Janus Henderson Group PLC Q3 FY2020 Earnings Call

Good morning. My name is Nicole, and I will be your conference facilitator today. Thank you for standing by. And welcome to the Janus Henderson Group Third Quarter 2020 Earnings Conference Call. In today's conference call, certain matters discussed may constitute forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements due to a number of factors, including, but not limited to, those described in the forward-looking statements and Risk Factors sections of the company's most recent Form 10-K and other more recent filings made with the SEC. Janus Henderson assumes no obligation to update any forward-looking statements made during the call. Thank you. And now it is my pleasure to introduce Dick Weil, Chief Executive Officer, Janus Henderson. Mr. Weil, you may begin your conference.

Welcome, everyone, to the third quarter 2020 earnings call for Janus Henderson. As usual, I'm joined by our CFO, Roger Thompson. Let me start by saying that I hope all of you, your friends, your family continue to be safe and healthy. I am really pleased to be back physically in our London office, taking this call at a safe distance alongside Roger. As we've said on previous calls, we'd like to take a long-term view of our business as somewhat at odds with the quarterly reporting cycle. So, to that extent, what we've done is to say on the first and third quarter calls, we'll run through quarterly results, and then we'll use the second and fourth quarter calls to do a bit of a deeper update on the business and strategy. In line with this, in today's presentation, I'll just give a brief summary at the start of the quarter from my perspective. And then I'll hand over to Roger, who will go through the results in more detail. Following our prepared remarks, we'll take your questions. So, turning to Slide 1. Our third quarter results were strong. AUM increased 6%. Our long-term investment performance was solid. Adjusted EPS of $0.70 was better compared both to prior quarter and to a year ago. Our balance sheet and cash flow generation remain very strong as we continue to return capital to shareholders during the quarter, both by dividends and also repurchases. Roger will take you through the financial details in more depth. But what I'd like to do is just try and tell you how I think about the quarter sitting in the context of our broader story, which really is about our strategy. If you turn to Slide 2. It's a reminder of our strategy, which is Simple Excellence. We're making great progress on delivering our strategy, building a strong and resilient foundation, which is designed to deliver organic growth and to increase profitability. Our path to achieving Simple Excellence is based on the five planks referenced on page two, and let me just quickly turn to each one of those five planks. First, producing dependable investment outcomes. Our long-term investment performance remains solid. Some of our strategies took a hit in the change in markets during the COVID-related beginning part of this year. But a number of our other strategies have done extremely well, and we've had the diversity and resilience to continue to drive forward. Overall, long-term investment performance remains solid. The second plank is that we have to excel in distribution and client experience. We've seen a significant improvement in net flow in this quarter. We can definitely see those numbers moving around, particularly with lumpy institutional flows over time. It's hard to draw an extrapolation line from quarter to quarter. But to me, I'm seeing good momentum in a number of areas in our business and improvement in execution. We are definitely getting closer to excelling in distribution and client experience, which puts us on a path to achieving our objective of organic growth. Just as an example, our fixed income retail flows were positive across the U.S., EMEA and APAC and have grown at double the industry rate in U.S. retail during the quarter. Another example is we're capitalizing on a strong list of global-focused products, which has been facilitated by our Global Head of Distribution, Suzanne Cain, and her team. They put in place this global-focused products program and it's working well. We're focusing on products with high-growth potential and are pleased with the year-to-date growth in those particular products. The third plank is focusing on increasing operational efficiency. In the quarter, we've completed some major projects that simplify the way we operate our business, and that also served to free up capacity to turn our attention not only to current business improvements but also generational steps forward in our infrastructure. We completed back-office systems lift-out. We consolidated TPAs. We took a number of other important steps during the quarter that move us forward. We told you last quarter that we'd be taking a hard look at our business model and expenses. We're doing that, taking a careful and thoughtful approach. We need to balance cost savings against appropriate levels of continued investment that are required to effectively drive our growth strategy and reach Simple Excellence. We're making really good progress in the project. It's been a focus and gotten attention from our Board and the management team, and we've had the help of some excellent third-party consultants. We are making progress. We've identified some very tangible areas of savings that we'll be pursuing and have a number of other ideas that we're continuing to work through. I look forward to updating you on progress in this area as the work progresses. I expect to be able to give you more detail about how we're doing this in the fourth quarter when we provide our expense guidance for the upcoming year. The fourth plank of our strategy is a proactive risk and control environment. We further strengthened our team with some senior hires, especially of the EMEA Head of Compliance, which is an important position for us. We're taking steps to further strengthen the control environment and relationships with regulators worldwide, so I'm pleased with the progress in this area. The fifth plank is to develop some new growth initiatives. We're focusing on areas of strength for us, combined with where we see our clients moving. Here, we're committed to delivering growth in a profitable way. For example, we continue to support growth in ETFs. We've seen really good momentum in our VLNA and JMBS ETFs in the U.S. Last week, we launched a AAA CLO ETF called JAAA in the U.S. It was the 11th largest ETF launch out of 1,600 in the last 10 years. Outside of ETFs, earlier this month, we also launched a U.K. asset-backed securities fund. I think we're doing good work in continuing to develop targeted new growth initiatives. Before turning it over to Roger, let me reiterate our commitment to delivering the benefits of our strategy to all of our key stakeholders, our clients, our employees, and our shareholders. We are driving forward in this regard with as much urgency as possible. We know that time is expensive and not always our friend, and we're really working as fast as we can to deliver on this strategy. Let me say just a word about INTECH. We've talked before about how we are facing some real challenges in our INTECH business, primarily driven by a couple of periods of underperformance in recent history and their investment strategies. Additionally, we face the challenge that a number of our clients are diversifying their portfolios, which can leave INTECH in the middle with a bit of a challenge to find its space. They've been fighting this battle for a while, and this quarter represents improvement. They had better investment results and better flow results. As we work to face the challenges in the INTECH part of our business, we understand it's going to take time to fully heal and get back to health. But this quarter does represent a step forward in our INTECH business, and that's good. However, as we think about the lumpy nature of that business and the large institutional account sizes, it's hard to extrapolate from quarter to quarter. It's fair to say there's still some very significant risks remaining in our INTECH business moving forward. When I look at the rest of the business, I believe we can see a clear path to continuing to drive forward toward organic growth, perhaps a bit more quickly. I am optimistic that the rest of the organization can continue on this path and continue with the positive steps we've made this quarter. I truly believe we are on the right path to achieving organic growth, driving greater profitability, and building our business for the long term. So with that, let me turn it over to Roger to take you through the quarter's results.

Thank you, Dick, and thanks, everyone, for joining us. Starting on Slide 4 with investment performance. Investment performance remained solid, with 58%, 61% and 73% of firmwide assets beating their respective benchmarks on a 1-, 3- and 5-year basis as of the 30th of September. The 1-year performance result in our equity capability primarily comes from segments of our U.S. equity business. We're encouraged by INTECH's improvement in its one-year performance, as Dick just mentioned. However, the longer-term performance will take longer to turn and hence remains a concern. Relative performance compared to peers is strong, with 68%, 74% and 78% of the AUM represented in the top two Morningstar quartiles on a 1-, 3- and 5-year basis. Now turning to total company flows. For the quarter, net outflows were $2.9 billion compared to the $8.2 billion last quarter and $12 billion in the first quarter, and they are the best they've been in the time series we show here. The quarterly flow number reflects lower redemptions primarily from the institutional business, which were partially offset by lower gross sales in the intermediary channel, as we typically see seasonally lower retail sales during the third quarter. We remain encouraged by the institutional outlook, given our diverse pipeline across strategies and regions. Additionally, we're optimistic that we're through the majority of the redemptions that were likely as a result of the changes in the investment management teams that we made over the last 18 months. The intermediary business saw positive flows in our fixed income and multi-asset capabilities, while outflows continued in our U.S. mid and SMID cap capabilities due to short-term underperformance, which we identified as a risk on last quarter's call. We're pleased with the improving flow trends and broader business momentum as we progress through 2020, but we know there's still much work to do. As Dick just indicated, excluding INTECH, which is likely to take longer to turn, we're optimistic about returning to positive organic flows in the near term. Moving to Slide 6, which shows the breakdown of flows in the quarter by capability. Equity net outflows for the third quarter were $5.1 billion compared to $4.2 billion in the prior quarter. The quarterly outflows were primarily from elevated outflows in certain U.S. strategies due to short-term underperformance. Flows into fixed income were positive $1.8 billion in the quarter compared to negative $700 million in the second quarter, primarily due to lower mandate redemptions but also growing positive flows in retail. In retail, we're capturing market share and seeing positive flows across several strategies around the globe. INTECH outflows improved in Q3 to $100 million, which includes a $1 billion funding out of Australia. We're pleased with INTECH's improving short-term performance and the better flow result this quarter. But as we've stated previously, INTECH is mostly institutional, and the results will likely be lumpy and fluctuate from quarter to quarter. Total inflows from multi-asset were $600 million, driven by inflows into the balanced strategy, while alternative outflows were $100 million. Slide 7 shows our standard presentation of the U.S. GAAP statement of income. Moving to Slide 8, which displays a strong set of summary financial results; there's a lot of green on this page. Adjusted third-quarter operating results were up compared to the second quarter, primarily from a 10% increase in average AUM. Total adjusted revenues in the quarter increased 9% compared to the prior quarter due to higher average AUM, partially offset by seasonally lower performance fees. Adjusted operating income in the third quarter of $162 million was up 17% over the prior quarter, driven principally by higher revenue, partially offset by higher expenses. The third-quarter adjusted operating margin was 36% compared to 33.5% in the prior quarter and 37% a year ago. Finishing up the financial results, adjusted diluted EPS was $0.70 for the third quarter compared to $0.67 for the prior quarter and up from $0.64 a year ago. On Slide 9, we've outlined the revenue drivers for the quarter. Higher average assets were the biggest driver of the quarterly change in adjusted total revenue. The net management fee margin for the third quarter was 45.8 basis points, up from 45.7 basis points in the second quarter and significantly increased from 44.4 basis points a year ago. The margin remains resilient and the increase of 1.4 basis points over the past 12 months reflects the ongoing mix shift and our focus on quality flows. Performance fees were $7 million in the quarter versus $17.2 million in the prior quarter when more accounts were eligible for fees, but up from $1.4 million in the same quarter of last year. We currently expect Q4 performance fees to be ahead of Q4 last year, but that will depend on final performance for the year. The third-quarter adjusted operating expenses came in at $288 million, which represents a 5% increase compared to the prior quarter. Adjusted employee compensation, which includes fixed and variable staff costs, was up 6% compared to the prior quarter, predominantly from higher profit-based incentive compensation. Adjusted LTI was down 13% from the second quarter due to the impact of the mark-to-market adjustments in both quarters and social security taxes on vestings in the U.K. that occurred in the prior quarter. The third-quarter adjusted comp-to-revenue ratio was 43.9%, aligning with our mid-40s guidance. Adjusted non-comp operating expenses were up 12% compared to the prior quarter. The increase is primarily related to marketing, FX, and professional fees. For the year, we anticipate our non-comp expenses to be down low-single digits compared to 2019. Lastly, our recurring effective tax rate for the third quarter was 21.3%, below the statutory rate guidance of 23% to 25%. The lower rate in the third quarter was impacted by a U.S. state refund received during the quarter. Finally, Slide 11 shows our capital management. Cash and cash equivalents were $927 million as of the 30th of September, of which Janus Henderson's portion was $909 million. As a reminder, you should think about the amount of cash we have on the balance sheet as what the Board and management are comfortable operating the business with due to regulatory requirements, a conservative working capital buffer, and cash set aside to meet the 2025 debt maturity. As we stated previously, we remain committed to returning excess from future cash flow generation to our shareholders. During the third quarter, we paid approximately $66 million in dividends to shareholders and declared a $0.36 per share dividend to be paid on the 23rd of November to shareholders of record as of the 9th of November. In the quarter, we purchased 2.4 million shares of our stock for a total of $50 million. Since we started our buyback program in Q3 2018, the buyback program has been 9% accretive. Now I'd like to turn it back over to Dick for a few comments before we begin Q&A.

Thank you, Roger. Before handing over to the operator for questions, I'd like to briefly address the elephant in the room, China's recent investment in our firm. As you know, China has made a significant investment holding approximately 9.9% of our shares. We value input and good ideas from all of our shareholders. If China has specific views or suggestions to share with us, we certainly will consider them as part of our broader thinking and take that seriously. We are deeply committed to driving shareholder value creation. Like most public companies, we can't really comment on market rumors or speculation. Our Board and management team will act responsibly and will act in the best interest of all our Janus Henderson shareholders. Our plans and focus, though, remain centered on delivering Simple Excellence, which we believe is the right path forward. We're making progress against the five planks of our strategy, and we're moving toward fully unlocking the growth synergies from the Janus Henderson merger. Achieving excellence takes time, and that can be frustrating, but it's the right path we are on, and our priority remains to deliver Simple Excellence and growth. As we turn to Q&A, please keep your questions directed on the quarterly results as there really isn't much more we can say about this trying situation. We appreciate your understanding. With that, let me turn it over to the operator for your questions.

Thank you. And we will take our first question from Ken Worthington with JPMorgan.

Hi, good morning. Thank you for taking my question. Thank you for your prepared remarks. I think consolidation remains the same today for the industry. When Janus merged with Henderson, you indicated that you had the size and scale at the time to compete. But if you looked at over the next few years, you might not be in a position or your position would be dramatically enhanced by the merger with Henderson. So as we think about Janus' size and scale today, do you think you have the size to effectively compete in the global asset management business over the next decade at your current pace of growth? Or does Janus benefit from pursuing acquisitions to better position the company again for the next decade?

Hi, Ken. Dick here. Thanks for the question. Size by itself helps a few things, right? It helps your ability to capture economies of scale, helps invest in a breadth of ideas, and helps invest in your infrastructure. It probably also helps you build a broader brand with key clients. So, there are some really good things that come with size. But there are some challenges with size as well. It typically doesn't help alpha, and it typically doesn't help excellence. Getting through consolidations or size accumulating inorganic transactions involves a huge amount of disruptions, which clients penalize very heavily. So, I think our priorities are clear. Our highest priority is to deliver excellence for the existing clients that we have. Our second priority is to drive organic growth. If we have the excellence and the platform well established through those two aspects, there might be inorganic opportunities that could enhance the scale and add qualitatively to our business in a way that offsets the disruption. But the key is you've got to be delivering that excellence. Size without excellence is just a bigger problem. So, we are pursuing that appropriate level of excellence, first as our highest priority. We'll keep trying to drive organic growth. I believe that a firm that establishes itself in that space is a better acquirer and is more ready to take on the challenges of future consolidation. But right now, our focus really is delivering on the excellence. If you think about how pressured we are to consolidate in the near-term, our margin this quarter at 36% is quite good. So, I don't think we're desperately missing out on economies of scale at the moment. Our priorities are correct, focusing on delivering on the existing Simple Excellence strategy and driving toward organic growth. With that said, we always have an ear open to opportunities and are in conversations about potential ideas. If we find something special that would more than offset the disruption it brings, we'd certainly be interested in something like that. But those opportunities don't happen very often.

Your comments are very helpful. Thank you very much.

We'll take our next question from Nigel Pittaway from Citi.

Great. Thank you very much. Just first of all, obviously, with the flows that you're trying to get organic growth in; I mean, what do you think is going to be the biggest driver of that? Is it going to be sort of equity outflows diminishing? Is it going to be stronger growth in fixed income? Where do you have the greatest hope that the improvement will come to push you into a growth situation?

Hi. It's Dick again. Thanks for that question. I think it's a complicated story for us. We have so many products operating in various parts of the world, and they're moving in different directions against different market backdrops, making it hard to give a simple answer. We've seen our traditionally strong U.S. equity franchise face challenges through this market environment this year, particularly in small and mid-cap investing, which has been the heart of our best investing. On the other hand, fixed income and European investing, as well as some of our absolute return strategies, have demonstrated substantial outperformance during this period. We're going to tell a complex story at all periods, with some products performing better than others in different market environments. It's about balance. If you pair those factors with excellent client service, experience, and a robust infrastructure that delivers the right information at the right time, then I believe you can be resilient through different market cycles. If everything you're doing is excellent, you will eventually see success over time. This is what we're working to achieve. There will be parts of our business that face challenges in every market environment, but hopefully, we can consistently offset that with all the positive initiatives and strategies we are implementing. I believe we are on the right path to delivering this, but we are not quite there yet.

Hi, Nigel. It's Roger. If I could add a couple of specifics. Dick has mentioned fixed income, which is performing strong across the board right now. In a market where fixed income is growing, we're taking market share globally. We're seeing outsized market growth and positive flows in the U.S. and around the world. In equity, the pipeline for growth in institutional equity has a number of interesting prospects. While there was nothing funded in Q3, we expect some positive flows to happen in the future. Furthermore, our ETF franchise is growing really well, with continued growth in VNLA and JMBS, and we're seeing excellent opportunities in this space. The recent launch of JAAA, one of the largest ETF launches in the last decade, is promising. So, we have many areas where we see potential growth ahead, despite a few parts of the business facing short-term challenges.

Okay. Thank you for that. And then maybe just as a follow-up. Obviously, you seem to have deferred further detail on the cost efficiency program by a quarter, and mentioned the need to balance investment with actual savings. I mean, how are you feeling about that balance currently? Do you think most of the savings generated will be reinvested? Or will there be some sort of relatively meaningful impact on the overall cost base?

Yes, nothing has changed there, Nigel. Now that we're three, four years through the merger, this is a good time to look at our business and how we operate, especially with COVID giving us a different lens. We're working on a detailed review, and we're taking a careful approach, because we don't want to disturb the momentum we've got. We're investing in the business and we will continue to do so, and there are efficiencies we will be capturing as well. We'll update our guidance as we normally do around Q4.

Hi. Just a first question for me. Dick, just to clarify the comments you made around the flows to INTECH. Is it fair to assume that the potential troubles in that business aren't necessarily that there's a pipeline of outflows or redemptions that have been requested, but rather it's probably more likely that you're expecting normalization back into outflows over the quarters, just given the performance track record?

Yes, I think that's a fair statement.

Okay. And then the second question I had, just on the buyback. So, obviously, there's a fair bit of capacity left. Is it possible to get through the entire amount in the quarter? Or could we expect some capacity might be left as the year ends from that $200 million?

Yes, Brendan, it's Roger. We are $103 million through the $200 million that the Board authorized through April next year. We'll likely continue with the same structured buyback program we've had before, looking at market volumes and conditions. I wouldn't expect us to do it all in one quarter, but you can see our daily market activity in Australia.

Thank you for taking my question. Just two from me. Can we start on equities and the gross sales; they've been trending down in the last four quarters. Is this a concern for you that sales aren't coming through as strongly as they were?

There are two pieces to that. One of it is what I just referred to regarding institutional. Q3 had no large institutional funding, but equities are part of that institutional pipeline I talked about. So, I think that's just about timing. Two, on the intermediary side, we're more in line with where we were in Q3 last year. We were slightly slower in the U.S. due to short-term underperformance in some of our U.S. strategies. So, this should not raise concerns on the institutional side, and I believe we are turning the corner on the equities side.

Alright. And just a second question, regarding both the near-term and medium term, you've discussed a mix shift that has been positively impacting margin as you grow more into, and receive more flows into FX and ETFs. Can you touch on how that will shift your mix on margin going forward?

That's very fair, Ed. We've been winning more in higher fee assets, while some of the assets we've lost have been lower fee. We have a very broad range of products and the pipeline is diverse. We are not immune to fee pressure, so you shouldn't expect that fee margin to improve infinitely. The fact that it has improved 1.4 basis points over the last year sets us apart from a significant amount of competitors. Over time, you should expect that fee margin to flatten out, and possibly come down a little, which is why we need to run an efficient, effective business. Winning significant mandates in enhanced equity and buy-and-hold fixed income products will likely come at a lower fee.

Good morning, or good afternoon. I wanted to ask two questions. Firstly, on the operating margin, it improved to 36% in the quarter. Is that indicative of some early wins on the cost transformation being realized or better market conditions helping out?

Yes, you've got a mix here this quarter; we had an improving market, less performance fees than we had in Q2, as Q3 is a light performance fee quarter. We're typically light on COVID-related spending in general. While marketing has increased from Q2, it's still below last year. So, overall, it's a combination of these factors. But I want to emphasize that we're always looking for ways to run an efficient business. So, yes, we've seen several factors that contributed to this quarter's results.

Yes, this is Dick again. Thanks for that. I agree that we've had more momentum in Japan, which has slowed recently. While there are positives happening, we do need to dig deeper and reenergize our business approach in that space. We had more growth earlier on but it has slowed. We recognize this and are focused on finding ways to reinvigorate operations.

Yes. There are some relevant points to consider; we haven't had a blockbuster launch, raising $1 billion in one go. However, we launched our adaptive allocation strategy in Japan for Dai-ichi Life last year and a product for Dai-ichi Frontier Life, both have shown modest but consistent growth. These kinds of consistent smaller launches are valuable over time. Positive growth is underway with Dai-ichi in Australia, which has occurred over the last 18 months.

Hi, good morning. Thanks for taking my questions. I appreciate your candor regarding the risks at INTECH. Can you remind us of the concentrations there? A few quarters ago, you mentioned a handful representing a plurality of the assets. Can you also remind us of the seasonality of that? Are those decisions concentrated more around Q4 or spread throughout the year?

The decisions are not seasonally limited, Patrick. Clients consider their mandates throughout the year. However, you are correct that INTECH is institutional, and some substantial mandates exist. Should any of these accounts opt out, it can notably affect our metrics. Right now, the five largest strategies of INTECH account for nearly 60% of its business — so there is concentration risk.

Great. And then the U.K. real estate strategy has garnered some attention. I don't know if you can detail the pipeline of redemption or any insight into when that might reopen?

No, we believe that reopening is unlikely until the first quarter of next year. We're still building the necessary liquidity in the fund. The material uncertainty clauses that affected the industry have been addressed, and while the fund is performing in the top quartile, we are cautious about reopening it too soon. The market isn't conducting many transactions, making property sales time-consuming.

Alright. Thank you. Can you discuss some of the investments you're making in the intermediary channel, particularly whether you're considering new vehicles and how those relationships are evolving?

We are launching new products and ensuring we have the right vehicles in different markets, which has generated a lot of success. Interestingly, as we reviewed flows at the Board, a significant portion came from products that didn't exist a few years prior. For example, our strategic income product has quickly become one of the top-selling funds in the U.S., and our ETF franchise is emerging as a strong player.

Yes. Customers are looking for consistent investment excellence. They want timely access to information and to engage in thought leadership that helps them excel in their roles. When they have issues, they expect friendly and effective resolution. We've been investing in technology to improve our operations and enhance service delivery without disrupting our existing momentum.

Got it. Also, the increase in G&A and professional services quarter-over-quarter, was that related to the efficiency plan given that we've seen some peers experience flat-to-lower costs in the COVID environment?

There are a couple of factors at play here. Partly, FX has influenced our costs as sterling strengthened against the dollar. Additionally, some one-off consultancy expenses in the quarter were included, but it's not directly related to the investments Dick mentioned. We are topping off our investments while ensuring efficiency is prioritized moving forward.

And we have no further questions at this time. Ladies and gentlemen, that brings us to the end of our conference today. We do appreciate your participation today.