Virtus Investment Partners, Inc. Q4 FY2020 Earnings Call

Good morning. My name is Joule, and I will be your conference operator today. I would like to welcome everyone to the Virtus Investment Partners’ Quarterly Conference Call. The slide presentation for this call is available in the Investor Relations section of the Virtus website www.virtus.com. This call is also being recorded and will be available for replay on the Virtus website. At this time, all participants are in a listen-only mode. After the speakers’ remarks, there will be a question-and-answer period and instructions will follow at that time. I would now turn the conference to your host, Sean Rourke.

Thank you, Sean. Good morning, everyone. I will start today by giving an overview of the results we reported this morning, as well as an update on the AllianzGI partnership, which has been finalized, before turning it over to Mike to provide more detail on the quarter. Then, before taking questions, I will make some comments on our announcement yesterday of our agreement with Westchester Capital Management. Turning to the results, we are pleased with the continued strong financial and operating performance of the business, which for the quarter included positive net flows representing an annualized organic growth rate of more than 9%, our second highest level of quarterly sales, our highest level of AUM revenues and earnings per share, continued excellent investment performance and consistent return of capital to shareholders and debt reduction. We are especially pleased with the trends over the course of 2020, which was a challenging year in many ways. In spite of that, we reported record earnings, generated positive net flows for the year with organic growth rate of nearly 5% and increased sales by more than 60%.

Thank you, George. Good morning, everyone. Starting with our results on slide seven, assets under management. At December 31st, long-term assets were $130.7 billion, up 14% from $115 billion at September 30th. The sequential increase reflected $13.4 billion of market appreciation and $2.6 billion of positive net flows. All asset classes contributed to AUM growth during the quarter led by domestic and international equity, which increased 18% and 17%, respectively, with fixed-income up 2% and alternative assets higher by 9%. Assets continued to be diversified by product type with open-end funds, institutional and retail separate accounts representing approximately 38%, 31% and 23% of long-term AUM, respectively. In terms of asset classes, equity assets represented 73% of long-term AUM, with 78% of that in domestic equity and 22% in international. Fixed-income assets as a percentage of total assets declined to 23% due to the rise in equity markets during the period. Regarding the AllianzGI partnership, the assets under management totaled $29.3 billion at December 31st, having increased $3.6 billion or 14% from September 30th due to market returns and positive net flows.

Thank you, Mike. Before we take your questions, I’d like to comment on our agreement with Westchester Capital Management, a premier manager of event driven investment strategies with $4.3 billion in assets at December 31st. Westchester Capital has a 30-year track record in merger arbitrage with category leading investment performance, delivering attractive returns across market environments. The firm is a pioneer in the space having launched the first merger arbitrage fund in 1989. We are excited to add Westchester Capital to our family of affiliated managers. Their non-correlated alternative strategies invest in publicly announced event opportunities such as mergers, acquisitions, takeovers, spinoffs and other corporate reorganizations. With the addition of Westchester Capital, we would further diversify our investment strategies and nearly double our assets under management in alternative strategies. There are funds which are already available across top platforms that will become available to a broader retail base through our robust distribution capabilities. In addition, consistent with our overall product strategy, Westchester Capital event driven strategies could be leveraged into other product structures. Like all our affiliated managers, Westchester Capital will continue to operate as an individual boutique retaining autonomy over its investment process and maintaining its independent structure, culture, and brand identity. Under the agreement, we would acquire 100% of the equity interests for the principals and third-party investors. The transaction structure includes an upfront payment, as well as potential contingent and future earn-out payments based upon the growth of the business. The closing payment for the transaction is $135 million, which, given our balance sheet and strong cash flow, can be funded without additional financing. We anticipate closing in the second half of this year pending customary fund shareholder approvals. The structure of the transaction provides for a strong alignment of interests in the form of employment agreements and participation in the profit pool, and the principals are reinvesting a significant portion of transaction proceeds into their investment strategies. We expect the transaction to be immediately accretive to earnings as adjusted by approximately 6% based on run rate earnings on a pro forma basis for the AllianzGI partnership. We look forward to providing more details as we get closer to closing. The addition of Westchester Capital as a boutique affiliate and the partnership with AllianzGI is illustrative of our multifaceted approach to inorganic growth and underscores a key element of our value proposition. Our long-term growth is not dependent on M&A. However, our model allows us to partner with distinctive boutiques and support their growth by offering new strategies through our broad distribution platform and into additional product structures. Our model also allows us to selectively partner with distinctive firms for a particular investment capability or capabilities. Both of these provide for further diversification of our strategies, product lines and clients, and gives us potential for greater opportunity through changing market cycles. With Westchester Capital, we added a targeted private capability that leverages our strength as a multi-boutique and our value proposition that is attractive to boutique firms that can focus on managing their clients’ assets, while getting the benefits of scale distribution and the resources of a larger organization. With AllianzGI, we significantly increased our scale with compelling and complementary products in a thoughtfully structured partnership that provides significant financial accretion. We believe our multifaceted and flexible approach to inorganic growth, combined with our ability to generate organic growth as we did in 2020, demonstrates that we are well-positioned to execute on our long-term growth strategy and create shareholder value. With that, we will now take your questions. Joule, would you please open up the lines?

Thank you. Our first question comes from Jeremy Campbell with Barclays. Your line is now open.

Hey. Thanks. George and Mike, I want a quick clarification on the AllianzGI accretion comment. It’s at least 30% would be on this quarter’s $5.15 quarterly EPS run rate, correct? And I guess when we are talking with AllianzGI, George, maybe you can comment a little bit about the underlying flow trends there right now and now that the deal is closed, how quickly you think the sales force can really get this in their hands and potentially accelerate that flow trend? And then just looking at your mosaic as a firm now, adding AllianzGI and adding non-correlated asset flows with the Westchester deal today, as you look at your product offerings and how you hope your sales force will hit the market over the next year or two, is there anything else that you see that would be an element of white space that would need to be added to further complement your suite of products?

Yes. So again, it’s at least 30% and it has taken into account the fourth quarter and our pro-forma view of things going forward. On AllianzGI, a couple of points to underscore: their products are very strong and Mike spoke to specific performance numbers. The other important point is the complementary nature of their strategies to ours. They add capabilities in multi-asset, sustainability and other areas that are very additive to our lineup. In the update that Mike provided, you can also see that they have continued to grow assets from both performance and ongoing sales prior to the changeover to us. These are well-marketed and well-supported products, and we are excited that our integration work with their team is preparing us to hit the ground running. I have listened in on multiple video calls as our wholesalers, national accounts and other distribution individuals prepare to bring these products to market. We have also brought in additional talented individuals along with the assets under management. We are ready to take advantage of these products and will let the market determine the pace, but we believe we have done everything we can to be prepared. Regarding white space, our focus with Westchester Capital addresses our interest in less correlated strategies. Historically, we have felt good about our coverage of traditional asset classes and AllianzGI expanded our capabilities in multi-asset, hybrids, convertibles and sustainability. Less correlated strategies have become increasingly attractive, particularly given recent market volatility, and Westchester fits well into that need. We continue to see opportunities to grow outside the U.S. and to expand alternative and less correlated strategies. Our approach is to avoid dependence on any single market cycle or strategy and instead offer a diversified set of distinctive managers covering many building blocks of a well-diversified portfolio.

Yeah. That’s correct. It’s on this quarter’s result.

Great. Thanks a lot, guys.

Thank you. Our next question comes from Sumeet Mody with Piper Sandler. Your line is now open.

Thanks. Good morning, guys. I have a couple of big picture questions, starting with the organic growth outlook for the year. Now that we have a little more clarity with the new administration and with vaccines potentially broadly available midyear, how do you view the environment? Do we revert back to the trend of late 2019 or is there room for additional opportunity with AllianzGI and Westchester to get continued strong organic growth across strategy offerings? Could you touch on some of the different strategies?

That’s a great question. Since we cannot predict the future precisely, we diversify to be successful in all environments. Our strategy is to have a broad array of distinctive managers that provide the building blocks of a well-diversified portfolio, which may be in or out of favor at different times. As investor demand changes, we aim to have products that are attractive in various markets. We have already started to see a rotation into more of our fixed-income strategies, which we think are strong offerings. Whether equity markets remain volatile, move up, or move down, we believe we have multiple strategies that could be attractive in each of those environments. Adding a less correlated strategy with Westchester further expands that capability. We try not to rely on any single market cycle or strategy; rather we build diversification through partnerships with different, differentiated managers.

Great. Thank you. And then one more high-level question on technology and data. Can you touch on how you look at technology both firm-wide and at the affiliate level, and how you think it could be used going forward, perhaps in areas you're not heavily in today like model portfolios or enhancing the distribution platform?

For technology, and data specifically, we did not have a lot of archaic systems, which made it easier for us to build out what is right for the business. We've been growing through transactions, so we continue to focus on technology opportunities. The data side is particularly interesting — we pull in a lot of data and have a long history of distribution data where we've tracked relationships and insights over time. We see further opportunities to leverage that and the digital element to bring in more data. From a firm-wide perspective, this can help level the playing field against larger competitors if we can use data effectively. Our success in retail distribution reflects not only the quality of our wholesalers and strategy leadership but also targeted opportunities informed by our data. For affiliates, one of the benefits of our model is making information, data, or technology available that they might not otherwise have. We look for ways to add value to affiliates by supporting them with tools and data that help them manage client assets effectively.

Great. Thanks, George.

Thank you. Our next question comes from Gayathri Ramkrishnan with Bank of America. Your line is now open.

Hi there. This is Gayathri on behalf of Mike Carrier. My question is on the Westchester deal structure. I’m curious about the rationale behind acquiring 100% of the equity, which is quite different from the AllianzGI partnership structure. More broadly, multi-boutique firms often like to retain some equity to keep interests aligned over the long term. How do you think about that as you integrate more partners going forward?

Every transaction is different, and part of our model is flexibility in how we partner. We do not want to limit opportunities by being pigeonholed into one structure. The Westchester structure is well-aligned for this manager given their objectives. Equity ownership at the affiliate level is not the only way to align interests. Our structures include uncapped earnings opportunities in the profits affiliates generate. In this model, even with 100% ownership at the parent level, principals have significant income participation. The deal aligns interests between leadership, the next generation, and us. We will remain flexible in how we approach future partnerships; the priority is partnering with the right firm for the asset class and strategy rather than adhering to a single structure.

Thank you. This concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Aylward.

Joule, it looks like we have a follow-up question on the queue.

And that follow-up question comes from Jeremy Campbell with Barclays. Your line is now open.

Hey. Thanks for the follow-up. I want to get your sense of demand in your CLO business. Market indicators suggest the CLO market is heating up. Do you have anything in warehouse or anything in the pipeline we should be aware of? Also, you mentioned fixed-income inflows and I know a headwind last year was the bank loan strategy. That looks like it’s starting to pick up in this rate environment. What are you seeing on the ground in that strategy?

Mike, do you want to respond to that?

Sure. Jeremy, no, we don’t have anything in the warehouse currently. Our teams stay close to the market and evaluate opportunities and we have seen the market strengthen over the last couple of months. If anything emerges from the teams on that front, we will let you know, but nothing to report at this point.

Is it fair to characterize that fixed-income inflows were helped by renewed interest in bank loan strategies? Loans have been out of favor but are showing improvement in this rate regime. What are you seeing on the ground in that type of strategy?

You are right. Within fixed-income we have multiple strategies. The bank loan strategy had been out of favor, but over the last few quarters we have seen improvement and increasing interest in that space. We have also seen interest in multi-sector and short-term bond strategies. It’s encouraging to see a continuation of strength in some equity products while also seeing rotation into credit-sensitive fixed-income strategies. It will be interesting to see how this trend plays out through the rest of the year.

Great. Thanks a lot again.

Okay. Thank you.

Thank you. This concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Aylward.

Okay. Well, I just want to thank everyone for joining us today. Certainly encourage you to call us if you have any other questions. Have a nice day. Thank you.

That concludes today’s call. Thank you for participating. You may now disconnect.