Earnings Call Transcript - CNS Q3 2024

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Cohen & Steers Third Quarter 2024 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. As a reminder, this conference is being recorded, Thursday, October 17, 2024. I would now like to turn the conference over to Brian Heller, Senior Vice President and Corporate Counsel of Cohen & Steers. Please go ahead.

Brian Heller, Senior VP and Corporate Counsel

Thank you and welcome to the Cohen & Steers Third Quarter 2024 Earnings Conference Call. Joining me are Joe Harvey, our Chief Executive Officer; Raja Dakkuri, our Chief Financial Officer; and Jon Cheigh, our Chief Investment Officer. I want to remind you that some of our comments and answers to your questions may include forward-looking statements. We believe these statements are reasonable based on information currently available to us, but actual outcomes could differ materially due to a number of factors, including those described in our accompanying third quarter earnings release and presentation, our most recent annual report on Form 10-K, and our other SEC filings. We assume no duty to update any forward-looking statement. Further, none of our statements constitute an offer to sell or the solicitation of an offer to buy the securities of any fund or other investment vehicles. Our presentation also contains non-GAAP financial measures referred to as as-adjusted financial measures, that we believe are meaningful in evaluating our performance. These non-GAAP financial measures should be read in conjunction with our GAAP results. A reconciliation of these non-GAAP financial measures is included in the earnings release and presentation to the extent reasonably available. The earnings release and presentation, as well as links to our SEC filings, are available in the Investor Relations section of our website at www.cohenandsteers.com. With that I will turn the call over to Raja.

Raja Dakkuri, CFO

Thank you, Brian, and good morning everyone. My remarks today will focus on our as-adjusted results. A reconciliation of GAAP to as-adjusted results can be found in the earnings release and presentation. Yesterday, we reported earnings of $0.77 per share compared to $0.68 sequentially. Revenue was $133 million compared to $122 million sequentially. The increase in revenue from the prior quarter was primarily due to higher average AUM. Our effective fee rate during the quarter was 58 basis points, which is consistent with the prior quarter. Operating income was $47.6 million compared to $42.5 million sequentially, and our operating margin improved to 35.7%. Total expenses were higher compared to the prior quarter, primarily due to an increase in compensation and benefits and, to a lesser extent, an increase in our distribution and service fees. The increase in compensation and benefits was in line with the sequential increase in revenue as the compensation ratio remained at 40.5%. The increase in distribution and service fees was due to higher AUM related to our open-end funds. Regarding taxes, our effective rate was 25.1% for the quarter. Our earnings presentation notes liquidity at the end of Q3 and prior quarters. Our liquidity totaled $348 million at quarter-end, which represents an increase versus Q2. AUM was $91.8 billion at quarter-end. This was an increase of over $11 billion from the prior quarter, primarily due to market appreciation. AUM was also impacted by net inflows during the period. Joe Harvey will provide an update on our flows and pipeline. Let me briefly touch on a few items to consider for the rest of the year. With respect to compensation and benefits, we maintain a measured approach. We would expect the compensation ratio to remain at 40.5% for the rest of the year. We still expect G&A to increase 6% to 7% for the year compared to 2023. Most of the increase is related to investments in our technology and infrastructure. And finally, we expect our effective tax rate for Q4 to be in line with the year-to-date rate of 25.3%. I will now turn it over to Jon Cheigh, who will discuss our investment performance.

Jon Cheigh, CIO

Thank you, Raja, and good morning. Today, I'd like to cover three topics: our performance scorecard, the investment environment for the quarter, and finally, our outlook for infrastructure and how we believe our listed infrastructure strategy is positioned to capture share of a growing market. Beginning with our performance scorecard. The third quarter marked a major turning point across most of our markets. Many of our asset classes saw double-digit returns in the quarter, aided by the three drivers I mentioned on the last call: attractive valuations, clarity on Fed rate cuts, and severe under-ownership of our asset classes. From a relative performance perspective, the third quarter saw 39% of our AUM outperform its benchmark. While our outperformance metrics were a touch softer over the last few months, we don't manage for the short-term. On a one-year basis, 96% of our AUM has outperformed its benchmark, while our 3-year, 5-year, and 10-year outperformance stands at 97%, 97%, and 99%, respectively. Our 1-year and 3-year excess returns of 394 basis points and 192 basis points, respectively, are at or above our targets. In particular, I’d highlight our global listed infrastructure performance, which is up 520 basis points versus its benchmark over the last 12 months. Congratulations to that investment team led by Ben Morton. 95% of our open-end fund AUM is rated 4 or 5-star by Morningstar, which is slightly up from 94% last quarter. In short, we have strongly delivered both the alpha and the beta for our investors over the last 12 months. Transitioning to investment market conditions. As I stated a moment ago, sentiment in the quarter shifted in favor of listed real assets as a group, led by real estate and global infrastructure, which outperformed the broader equity market by a wide margin. For example, US REITs rose by nearly 17% in the quarter, while global listed infrastructure rose by more than 13%. Preferred securities were up 5.6%. Our comparison US equities rose 5.9% and MSCI World was up about 6.5%. Amid easing inflationary pressures in a cooling labor market alongside already tight policy, the Fed cut its benchmark rate by 50 basis points in September while also suggesting a steady path of additional cuts through 2025. While rate markets likely got too dovish a month or so ago, the general trend of lower rates augurs well for continued improvements in sentiment and performance for listed real assets. This important shift adds to the already sound earnings for listed real asset companies that we anticipate for the remainder of 2024 and 2025. Also worth noting is that despite REITs' significant outperformance in the quarter, they remain attractively valued compared with stocks on a historical multiple basis. Private real estate, meanwhile, as measured by the preliminary results for the NCREIF ODCE Index, had a total return of 0.25% for the quarter, which, while modest, marks the first positive quarter in two years and is consistent with the lead-lag relationship with listed real estate, which bottomed one year ago. Peak to trough, the index is down 18.6% over the last two years while US REITs were up 32.5% in the same time frame. On the private side of our business, we remain focused on taking advantage of repriced real estate, particularly shopping centers, where we see attractive cash yields coupled with underappreciated future growth prospects. As I just mentioned, listed infrastructure also handily outperformed equities in the quarter. The start of a new rate-cutting cycle supported more interest rate-sensitive stocks in the communications and electric utility sectors. Additionally, investors continue to evaluate the implications of increased power demand and began to price some of this into the share valuations for some utilities, natural gas producers, pipeline owners, and independent power producers. Turning to fixed income, preferred securities had a solid gain amid the decline in bond yields. Returns in preferreds outperformed high-yield bonds but modestly trailed investment-grade bonds and 10-year treasuries. However, preferreds remained the top-performing fixed income category year-to-date. Notably, the technical backdrop for preferreds remained positive amid limited net new supply in an environment of strong demand for quality income. As the rate-cutting cycle unfolds, lower yields on money market funds and short-term bonds may lessen the appeal of safe havens and result in investor demand for higher-income solutions such as preferred securities. Turning to the topic of listed infrastructure, I would like to discuss our optimism on three levels: first, on infrastructure as an asset class; second, for listed infrastructure in particular; and last, for CNS’ investment strategy and our ability to take share of a growing market. First, to reiterate the investment case for infrastructure. The ownership of essential assets, as in the past, continues to deliver very attractive, less economically sensitive, and more inflation-resistant total returns. This investment profile funds further support in the economic trends of decarbonization, digitization, deglobalization, and, I'll add another D, debt. The world has significant infrastructure investment requirements, and sovereigns have too much debt to adequately address these needs. Infrastructure companies, both listed and private, will have significant investment opportunities to deliver new projects and expansions that are attractive for both investors and the public sector. Secondly, listed versus private infrastructure. Historically, private infrastructure has not delivered meaningful illiquidity return premiums relative to listed. This statement is surprising to investors because they have observed that such a premium has existed in areas like corporate private equity, venture capital, and private debt. In contrast to the long-term tight correlation of listed and private, over the last 2.5 years, private infrastructure, as measured by the Burgiss Private IQ data, has returned more than listed as of the last reported date. Our high conviction view is that this anomaly will normalize, just as the disconnect between listed and private real estate has normalized dramatically the last two years. From today's valuation starting point, we believe listed infrastructure will have more compelling returns versus private. Additionally, listed gives investors greater access to areas like core digital infrastructure, dominant marine ports, and utilities without sacrificing liquidity or experiencing a J-curve of returns common in private. We also believe that society's essential assets are best owned by transparent listed companies with governance that is subject to the discipline of public market standards. Finally, while we expect the overall infrastructure and listed infrastructure markets to grow, we also expect that our significant and deep team and compelling short- and long-term track record will help us to win more than our fair share over time, just as we have done within listed real estate. Already we are seeing takeaway opportunities from our competitors who haven't delivered returns relative to what our team has produced over its 20-year track record. Over the last 12 months, our global infrastructure fund has returned 33.3%, beating its benchmark by almost 5 percentage points and handily beating private infrastructure and the vast majority of our peers. We remain very excited about what's unfolding within infrastructure and specifically, our opportunities to deliver for both our existing and new investors. With that, let me turn it to our CEO, Joe Harvey.

Joseph Harvey, CEO

Thank you, Jon, and good morning. I'd like to formally welcome Raja as Chief Financial Officer to his first Cohen & Steers earnings call. Today, I’ll review our key metrics and business trends for the third quarter and talk about our initiatives for future growth. The third quarter marked a major turning point in the market and business cycles for many of our asset classes. This manifested in both appreciation and net inflows for us in the quarter. Our relative outperformance batting average in the quarter was moderate, as can happen when oversold, out-of-favor stocks or sectors lead turning point rallies such as this. For our clients' portfolios, we will take the beta and appreciation over the alpha for the quarter. As Jon laid out, our one-year and longer period investment performance remains stellar and at the top of our corporate priorities. Business-wise, after 2.5 years of headwinds due to regime change, we now have some tailwinds brewing and feel good about our positioning. Our relative performance is strong. The return cycle has turned broadly positive for what we do. Business activity is up. Our fee rates are stable. We continue to enhance distribution, and we have meaningful new initiatives in front of us. Two of the more challenging asset allocation dynamics of recent years were the restoration of fixed income allocations and investor portfolios, which drew away from listed allocations, and private allocations that were either increasing or inaccessible due to illiquidity. We believe we are finally in the late stages of that process. There is still $6.4 trillion sitting in US money market funds realizing a solid but perhaps fleeting yield considering the downward trend in rates. On the private side, investors may start to rethink the calculus of opportunity cost, recognizing that overallocation to private constrains the ability to capitalize on the types of opportunities we have seen over the past few years. This may seem counterintuitive in light of the fervor over trends such as private credit. But this idea continues to resonate with me, especially in light of the crowding of capital in certain private markets. Of course, more listed allocations could benefit us. Turning to our key metrics and flows. In the third quarter, we had firm-wide net inflows of $1.3 billion. After nine consecutive quarters of outflows, this was our first quarter of firm-wide net inflows since the first quarter of 2022 when the Fed began its series of rate hikes. We had net inflows in each major business segment with the exception of defined contribution and Japan sub-advisory, both of which had modest outflows. US REIT strategies led the way with $1.3 billion in net inflows. By vehicle, open-end funds accounted for $1.2 billion of those inflows. Institutional advisory had $9 million in net inflows with no account terminations in the quarter. Sub-advisory ex-Japan had $131 million in net inflows, and Japan sub-advisory had net-net outflows of $32 million. This year-to-date, we've had net inflows in North America and Asia Pacific ex-Japan, which includes Australia. Our flagship US REIT fund, Cohen & Steers Realty Shares, and its institutional sibling accounted for the lion's share of flows. Driving those flows were allocations by a major asset management multi-strategy allocator and several independent RIAs. These flows were offset by outflows of $221 million from our international real estate fund, primarily from an RIA that reduces weighting in international real estate, which has underperformed US real estate for some time. Preferred strategy flows turned nominally positive after 10 straight quarters of net outflows. Sub-advisory ex-Japan was more active in the quarter with inflows of $454 million from two Australian financial institutions through open-ended vehicles. We are seeing a general uptick in activity in Australia. These inflows were partially offset by a $192 million outflow completing a liquidation that began last quarter from a European institution that terminated a US-domiciled allocator. Our unfunded pipeline was $651 million compared with $1 billion last quarter. $617 million of last quarter's pipeline funded, and we were awarded $170 million in three new mandates, with there being $51 million in net positive adjustments to what was already in the pipeline. The pipeline composition is 53% US real estate, 22% global listed infrastructure, and 19% private real estate. We do know of $1 billion in expected redemptions pending from advisory and sub-advisory clients that will likely be split roughly half in the fourth quarter and half in the first quarter of 2025. About one-third of the changes are eliminations of US REITs and listed infrastructure from strategic allocations. The remainder are sub-advisory mandates where the vehicles have competitive pressures due to the investment architecture for multi-strategy vehicles or from fee pressures. Thinking about the state of the industry, over many years, asset management has been a high-margin, innovative, industrious, and accordingly, a very competitive business. Even now, these dynamic and innovative forces drive the industry's continuing evolution. Key areas of strategic change today include the migration of investment advisers from wirehouses to independent and enterprise RIA firms, shifts in vehicle preferences to ETFs, the integration of insurance companies with their portfolios with private equity, and the adoption of private strategies in the wealth channel. So what are we doing to adapt to capitalize on these strategic shifts? First and on the leading edge for several of these trends, beginning this fourth quarter, we realigned our US wealth distribution team to engage with advisers in a cross-channel capacity nationally. This is a move that aligns with RIAs having the highest growth rate in AUM. Accordingly, we want to enhance our outstanding wealth market position that we have built over 30 years. Each of our adviser consultants will cover our clients and prospects regardless of whether they affiliate with a broker-dealer, are running an independent RIA, or some combination thereof. In addition, we have created a group to focus exclusively on the largest RIAs who allocate using an endowment model approach, possess dedicated due diligence and asset allocation capabilities, and have increasingly demonstrated a proclivity toward private markets. These firms also value active strategies where there are persistent sources of alpha and are willing to allocate fee and risk budgets accordingly. We believe our new sales structure will both drive our core business and open new relationships with the fastest-growing wealth advisory teams in the industry. In addition, considering the criticality of the RIA channel for launching new strategies, we expect it will facilitate the launch of our first active ETFs planned for early next year and include US REITs, global preferreds, and our natural resource equity strategies. Further, with respect to our non-traded REIT, the second phase of our capital raising strategy post the seed capital round has commenced with RIAs. John talked about the positioning of our global-listed infrastructure strategy, which has $9.5 billion in AUM. We are seeing early signs of increasing allocations to infrastructure in more channels. The timing couldn't be better as our performance ranks highly among our peers. The significant growth in private allocations is pretty well-known, and we believe future investment opportunities will be abundant due to the underinvestment in infrastructure as well as the emergence of new opportunities such as digital infrastructure, AI, and the associated demand for power. We believe that just like in real estate, better portfolios can be built in infrastructure across both listed and private markets based on the complementary nature and varying return cycles of the subsectors. In institutional advisory, we are working on both new allocations and takeaways from underperforming managers. Turning to our real estate franchise, we are excited about the timing of the cycle as listed is experiencing a new return cycle, and we believe the private market is well into its price troughing process. As we discussed on our last several calls, we are deploying our seed capital in our non-traded REIT focusing on open-air shopping centers, both grocery-anchored and certain power centers. From its initial real property acquisition in January through September, Cohen & Steers REIT income opportunities REIT has been a top-performing non-traded REIT with a total return of 8.3% for Class I shares. By comparison, the return on the widely used core property index NCREIF ODCE was negative 2.6% for the nine months through September. Return drivers include our shopping center strategy as well as alpha from our listed REIT sleeve. Both of these strategy elements are differentiating factors for our non-traded REIT and demonstrate using listed and private together. We continue to work on developing advisory strategies and other vehicles to provide our listed private expertise to our clients. In closing, we are excited about the investment environment for both our strategies and growth initiatives. I would like to thank all of our employees for persevering through the regime change and preparing for our next phase of growth. We look forward to reporting our fourth quarter and full year 2024 results in January. At this point, I will turn the call back to Julie Anne, who will facilitate a Q&A session.

Operator, Operator

Thank you. Our first question comes from John Dunn from Evercore ISI. Please go ahead, your line is open.

John Dunn, Analyst

Hi. It seems like money is flowing into your higher fee areas. Can you maybe talk about how you expect the fee rate and incremental margins to be for the new business that's coming online?

Raja Dakkuri, CFO

Yes, John, thanks for the question. Yes, as you properly noted, the inflows are going into certain of the open-ended funds which tend to be the higher fee. And so we'll just have to see how that develops over time. And in terms of us being pleased with that flow, we definitely are. And then as Joe talked about in terms of CNS REIT, we're seeing the momentum there in terms of the returns and how that's presenting itself as compared to the index.

Joseph Harvey, CEO

I'll just add, John, if you look at our average fee rates over the past three years or so, they've been very consistent. And over that time period, there have been puts and takes in terms of the mix shift between our different vehicles. But most importantly, our strong investment performance puts us in a very good position to compete for institutional advisory business with attractive fees that we've been accustomed to. We can't necessarily control where monies flow, whether it's into our open-end funds or into institutional advisory. But I think the track record of stable fees is a long one and one we think will persist.

John Dunn, Analyst

Got it. And then you mentioned your two newer focuses over the next couple of years are active ETFs in private real estate. It is likely to be two competitive spaces. Look, how are you approaching developing them? And what do you think it actually takes to be successful in those two areas?

Joseph Harvey, CEO

Well, investors now want to invest in vehicles that they prefer, and the flows into ETFs are starting to validate that, particularly active ETFs. So we are going to lead with our core strategies, one in real estate and one in preferreds, and that will help us reach investors who have shifted their preferences to that vehicle. But we want to be able to offer to the most segments of the market our strategy. So we've been bringing on various talent that will help us with the launch of active ETFs in terms of capital markets and sales. And our new Head of Wealth has a good track record from his prior firms of launching active ETF strategies. So that's some of the elements to the active ETF part of it. In terms of the private real estate area, our non-traded REIT is one of the things we are most excited about. And as I talked about, we believe one of the differentiating factors is the property sector that we're focused on initially, which we think is very mispriced. And we can go into the details behind that. But the other factor is how we're using listed to complement the private allocation, which has not really been done to the extent that it should be. In other words, other non-traded REIT managers think about having a sleeve to provide liquidity and invest in CMBS or other fixed income. But we use our active listed real estate team to complement what we're doing on the private side of the portfolio. And so far, it's worked extremely well because the alpha that our listed team has added this year has been spectacular.

John Dunn, Analyst

Thanks very much.

Operator, Operator

Our next question comes from Ben Rubin from UBS. Please go ahead, your line is open.

Benjamin Rubin, Analyst

Hi, good morning. Thank you for taking my questions. Last quarter, net flows into your US real estate strategies were the strongest in recent years, as you pointed out. And it sounds like some of those past headwinds are shifting now towards tailwinds. And that said, could you just provide any additional color or drill down on the nature of last quarter's inflows? You mentioned in your prior remarks a big win from a large asset allocator. So were the flows last quarter more broad-based? Or are they driven by just a few lumpier mandates? And then secondly, have you seen that same level of engagement sustain quarter-to-date, either in the form of client RFPs or flows? Thanks for taking my questions.

Joseph Harvey, CEO

You made an insightful point regarding the flows in the third quarter. We had a significant allocator, with whom we've had a long-term relationship, that has been very strategic about their allocations throughout various market cycles. The key takeaway is that we are optimistic about investors like this beginning to allocate funds, as they often lead the way during shifts in the cycle. While these contributions are included in our wealth flows, I view them more as institutional investments. We believe the wealth channel is still in its early stages of returning to our asset classes. Consequently, the flows during this quarter have been more concentrated. Historically, as the cycle continues, we expect these flows to broaden within the wealth channel. Could you please repeat the second part of your question? I apologize.

Benjamin Rubin, Analyst

Yes, of course. Thanks for answering the first part. Second part was about the level of engagement you're seeing quarter-to-date, are you seeing a sustained momentum either in the form of RFPs or flows? Or has the pace moderated from September?

Joseph Harvey, CEO

Well, we are not going to discuss the October flows. We'll report those in the first week of November. But as it relates to just overall business activity, it's ticked up, I'd say, across the board. And so that's very encouraging.

Jon Cheigh, CIO

This is Jon. I believe our activity has been robust throughout the year. However, many did not perceive a catalyst or sense of urgency due to various issues they were facing, such as illiquidity in private portfolios or changes among managers in the fixed income area. As a result, it wasn't a top priority for them. Currently, we are experiencing a similar or increased level of activity, but perhaps with a slightly enhanced awareness that US REITs and other asset classes have underperformed compared to US equities. While there may have been a brief oversight, there is an understanding that this isn't just a short-term allocation. The focus is on how these asset classes will perform over the next three to seven years. The movements we are observing from allocators indicate they are shifting from no exposure to market-level investments, which means there is some inclusion of these asset classes in their portfolios.

Benjamin Rubin, Analyst

Got it. My second one is on margins specifically. So your operating margins last quarter showed some nice improvement. But if I'm looking at 2024 versus the first nine months of last year, your margins are actually lower despite some market tailwinds. So as I'm thinking about the pace of margin expansion next year, what will be the primary drivers? And additionally, how flexible do you see your expense base today that will allow you to expand margins off this space? Thank you.

Joseph Harvey, CEO

Let me start and then Raja can perhaps fill in. Last year, two significant factors impacted our margins. The first was depreciation in our asset classes that began the prior year and carried through into this year. The second was the development of our private real estate investment capabilities. We have not seen a substantial amount of fee-paying assets contributing to our AUM and revenues yet. Looking ahead, if the appreciation continues and starts to reflect in our average AUM, that will be a major factor in improving our margins. Additionally, as we increase AUM in our private real estate business, it will help counterbalance the expenses associated with our private real estate team.

Benjamin Rubin, Analyst

Great. And if I could just squeeze one more in. As you mentioned in your prepared remarks, the balance sheet cash and securities continue to build last quarter, and now you're holding more liquidity than this time last year. So I know you aren't in the market buying shares. So I'm just curious if your capital return framework or your priorities will shift as we enter a macro backdrop, which should be more conducive to flows and thus earnings growth. Thank you.

Joseph Harvey, CEO

Sure. That's always a dynamic question or analysis, but let's start with the foundation. We believe in maintaining a very strong balance sheet due to the nature of investing in liquid markets. Our most important revenue driver is completely out of our control. To further clarify, last year, when we experienced depreciation of our asset classes, we arranged a line of credit to give us additional flexibility. One change in our business with the launch of private strategies is the increased need for co-investment with these vehicles, making the business a bit more capital intensive. However, as we stand today with appreciation in our assets, we are in a very strong position regarding our improving cash flow profile. Additionally, earlier this year, when the stock was included in the S&P 600 Small Cap Index, we executed an inclusion trade to raise more capital. Taking all these factors into account, we currently have an exceptionally strong balance sheet. In terms of capital use, we consider our seed strategies and their requirements. For our core business, we are steady state. Each time we launch something new, we often wind down another initiative. The private co-investments remain stable, and we want to ensure we have enough capital for any opportunistic opportunities. Regarding our dividend policy, we typically address our quarterly dividend in the first quarter. Our goal is to maintain a predictable and growing quarterly dividend. We have issued special dividends after assessing our needs, with the last special payment made in 2021 during the pandemic and coinciding with the start of our private investments. Hopefully, that gives some context. I want to emphasize that our balance sheet is very strong, and given the current market conditions, our cash flow profile is also improving.

Benjamin Rubin, Analyst

Understood. Thank you for taking my questions.

Operator, Operator

We have no further questions in queue. I'd like to turn the call back over to Joe Harvey for closing remarks.

Joseph Harvey, CEO

Well, again, thanks everyone for joining. We look forward to talking to you next quarter. Thank you, Julie Anne, for moderating the call.

Operator, Operator

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