Virtus Investment Partners, Inc. Q2 FY2025 Earnings Call

Good morning. My name is Didi, 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 being recorded and will be available for replay on the Virtus website. I will now turn the conference to your host, Sean Rourke.

Thanks, Didi, and good morning, everyone. On behalf of Virtus Investment Partners, I'd like to welcome you to the discussion of our operating and financial results for the second quarter of 2025. Our speakers today are George Aylward, President and CEO; and Mike Angerthal, Chief Financial Officer. Following their prepared remarks, we'll have a Q&A period. Before we begin, please note the disclosures on Page 2 of the slide presentation. Certain matters discussed on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, and as such, are subject to known and unknown risks and uncertainties, including, but not limited to, those factors set forth in today's news release and discussed in our SEC filings. These risks and uncertainties may cause actual results to differ materially from those discussed in the statements. In addition to results presented on a GAAP basis, we use certain non-GAAP measures to evaluate our financial results. Our non-GAAP financial measures are not substitutes for GAAP financial results and should be read in conjunction with the GAAP results. Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in today's news release and financial supplement, which are available on our website. Now I'd like to turn the call over to George. George?

Thank you, Sean, and good morning, everyone. Today, I'll start with an overview of the results we reported this morning, and then I'll turn it over to Mike for more detail. The second quarter began with challenging market conditions and volatility but then had steady improvement, culminating in momentum by June, which is reflected in our financial and operating results. Assets under management grew 2% in the quarter, benefiting from the market rebound off the April lows. Net outflows across products were primarily in our quality-oriented equity strategies, which faced headwinds in a market environment that largely favored momentum-driven strategies. Key highlights of the quarter included higher earnings per share and operating margin, continued positive net flows in ETFs, strong long-term relative investment performance, our highest level of share repurchases in three years, and low net leverage and meaningful liquidity, providing ongoing flexibility to invest in the business and return capital to shareholders. We continue to focus on the execution of various initiatives related to expanding our offerings and channel availability, both organically as well as through inorganic opportunities. As we commented on last quarter, we have been focused on expanding our offerings of retail separate accounts, ETFs, and global funds. For ETFs and global funds, we anticipate launching multiple products over the coming quarters, including from Silvant, Sykes, Stone Harbor, and AlphaSimplex. Retail separate accounts, we are expanding our offerings of fixed income and high conviction growth equity strategies as well as products that leverage multiple managers and strategies. In addition, we are leveraging our fixed income capabilities with our first interval fund. We also have efforts underway to increase the availability of our growing ETF offerings and to expand the asset-raising capabilities of our well-regarded wealth management business within Kayne Anderson, which has grown to nearly $9 billion in assets. As we focus on growth opportunities, we would note that the environment continues to be highly attractive for product expansion, distribution enhancing or scale-oriented inorganic transactions. We remain optimistic about such opportunities, particularly in the areas of current and growing investor interest, such as private markets and differentiated and compelling traditional strategies, which we're actively pursuing. The number of opportunities at various stages in the pipeline is at its highest level as well as a broad range of structures, capabilities, and sizes. Our strong liquidity and flexible balance sheet position us well to act on any strategically and financially compelling opportunities. Turning to investment performance. We are pleased with the performance we generated over market cycles. Over the 10-year period, 74% of our equity assets and 69% of our fixed income assets beat their benchmark. For just mutual funds, 73% of equity funds and 85% of fixed funds outperformed the peer median. I would also note that 27 of our retail funds are rated 4 or 5 stars, and 86% of our rated fund retail fund assets were in 3, 4, or 5 stars. We have included a new slide that provides additional investment performance information. Turning now to a review of the results. Total assets under management were $171 billion at June 30, up $4 billion sequentially due to market performance. Total sales of $5.6 billion compared with $6.2 billion in the first quarter with a modest decline across products, which was in part a reflection of market disruption, particularly early in the quarter. Trends improved over the course of the quarter with June being our best month of net flows, including essentially breakeven net flows in open-end funds. Total net outflows for the quarter of $3.9 billion were largely in equity strategies as fixed income, alternatives, and multi-assets each had modest net outflows. We did continue to have positive net flows in ETFs, which reached $3.7 billion in AUM with an organic growth rate of 74% over the trailing 12 months and which had $3.9 billion as of yesterday. Looking at flows across assets, the equity net outflows were driven by strategies with a quality orientation in a market that favored momentum as well as we reduced sales from the soft closing of the smid-cap core equity model offering late last year. Fixed income net flows were modestly negative for the quarter with net outflows in April and May and a return to positive flows in June. Relative investment performance of our fixed income strategies has been strong for the recent one-year period as well as the longer term, creating demand for funds across the spectrum of credit quality and duration, several of which were among our top-selling funds in ETFs in the quarter. Net flows of alternative strategies were also modestly negative with favorable trends throughout the quarter, including positive net flows in June. In terms of what we're seeing in July, market sentiment has continued to trend more favorably, and we are seeing a stronger flow profile for our fixed income funds, though not yet for the equity funds. ETFs, as I noted, continued the positive trend with an increase in sales. In institutional, trends are similar to the second quarter with known redemptions exceeding known wins with redemptions primarily in quality large cap, while known wins span a range of strategies, including emerging market debt and global and domestic REITs. We also anticipate launching a new CLO later in the third quarter, targeting approximately $400 million in AUM. Turning now to our financial results. The sequential improvement in our financial results reflected the impact of the prior-quarter seasonal expenses, partially offset by lower average AUM levels. The operating margin was 31.3%, up sequentially from 27.6%, which included the impact of the seasonal expenses. Earnings per share as adjusted of $6.25 increased from $5.73 in the first quarter. Relative to the more comparable prior-year period, earnings per share as adjusted decreased 4% on lower average assets. In terms of our balance sheet and capital, during the quarter, we increased our share buyback to $30 million to repurchase over 175,000 shares, which represented 3% of beginning outstanding shares. We ended the quarter with significant liquidity and a modest net debt position, providing ongoing opportunities to invest in the growth of the business and return capital to shareholders. So with that, I'll turn the call over to Mike. Mike?

Thank you, George. Good to be with you all this morning. Starting with our results on Slide 7, assets under management. Our total assets under management at June 30 were $170.7 billion and represented a broad range of products and asset classes. By product, institutional is our largest category at 33% of AUM. Retail separate accounts, including wealth management at 28% and U.S. retail mutual funds at 27%. The remaining 12% comprises closed-end funds, global funds, and ETFs. We are also diversified within asset classes in equities between international and domestic and within domestic, well represented among mid, small, and large-cap strategies. And fixed income is well diversified across duration, credit quality, and geography. Turning to Slide 8, asset flows. Sales of $5.6 billion compared with $6.2 billion in the first quarter. Reviewing by product, institutional sales of $1.3 billion compared with $1.5 billion last quarter as higher sales of alternative strategies were offset by lower sales of fixed income and global equity. Retail separate account sales of $1.5 billion declined from $1.7 billion in the prior quarter, primarily due to lower smid-cap equity. Open-end fund sales of $2.8 billion compared with $3 billion as higher sales of large cap and international were offset by other strategies. Within open-end funds, ETF sales were again strong at $0.4 billion, essentially unchanged from the first quarter. Total net outflows of $3.9 billion compared with $3 billion last quarter and reviewing by product, institutional net outflows of $2.2 billion increased from $1.2 billion with the net outflows driven by quality-oriented large-cap growth. As always, institutional flows will fluctuate depending on the timing of client actions. Retail separate accounts had net outflows of $0.8 billion, largely reflecting the continued impact of the soft closing of a smid-cap core equity model offering late last year. We do offer other smid-cap strategies as well as mid-cap, where we have significant capacity and flows have been positive. In addition, we recently introduced an SMA, leveraging the strong performance of our high conviction large-cap growth capability. For open-end funds, net outflows of $1 billion were at generally the same level as the prior quarter and were driven by equity strategies as fixed income net flows were flat. Net flows trended favorably during the quarter with June essentially breakeven. Within open-end funds, ETFs continued to generate a strong double-digit organic growth rate with $0.2 billion of positive net flows. Turning to Slide 9. Investment management fees as adjusted of $171.9 million decreased 4%, reflecting the 4% sequential decline in average assets under management and a lower average fee rate. The average fee rate was 41.3 basis points or 41.1 basis points, excluding performance fees and compared with 41.7 basis points in the first quarter. The change in the fee rate from the first quarter largely reflected the mix of asset classes within retail funds given relatively stronger flows of fixed income strategies. Looking ahead, we believe the second quarter normalized average fee rate is reasonable for modeling purposes. As always, the fee rate will be impacted by markets and the mix of assets. Slide 10 shows the 5-quarter trend in employment expenses. Total employment expenses as adjusted of $97.2 million decreased $12 million or 11% sequentially, reflecting the impact of seasonal expenses in the prior quarter as well as lower variable incentive compensation. Employment expenses were 50.9% of revenues as adjusted, up from the seasonally adjusted prior-quarter level of 50.3% due to lower revenues. Looking ahead, it is reasonable to anticipate employment expenses as a percentage of revenues would trend toward the middle of our 49% to 51% range. As always, it will be variable based on market performance, in particular as well as profits and sales. Turning to Slide 11. Other operating expenses as adjusted were $32 million with a 2% sequential increase due to $0.9 million of annual equity grants to the Board of Directors. Excluding the grants, other operating expenses declined modestly from the prior quarter. As a percentage of second quarter revenues, other operating expenses were 16.7%, up from 15.8%, primarily due to the annual grants. Other operating expenses have remained within a narrow range of $30 million to $32 million per quarter, and we continue to believe that this level is appropriate for modeling purposes. Slide 12 illustrates the trend in earnings. Operating income as adjusted of $59.8 million increased 10% sequentially due to the impact of the prior quarter seasonal expenses. Excluding those items, operating income decreased 7%, primarily due to lower average assets under management. The operating margin as adjusted of 31.3% compared with 27.6% in the first quarter. With respect to nonoperating items, interest and dividend income of $5.3 million included an elevated level of CLO interest income. Looking ahead to the third quarter, it would be reasonable to anticipate interest and dividend income of approximately $4.3 million. Other income, which largely reflects the earnings from our equity stake in Zevenbergen Capital, increased modestly to $1.2 million. Noncontrolling interests, which reflect minority interest in SGA, were higher sequentially by $0.7 million. For both other income and noncontrolling interests, the second quarter is a reasonable run rate for modeling. Net income as adjusted of $6.25 per diluted share increased 9% from $5.73 in the first quarter. In terms of GAAP results, net income per share of $6.12 increased from $4.05 per share in the first quarter due to the impact of first quarter seasonal items as well as $0.50 of fair value adjustments to minority interest and $0.32 of fair value adjustments to contingent considerations. Slide 13 shows the trend of our capital liquidity and select balance sheet items. Cash and equivalents at June 30 were $172.2 million. In addition, we had $148.2 million of seed capital investments to support growth initiatives and $126.7 million of other investments, primarily in our CLOs. Working capital was $144 million, up 5% from $137.2 million as cash generated more than offset return of capital. During the second quarter, we repurchased 175,872 shares of common stock at an average price of $171 per share for a total of reduction in our share count. At June 30, gross debt-to-EBITDA was 0.7x, unchanged from March 31, and we ended the quarter with $62.5 million of net debt or 0.2x EBITDA. Our adequate levels of liquidity, including an undrawn $175 million revolver and modest leverage provide financial flexibility to continue to invest in the business and return capital. Looking ahead, we would note that anticipated capital uses in the third quarter include the potential new CLO, where our commitment would be about $30 million. Also, as a reminder, we will have the last of our scheduled minority interest purchases with SGA, which should also approximate $30 million. With that, let me turn the call back over to George. George?

Thank you, Mike. So we're now going to take your questions. Didi, would you please open up the line?

And our first question comes from Ben Budish of Barclays.

Mike, you mentioned $30 million in share repurchases in Q2, which I believe is the highest we've seen in a while. I'm interested in understanding your perspective on this, especially considering there may have been some opportunistic timing involved. You also mentioned potential future uses of capital, including the CLO, seed capital, and the SGA minority interest paydown. How should we consider any additional capital available for repurchases, as well as your current priorities between repurchases and dividends?

Yes. And I appreciate you highlighting the capital uses. As you know, we take a balanced approach to capital management, and we have leaned in both in this quarter as we particularly saw a compelling valuation in our stock. And year-to-date, we've now done $50 million of buybacks, which eclipsed the total level of 2024. So I think that brings a payout ratio over 100%. So we'll look at all factors around the highest and best use of capital. George alluded to inorganic opportunities potentially coming down, continuing to invest in the business as well as the two specific uses of capital here in the third quarter. So we will balance all of that as we continue to make capital decisions that we think will deliver long-term shareholder value.

I appreciate that. Maybe along the same lines, George, you mentioned the environment is attractive for a number of things, and your pipeline is at its highest level. Curious if you could share any additional color on the sort of the types of assets you're looking at. Has there been any change to the way you're thinking about the strategy? You mentioned private markets specifically. I'm curious how you think about the ability to compete given so many scaled competitors, where there may be more types of opportunities that make sense? But any additional commentary there would be helpful.

Sure. Yes. So again, what I indicated is just the level of activity is at its highest level. So we're spending a lot of time evaluating different opportunities. As we look at those, they could come along the lines of either attractive product extensions, distribution expansion, or those that will just fundamentally enhance scale and therefore, accretion. So it's been very interesting. I think there's a great environment out there as I think the opportunities between - I specifically referenced private markets, but in addition to private markets, there are very attractive traditional strategies that are still things that are in demand to investors. I think as we look at it, our view is that there's an opportunity that the - on the private market side, in particular, that there has been a lot of growth in that area and a lot of that growth in that area has been very narrow in terms of the number of players that have been providing those. So we do think like there is in our general business, there is an opportunity set for more differentiated individual boutique types of capabilities to sort of diversify some of the exposures that investors are currently having, which has generally been in a small number of scale players. So again, our goal is really always to offer something that's a little more differentiated and separate rather than just going directly against a scale player with a general type of strategy. So generally, we always look at strategies that are a little different, a little differentiated and have a different set of attractions and can really balance out the exposures that people have. So we find it interesting. We do think that the industry continues to contemplate how to converge some of the privates and the publics. I think on the public side, I just think there are opportunities to enhance and further consolidate on distribution opportunities.

Just in terms of just thinking through the guidance on the comp side, you guys have been terrific at managing expenses. How much of the sort of comp is just related to the variable revenue backdrop? How much is more structural? So I guess the question is, as we look ahead to the extent that markets continue to normalize, is there any catch-up spending that needs to potentially come back? And if so, where might that be?

Yes. I think we did guide specifically on the employment row back to the middle of our range. As you know, we've been in that 49% to 51% range in this quarter, where the beginning period assets were impacted by the drawdown in March and April, we ticked up toward the high end of the range. I think where ending assets are about 2% above average, we would, all else being equal, just use an appropriate midpoint of that employment range for modeling purposes going forward. And as you know, that range is always impacted by market conditions as well as profits and sales. But I think there is a positive impact on the leverageability of the market. I think other operating, we've been managing that also in a tight range, $30 million to $32 million, which remains appropriate for modeling purposes. So I don't foresee any catch-up spending. I think we're in a position to continue to deliver incremental margins in that 50% to 55% level as we look forward.

Yes. I mean the one thing I would just add to it because I think embedded in your question was specifics around the extent of which our comp is variable. So as a reminder, our compensation is highly variable. Our investment managers' incentives are really profit-based. Our sales base are generally based on sales or performance, and even our overarching corporate plans are all highly variable. So we do have base salaries, etc. But in terms of a catch-up, it would really just be through the variable as a percentage of revenue, if that's helpful. Yes. So I mean, on the flows in terms of July, so we gave a little bit of an impression. And again, July is only one month. But going back to the second quarter, obviously, June was a much more pleasurable month than was that of April. And there was really a pausing in terms of certain investor appetite at the end of the first quarter into the beginning, and then Liberation Day obviously did create a little bit of uncertainty around where people can invest. So we saw that in our sales. We also saw that in terms of the whole quality versus momentum environment, which for us is more acute because we are slightly over-concentrated on the quality side for some of our equity strategies. So I think as we signaled in the scripts, we were basically seeing an improving experience throughout that quarter. And then particularly as you got to the end of the quarter, fixed income alternatives, etc., were actually doing much better and we're modestly breakeven to positive. And then most of that has continued in July. We continue to see strength around the fixed income, which is very helpful. And in particular, the ETFs, again, our business has been a smaller business, but it's been growing at a very good rate. And as we've indicated, we don't have full availability for all of our ETFs everywhere we want it. So that's a big focus, and we're pleased to see some of that growing. In terms of the institutional side, again, with the longer time horizons that they have, there’s a little less cyclicality in terms of what they’re looking for. Again, we did highlight where we have had outflows has been in more of the quality large-cap side, but we indicated on the inflow side, we do actually see opportunities and it's been a long time for emerging market debt. I hope it's a trend as well as in some of our global and domestic REITs. Mike, is there other things you'd highlight there?

Yes. I would just remind you that we do have a CLO that we anticipate offering and issuing in the back half of the year, and there is breadth in the institutional pipeline across managers, including our focused growth sort of momentum managers where we've seen some success there as well.

Just first on the - following up on the M&A outlook. You mentioned there are conversations, plenty of activity. You're looking at private markets, traditionals. But can you dig into some of the valuations that you're seeing on a big picture way? Does it still remain tough from a valuation standpoint in private markets? And then just within private markets, where are some of the areas that you might be most interested in?

I'm not going to provide specific details, but regarding valuations, private market valuations tend to be higher than those in public markets. There are variations based on subcategories such as private equity, private credit, and real assets, and also whether the focus is on direct origination or allocation. It's challenging to pinpoint a specific valuation multiple in this area, similar to the traditional markets, which continue to show lower valuations compared to private ones. However, there is a premium for assets that are more appealing and stable, while less attractive assets receive a lower premium. This is part of our ongoing discussions. Ultimately, when we and others evaluate these markets, the key factor is the long-term strategic value that will be crucial moving forward. We believe that a well-diversified portfolio should include both public and private elements.

Great. That makes sense. And then just following up on flows as well. You did mention early in the second quarter was tougher, but June was a brighter picture. On July, can you just frame a little bit how July compares to June versus a little bit earlier in the quarter? Did that momentum continue, pull back a little bit? Just a little bit more color there would be great.

Yes, the momentum continues. June was a significantly better month compared to April, and that positive trend continued. We even noted that in certain areas, such as our ETFs and fixed income, there not only was continued interest but perhaps a slight increase as well. We're quite optimistic about this development. On the equity side, while we did experience outflows in quality-oriented equities, which Mike mentioned, not all of our equity offerings fall under that category. We also have more style-agnostic options and some aggressive strategies where we have noticed potential opportunities. These newer offerings have recently been expanded into our retail separate accounts, which we hope will appeal to those with a higher risk appetite. Additionally, on the fixed income side, we've observed that flows into open-end funds and ETFs have become more appealing, especially during June and July. Recently, we've expanded our SMA offerings to cater to investors who prefer those over registered fund vehicles, and this option is currently available.

And our next question comes from Michael Cyprys of Morgan Stanley.

Just wanted to ask about ETFs. I was hoping you might be able to elaborate a bit on the success that you're seeing across your ETF platform, the gross sales flows up year-to-date nicely. Maybe also talk about some of the initiatives that you're thinking about over the next 12 months to drive even accelerated growth across the ETF platform as you look out from here. Maybe you can just remind us how you're incenting the sales force to drive growth on the sale of ETFs and how sort of those sales incentive compensation payments and such compare to mutual funds?

We are very pleased with the performance of our ETFs. Our complex is relatively new, and over the last five to six years, we have been launching products and building track records, especially since most of our offerings are more actively managed rather than passive, which requires a bit of history to gain traction. We are encouraged to see these funds starting to attract assets, with growth rates around 74%, consistent gross sales, and positive net flows. As these funds increase in size, it helps us improve access. We are focused on two main areas: expanding our product offerings and making sure we achieve the right level of scale to gain acceptance across various channels. So far, the early results have been quite positive. As for our sales force, they work closely with financial advisers regarding their preferred investment vehicles. The market has shifted, and some advisers now prefer ETFs over traditional funds or separate accounts. Our wholesalers are assessing which investment structure is the best fit for each client. We aim to align incentives for our sales team with positive behaviors and contributions to the company, while also focusing on maintaining and growing assets effectively.

Great. And then just a follow-up question on the appetite for inorganic activity. Just curious how you're thinking about prioritizing private market opportunities for properties there versus more scale-driven on the traditional side and otherwise. And broadly, if you could talk about some of the steps you would look to take to navigate the complexity of potentially bringing in illiquids to a platform that historically has operated in liquid public markets?

Yes. So in terms of the different types of opportunities, all of them have different attractive characteristics. And then I also referenced that in terms of structures, and again, our model is a little more flexible in terms of how we partner in terms of minority, majority JV, wholly owned, etc., right? So each of them, as we evaluate things like that, we look at them individually and the nature of their contribution and then relative to the nature of the other. So again, we will only do an inorganic transaction if we do believe fundamentally, it is a way to create a good use of capital to create long-term shareholder value. In terms of the second part of your question about integrating into a platform that's more traditionally public. Again, I think that goes back to the way that you're partnering because we basically partner with firms and work with firms or have that expertise. But in many ways, some of the private markets are being sold by wholesalers that are selling the public markets. So in many ways, we always say that our sales force is really dealing with 80% of the book of the financial adviser, and we just need the other product to address the other 20% of the need. And again, we do have a view that on the private market side, investors need to have more choices than what is currently available. And that's really our goal is to sort of find that and then to leverage the infrastructure we have on the distribution side as well in many ways on the operational side to bring that to market.

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

Well, I just want to thank everyone today for joining us. And absolutely, as we always do, please, if you have any other questions, reach out. Thank you.

That concludes today's call. Thank you for participating, and you may now disconnect.