advisor segment versus the Wholesale, I noticed there's kind of a pretty good delta there in terms of performance. Is that a function of different funds in the Advisor segment? What was the difference there?

[Henry John Herrmann:]

Sorry. It -- this is Hank. I didn't quite understand your question. Could you turn me again, please? I apologize.

[Macrae Sykes:]

Sure. The market action for the Advisor segment in the equity space -- in the equity funds seem to be much better than the Wholesale segment. I was just curious as to what was -- is that related to the makeup of the funds that are sold in the Advisors segment or something else?

[Henry John Herrmann:]

I'm still at a loss, I apologize. One more time.

[Macrae Sykes:]

So the net return from the equity funds in the Advisors fund -- in the Advisors segment of AUM seemed much stronger than the Wholesale returns. And I was just curious as to what the difference was there in terms of, could it be just the makeup of the funds that are sold in the Advisors segment?

[Henry John Herrmann:]

I think it has to do with mix.

[Thomas William Butch:]

Yes. It's probably the mix and the greater way in the Wholesale channel and the asset strategy.

[Michael Durwood Strohm:]

And just to add on to that, I understand what you're asking, as it pertains to the asset strategy. I can't speak for the others.

[Henry John Herrmann:]

Mike, I can't quite hear you. Could you speak up please?

[Michael Durwood Strohm:]

How's this?

[Henry John Herrmann:]

Good. Closer to the mic or something.

[Michael Durwood Strohm:]

Yes. As it pertains to asset strategy, the difference is in the advisors and Ivy is often time attributable to differences in flows. So if you get flows timing differences in the 2 channels, even though they're managed exactly the same, you can see performance differences. They won't be dramatic, but it -- I think it helps explain it.

[Macrae Sykes:]

Great. And then my last question is, as cash continues to build, I know you paid the special last year. Can we expect any change to your sort of normal focus on capital deployment this year?

[Henry John Herrmann:]

There is really no change in the things we've been saying for a very long time. We intend to offset the share grants through share repurchases. And we continue to focus on growing the dividend over time. And periodically, for one reason or another, it seems appropriate to have a special dividend. We certainly would consider that as we did last year. But at the moment, we have no plans for that.

[Operator:]

Your next question comes from the line of Roger Freeman with Barclays.

[Roger A. Freeman:]

Just quickly on the gold exposure, you said you added to it. I think it was around 10% portfolio last quarter. How much did that go up to?

[Michael Durwood Strohm:]

Well, we're still about 10%. We've had a fairly significant pullback in the price so that's included in our overall holding. But we've added a little bit. We added probably about 1% on the pullback. So today's valuation, that's right about -- a little over 9% of the fund.

[Roger A. Freeman:]

Okay. And I know you talked about the hedging strategies before but as it applies to gold, do you hedge that exposure ever with the futures or otherwise?

[Michael Durwood Strohm:]

Well, you could. The problem with hedging with gold futures is that it generates a bad income problem, not unlike owning gold bullion. And so that's something you got to be very mindful of. So in one way, it's a hedge from a technical perspective, but it doesn't mitigate a reduction in -- well, results in another kind of problem, as it pertains to managing good and bad income, which is a problem that we have with gold. You can hedge it, if you feel strongly about the direction of interest rates or if you feel strongly about the directions of other currencies. Those tend to not to be tightly correlated trades. So it's very difficult to do it that way. But I think the key thing to keep in mind is that gold is a hedge. I mean, gold is a hedge against paper currency. So in that context, you wouldn't -- I understand your question and why you're asking that, but if you think about it in the broader sense of what is gold exactly, it's an alternative to paper currency, then it in itself is a hedge.

[Roger A. Freeman:]

Okay. And just -- you raised an interesting point on the good and bad, I guess that's sort for qualified and non-qualified income. The cap on for 40x funds is what, 10%? Does that put you near -- can you get much bigger than that? Or are you near the sort of the effective limit?

[Michael Durwood Strohm:]

Well, the only cap we have is the concentration limit. I think that's what you're referring to. And the concentration limit is 25%. So we could technically have no more than 25% of the fund in gold bullion as an asset class. Currently, we're just under 10%. So it could get bigger. But as a practical matter, I'll tell you that we have set for ourselves a limit of about 15% in order to manage the good income, bad income problem. Once you get above that level, and there is nothing scientific about that; it just comes with experience. That once what you get above that level, then you get into worrying about whether or not I'm going to have enough good income in other asset classes to offset income in gold if I want to take profits.

[Roger A. Freeman:]

Right. Yes. Okay. Yes, that's what I was getting at -- the latter part. Great. Thanks. And then on the I guess on the core equity strategy, it looks like the Lipper rankings dropped a few notches there, and you talked about interest in the product. It seemed a little inconsistent. What drove any of the underperformance there? Or is it -- do you see it the same way?

[Thomas William Butch:]

I'm going to -- this is Tom. I'm going to speak to your question relative to the interest in the product. The 1, 3 and 5-year numbers are still hugely competitive. So I think sometimes we overreact to some modest changes in rankings. But certainly from every perspective, advisors look at product; it's still very competitive.

[Roger A. Freeman:]

Okay. And just lastly, the Advisor account, it looks like it went down a bit. I think last quarter you were saying you thought it had probably bottomed out and hoped that it will grow this year. Is this just a function of sort of the performance benchmarking year end or anything else going on there?

[Thomas William Butch:]

That's a great question. I would stick to that statement that we do think it will bottom this year and we would expect and hope to finish the year at a higher Advisor account than we did at the end of last year. We have smooth, to a certain extent, the ins and particularly the outs of Advisors, that is, the calling of Advisors has -- is not sort of a onetime, big bang event at year end that it used to be. But as you pointed out, each quarter really, we do have an adjustment. And so if we look at the year-to-date, kits, which are leading indicator of future activations, are very constructive on the classic side of the business. And so I think your analysis is correct that as you do mostly with quantification levels at quarter and year end and that the thesis of bottoming out for this year remains intact.

[Operator:]

Your next question comes from the line of Michael Lipper with Lipper Advisory.

[Michael Lipper:]

Good morning, Hank. First, I want to compliment you for continuing to show the distribution cost analysis, breaking it down by Wholesale and Advisors channel. I understood that moving from the fourth quarter to the first quarter, looking at direct expenses, there was an element of taxes but the direct expense in the Wholesale channel went up roughly twice what it did to the Advisor channel. Is this putting out more incentive? I also compliment you in keeping your indirect expenses on both channels reasonably level.

[Henry John Herrmann:]

Well, maybe Mr. Connealy will comment. And I'll go from there.

[Daniel Paul Connealy:]

I think the main reason for the uptick is this very strong sales, and so your direct cost, your associated weaker sales level and also your asset levels. So both increased during the quarter. The asset level grew, and we had strong sales. And that's why the indirect in those sale was much higher. The sales in the Advisor fund were also higher but not to the extent of the increase.

[Michael Lipper:]

But the increase I'm talking about is the direct. And let me make sure I understood that the increase in sales in the Wholesale. If we look at the revenues roughly, they're roughly the same dollar level of increase.

[Henry John Herrmann:]

The revenues -- Mike, this is Hank. It's more important to think about gross sales when you're talking about this in the Wholesale channel, as opposed to revenues. Revenues are a combination of AUMs and fees and [indiscernible] fees and so forth. Gross sales dramatically improved in the Wholesale channel sequentially, up 40%. And the AUMs in that channel rose, off the top of my head, I've forgotten exactly, but like 5%. So we've got 5% help on the revenue side from the AUM channel. But the 40% lift in gross sales, that's a 40% lift in commissions paid to the wholesalers and to the broker-dealers. And so that's the normal kind of pattern. What I've tried to communicate over time is that when you think about our distribution margin, very strong sales always going to push down -- or push up the total expenses and hurt the margin there. On the other hand, that's the whole point. Obviously, we're trying to gather assets over time with the bet -- that markets will -- equity markets will appreciate and we'll earn the fees on the assets we've collected and so forth, which I know you understand. So the big issue was simply on the direct side is a very, very sharp increase in terms of quarterly impact. I don't remember a time when we had such a step up sequentially.

[Operator:]

Your last question comes from the line of Bill Katz with Citi.

[William R. Katz:]

Just a quick follow-up. I told myself I was going to refrain from the question, but I just can't help myself because no one else asked the question. Hank, just in terms of your long-term margin target, if I look at your assets, they're up about 11% year-on-year. I think your incremental margin was about almost 40% year-on-year and your operating margin itself increased by about 100 basis points or so. So as you look out, given the scaling of your assets and diversification of the business, can you just sort of update us on your thoughts on the timing to get to this 30% margin and whether or not that's a top or could there be more opportunity on the inside of that?

[Henry John Herrmann:]

Well, I'd like to get to my first goal before I think about another goal. And as you know, there's nothing like real strong sales and just an OK market action to cause operating margin to pull off a little bit. But I haven't had -- I have no reason to think that the business model is any different than when we first talked about this. So I continue to believe we'll be marching higher over time, which I've tried to comment on in my opening remarks.

[Operator:]

And there are currently no further questions in queue.

[Henry John Herrmann:]

If that's all the questions, we appreciate your time very much. Thank you for your support. We look forward to talking to you through the quarter, and at next quarter-end briefing. Take care.

[Operator:]

Thank you for your participation in today's conference call. This concludes today's call. You may now disconnect your lines.