Acadian Asset Management Inc. Q2 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to the BrightSphere Investment Group Earnings Conference Call and Webcast for the Second Quarter 2020. Operator provided instructions. After the presentation, we will conduct a question-and-answer session. Operator provided instructions. Please note, this call is being recorded today, Thursday, August 6, 2020, at 11 a.m. Eastern time. I would now like to turn the meeting over to Elie Sugarman, Managing Director, Strategic Development. Please go ahead, Elie.

Good morning, and welcome to BrightSphere's conference call to discuss our results for the second quarter ended June 30, 2020. Before we get started, please note that we may make forward-looking statements about our business and financial performance. Each forward-looking statement is subject to risks and uncertainties that could cause actual results to differ materially from those projected. Additional information regarding these risks and uncertainties appears in our SEC filings, including our Form 8-K filed today containing the earnings release and in our 2019 Form 10-K and in our 10-Q for the first quarter of 2020. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update them as a result of new information or future events. We may also reference certain non-GAAP financial measures. Information about any non-GAAP measures referenced, including a reconciliation of those measures to GAAP measures, can be found on our website along with the slides that we will use as part of today's discussion. Finally, nothing herein shall be deemed to be an offer or solicitation to buy any investment products. Suren Rana, our President and Chief Executive Officer, will lead the call. And now I'm pleased to turn it over to Suren. Suren?

Thanks, Elie. Good morning, everyone, and thank you for joining us today. I hope everyone and their loved ones are healthy and well. Let me start with Slide 5 of the presentation deck as usual to provide some key updates on our business in the second quarter. We reported ENI per share of $0.41 for the second quarter of 2020 compared to $0.45 in the second quarter of last year and $0.40 in the first quarter of this year. While our revenue declined more compared to the year-ago quarter due to the impact of the market decline on our average AUM, the impact on ENI was much lower, and this was due to our continuing discipline on the OpEx, and the built-in variability that we have discussed from time to time on our other costs like variable compensation and employee share of the distributions. Also, the repurchases that we did in Q1 and Q2 helped to further reduce the impact of the revenue decline on ENI on a per share basis. We previously announced divestitures of Barrow Hanley and Copper Rock which result in a more attractive pro forma business mix that has consistently generated positive net flows historically. In the second quarter, too, our total net client cash flows on a pro forma basis, that is excluding Barrow Hanley and Copper Rock, were positive across our three segments with a total of $0.4 billion, which is another encouraging data point for the pro forma business. We will use the $335 million of expected after-tax proceeds primarily to pay down debt and repurchase our shares, which we would expect to produce double-digit accretion to ENI per share in 2021. The additional capital also allows us to seed new strategies to enhance organic growth of our affiliates. In the Quant & Solutions segment, our investment performance continued to be strong, with 47%, 48% and 88% of strategies by revenue beating their benchmarks over the prior 3, 5 and 10-year periods. In the Alternative segment, we continue to expect to reach our AUM growth target, but with a slower pace, causing a timing delay of about two quarters. In the Liquid Alpha segment, we now have positive flows on a pro forma basis in the second quarter that is excluding Barrow Hanley and Copper Rock. We are on track to deliver annualized cost savings of over $20 million by Q1 of 2021 from the previously announced repositioning of our corporate center, which will have an annual pre-tax income impact of a similar amount, that's $20 million. In the second quarter, we repurchased 3% of our outstanding shares which were executed in the early part of the quarter and previously announced on our last earnings call. As we announced then, we intend to focus on fully paying down our revolver first and then we will resume repurchases. Moving to leverage. We reduced the outstanding amount on our revolver to $130 million compared to $220 million at the end of the first quarter. This reduced our net leverage ratio from 2x last quarter to 1.7x for the second quarter. On Slide 7, I'll briefly recap the long-term strategy that we're executing on. The centerpiece of our strategy is our attractive business mix. In the top section, we highlight that 88% of our business, pro forma for the recently announced divestitures, comes from Quant & Solutions segment, which is primarily Acadian, and Alternative segment, which is primarily Landmark. Each of Acadian and Landmark are leading scale players in their respective fields, and we are seeing secular growth tailwinds in both these areas. This attractive business mix generates strong free cash flow, and it will focus on deploying our free cash flow accretively to: one, reduce debt and maintain a strong balance sheet; two, repurchase our stock, given our stock still trades at a meaningful discount to intrinsic value; and three, seed new strategies at our affiliates that can drive future organic growth. Given the divestiture of two affiliates, it's also worthwhile to recap what our key businesses are on a pro forma basis which we lay out on Slide 8. So on Slide 8, on the left is our Quant & Solutions segment, which is primarily Acadian, and comprises 68% of our EBITDA on a pro forma basis. Acadian is a highly specialized and differentiated business with broad-based quant capability and ongoing investment in cutting-edge research, data and technology, which allows us to generate alpha in the specific exposures and strategies that the client desire as markets continue to evolve. In the middle is our Alternative segment, which is primarily Landmark, as I said, and comprises 20% of our EBITDA on a pro forma basis. As we've discussed before, we expect this business to continue growing very well as we raise our next vintage funds. This business is also very well-positioned for the long term because the demand for private market strategies continues to grow and secondary strategies can efficiently meet that growing demand. Importantly, Landmark is a pioneer and one of the top few names in the secondaries business. On the right is our Liquid Alpha segment, which is now primarily GSW, and comprises 12% of our EBITDA on a pro forma basis. This business diversifies and complements our overall business as well. In this business, we provide a mix of fundamental long on least strategy in equities and fixed income across cap ranges and regions. And we believe this segment is well-positioned to benefit when value returns to favor. Slide 9 and 10 highlights how our pro forma business mix is more attractive by various metrics. For example, if you look at the bottom half of Slide 9, you will see that 88% of our EBITDA on a pro forma basis comes from Quant & Solutions and Alternative segments. Next few slides show our segment results in greater detail that you can review. I will point out a couple of things on Slide 13 regarding our Liquid Alpha segment. Our management fee rate in the segment was 31 basis points for Q2. As disclosed in footnote one, pro forma for the divestitures, management fee rate for Q2 would be higher at 40 basis points. Similarly, ENI operating margin was 39.3% for Q2. As disclosed in footnote two, pro forma for the divestitures, ENI operating margin for Q2 would be higher at 45.5%. Finally, turning to our flows on Slide 14. Looking at the chart on the left, as I mentioned earlier, pro forma for Barrow Hanley and Copper Rock divestitures, we saw positive flows across our three segments. Looking ahead, we're pleased by these trends and are hopeful that the fundraising in the Alternative segment will pick up pace next year, further improving our overall slots. Now I'd like to turn the call back to the operator. Happy to answer questions at this point. Thank you.

Operator provided instructions. Our first question comes from Craig Siegenthaler with Credit Suisse. Your line is open.

Good morning, Suren. Hope all is well. After a successful disposition of Barrow Hanley and Copper Rock, I just wanted your perspective on the potential for similar exits with your two other traditional affiliates, which could actually improve your business mix, and more importantly, your organic growth rate further?

Hi, Craig, thanks. Yes, as we've mentioned, when we announced those divestitures, pro forma with regards to the divestitures, we have a very strong business mix now with a strong record of producing positive flows. And the Liquid Alpha segment, too, had positive flows this quarter, may not happen every quarter, but we do like the diversification that we have in our overall business. Having said that, as you pointed out, it is our duty to consider any compelling opportunity that may come up from time to time to enhance shareholder value or things that may be compellingly attractive to shareholder value. So we will consider those things as they come up.

Thanks, Suren. And just as my follow-up on Landmark, I think many of us were already running with a two-quarter delay on the Landmark fundraising cycle after the May earnings call. Does this two-quarter delay equate to 1Q 2021 when we should start seeing the first closes? Or is this actually incremental to what you were saying on the last earnings call?

Thanks for asking that. To the extent there is confusion, we definitely want to clarify that we were just reiterating the prior discussions that we've had on the last earnings call that is the same two-quarter delay. Initially, we had been saying that the second half of 2020 is when we would expect fundraising to pick up pace. And what that means is that most of the fundraising moved to 2021, and the first half of 2022, which was earlier the second half of 2020 and all of 2021.

Operator provided instructions. Our next question comes from Mike Carrier with Bank of America Merrill Lynch. Your line is open.

Good morning. Thanks for taking the question. First one, just on the accretion with the divestitures and the pay down and buybacks. I don't know if you — when you announced the transaction, you mentioned sort of the net income impact, and I just want to make sure that correlates to the economic net income. I just kind of want to know the earnings that you're going to be losing. And then obviously, you can back into the buyback and the debt pay down, but I think maybe slightly tougher to get to certain levels of accretion given what that earnings loss is.

Hi, Mike, yes, if I understood the question correctly, yes, the guidance that we gave last week was that, yes, we would lose the EBITDA and the earnings from the affiliates that we are divesting. But by deploying those proceeds in paying down debt and repurchasing shares, we expect double-digit accretion to the ENI per share. So we were referring to ENI in terms of ENI per share in terms of the accretion. So essentially, if you do the math, we had announced that $40 million annualized EBITDA that we would lose from those divestitures and you can tax effect that. But by using the proceeds and paying down the debt and repurchasing our shares, and we use a variety of our repurchase price scenarios and debt pay down scenarios. But in most scenarios, we are comfortable that we pay down debt as well as get about a double-digit EPS accretion to ENI per share. Does that answer your question, Mike?

Yes, yes. That makes sense. And then just on some of the pro forma expense ratio guidance that you gave, just given the timing of these transactions, is that like a pretty good base for us to be thinking for 2021?

Yes. Yes, the guidance that we've given on the ratios in the investor deck, that's pretty good from my 2021 perspective. Some of the ratios, particularly the OpEx ratio do obviously vary depending on the revenue and what the market does. But with that qualifier, they're generally good based on what we know so far.

Operator provided instructions. Our next question is from Michael Cyprys from Morgan Stanley. Your line is open.

Hey, good morning. Thanks for taking the question. I just want to come back to the Quant & Solutions business. I was just hoping you can open the curtain there a bit more on the Quant & Solutions business detail and maybe just give us some color around the diversity and the mix of strategies that they have. And maybe just more specifically, if you were able to help us frame and quantify, say, the top three strategies, how much would be in each of those top three strategies? And then if you could maybe help us understand the top three flowing strategies, what those are indicating recently? And how much is coming in across those different top line strategies?

Hi, Mike, yes, it's one of the largest businesses we have, especially on a pro forma basis; it's more than half of our revenue or EBITDA. That's a very diversified business with a variety of strategies, and we're continuing to see new strategies. So some of the larger strategies, for example, as a regional strategy, emerging market strategies, one of the larger strategies there. We have a variety of non-U.S. regional strategies with different flavors in terms of cap ranges and markets like Japan. We have managed volatility strategies which, again, are low volatility strategies, but also are further dissected by regions. And we have a number of new strategies that are getting good traction from clients like the multi-asset product that we've touched on. There are specific factor strategies where clients are looking for exposure to a specific factor or a combination of two or three factors or more and a much smaller part of our business where we are always experimenting with new things. So it's a very diversified business. And depending on different market environments, different strategies become inflowing or outflowing, but on balance, a lot of things do tend to offset each other. So we're pleased with the capability. The core capabilities, ultimately, are the alpha model and the investment we're doing in the data and the research and the academic research and the team, but it diversifies a lot by region, by the specific objectives that the clients have.

Okay. And just in the quarter, it looked like about $300 million inflows or so into Quant & Solutions. I imagine all that's at Acadian. There was a negative revenue impact associated with those inflows on Page 14; it looks like $6.8 million negative revenue annualized impact there. I guess that's just the redemptions going out the door at a higher fee rate than the gross sales. So just hoping you could elaborate around that. Maybe just help us a little bit more color there and maybe give us a sense on which strategies were inflowing versus outflowing in the quarter?

Yes, certainly, Mike. And then I would say that what you see on the revenue side, it's a little bit of happenstance, if you will, that we are not seeing any kind of fee compression or any particular strategies that are outflowing in a recurring way. It's just a function of whether we have the combination of inflows and outflows, whether we have higher-fee outflows in a particular quarter compared to inflows because we do have a range of strategies and that also vary by fee, because some are easier to implement, so maybe lower fee, not necessarily lower margin because they are easier to implement, and some are higher fee. So it just depends on the combination. It is a very institutional business, and hence, can be lumpy and choppy. But I wouldn't necessarily see a particular pattern in terms of higher-fee inflowing or lower-fee inflowing and vice versa.

And just any color on which strategies are inflowing versus outflowing in the quarter?

It changes from quarter to quarter. So we — as you would expect, for example, the low-vol strategies in Q1 we had more demand than what we saw in the second quarter. So that strategy in the second quarter wasn't inflowing, but it does change quite a bit from quarter to quarter.

Operator provided instructions. Our next question comes from Robert Lee with KBW. Your line is open.

Great. Thank you. Thanks for taking my questions. Maybe shifting to Landmark. Maybe similar to Acadian. Any sense of the cadence or pace of fundraising there? And specifically, what I mean by that is, assuming you run multiple products, not all the same size. So if you think of that fundraising starting to close, say, in the first quarter of 2021, will it be some of the larger strategies that you expect to start getting their closes earlier? Or are larger strategies later in the cycle? Just trying to get some sense of, over the course of that year, fundraising, kind of what we should think of as a pattern, like larger funds later, small funds first? And then second part of that, just to get a flavor of the mix of strategy that, obviously, PEs are important but it's more than one strategy — some sense of what are the specific strategies they're raising for and maybe how different they are.

Yes. Thanks, Rob. Yes, somewhat similar to Acadian, Landmark is also a very diversified business. The core strength is obviously the secondary aspect, which they are one of the pioneers in that business. But also because they are one of the pioneers in the business, it's diversified. So there will be primary strategies; we have private equity, real estate, and real assets, which, for example, infrastructure. As you would expect, private equity is one of the larger strategies being one of the more established and one of the earlier secondary asset classes. So it's diversified and we obviously target to grow AUM and ideally continue to expand the secondary asset class and beyond over time. But in terms of 2021 and onwards, we wouldn't expect any sort of backend concentration from that perspective. A simplified assumption would be that 2021 onwards, fundraising is spread evenly over five, six, seven quarters.

And maybe as a follow-up. With the pending transaction for the fourth quarter, is there any later color on kind of one in the fourth quarter? Are they closing October one versus December 31 so they had some information on that buyback heading into the year, at least in the fourth quarter? So any sense that sort of happening quickly in fourth quarter terms or more toward year-end?

Yes. I would assume almost toward the year-end could happen sooner, but I would assume December.

Operator provided instructions. Our next question is from Chris Harris with Wells Fargo. Your line is open.

So first question on expenses. The operating expense ratio was 43.4% in the second quarter. Your guidance is 45% to 48% for the year. So I know you're giving us a ratio here and not actual numbers, but that seems to imply higher expenses in the second half relative to the second quarter. Is that a reasonable assumption? I mean, do we have that right? And if so, what could be driving the expenses up in the second half?

Yes, certainly. Thanks, Chris. The ratio is again a range of evolving assumptions regarding the revenue. But in the second quarter, you'll see that, compared to the first quarter, the dollar amount of expenses was lower. And some of that was driven by T&E, third-party vendors, some slowdown in recruitment that we had, for example, at Landmark. So we would expect some of this to pick up in third quarter and fourth quarter. Partly that, yes, we would expect some of the operating expenses to increase. And then it's really, in terms of ratio, it's really the expectation around what would happen on the market side. So it's a range for that reason.

Okay. Is there any light you can shed on possible performance fees in the second half? I know traditionally, Q4 tends to be a pretty strong quarter for you guys as it relates to that. Is that something we should still be modeling for? And then kind of an unrelated follow-up, what are your thoughts on the pro forma tax rate of this company? Is that really much different than where it stands today?

On performance fees, yes, you're right that we would expect, generally, performance fees still to come in Q4. And generally, there is always something. It's always hard to predict, of course. But Q4 would be the right quarter to model some performance fee. Regarding the pro forma tax rate, not that we know of any material difference today; we will run with the current assumptions and update if anything changes.

Operator provided instructions. Our next question is from Kenneth Lee with RBC Capital Markets. Your line is open.

Hi, thanks for taking my question. Just one in terms of the seed capital plans for seed capital investments. Wondering if you could just share with us any updated thoughts on any specific areas which you're looking to invest in?

Yes, on the seed capital, as we said, it's a similar approach as to our overall business that we are focusing our business on the growing parts of the industry. So you would expect our seed portfolio also to be reflective of that. So it would be primarily Acadian and Landmark in terms of seeding new strategies that we expect to have client demand. Our current portfolio is invested, for example, in the multi-asset class strategy at Acadian and a few others. And similarly, we have participated in GP commitment in some of the Landmark funds that were raised in the last vintage. So generally, that's how it would evolve with the growth of the AUM.

Got you. Very helpful. And just one follow-up, if I may. Wondering if you could just comment on your unfunded institutional pipeline and what sort of products you are seeing in demand there? Thanks.

I see. Got it. Yes, we generally have not shared any specifics on pipelines in the sense that maybe we always, as you would expect, have some wins but not funded, and they eventually are funded, but the timing varies. So we're reasonably satisfied with our pipeline. I would say that it's not very different from what we normally have in the pipeline.

Operator provided instructions. Our next question is from Patrick Toma with Autonomous Research. Your line is open. Patrick Toma with Autonomous Research. Your line is open.

Hey, good morning. All my questions have been answered.

Operator provided instructions. Our next question is from John Dunn with Evercore. Your line is open.

Hi, just given the strategic shift, can you talk about how big a piece of the puzzle do you think the non-U.S. domiciled flows is going to be to growth? Basically, how should we be thinking about that piece?

Yes, John. The non-U.S. continues to be an important market, both for Acadian and Landmark, in particular, because those products are in demand, both in the U.S. and overseas. I would say that with regards to GSW, probably less so because one of the larger strategies there is international, which is more in demand in the U.S. But with our larger affiliates, Acadian and Landmark, international distribution continues to be important. Both of those affiliates have very sizable distribution efforts directly at the affiliate level in the U.S. as well as internationally.

Got you. And then I know adding new clients is more complicated due to COVID. But can you give us any color on how maybe existing clients may be looking at adding new strategies?

Yes, that's an interesting dynamic. You touched on that — we're seeing that adding new clients is logistically a little bit more challenging than before when you were able to go see a client in person. But by the same logic, any clients that do need to allocate more are generally going to their existing managers. And we're seeing that, too. So whether it's a client looking for something different, and we already have that in our wheelhouse, then we have somewhat of an advantage. So we do see that dynamic. At both, for example, Acadian and GSW, which are more on the liquid side, and on the illiquid side, Landmark is obviously more a raised phenomena. And there, the delay that we mentioned is more related to the travel and logistics issues as clients settle into new processes, but we do have a number of clients that are repeat clients across prior vintages that we would expect, though there are processes to go through.

This does conclude our question-and-answer session. I'd now like to turn the conference back over to Suren Rana for any closing remarks.

Thank you. To summarize, we're pleased about our pro forma business mix and the net flow trajectory this new mix offers, and we look forward to continuing to unlock and create shareholder value. Thanks, everyone, for taking the time. Stay safe and healthy.