Earnings Call Transcript
Franklin Resources Inc (BEN)
Earnings Call Transcript - BEN Q2 2022
Operator, Operator
Welcome to Franklin Resources Earnings Conference Call for the Two Quarter and Fiscal Year 2022. Hello. My name is Grace and I'll be your call operator today. As a reminder, this conference is being recorded. And at this time, all participants are in a listen-only mode. I would now like to turn the conference over to your host, Selene Oh, Head of Investor Relations for Franklin Resources. You may begin.
Selene Oh, Head of Investor Relations
Good morning, and thank you for joining us today to discuss our quarterly results. Statements made on this conference call regarding Franklin Resources Inc., which are not historical or forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a number of known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from any future results expressed or implied by such forward-looking statements. These and other risks, uncertainties and other important factors are discussed in more detail in Franklin's recent filings with the Securities and Exchange Commission including in the Risk Factors and the MD&A sections of Franklin's most recent Form 10-K and 10-Q filings. Now, I'd like to turn the call over to Jenny Johnson, our President and Chief Executive Officer.
Jenny Johnson, President and CEO
Thank you, Selene. Hello, everyone, and thank you for joining us today to discuss Franklin Templeton's results for our second fiscal quarter. I'm joined by Matt Nicholls, our CFO, who recently expanded his responsibilities to include Chief Operating Officer; and Adam Spector, our Head of Global Distribution. This quarter global financial markets were impacted by a continuation of macroeconomic pressures due to increased inflation and related higher interest rates, both of which have been significantly exacerbated by geopolitical and economic shifts resulting from the Russia-Ukraine war. This quarter's volatile market environment challenged industry flows particularly in taxable fixed income strategies. We were impacted by these pressures and had $11.7 billion in long-term net outflows, although we continue to drive net inflows into key growth areas and our effective fee rate remains stable. The heightened market volatility and implications of a rapidly changing investment environment remind us of the importance of the investments we've made over the past several years to diversify our business to better serve our clients through all market conditions. Our investment teams each look at the market through a different lens to provide deep expertise and investment specialization. For instance, if you look at our fixed income franchise, Brandywine Global, Franklin Templeton Fixed Income, Templeton Global Macro, and Western Asset, each of these specialist investment managers has a different interest rate outlook, resulting in varying investment outcomes across our products. And although we saw net outflows in certain U.S. and global taxable strategies, those were partially offset by inflows into short duration bank loans and corporate strategies. Additionally, we've been able to benefit as investors look to reposition their portfolios in search of yield across asset classes. Our flagship income fund and alternative asset strategies of Benefit Street Partners and Clarion Partners, for example, represent important diversification tools for our clients. BSP and Clarion have been key contributors to our success and generated a combined $2 billion in long-term net inflows during the second quarter and each reached record highs in assets under management. Our multi-asset class category recorded $2.3 billion in positive net flows for the quarter, driven by the Franklin Income Fund that has an approach that is adjustable to changing market conditions with $75 billion in U.S. AUM. The income fund has also seen increased interest from investors in Asia and Europe, and the strategy was recently launched into the SMA vehicle to meet client demand. To illustrate how we've been able to diversify into other strategies, 17 of our top 20 funds with net inflows are outside of our largest 20 funds and on average now exceed $5 billion in AUM. Close connectivity with our customers during periods of market uncertainty is extremely important as investors look to reposition their portfolios and we've been actively engaging with our clients with thought leadership, Franklin Templeton Institute, and our specialist investment managers to help navigate how geopolitical and macroeconomic shifts impact their investment decisions and their long-term financial goals. Specifically, webinar attendance by financial advisers grew by 62% in the second quarter and video views increased by 90%. Turning to investment performance, strong long-term investment performance resulted in 65%, 68%, and 77% of our strategy composite AUM outperforming their respective benchmarks over a three, five, and ten-year period. There was a decrease in our one-year investment performance primarily due to certain U.S. taxable fixed income strategies which was partially offset by strong performance in global fixed income strategies with notable improvements in performance for Templeton Global Bond Fund whose performance is in the top decile for the one-year period. We continue to make progress on our corporate initiatives, which include growing alternative assets, advancing technology to customize portfolios in our SMAs, and expanding our presence in wealth management and ETFs. Our alternative asset business continues to develop, growing 2.3% from the prior quarter to a record $158 billion in AUM with contributions from a diverse group of strategies including the aforementioned $2 billion of net inflows into Benefit Street Partners and Clarion Partners. On April 1, we completed our acquisition of Lexington Partners, a leading global manager of secondary private equity and co-investment funds with total AUM of $57 billion as of March 31. That AUM will be included in our quarterly reporting starting in the third quarter, and we expect further growth as a result of new fundraising. When including Lexington, Franklin Templeton increased its presence in alternatives by 39% to become a $215 billion manager of alternative assets, an area of increasing importance for both individual and institutional investors. SMA AUM ended the quarter at $126.1 billion. We continued to make progress with SMA strategies, particularly in the use of technology to customize portfolios. This quarter, Canvas, our recently acquired custom indexing solution, increased by 21% in AUM driven by net inflows of $600 million and the number of partnerships grew by 15%. Wealth Management AUM ended the quarter at $34.1 billion. Fiduciary Trust International generated its sixth quarter of consecutive positive long-term net inflows, and we continue to explore ways to accelerate growth of the business via acquisitions. We also experienced growth in our ETF business in the quarter with positive net flows and approximately $13 billion in AUM, which are balanced between actively managed and passive strategies. Looking briefly at our financial results, adjusted revenues were $1.6 billion, a decrease of 6% from the prior quarter, primarily due to lower average AUM, two fewer calendar days, and a decrease in performance fees. Expenses were flat quarter-over-quarter but would have been lower had it not been for non-recurring or certain episodic items that are included in our adjusted results. Adjusted operating income was $577 million, and importantly, our adjusted effective fee rate stayed relatively consistent at 38.5 basis points. With $6.8 billion in cash and investments as of March 31, the ongoing strength of our balance sheet enables us to invest with confidence in the business and make sure we're positioned appropriately in an ever-evolving industry. In closing, it's a transformative time in the asset management industry while the economic climate and geopolitical tensions present additional complexities and uncertainties. Over the past two years, we've made significant strides to expand our capabilities and provide our clients with deep expertise and specialization. It's this broad diversity that is allowing us to navigate through the current volatility. I would like to thank our employees for their tireless work and ongoing efforts on behalf of our clients. Now, let's turn it over to your questions.
Operator, Operator
Thank you. Your first question comes from Craig Siegenthaler from Bank of America. Your line is open.
Craig Siegenthaler, Analyst
Good morning, Jenny, Matt. Hope you both are doing well. And Matt, congratulations on the CEO appointment.
Matt Nicholls, CFO
Thank you.
Craig Siegenthaler, Analyst
So given your large fixed income franchise across Western, Brandywine, and Franklin, I wanted to get your perspective on how investors are reacting to rising rates. And my question really is, are you seeing a different flow pattern or behavior between the retail and institutional channels? And then when the money is leaving, do you see where it's going? Is it going into cash, private credit, equities? And are you able to recapture it?
Jenny Johnson, President and CEO
I'm going to let Adam get into details, but I mean, we're definitely seeing good flows into short-duration bank loans and corporate strategies. I mean, so it's not all – there's more of a kind of a shift in where it's going. But Adam, do you want to go into a little bit more detail?
Adam Spector, Head of Global Distribution
Sure. Thanks, Jenny. First of all, I would say that the changes that we've seen are not really all that different on the institutional and the retail side. We see pretty similar patterns going on right now. That's really a part I think driven by the fact of how professional the wealth channel is these days. I don't see it behaving that much differently than the institutional channel. What we've seen is that core type strategies, intermediate duration was hit the worst. I think if you take a look at active flows for U.S. mutual funds as an example for the month of March, the industry lost something like $71 billion, and 75% or so of that was in core taxable fixed income. So that part of the market got hit really, really hard. Where is that money going? As Jenny said, we see short duration picking up a lot. Our short duration sales in some of our funds was up over 80%. We see it going to some credit strategies, floating rate, and importantly also to private credit, where we're a significant player. That in part is propelling the growth in our alts business where in our private markets businesses, as Jenny said earlier, we had $2 billion worth of growth in the quarter. The other place, especially in some of our wealth channels that we've seen a pivot to, is alternative sources of yield to fixed income. We're really pleased that we have the ability to offer our clients the income fund, which is one of our largest funds at Franklin and one of our top flow generators for the quarter, where we saw an increase in our net of over $2 billion quarter-over-quarter. And I think we have to assume some of that money from fixed income is following to there. So we feel good, Craig, in general about being able to retain a portion of the outflows even though the segment where we're strongest had the worst outflows in the industry.
Craig Siegenthaler, Analyst
Thank you for that. And just as my follow-up on a similar topic, as we try to forecast the model bond flows, do you think it gets worse from here just because we've only had one rate hike and there could be eight or nine more? And I know that's more of a short duration front end of the curve sort of comment and the long end might matter more, but I would love your perspective on this topic given what you're seeing from clients?
Adam Spector, Head of Global Distribution
I believe the positive news is that we're witnessing a strong trend of diversification across the business. Regarding multiple rate hikes, these will affect our various specialist investment managers in unique ways since we have different positions along the curve. This suggests that no matter what actions the Fed takes, we will have products that perform well and can continue to grow. We are particularly pleased that our sales are more diversified than ever, which gives us confidence in our ability to expand regardless of the overall economic environment.
Craig Siegenthaler, Analyst
Adam, thank you for the responses here.
Adam Spector, Head of Global Distribution
Thank you.
Operator, Operator
Thank you. Next up, we have Bill Katz from Citi. Your line is open, sir.
Bill Katz, Analyst
Okay. Thank you so much for taking the questions. So maybe coming to expenses for a moment. I seem to be a few sort of ins and outs as I see it. Just wondering if you could unpack a little bit about what is the right start point for expenses into new quarter? And how should we be thinking about the expense outlook maybe with and without the impact of Lexington? And does the charge you took for TA have any sort of incremental synergies or other impacts as we look out over the next several quarters? Thank you.
Matt Nicholls, CFO
Okay, Bill. Thank you, good morning. Maybe it's best if I just update some guidance and I'll also give some breakdown inclusive of Lexington, so we can sort of reset where we're at, not give both annual guidance and some quarterly guidance for next quarter on the breakdowns. We expect full year 2022 adjusted operating expenses to be in the range of $3.9 billion to $3.95 billion excluding performance fees, but now including Lexington Partners. You may recall, last quarter I had said that our expense guide for 2022 on adjusted operating expenses would be $3.9 billion to $3.95 billion excluding both performance fees and excluding Lexington. But now it's including performance fees and including Lexington Partners, so that's one important change due to market conditions and revenues and assets under management and so forth. Given we've now closed Lexington, as I mentioned, I'll give a few line items which I hope will be useful for the third quarter. We expect G&A to be in the range of $140 million again inclusive of Lexington occupancy to be around $57 million and information services and technology to be around $125 million. That's all inclusive of Lexington.
Bill Katz, Analyst
That's very helpful. Thank you very much. And maybe coming back to alternatives as my follow-up. Jenny, I heard you talk about the sort of good growth out of Clarion and Benefit Street sort of adding $2 billion, but I also think you mentioned you had some outflows on the liquid side. So wondering if you could maybe unpack that a little bit more. And then as you think about Lexington, where are they in their flagship capital raising cycle? And how do you see the opportunity to sort of leverage it more broadly through the Franklin footprint? Thank you.
Jenny Johnson, President and CEO
Yes. Look, some of the outflows were in some of our macro strategies on the alternative side. As far as Lexington and the capital raise, I mean, and we're not talking specifically about the fundraise. But if you look at – when we announced the deal I think they had $34 billion in fee generating revenue – or AUM and now they're up to $42 billion. You can look at comparable secondaries and see sort of how they've done on their rate versus others. We're really excited about it but we're not giving any more specific details on this particular fund raise.
Adam Spector, Head of Global Distribution
Jenny, the one thing I might add to that is that the distribution team has been working with Lexington. Obviously, they have a long history of accomplished fundraising on their own. The areas where we think we're going to be able to add the most at Franklin Templeton are in the retail distribution of their products as well as in select markets. We've had a number of examples already where they might be strong in a particular country or segment but they don't quite know everyone in the market or there's a country where they don't really have a presence. So just like we do with the rest of our specialist investment managers, it's really an opt-in model and we've had discussions with them about where they're strong and where they need some help and we're filling in the gaps which we think will help their already strong sales process get even better.
Jenny Johnson, President and CEO
And I think, actually, Adam, that's a great point. I mean you talk about sort of the big areas of growth. Alternatives is obviously our big area of focus. I mean, BCG came out and said by 2025, alternatives will represent 16% of AUM but 46% of global AUM revenue. So as we all know, all flows aren't created equal. The big opportunity, we think, is in the retail channel. You just again take the $13 trillion in assets in the top four largest wirehouses. A 1% move is $130 billion, and they've all stated that they know that the democratization of alternatives is really important as we've seen the reduction of companies going public and more and more private credit. We think taking our vast retail distribution capabilities and marrying it with these alternatives is really complicated. There's a lot of training that goes on. It's not just getting it on the platform. There's a lot of material that has to be there, but it's just a tremendous opportunity. And Lexington, part of their fundraise has been successful in the retail channel. So we're excited about the opportunities. We actually think secondary private equity is a great way because you don't have the J-curve issue for the retail or the wealth channel to access private equity.
Bill Katz, Analyst
Thank you very much.
Operator, Operator
Thank you, Bill. And your next question comes from the line of Brennan Hawken from UBS. Your line is open, sir.
Brennan Hawken, Analyst
Good morning. Thank you for answering my questions. I have a follow-up regarding the updated expense guide. Does the full-year expectation take into account what we've observed so far this quarter, or is it based on the figures as of March 31 when you provided that update? How should we approach this as we monitor the markets and make adjustments?
Matt Nicholls, CFO
It includes market to-date. But of course, we obviously know how volatile the market is, Brennan. I think we've highlighted in the past that approximately 35% to 40% of our adjusted expense base is variable, along with market and performance. I think we've also added to that the other piece of 60% to 65% in terms of long-term effectiveness and efficiencies we continue to review. So if the market gets tougher, we're equipped to make moves, further moves.
Brennan Hawken, Analyst
Great, that's helpful. Thanks for that. How are you managing expense discipline while still making important investments in the business that contribute to your competitive positioning and strength in the marketplace?
Jenny Johnson, President and CEO
I think...
Matt Nicholls, CFO
Oh, go ahead, Jenny.
Jenny Johnson, President and CEO
Sorry, Matt, I was just going to answer…
Matt Nicholls, CFO
Oh, go ahead.
Jenny Johnson, President and CEO
…more details, but I would say philosophically, you will always see us thinking in terms of what's long-term right for the business versus any kind of short-term. So we're going to work hard to reduce costs, where we can reduce costs but never at the expense of strategically positioning us for the long-term. So we're making some significant investments in wealth technology, for example, and even in the blockchain space and others because we think they're going to be important over the long run. It will take a little time for us to pay off meaningfully and hit the bottom line, but they will be really important for us in the long-term positioning of the business. So go ahead, Matt.
Matt Nicholls, CFO
Yeah, the only thing I'd add to that is, I think part of your question, Brennan, is how are we doing that? Where are we finding the money from, when we are managing to reduce expenses and keep up with where the market is going in this volatility? It's basically because we've also been through a very significant merger. Remember, when you go through significant mergers, even at the holding company level where we focused most of the cost synergies, that created some flexibility for the company. It continues to create flexibility for the company in terms of our operation and how we run the firm. We have to focus on one thing at a time, but we certainly earmarked other areas where we can make moves when we have time to make the moves, candidly. So that's where we get the additional flexibility from as we take in.
Brennan Hawken, Analyst
Excellent. Thanks for all that color.
Matt Nicholls, CFO
Thank you.
Operator, Operator
Thank you. Next up we have Alex Blostein from Goldman Sachs. Your line is open, sir.
Alex Blostein, Analyst
Great. Thanks. Good morning, everybody. So Jenny, maybe just to build on some of your comments around the alternatives and the wealth management and all kind of your aspirations there with Lexington especially coming into the fold now. We've seen a number of players both kind of traditional and the old trying to tackle the channel. But outside of Lexington, most people have had a part of time really making a dent at least so far in a sizable way. So maybe help us frame what the asset base is there today across all of your kind of illiquid product on the wealth channel, warehouses and the like. And if you look out the next couple of years, what would you consider to be a success? What would you want that to look like?
Jenny Johnson, President and CEO
I don't think we've publicly shared the percentage of our alternatives in the retail channel, and it's really a complex situation. Franklin Templeton has strong wealth distribution capabilities in the industry. Initially, we thought it would be straightforward to integrate our alternative products into that channel. However, the real challenge lies in getting onto the platforms and then ensuring that financial advisers receive the necessary training and understand how to market and position alternatives effectively. This involves detailed marketing materials, reporting, and follow-up capabilities. Our investment in Case is an example of how we are streamlining this process for wealth managers to better offer alternatives. We have all the necessary ingredients to succeed; the challenge is in combining and executing them properly to create the best outcomes. We're dedicating significant resources to this effort, which is among our top priorities. We are increasing our teams to support alternatives, ensuring we have specialists for each product, along with the required training and materials. From what I've gathered, it took Blackstone several years to make significant progress in the wealth channel. Although they have made it easier for others, it remains a complex task—more so than we initially anticipated.
Alex Blostein, Analyst
Got you. Appreciate it.
Jenny Johnson, President and CEO
Adam, you like to add?
Adam Spector, Head of Global Distribution
Yes, I can add a couple of things to that. We don't break out specifically the illiquid alternatives, but alternatives in general in the retail channel for us are over $14 billion, and our gross sales in that channel have been over $1 billion a quarter for the last few quarters. So we see strong momentum there. As Jenny said, excellence in that area requires really good product which we think we have, a significant distribution force which we have, good relationships with the home offices, which we have. But then that all need to be knit together with really superior training, education, product structuring, etc. And that's where a lot of our attention is at this point because we think we have all the pieces. It's bringing it together and bringing it into our partner firms.
Alex Blostein, Analyst
Great. Thanks so much for that. And my follow-up is, back to Western for a second. Fully appreciate the industry dynamics and we've obviously seen the flows for longer duration, more maybe credit-sensitive funds face a lot of flow headwinds in the last couple of months and that may continue. But as I think about the relative position of Western against some of the other larger bond platforms. The relative investment performance has suffered quite a bit as well and that's not uncommon, I guess, in times of more kind of credit or duration-related dislocation for Western, just given the nature of the way they invest. How well understood is that with clients? So in other words, do you guys think that the relative underperformance at Western could have a longer-lasting effect on their ability to recoup some of the outflows that they're seeing right now?
Jenny Johnson, President and CEO
I would say a couple of things. So one is I mean you talk to Western and they feel they have a lot of conviction that the market is overestimating the Fed increase. Now we have different fixed income teams, Brandywine, Franklin Templeton, things to come that believe that that's not the case, right? That's the benefit that we have of diverse managers who are truly independent. Western is really good at communicating with the clients about their positioning and why they're positioned the way they are. The one thing is we've gone back and looked at Western's performance over rising rate cycles and I have to tell you they bounce back very quickly. I mean, in 100% of the cases, that we looked at back to 2000 and even before that, within the next six months, they outperformed the benchmark. So are they right or wrong? There's strong conviction on their positioning. They have great relationships with clients and they are doing a great job of communicating their positioning. It remains to be seen whether they're correct or not.
Adam Spector, Head of Global Distribution
Yes. I'll add a couple of things to that. First of all, Jenny said they have great relationships with clients. If you take a look at some of the industry metrics, they are literally off the chart in how they score in terms of their client engagement and client service. So very strong client relationships. And when you talk about performance look, they had a one-year period that was really tough as the correlations broke down and their duration hedge didn't pay off against the credit. That's essentially what happened. But look at their long-term performance. 95% of their assets are outperforming on the three-year, 98% are outperforming on the five-year. That is not a manager that's performance challenged. That's a manager that has soft performance in the short run and our confidence in our sales force still have the utmost confidence in them.
Brennan Hawken, Analyst
Excellent.
Matt Nicholls, CFO
Alex, while we're on the topic, it's important to note that from a financial viewpoint, the impact on operating income from the flows you mentioned is relatively low. This applies not only to Western but also to the broader fixed income sector. In contrast, we're experiencing a significant positive operating income impact from the growth in alternatives and other growth areas we've discussed.
Brennan Hawken, Analyst
Yes, it's definitely coming through. Great. Thanks so much. Thank you.
Operator, Operator
Next we have Ken Worthington from JPMorgan. Your line is open.
Ken Worthington, Analyst
Thank you for the opportunity to ask a follow-up question regarding the integration of alternative platforms, especially with the addition of Lexington. Could you explain how you plan to integrate these platforms and also where you might choose not to do so? Starting with distribution, will you be merging the different alternative sales teams, or will they remain separate but cross-trained? Additionally, how will you incorporate their expertise into your overall sales strategy? On another note, how proactive do you intend to be in product development, particularly for new products aimed at other distribution channels where you have established relationships in Franklin? Lastly, how quickly do you anticipate launching these products?
Jenny Johnson, President and CEO
Let me start, Adam, and then I'll hand it over to you. The good news is that each manager has their own, typically institutional, sales teams and relationships that we've kept intact because they are successful. However, on the retail side, we need to leverage the broader Franklin Templeton. This also applies to our 18 specialized investment managers, where we have institutional capability and what we call Institutional Portfolio Managers. These product specialists work closely with the investment team and can be brought in by the distribution team to discuss specific products. They are closely connected to the investment team, extending its reach. We can utilize them to enhance our distribution efforts. The line between institutional and wealth channels generally exists, but there are overlaps. If an institutional team has relationships that are lacking, our centralized institutional team will facilitate introductions to our specialized investment managers. Collaboration is crucial for us. We aim to maintain our strong momentum. For example, Lexington's growth from $34 billion to $42 billion pre-close demonstrates the effectiveness of their distribution team. We also believe that secondary private equity is well-suited for the wealth channel. Regarding product capability, we think the wealth channel can access alternatives through mechanisms like managed accounts with allocations to alternatives in 401(k) plans. Our centralized product team is focused on how to integrate capabilities to provide comprehensive solutions. We expect our teams to collaborate to develop these solution-oriented products. Adam, would you like to add anything?
Adam Spector, Head of Global Distribution
Sure. The one thing Jenny, I would put in at the top is that hopefully it goes without being said, but the one place where we're not going to integrate anything is on the investment teams or the investment process, right? These teams are absolutely distinct. Jenny is right that really our distribution model in general is a general specialist model where the folks who sit at the center are responsible for knowing their clients better than anyone else and then bringing in the right specialists from the various specialized investment managers. On the outside, institutionally, we're actually adding specialists alternative salespeople to introduce the various alternative SIMs to the relevant gatekeepers in the institutional markets. We also see an uptake in the use of our salespeople outside of the U.S. where some of the alternative firms don't have as significant of a presence. Again, it's really an opt-in model and we help each firm as they need it. On the wealth platforms, branding is an important consideration. How we're tackling that at this point is that each of our alternative SIMs are going to retain their own branding, but the distribution effort will be under FT alternatives. There's really a single point of contact in the wealth channel, but the individual brands remain. That also really enables us to do some interesting things in terms of multi-affiliate products in that channel. The product development is going well. We're focused both on one-time raise products, as well as evergreen products. Another area of ours that you know we're focused on is ESG and the inclusion of ESG into alternative products is something we've focused on as well, which we think will yield significant results.
Ken Worthington, Analyst
Okay. Great. And just a simple reporting question. There's a pretty big gap for Lexington between fee-paying AUM and AUM. How are you going to report it? Are you reporting the fee-paying or are you going to report the total AUM and we'll just sort of get the gap to close the fee rate or...?
Matt Nicholls, CFO
Yes. I mean, yes, just to be so we're consistent with how we report other things. We're going to report all of the AUM. We're going to be very transparent about the fee rates. I mean, if you take the full AUM, the effective fee rate is probably something like low 60s. If you include just the fee-based AUM, it's going to be in the mid-80s to low 80s, plus performance fees. So that's the way we will do it.
Ken Worthington, Analyst
Okay. Thank you.
Matt Nicholls, CFO
Thank you.
Operator, Operator
Thank you. Next we have Robert Lee from KBW. Your line is open.
Robert Lee, Analyst
Great. Good morning. Thanks for taking my questions. Really two. First, maybe just can you update us on the wealth management channel? I know you've talked a bit about it in a place we wanted to do some more acquisitions. But it's up to $35 billion had inflows. Can you maybe dig a little deeper in some of your initiatives there on continuing to drive that kind of very sticky growth business? And then I'll have a follow-up on fintech.
Jenny Johnson, President and CEO
Yes. We are very enthusiastic about that business and have identified it as a strategic priority for growth. As you noted, it has experienced six consecutive quarters of positive net flows. This business has long-lasting relationships, averaging around 16 years, which makes it very stable and appealing to us. We recently completed two acquisitions, and we are pleased with the performance, as the assets under management for those entities have increased by approximately 29%. We are actively seeking additional opportunities that would enhance our capabilities or expand our geographical reach. We prefer not to pursue just any assets; instead, we look for partnerships with entities seeking a long-term relationship that will allow them to enhance the services they provide to clients through a broader fiduciary trust. This business has a long history, close to 80 years, and has a deep understanding of multigenerational wealth, which includes education aboutinheritances and related topics. It represents an ideal environment for clients with those specific needs.
Robert Lee, Analyst
Okay, great. As a follow-up, you mentioned in the press release that financial technology has been an interest of yours for many years and that you've embraced innovation in this area. Could you highlight any specific examples beyond the Embark transaction that you believe have helped differentiate you in terms of distribution or performance? Are there any early investments that particularly excite you in terms of their potential to accelerate growth in the coming years?
Jenny Johnson, President and CEO
Yes, I'm currently at a wealth adviser fintech conference. We acquired AdvisorEngine, which includes Juncture, a CRM system designed for registered investment advisors (RIAs). This acquisition, although small, allows us to engage with approximately 12,000 users of the CRM system, providing us another avenue to connect with that channel. Our in-house developed tool, Go, serves as our gold optimization engine and will be integrated into a cloud-based financial planning platform. This integration helps us sell our models and allows clients to select between open architecture and our proprietary models. As the advisory industry shifts to a fee-based model, clients not only value investment advice but also expect advisers to offer additional services like tax efficiency, which emphasizes the importance of Canvas. Financial planning, tax efficiency, and education are now essential, with fee-based advisers expected to deliver services that were once exclusive to the ultra-high-net-worth segment, including estate and trust planning. Our goal is to support advisers in building their businesses and fostering loyalty within the fintech ecosystem. AdvisorEngine's Juncture platform serves around $600 billion in assets, enhancing our ability to communicate and share our capabilities while ultimately deepening our relationships with advisers.
Adam Spector, Head of Global Distribution
Jenny, I would also add that it really helps us talk to a wider group of people at an investment advisory firm. Instead of just talking to people who are in the CIO organization, you're now talking to the business management group and you're talking about how they want to run their business and you're talking to them about how to help grow their business, which in the end helps position you better when you're actually trying to sell an investment product.
Robert Lee, Analyst
Great. Thank you so much for the added color. Appreciate it.
Operator, Operator
Thank you. Next up we have Michael Cyprys from Morgan Stanley. Your line is open, sir.
Michael Cyprys, Analyst
Good afternoon. Thanks for taking the question. Just on the SMA front, I was hoping you could maybe elaborate a bit more on some of the initiatives there. I think you mentioned that the Franklin income strategy you're now offering that in SMA. Maybe you could talk a little bit about how you navigated some of the challenges and complexity of offering such a strategy like that in SMA? And how you're thinking about offering other additional strategies in the SMA wrapper?
Adam Spector, Head of Global Distribution
Yeah. The complexities largely come from a technological and operational standpoint. Legg Mason had a real lead on the industry, the number one provider of model-based SMAs, really strong technology and operational platform that we are now onboarding legacy Franklin strategies onto, which is accelerating their growth. If you take a look recently at what we've been where we've been flattish in SMAs, it's really because we've seen some outflows on the legacy side with groups like Western and ClearBridge, but strong inflows onto newer SIMs that we've onboarded onto the platform like Martin Currie and Franklin Templeton Fixed Income, the Canvas platform. So again, we see diversification paying off well in the SMA space. We think that the other way that this could really go is adoption outside of the United States where we have some interest in some of our distribution partners to grow SMAs there as well.
Michael Cyprys, Analyst
Great. And just a follow-up question for Matt. With the $6 billion of cash and investments on the balance sheet, maybe you could just help flesh out how much which you think is truly excess here that you're sitting with today? I think you had called out around $4 billion after regulatory capital and product development. Is that the right number we should be thinking about, that's truly excess? Or maybe you can help bridge the remaining gap there?
Matt Nicholls, CFO
Yeah. I mean, I think we would define pure excess as being a lot lower than that. You know how conservative we are Mike, so I think we put it around $1 billion. But as I've mentioned beforehand, if you're talking about M&A, for example, these transactions are structured in a way that is sensible in this market in particular, the capability to be able to do larger things with in a structured way so you need less upfront is something that means that that amount of excess cash, let's say, can be stretched to create a much larger opportunity if there is one out there for us.
Michael Cyprys, Analyst
Got it. And any help on bridging from the $4 billion down to the $1 billion that you referenced?
Matt Nicholls, CFO
We have some regulatory capital amounting to a few hundred million dollars, which is mentioned on the chart. Additionally, we maintain a supplemental liquidity provision internally that allows us to keep several months' worth of operating expenses in cash on our balance sheet. Furthermore, we recently spent $1 billion, which is noted in the footnote of the commentary for clarity, as the cash and investments are as of March 31. This $1 billion was for the upfront consideration for Lexington, effectively bridging the gap. Lastly, we discussed the $1 billion surplus.
Michael Cyprys, Analyst
Great, thanks so much.
Matt Nicholls, CFO
Thank you.
Operator, Operator
Thank you. Next we have Dan Fannon from Jeffries. Your line is open.
Dan Fannon, Analyst
Thank you. I want to follow up on the topic of your interest in mergers and acquisitions, especially considering you've recently completed a significant deal and have been active in this area for a while. In light of this context, are there specific properties you're interested in? You've also been mentioned in recent news regarding larger properties. Can you discuss your short-term appetite for larger M&A? Additionally, looking ahead, where do you see product gaps, particularly in alternative investments, and are you also exploring more traditional areas to enhance your product offering?
Jenny Johnson, President and CEO
We haven't changed our focus. Given the current market volatility and the recent significant deal we've completed, the expectations are high, but our strategy remains centered on long-term growth. Regarding product gaps, we feel confident about our capabilities in the alternative space. The area where we lack is mainly in infrastructure, and there are also geographic considerations, particularly in Asia where Clarion might not have a strong presence. It's challenging to sell a real estate manager without local offerings, and our focus tends to be more U.S.-centric. The expectations for us have indeed become elevated. Wealth management is still a priority. In terms of traditional products, if we identify a suitable ETF manager to add to our portfolio, it could be a compelling opportunity. For now, we are committed to growing organically and are pleased with our existing capabilities, but we would consider the right opportunity in the future.
Matt Nicholls, CFO
Yeah. And there's some specialists in the alternative asset area, where we do have a couple of gaps and we've talked about those. I mean, I think just at a high level, it's worthwhile making the point that from zero, pretty much zero three years ago, we now have about 15% of our AUM in alts. I think that probably translates into something like 18% or so of revenue and probably more like 20% plus in operating income. Our objective overall is to, as Jenny mentioned earlier, that half of revenues are going to eventually come from alts in some form or other private markets to be broadly defined. We intend to continue to increase that percentage contribution from alternative assets.
Dan Fannon, Analyst
Got it. And then a follow-up on flows and just the institutional backlog. First off, if you could maybe talk about the makeup of that historically? When Legg Mason disclosed it, it was a lot of Western and I do want to follow-up on Western as well and talk about if you could give us the numbers of kind of the makeup of what would be the core and core plus AUM, because those numbers are pretty stark in terms of the performance. If I remember correctly, I think most of that is institutional. So in terms of the potential for redemptions as you think about that book, maybe in the context of the institutional backlog as a whole for the firm and then kind of looking at the Western potential risk of some of the institutional AUM, kind of some context around kind of the more near-term dynamics and conversations with clients and flow trends.
Adam Spector, Head of Global Distribution
Sure. First of all, have we had challenges in core and core plus? Absolutely. But they're still very, very significant asset gatherers and among our top funds for gross sales. While the net hasn't been strong, we still see a real commitment of clients there. I think that shows in the funding pipeline, where we still have a significant chunk of Western product in there. But if you take a look at that, and we don't really break it down by SIM, I don't believe there's any one SIM that accounts for more than 25% of that funding pipeline. So again, as we continue to diversify our business, we're seeing diversification on the wealth front, as well as on the institutional front. The other thing about Western is they manage a lot more than core and core plus. As sales have slowed down in those areas, we've seen a pickup in some of the other areas. Western is more active than some of their other funds. You don't get to a point where you have 95% of your assets outperforming over the three-year without taking some risk in the shorter term. Right now that risk hasn't paid off. The market understands well the way that Western manages money and it will pay off over time. As Jenny said, every time they've had a dip like this before, they've come roaring back.
Dan Fannon, Analyst
Okay. Thank you.
Operator, Operator
Thank you. And we have a follow-up question from Bill Katz from Citi. Your line is open.
Bill Katz, Analyst
Okay. Thanks so much for taking my question. Maybe two-part. Jenny, you mentioned that getting the ultra into the retail wealth management is sort of one or two of your key priorities. Can you maybe expand on what your top priority is? And then for Matt, I'm sorry to belabor the question here. Can you just come back and unpack the expense numbers a little bit more and pretty substantial improvement in efficiency so I appreciate revenues are down. How much of the incremental savings is coming from the legacy business versus maybe more synergized opportunity with Lexington? Thank you.
Jenny Johnson, President and CEO
Yes, our top priority is ensuring we have the right product capabilities for the future, which is why we are exploring M&A opportunities. Additionally, we need to ensure that we can distribute these products through the appropriate channels. We understand that not all flows are equal; alternatives make up 15% of assets under management and 46% of revenues, representing a significant growth area that we need to address effectively. Furthermore, we are focusing on not just current needs but also future possibilities, which includes keeping an eye on FinTech investments and the potential disruptiveness of blockchain technology. These are key strategic initiatives for us. It's also crucial to operate our business as efficiently as possible. Fees in this industry only tend to go in one direction, so we must continuously strive for efficiency. We decided to outsource a large portion of our back office functions because some service providers have become more efficient than we can be. Previously, we were the largest global manager without any service provider fully covering us, but that has changed. These adjustments are part of our efforts to continuously reinvent our operations, ensuring we maintain efficiencies in response to fee pressure while also being able to invest in new opportunities.
Matt Nicholls, CFO
In terms of the cost and expense question, Bill, there are essentially no cost synergies associated with the Lexington transaction. It's entirely about revenue synergies for us, as it is for all the alternative asset firms or SIMs we've acquired. While there might be some modest expense savings from implementing Workday financial across the firm, it doesn't significantly impact our overall costs. Thus, there are no expense reductions related to the Lexington transactions or from our legacy operations in response to market dynamics.
Jenny Johnson, President and CEO
I just want to emphasize a priority because I genuinely believe sustainable finance is here to stay, and we made the hire to ensure we have a voice at the top. We think ESG might not be the right term; it's really about the long-term impact on both the companies and the community and environment. In Europe, with the current conflict and oil prices, people might shift their priorities regarding ESG. However, we see that 40% of our pipeline is coming from Article 8 and 9 type products, and we believe that's going to continue. Therefore, it's essential for us to focus on product development. As Adam mentioned, it's crucial that we include top sustainable finance products, especially in the alternative space.
Bill Katz, Analyst
Thank you, again.
Matt Nicholls, CFO
Thanks, Bill.
Operator, Operator
Thank you, presenters. This concludes today's conference call. Thank you all for joining. You may now all disconnect.