Waddell & Reed Financial Inc
Q2 2013 Earnings Call Transcript

Published: 30 Jul 2013

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the second quarter 2013 earnings conference call. [Operator Instructions] Thank you. I would now like to turn the conference over to Mr. Hank Herrmann, Chairman and Chief Executive Officer of Waddell & Reed. You may begin.

[Henry John Herrmann:]

Thank you, Victoria. Good morning. With me today are Tom Butch, our Chief Marketing Officer; Dan Connealy, Chief Financial Officer; Mike Strohm, our Chief Operations Officer; Phil Sanders; our Chief Investment Officer; and Nicole Russell, our VP of Investor Relations. Mike Avery is out of the country and is unable to be on the call with us this morning. Nicole, would you read the forward-looking statement, 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. Earlier, we reported financial and operating results for the quarter ended June 30. Earnings per diluted share were $0.61 and included a charge of $0.06 per share, after taxes, for costs incurred in conjunction with the offering of our first closed-end fund, the Ivy High Income Opportunities Fund. Excluding these costs, earnings per diluted share were $0.67, a 6% increase compared to the previous quarter and a 40% improvement compared to the same quarter last year. Operating revenues grew sequentially for the sixth consecutive quarter, driven by a combination of organic growth and the positive impact of strong financial markets. Our operating margin, excluding costs associated with the launch of the closed-end fund, was 28.2% during the most recent quarter, its highest levels since 2004. Our focus remains on the elements of our business under our control, maintaining consistency in our investment process, bringing to market a comprehensive suite of products and capital expense management. Assuming positive market action, we expect that our operating margin will improve further, as asset levels continue to grow. As noted in our earnings release, we launched our company's first closed-end fund in May. Our efforts were successful in raising a total of $331 million; including leveraged fund assets, are currently around $445 million. This first success suggests the possibility of similar activity in the future. In early July, we internalized the management of the sub-advised Ivy Global Natural Resources fund following the manager's retirement from Mackenzie. Based on the investment capabilities in this sector and the performance of our existing products within it, we expect to manage these trends -- excuse me, this transition successfully. The in-house management of the fund will result in the reduction of sub-advisory costs beginning this quarter and should have no effect on the long-standing relationship with Mackenzie. Company-wide sales were $6.8 billion, slightly exceeding the first quarter strong volume and 15% higher than the same period last year. Net flows were $935 million, which is representing a slowdown compared to the previous quarter's $2.1 billion but exceeded last year's $376 million. Our experience with fixed income flows was modestly negative during the quarter, as demand for this asset class fell and redemptions rose during the month of June, offsetting monthly inflows in April and May. Fixed income flows are positive in July, as are flows in our other asset classes. July's inflows are in excess of the run rate preceding the June pullback. This is especially noteworthy given many of our advisors have been in Europe over the last week or more. While we are not immune to industry trends, we continue to meaningfully outperform relatively. During the quarter, organic -- the organic growth was 3.6%, while the industry was in net redemptions. Looking at the contribution of -- in each channel during the quarter, sales in the Wholesale channel continued at first quarter levels, while flows moderated as investors' concerned over monetary policy lead to an increase in redemptions, most notably fixed income products. Sales of fixed income products were helped in the quarter by the proceeds from the IPO of our Ivy High Income Opportunities Funds. Redemptions were stable during the first 2 months of the quarter, but rose in June. June was the only month in the year in which we experienced outflows in fixed income. Month-to-date, July average daily sales have improved compared with those in the second quarter. Flows are positive across the equities and fixed income. Our Advisor channel marked another quarter of record sales with $1.4 billion of new sales. Net flows remained positive at $259 million, representing a 3% rate of organic growth, while actions have softened in line with seasonal trends typical of this channel, a point mentioned earlier. The effectiveness by which our advisors come to market helping clients focus on the long-term needs rather than reacting to erratic moods of the market has once again proven invaluable. The channels redemption rate remains about 9%, and it was 8.4% in the month of June. Change in preferences in product structure by advisors managing the finance assets have seen the trend towards fee-based products as opposed to transaction-based business. As broker/dealer, we are able to capture the recurring margin on these assets, which, combined with high retention quality of assets in this channel, adds to the stability of revenues. Most of our institutional efforts are somewhat lower than expected, especially considering the healthy pipeline of opportunities and yet to be funded wins. Our core and mid-cap products are competing well, although our current sales cycle is running longer than usual. We expect significant funding will occur before year end. Operator, at this time, I would like to open the call for questions.

[Operator:]

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

[Cynthia Mayer:]

On the Institutional, it sounds like you have a bunch of one but not funded mandates. But the redemptions also ticked up a little bit. And I'm wondering, was that anything in particular? Was that Pictet? Any color you can give on that?

[Henry John Herrmann:]

Not too much of that was Pictet. A big portion of it was Mackenzie with a rebalancing that occurred in their portfolio product lineup in the second quarter. It's not going to be repeating development, and it's -- wasn't relevant to Global Natural Resources' decision, but it was about half of the redemptions.

[Cynthia Mayer:]

Okay. Great. And then, the distribution margin, I know you don't really look at it that way, but it seemed better than usual even -- and even better if you adjust for the closed-end fund. Is that a matter of maybe coming off very strong sales of 1Q somehow, or is it a matter of getting more scale so that the fixed costs are now being absorbed better? Or anything else you can point us to?

[Henry John Herrmann:]

It's a combination of things, really, but a little bit of scale in the Advisors channel. I presume we're talking about the Advisors channel distribution margin, correct?

[Cynthia Mayer:]

Yes. But also, the all-in-one?

[Henry John Herrmann:]

Okay. Well, let's talk about -- I think the Advisors channel is the one that needs some focus. You know that we have a positive margin in Advisors channel in the quarter, and my long-standing guidance on -- that the margin was a negative 5% to 0. And so, we significantly exceeded that in the quarter. It's a combination of 1 -- a couple of accounting entries that may be helpful a little bit better, not better transitory. But also, the benefit of fee-based business rising in the channel. And then, to a certain extent, good market action and just okay sales. So those 3 things put together, why we had it, I wouldn't, at this point of time, want to suggest that we're going to stay in a positive margin going forward.

[Cynthia Mayer:]

Okay. And last question. Just on the buybacks, It looked like you bought back a little bit more than usual. Is that the -- associated with Legend, or is that a shift upward in buybacks that's more indicative of a more lasting shift?

[Henry John Herrmann:]

The buybacks were front end loaded into the first month of the quarter as a result of the buybacks from restricted share grants that were maturing on the part of employees. And then, thereafter, the buybacks were pretty modest. I guess, in hindsight, I should have bought everything I'm planning to buy in the first month of the year, but my portfolio management skills are under question. We have no real change in plan from the comments we made at the end of the fourth quarter. We intend to purchase sufficient number of shares to offset restricted share grants. And if my psycho sense is right, we might go beyond that.

[Operator:]

Your next question is from Bill Katz with Citi.

[William R. Katz:]

Just staying on the distribution question within the Advisor channel for the moment. Just if you take your discussion that the fee-based business is rising at sustainable growth -- unit growth. Is it fair to say though that the underlying margin story could be better than that negative 5% to 0 bound? Or is that too optimistic?

[Henry John Herrmann:]

I'm going to stick with my commentary. But my prejudice at this point would say that it's more looking -- leaning toward 0 than minus 5%. In other words, I think there are certain developments in the business that are going to create a little bit better bias than my guidance in the past.

[William R. Katz:]

Okay. That's helpful. And then, just on the closed-end fund very interesting commentary, as you think about the second half of this year, where might you see some opportunity to raise some incremental proceeds and maybe what kind of distribution diversification you have within. I know that you're using all the wire house, as this was done in the Independent channels. So I'm curious of some of the dynamics pacing the opportunity here.

[Thomas William Butch:]

Bill, it's Tom. I don't know whether your question reflects interest specifically in a next possible closed-end or is a broader question...

[William R. Katz:]

It was a combination of it. Curious of -- obviously, it's is your first one. So I'm curious of sort of the opportunity set in front of you, it could be a good opportunity it seems.

[Thomas William Butch:]

Okay. Bill, talking first then about a potential next closed-end. In a very fertile marketplace this year, it's extremely competitive to get slots. I think it's fair to say that we and our broker/dealer partners were satisfied with the results of our first effort, and I think there will be subsequent opportunities. We've had some preliminary discussions. There's nothing imminent in that regard. But certainly, we learned a lot and we look forward to subsequent opportunities. The lead time on those is pretty significant. And so, it's hard to say when that might be possible. In terms of broader opportunities relative to different distribution channels in the Wholesale side, we're well diversified, about 1/2 in the wire houses and 1/2 distributed among independents and the RAA supermarket environment. And so, there's plentiful opportunity in all of those places. We have good penetration in the wires, but we'd hope to deepen that. And I think the go-forward growth opportunity is also very good on the independent side, where we're directing incremental resources for wholesaling to a lot of firms that are big sellers [indiscernible] to date, we may not have the penetration we do at the wire. So it's broad-based, and we see opportunities across the environment, especially as the marketplace is starting to embrace a lot of the products which -- product categories where we have good performance, which in the past few years have been ignored.

[William R. Katz:]

Okay. And just one last one for me. You did a nice job holding the line on compensation this quarter relative to sort of core operating metrics. And so, I'm curious, as you think about on a go-forward basis, is there any [indiscernible] bias [indiscernible] incremental guidance as you look into third or fourth quarters around comp levels?

[Daniel Paul Connealy:]

Bill, this is Dan. I would say, in the third quarter and the fourth quarter, really, it should be in the range of 48 to 49. So about the same level.

[Operator:]

Your next question is from Michael Kim with Sandler O'Neill.

[Michael S. Kim:]

Just a couple of questions. First -- so your equity fund flow has held up well across both the Wholesale and Advisors channels last quarter. So I'm just wondering -- as you look across your funds and given your comments around ongoing inflows thus far this quarter on the equity side, just wondering where you're generating the growth, particularly given what seemed like more mixed trends across the industry?

[Thomas William Butch:]

Hey. Mike, it's Tom again. As I suggested in my prior comment, the appetite for equity products seems to be coming around and that's reflected in the appetite for, for example, our Science and Technology Fund, which is gathering material flows after having been a very good performer in a category which was ignored for a long time. Outflows in that are very strong. We continue to see good attention to our Mid-Cap Growth strategy. And the High Income product, which, as Hank mentioned, in June, our fixed income flows were rocky, but that has come back quite well here in July. And even a product like our balanced product which is a pure vanilla balanced product is gathering good flows as well. So the tilt to equity has enabled us to show things, if you will, which have not been in favor in the recent past in the appetite for the things that have worked for us over the last couple of years seems to have come back in the quarter.

[Michael S. Kim:]

Okay. That's helpful. And then, maybe a couple of questions on asset strategy. I know Mike isn't on the call, but any update on the fund in terms of positioning? I think, last quarter, you kind of talked about adopting a bit more of a conservative stance. And then, maybe for Tom, any insights into realtime flow trends just given the kind of the recent step-up in market volatility?

[Henry John Herrmann:]

Its Hank, on portfolio structure not dramatically different, but a little bit more of a tilt to cyclicals, maybe a little bit more of a tilt away from emerging. And I would say fixed is about where it was before or maybe a tad less. People have asked about gold, and I'd say right at the moment, I'm not exactly sure, but I'd say it's running some place around 8% of the portfolio. That's quick and dirty.

[Thomas William Butch:]

And then, on flows, the color I would give is that, on a gross basis, flows are still strong. They would trail only other -- one other fund in terms of gross, and that is kind of flattish quarter-to-date.

[Operator:]

Your next question is from Robert Lee with KBW.

[Robert Lee:]

Quick question. Going back to distribution merge, actually on the revenue side. I mean, considering that asset growth was pretty modest in the quarter and sales, I guess, held by a tough June were probably also modest. It seemed like the revenue has picked up particularly in Advisors a little bit more. Is there some kind of mix issue, I don't know if maybe you have more annuity sales or something in the quarter? I'm just trying to get a sense if there was any kind of mix issue that particularly held back the quarter?

[Henry John Herrmann:]

Well, one thing I'd remind you. I was -- the quarter's point end was a lot lower than the high point during the quarter. So that needs to be kept in mind. But other than that, I don't think of anything in particular.

[Thomas William Butch:]

I don't think mix changes all of that materially, as Hank pointed out, with sizable part of flows now going into fee-based product, which is asset allocated routinely and systematically. You're not going to have, I don't think, material mix shifts in the product adoption because it's sort of on autopilot, if you will. That's oversimplified, but that's been allocated. And with those products growing as a percentage of revenues sales and assets under management, I think that's probably the most material factor underneath your question.

[Robert Lee:]

I mean, within the Advisor channel -- and I apologize if this is in the -- I don't think it's in the presentation, but what proportion of assets in Advisor are now in the kind of SMA-type products?

[Thomas William Butch:]

Well, it's not really an SMA-type product. I'm not splitting hairs. It's just a -- it's a mutual fund wrap product. So the assets should be about 28%, the revenues about 40% and the sales about 55%.

[Operator:]

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

[J. Jeffrey Hopson:]

For Tom, I guess, given the volatility, I'm surprised -- well, maybe a little surprised there hasn't been any investor fatigue, so to speak, based upon what you're seeing in July. Would you confirm that? It seems like people are fairly engaged. And then, any new messages -- are you -- on the equity side, are you promoting equities, would you say? Are you going with the flow, so to speak? Anything else that you've kind of -- any new messages that you have for -- in the Wholesale channel?

[Thomas William Butch:]

I can't confirm to your first question that there's not a indication of fatigue in the flows, by any means. And relative to your second question, we came out very early in the year in the piece we did in January with our outlook, very favorable on equities. And so, that messaging has really been in place all year. It's not so much the messaging, but the adoption of it that seems to be resonating at this point.

[J. Jeffrey Hopson:]

Okay. And on the closed-end funds, I think you kind of mentioned this a little bit. But certainly, raising money is good. I suspect that it increased your visibility within distribution maybe with some new advisors. Any thoughts there additionally on how conceivably it would have helped you on the distribution side?

[Thomas William Butch:]

That's a great point, Jeff, in that a lot of advisors -- many of them with large practices that use closed-end funds are those who you don't see routinely in the daily wholesaling activity. And so, it was important to us at 2 levels

[Operator:]

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

[Macrae Sykes:]

You've certainly done a great job of building the Advisor channel. Would it ever make sense to spin it off for some other aspect of financial engineering, or do the overall aspects of diversification distribution overrule that?

[Henry John Herrmann:]

I'm sorry, I didn't follow the question. Would you ask me again, please? I apologize.

[J. Jeffrey Hopson:]

No problem. Would it ever make sense to spin off the Advisor segment into a separate entity or some other financial engineering, or including it on the overall platform improve the distribution diversification?

[Henry John Herrmann:]

Well, if spinning out, I guess, is the question on the Advisors channel, and I'd say it makes no sense at all. That's a very valuable asset. To simplify it, it's essentially a cash cow with a very, very attractive financial attributes that generates a lot of ability for us to invest in growth in other parts of our strategy. And the mere stability of that asset base is incredibly important. So it's a trade-off. You get very, very attractive financial characteristics, a stable business, relatively slower growth. Although growth has been doing a little better, but still relatively stable growth. But the resources that are generated by that business transfer very attractively into Wholesale, which, at the point of distribution, you know is a fairly significant negative margin and there is a lots of investment that's required to sustain your position in that business. The benefit, of course, of Wholesale is you get very rapid growth rate relatively and you accumulate assets sufficiently larger such that if you -- in periods when you get favorable market action is very beneficial. I hope that was responsive to your question.

[Operator:]

Your next question is from Roger Freeman with Barclays.

[Roger A. Freeman:]

Just back on the underwriting and distribution margin, just -- Hank, you mentioned there were some, maybe transitory accounting benefits. Just wondering, would the Advisors margin would still been positive excluding that? Could you look at that? And also, Wholesale, both of which had higher growth sales sequentially. You would have thought they would have added -- put some pressure on margins.

[Daniel Paul Connealy:]

This is Dan. We did have an adjustment to our pension accrual, and it really is because we made an additional investment in the pension. So the outlook for the rest of the year is going to be a bit lower than we were accruing, so that benefited this quarter. And in addition, the healthcare reserves were also better because we just had better experiences here than what we had been accruing. So that's probably about $900,000. But we still would have been positive, but it just inflated the margin there a bit.

[Roger A. Freeman:]

Got it. Okay. That's helpful. And then, just on the bringing the Natural Resources in-house, do you expect any -- or is there a risk of any redemptions despite of switching out the portfolio manager? Did they have any institutional money? How much?

[Henry John Herrmann:]

Not traditional institutional money. In a sense, I think you're talking about it. Remember the fund has been in redemptions for some time. So there was one sizable withdrawal that just sort of reflects it because some certain broker/dealer platforms, change of manager and on a preferred shelf will be a cause for immediate elimination of that. There's no such additional exposure. The fund is sort of on preferred list elsewhere. And again, it's least possible that it will be removed from those. But that wouldn't be a one-time hit. Those funds might attrit over time. At the same time, we've done our best to get the manager who runs our Ivy Energy Fund and has very good track record with it in front of the firms. And so, I think what we've seen in terms of a one-time outflow probably has transpired, and it's our job now to move forward with the new manager and try to reestablish some momentum in the product.

[Daniel Paul Connealy:]

The products'relative performance is in, at least, the top third of this category, which is also helpful.

[Roger A. Freeman:]

Right. Yes, for sure. How big was the one sizable one?

[Thomas William Butch:]

It was about $30 million, I think. Don't quote me on assets or their magnitude.

[Roger A. Freeman:]

Okay. All right. And then, I guess, lastly, I just -- if I heard your comments correctly, Hank, on asset strategy, gold if it's 8%-ish is just a function of gold prices having gone down last quarter, you didn't add to gold exposure like you did last quarter. Is that fair to conclude?

[Henry John Herrmann:]

Gold positions have gone up and down on a tactical kind of basis. So I think it may have been -- went down and then went up when technically, I guess my sense was it kind of bottomed.

[Operator:]

Your next question is from Eric Berg with RBC Capital Markets.

[Eric N. Berg:]

I was a little surprised to hear the commentary about fixed income recovering after June. I realized that things have stabilized to a certain extent. But given how low rates are and the increased volatility, I would have thought that there would be elevated anxiety and that money would continue to flow out of fixed income. What's your best sense of what's going on, as we speak?

[Henry John Herrmann:]

Well, I think it's a bit of a mystery to a lot of folks. And I think that there is -- there definitely was rotation out, but then you had such a significant correction in high-yield, both in munis and in corporates, that a lot of people thought, I don't think the tapering is going to lead to a whole bunch higher move in yields. And some people rotated back in and others found money to move. So I think it's a combination of those 2 things. And for my own view, I'm not so sure that we're about to embark on a significant acceleration in GDP. And I see inflation going lower. And therefore, at least, for now, I'm skeptical. But there's a lot of reason to think that rates are going to be moving up. And I just see, in my own senses, that a lot of others are, at this point in time, sort of ignoring the tapering process. It seems like conventionalism at this point to assume that something is going to happen in September. But I think the Fed has done a pretty good job of signaling. Tapering doesn't mean raising rates. The bond market has shifted out its assumption about when rates will first go up to right now, I believe, June of 2016, and that environment to pick up between shorter maturities and high yields and loans for that matter is just pretty darn attractive. And so, as a consequence, I think there was a knee-jerk reaction. And then after that, significant jump in yields. It was too much hunting for the bees. So that's my point.

[Operator:]

Your next question is from Matt Kelley with Morgan Stanley.

[Thomas Whitehead:]

This is Tom Whitehead calling in for Matt. A couple of questions for Dan. The first is on G&A. I think you guys had guided the $17 million or $18 million coming into this quarter. And if we back out the fund loans, you came in at about $20 million. How should we think about this as a run rate going forward?

[Daniel Paul Connealy:]

You're talking about [indiscernible] probably $19 million to $20 million would be a run rate. There were just some factors in the last couple of quarters that made that hard to predict. So that's what I would model.

[Thomas Whitehead:]

Okay. Great. And then, the second question -- and I apologize in advance, it's sort of in the weeds. But you broke out about $1.8 million of distribution expenses from the closed-end fund launch. Could you give us a split of how much of that came through Advisor and how much through Wholesale?

[Daniel Paul Connealy:]

I believe most of it was from Wholesale, but there was some Advisor.

[Thomas William Butch:]

[indiscernible] well, the assets raised. on the Advisor world, a modest part, less than 10% of the total.

[Operator:]

Your next question is from Michael Lipper with Lipper Advisory.

[Michael Lipper:]

This is a series of questions that probably require estimates and it all focuses on the learning that you have done on closed-end. First is, can you identify the average-sized ticket that was purchased by individuals through the Wholesale channel for the closed-end, and how does that compare with the -- your average size ticket in the Wholesale on open end? And then, I have some others.

[Henry John Herrmann:]

I really don't think we have that sort of granularity to be able to answer your question, sir. I think we get just large trade numbers from each branch. And without the specificity that you might need to answer that question.

[Michael Lipper:]

This is -- your next answer is probably the same. But would you have any idea of how many new households you have added because of the closed-end?

[Daniel Paul Connealy:]

Well, I really don't have that sort of detail either. We don't give that sort of detail. So I'm afraid we can't answer that one.

[Michael Lipper:]

Then in looking at further closed-ends, and that sounds like an attractive market that you are looking at, do you have any way to scale how large an opportunity that might be for you? And only phrase it in terms of 2014 because 2013 schedules are pretty well locked.

[Thomas William Butch:]

So let me just take a shot at this, and the answer is probably one you would expect, which is that it's a mosaic of a lot of things. The first of which is the appetite for particular asset classes at point in time. And so, that's one important factor. For us, it's also the salience that we have in the open end market in certain categories. And does that translate well into the closed-end environment. And third is just the appetite for the closed-end product in general which adds inflows certainly has been flowing here in the recent past. So I would just reiterate that we are in touch with our distribution partners. We're not -- don't have anything imminent. But certainly, is our hope to continue those conversations and hopefully something germinates from that.

[Michael Lipper:]

Could you describe your leverage philosophy on this closed-end? And what the similar approaches might be used on any future?

[Daniel Paul Connealy:]

For this particular offering, I was able to get leverage up to 30% -- 33%. And at the month end, we -- we're not close to that.

[Michael Lipper:]

And that's your decision, not to take the full SEC-permitted leverage?

[Daniel Paul Connealy:]

Well, it was a new fund. There is a process of getting used to that. And so, it may be a little bit higher today.

[Henry John Herrmann:]

But, yes, it is our decision; and, yes, we aren't fully leveraged relative to what perspectives would allow.

[Operator:]

Your next question is from Daniel Fannon with Jefferies & Company.

[Daniel Thomas Fannon:]

Just a question on the termination of the sub-advisory agreement. It looks to be, if we just -- from an accretion perspective, it looks to be highly accretive we just take it out of -- take those expenses down. Wondering if there might be any other offsets throughout the P&L that would offset some of that accretion. And then, also I'm just curious around timing in terms of the termination. It seems like given how accretive it is, curious as to why you didn't do this previously?

[Daniel Paul Connealy:]

Well, as Hank mentioned, it was in response to the retirement of the portfolio manager. So -- then our opportunities were to gauge whether we had the talent or whether they had the talent. And we made the decision that we can manage that very well ourselves. So that was the timing of it.

[Henry John Herrmann:]

Just keep in mind that Fred Sturm had a very, very strong relationship with the broker/dealer community and was highly respected. In that sort of circumstance if you, for no reason, were to take [indiscernible] surely would experience some material negative impact and outflows. So that goes directly to the question you raised. When Fred decided to retire, it changed the equation, one, and two, to fund the [indiscernible] outflows for quite a while in part because of the performance, but also because it's just a general move away from Natural Resource funds that led to that. The decision was quite a bit simpler than it would've been in previous periods.

[Daniel Thomas Fannon:]

Okay. And then, just on the P&L, is there any other greater accruals or anything from comps that might offset or just remove those expenses going forward?

[Henry John Herrmann:]

While there maybe some minor, some portfolio compensation adjustments and that will, of course, also depends on performance. So it's very hard to say what those might be.

[Operator:]

You have a follow-up question from the line of Bill Katz with Citi.

[William R. Katz:]

I heard you on the margins tipping higher and you're showing 28% now if you still would back out the $900,000 that Dan just highlight in the Advisor channel. You're looking at incremental margin on a year-on-year basis, you're running well north of 60% something less than excess $900,000. Any input [ph] on, I know your long-term goal is towards 30%, but is there any sticking points to that 30% in terms of incremental spend or could the margin drift up over time beyond that consumer market so to continue to move higher?

[Daniel Paul Connealy:]

Well, Bill, I think part of the expenses -- we put a lot of marketing emphasis both from our marketing department and our wholesalers on banking this first closed-end fund successful. So to the extent that we spend money on trying to raise that fund, that's included in the closed-end fund cost that we have discussed. Were it not for that effort, they could have been -- they would also be spending money, but perhaps on different things. So I don't think it's probably proper to extrapolate that here we are at 28.2%, and we only have up to go from here.

[Daniel Paul Connealy:]

Bill, the thing we've talked about in the past is the difficulty of figuring out when and how. But clearly, in a moderately good sales environment and a strong market action environment the combination is a positive prejudice toward our distribution and operating margins. We did sort of have that combination in the second quarter. Having said that, we continue to pay capital attention to expenses, particularly in direct expenses and distribution categories. And we managed pretty carefully too some presumptions about market actions coming into the year, and we seldom will deviate very much from that budget. As you would probably guess, our thoughts on market action prove pretty conservatively relative to what we experienced. So net-net, in the short run anyway, assuming no diabolical commentary out of the Fed, for instance, I would say the prejudice is still positive in terms of operating margin.

[Operator:]

Your next question is from Greggory Warren with Morningstar.

[Greggory Warren:]

You guys noted that flows were looking a little bit better on the fixed income side coming into July. I'm just wondering -- we've had a lot of conversation around this great rotation in the sense being that the rotation is taking place more within fixed income than it is fixed income to equities. So I'm kind of curious to see what you guys have been seeing. The flows from what I can see through the third work of July aren't that great in July, but they're better than -- I mean, significantly better than June. And I'm just kind of wondering what you guys are really seeing up there?

[Henry John Herrmann:]

Well, I do think that there is a movement toward equities, but I don't think it's anything like the powerful move that is incorporated into the idea of the great rotation. But if you think of Tom's list of products that are selling very well, there are 3 in there that basically equity products that if you asked us that question a year ago, we wouldn't have been included in his response. But I -- it's also true that there is a rotation going on inside the fixed income that's been discussed and obviously you've heard it in the sense that they're still focused on high yield. It's also interesting that I don't think there is a quite as greedy as a reach for yield as there was earlier, because there's been a pretty big beating in emerging as one example of what we're talking about and this uncertainty around currencies has caused folks to be a little more careful there. And it's not just go out of credit [ph] and go out of credit into high yield, it's also -- something I suspect coming out of foreign emerging and coming into domestic high yield. That's the best answer I have, and I'm not sure it's a good answer.

[Greggory Warren:]

It's kind of hard to find a good answer in this right now. Do you guys have a sense for where the greatest interest in equities is coming from? Is it Wholesale, Advisors or on the institutional side?

[Thomas William Butch:]

I think it's both. And I think sometimes we want to separate them more than they are really in fact separable. So we continue to see very good interest from the institutional side in at least a couple of our core-ish equity strategies. And I do think, from Hank's point, there's a greater appetite among retail advisors and their firms, if you read their firm's guidance and their firm's analysis toward equity as well. So I agree that there's not a great rotation, maybe there's a nascent rotation or something like that.

[Operator:]

[Operator Instructions] And there are currently no further phone questions.

[Henry John Herrmann:]

Operator, I think we're done.

[Operator:]

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