Virtus Investment Partners, Inc. Q3 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 third 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 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 these 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 them. 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. I'll begin by providing an overview of our results reported this morning before handing it over to Mike for more details. We achieved solid financial results in the third quarter, mainly due to higher average assets under management and positive market trends. However, we experienced net outflows as our quality-oriented strategies faced challenges in a market that favored momentum. Our priorities include enhancing our retail separate account offerings, expanding ETF availability in key channels, and growing our wealth management business. Notable highlights from the quarter included an increase in earnings per share and operating margin, strong growth in ETF assets with our highest quarterly sales and net flows, positive net flows in fixed income and alternative strategies, an increase in our quarterly dividend for the eighth straight year, and we completed a debt refinancing that enhances our liquidity and flexibility for business investments and shareholder returns. Our ETF business was particularly strong this quarter, with assets reaching $4.7 billion, a 79% increase from the prior year, accompanied by a strong organic growth rate. In the third quarter, ETF sales and flows peaked at $0.9 billion each, driven by robust investment performance and demand for certain strategies. As of September 30, 77% of ETF assets under management surpassed their benchmarks over a three-year period, and 85% outperformed peers in the same timeframe. We're committed to broadening access to our ETFs in key distribution channels and launching new, attractive offerings. Currently, we have 21 ETFs across different strategies and several actively managed funds in the filing stage, with anticipated launches including growth equity-oriented ETFs from Silvant, a real estate income ETF managed by Duff & Phelps, and a multi-managed fixed income ETF in collaboration with Sykes, as well as a series of building block ETFs from Virtus Systematic, following the introduction of a global macro ETF from AlphaSimplex in the third quarter. Regarding inorganic growth, I want to emphasize our disciplined approach; we remain open to attractive opportunities but will only pursue those that are both financially and strategically beneficial. In the quarter, we incurred $1 million in specific business initiative expenses related to inorganic activities. Now, regarding investment performance, while recent equity performance illustrates our quality orientation in a market with positive momentum, we are satisfied with the performance generated across market cycles. Over the last decade, 70% of our equity assets and 77% of our fixed income assets outperformed their benchmarks. Specifically, for mutual funds, 70% of our equity funds and 80% of our fixed income funds surpassed the peer median. Additionally, 25 of our retail funds received 4 and 5-star ratings, with 84% of our rated retail fund assets in 3, 4, or 5-star funds. Now, let's review the results. Total assets under management stood at $169 billion by September 30, slightly down from the previous quarter as strong market performance was countered by net outflows. Total sales reached $6.3 billion, a 12% increase from $5.6 billion in the second quarter, driven by higher fixed income and alternative strategy sales. We saw increased sales in institutional and ETFs. Total net outflows for the quarter remained at $3.9 billion compared to the previous quarter, even with our highest ETF flows and positive flows in fixed income and alternative strategies, which were outweighed by outflows in quality equity strategies. When examining flows across asset classes, the equity net outflows mainly reflect our focus on quality-oriented strategies. While quality has historically outperformed in longer market cycles, it often lags in risk-on environments, especially evident over the past two years. Fixed income net flows were positive for both the quarter and the trailing twelve months, backed by strong investment performance in both short and long-term periods. During the quarter, we experienced positive net flows in our fixed income strategies across several products, including ETFs, institutional accounts, and retail separate accounts. Net flows for alternative strategies were also positive, primarily driven by ETFs. In October, we are seeing trends in flows across products and asset classes that remain consistent. ETF sales and net flows continue to be strong, but U.S. retail mutual fund headwinds are ongoing. In the institutional space, trends mirror those of the third quarter, with known redemptions exceeding known wins, though we have seen wins across several strategies, including emerging market debt and both global and domestic REITs. Now, let's move to our financial results. The sequential improvement reflected growth in average assets under management and consistent operating expenses. The operating margin rose by 170 basis points to 33%, or 33.4% excluding discrete items, with an incremental margin above 50%. Adjusted earnings per share were $6.69, up from $6.25 in the second quarter. Compared to the same period last year, adjusted earnings per share decreased by 3% due to lower average assets. In terms of our balance sheet and capital, due to the approaching maturity of our previous credit agreement, we refinanced with a new $400 million term loan and a $250 million revolving credit facility, enhancing our financial flexibility and extending our debt maturity profile with favorable terms. This refinancing added $158 million in cash to our balance sheet at the end of September. We also increased our quarterly dividend, marking the eighth consecutive annual rise. Regarding share repurchases, we did not buy back shares in the third quarter due to other priorities. For context, we repurchased $50 million in shares during the first half of the year, which exceeded the total of our repurchases in each of the prior two years. Buybacks continue to be a key part of our capital management strategy. With a solid liquidity position, we plan to balance returning capital to shareholders while investing in the business, including potential inorganic opportunities. Now, 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 September 30 were $169.3 billion, and average assets increased 2% to $170.3 billion. Our AUM 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. Within open-end funds, ETF assets under management grew to $4.7 billion, up by $1 billion sequentially on continued strong net flows and have increased 79% over the prior year. 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 grew 12% to $6.3 billion with higher sales of both fixed income and alternative strategies. Reviewing by product, institutional sales of $2 billion compared with $1.3 billion last quarter, driven by fixed income and multi-asset strategies, and included the issuance of a new $0.4 billion CLO. Retail separate account sales were $1.4 billion, essentially unchanged from the prior quarter. Open-end fund sales of $2.8 billion were consistent with the prior quarter as strong growth in ETF sales were offset by lower sales of U.S. retail funds. ETF sales were $0.9 billion, more than double the prior quarter level. Total net outflows were $3.9 billion, consistent with the prior quarter. Reviewing by product, institutional net outflows of $1.5 billion improved from $2.2 billion due to the increase in inflows into fixed income strategies. As always, institutional flows will fluctuate depending on the timing of client actions. Retail separate accounts had net outflows of $1.2 billion, driven by small and SMID-cap strategies, while large cap and fixed income generated positive net flows. We also continue to see positive net flows in our style-agnostic, high conviction, large-cap growth offerings. For open-end funds, net outflows of $1.1 billion compared with $1 billion in the prior quarter and were driven by equity strategies within U.S. retail funds, which more than offset positive net flows in ETFs. ETFs continued to generate strong double-digit organic growth rate with $0.9 billion of positive net flows. Turning to Slide 9. Investment management fees as adjusted of $176.6 million increased 3%, reflecting a consistent average fee rate and an increase in average assets under management. The average fee rate, excluding performance fees, was 41.1 basis points, unchanged from the prior quarter. Looking ahead, we believe this fee rate is reasonable for the fourth quarter modeling purposes. And 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 $98.7 million increased slightly due to higher variable incentive compensation. As a percentage of revenues, employment expenses as adjusted declined by 70 basis points to 50.2%. Looking ahead, it is reasonable to anticipate employment expenses as a percentage of revenues will remain within our recent 49% to 51% range. Turning to Slide 11. Other operating expenses as adjusted were $31.1 million, down from $32 million due to lower rent expense from office consolidation and the prior quarter impact of the annual equity grants to the Board of Directors, partially offset by $1 million of discrete business initiative expenses. As a percentage of revenue, other operating expenses were 15.8%, down from 16.7%. For modeling purposes, our range of $30 million to $32 million per quarter remains appropriate. Slide 12 illustrates the trend in earnings. Operating income as adjusted of $65 million increased 9% sequentially due to higher revenues and relatively stable operating expenses. The operating margin as adjusted of 33% increased 170 basis points from the second quarter. Excluding the discrete business initiative expenses, the operating margin was 33.4%. With respect to non-operating items, interest and dividend income of $4.1 million declined sequentially due to elevated CLO interest income in the prior quarter. Looking ahead to the fourth quarter, it would be reasonable to anticipate a higher level of interest income given increased cash balances at the end of the quarter as a result of the recent debt refinancing, offset partially by lower CLO interest income. Interest expense was $4.8 million in the third quarter. It would be reasonable to assume that will increase in the fourth quarter given the higher debt level. Noncontrolling interest, which reflects minority interest in one of our managers, were modestly lower, primarily due to the increase in our ownership late in the quarter. A reasonable run rate for the fourth quarter is approximately $2 million. Net income as adjusted of $6.69 per diluted share, which included $0.11 of discrete expenses, increased 7% from $6.25 in the second quarter. In terms of GAAP results, net income per share of $4.65 decreased from $6.12 per share in the second quarter due to $1.54 of unrealized losses on investments, partially offset by $0.42 of fair value adjustments to minority interests. Slide 13 shows the trend of our capital liquidity and select balance sheet items. On September 26, we completed the refinancing of our credit agreement, increasing the company's financial flexibility and extending the maturity profile. The new $400 million term loan has a 7-year maturity, and the revolver provides $250 million of capacity through 2030, each bearing interest at SOFR plus 225 basis points. Cash and equivalents at September 30 were $371 million. In addition, we had $300 million of other investments, including seed capital to support growth initiatives. During the third quarter, we raised our quarterly common dividend by 7% to $2.40 per share. Other uses of capital during the quarter included $29.7 million to sponsor the new CLO as well as $14.8 million for a planned increase in equity of our majority-owned affiliate. The last of the scheduled equity purchases of the affiliate will be approximately $7 million in the fourth quarter. At September 30, gross debt to EBITDA was 1.3x, up from 0.7x at June 30 due to the upsizing of our credit facility. We ended the quarter with $29 million of net debt or 0.1x EBITDA, which declined from 0.2x at June 30. Our strong levels of liquidity, including the undrawn revolver and modest net leverage provide meaningful financial flexibility to continue to invest in the business and return capital. And with that, let me turn the call back over to George.

Thank you, Mike. So we'll now take your questions. Didi, would you open up the lines, please?

And our first question comes from Ben Budish of Barclays.

Maybe just first on the ETF side, you've noted that that's an area of strength. Could you just maybe unpack for us a little bit, what are the key strategies that are attracting the most interest? Is it the wrapper itself? Is it the particular strategies that are offered in that wrapper, the franchises? And how do you think about that in terms of what informs the future pipeline? You mentioned a couple of things upcoming, but as you think about the next couple of years, how are you thinking what might make sense either to launch or to kind of rewrap? How are you thinking about all that?

Sure. Yes. So I think in terms of what's driving, I think it's both components. The ETF wrapper itself is highly preferred by a large number of investors and financial advisers. Transparency benefits, tax efficiency. So I think in certain instances for specific strategies, it's become a vehicle of choice. In terms of what strategies people are accessing. Our ETF business is a newer business, and we've been building out track records in many of our strategies. Currently, we've seen growth occurring in several of them, particularly those in the alternative space or those that have certain types of return patterns that are being found to be very attractive. I commented a little bit on some of our pipeline because we really do see a lot of opportunities for very specific types of strategies in the ETF wrapper that will increasingly be utilized in portfolios. I also made comments about getting availability for ETFs, which is a big focus for us. A lot of times with newer ETFs, it's harder to get access in certain subchannels. As we grow them, we had one this quarter where we got to a level of access that drove some of our flows this quarter. That continues to be a priority for us. Separately, I would note for the ETF share class relief, we are one of the firms that do have filings in process related to that as well.

Very helpful. Maybe just following up in terms of growth priorities. You mentioned inorganic opportunities in your kind of brief comments about uses of capital. Just any update on pipeline potential timing? Are there any changes in the environment that make things more or less feasible? You talked about sort of growth versus momentum. Does that sort of inform the types of assets you're interested in acquiring? Just any update there would be helpful as well.

Yes. But on the last point in terms of quality versus momentum, having been in a period where for the last 2 years, quality has significantly underperformed momentum. That is a current event. For a long-term M&A strategy, that might not necessarily have a huge impact on it, though it would influence it. We look forward to the reversion for quality coming back into favor, which is generally when quality-oriented strategies have their best performance. So, unless momentum continues to lead the markets for the next multiple years, we will have a headwind. When it inverts, we'll be well positioned to capitalize on that. As for inorganic, again, I repeated some comments from last quarter; activity remains very active, and there are many opportunities in terms of things that could potentially make sense. We focus on a disciplined and targeted approach regarding what makes sense in terms of adding another differentiated high-performing traditional capability, private market expansion, or gaining access to more clients outside the U.S. Those are the three areas I've previously commented on. Nothing specific to announce at this time, but again, it remains a very active area for us.

And our next question comes from Crispin Love of Piper Sandler.

First, just looking big picture at net flows, they've been pretty elevated for 4 consecutive quarters net outflows. When you look forward, do you see any key levers to be able to improve those flows to get to more neutral, at least less negative outside of just quality coming more into favor versus momentum?

Yes. Well, a couple of things. We did have positive flows in fixed income strategies in the quarter, along with positive flows in alternative strategies and ETFs. Our flows are really around our overweight to quality-oriented equity strategies. Our equity strategies that are not highly correlated to quality are experiencing positive flows. It's just our significant overweight in those types of strategies that overshadow any of the other areas that have performed positively. Our focus now while the cycle remains negative for us is to grow those strategies that don't share that same correlation. As previously mentioned, some of our more style-agnostic or momentum-oriented equity strategies are experiencing positive flows, but they're just a smaller part of our business, so they won't be able to overshadow the quality and momentum. The quality versus momentum has been unusually stark over the past 2 years, with examples such as the S&P MidCap Quality Index trailing the S&P MidCap momentum by about 32%, ranking in the 93rd percentile of historical data, the worst level since October of 2000. Similarly, for small-cap, the Morningstar U.S. Small Cap quality trailed the Morningstar U.S. Small Cap momentum by about 82%, marking the worst level since 2008. Historically, following an inversion, quality has some of its strongest outperformance, and that's when we believe we can capitalize.

Great. I appreciate all the color there. And then just second question for me on other OpEx. You had the office space consolidation. Is this something that you've been thinking about for several quarters? And then shouldn't that drive down the run rate for OpEx moving forward? Or are there offsets in there as well? And then also, if you can just detail what the $1 million of discrete business initiative expenses were in the quarter?

Sure, Crispin. I'll jump in. It's Mike. With respect to the office consolidation, this is the quarter that you actually see it in the run rate. Those are some actions that we have taken starting late last year and earlier this year that have now been reflected in the run rate. We talked about the $30 million to $32 million range ex the discrete items coming in at the low end of that range, due to the benefit of that office consolidation. We provided transparency around the discrete items because as George alluded to, they are generally related to elevated levels based on some of the inorganic activity we have been pursuing. We thought providing that transparency would be helpful in the analysis of other operating expenses. Again, they are specific to those activities and at levels higher than what we would anticipate at a more normalized level.

And our next question comes from Bill Katz of TD Cowen.

Okay. Just sticking on the discrete spend here. Is that now over? Or should we anticipate that this will persist? Also, are you back in the market for buybacks at present?

Yes. On the first part of your question, again, we were clear in the prepared comments that we're still being very active, and there are still a lot of opportunities for us. We'll stand by that, saying that we are actively evaluating potential opportunities. Regarding buybacks, there is nothing specific to share other than we continue to view buybacks as a core element of our capital strategy. Halfway through the year, we bought back $50 million, which has us at the highest level over 2 years. This remains something we will evaluate, but we must balance it with other factors and priorities.

Okay. Just as a follow-up, going back to your commentary that in the fourth quarter, the institutional trends are still looking like they were in the prior quarter. Can you unpack that a little bit, where you're seeing strength and where you’re seeing the weakness? And what you're seeing generally in terms of allocations, specifically the demand for liquid alternatives?

Yes. Two areas I was actually very happy to see are emerging market debt, which may have not been favored previously, and positive results in global REITs and domestic REITs. Generally, in institutional, we have a nice non-U.S. institutional business. I believe both areas I referenced are non-U.S. You have a slightly different investor profile there, which is why we can see interest in strategies that may not be as favored in the U.S. retail market or U.S. institutional market but offer opportunities. Those are the two areas I would highlight, but there are a variety of managers across various geographies as well.

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

Just want to ask about ETFs. I was hoping maybe you could speak to how broadly distributed your ETFs are today across the wires, IBDs, RIAs, etc., how that compares to where you'd like that to be? Talk about some of the steps you're taking to expand your distribution presence for your ETFs, including in models? If you could maybe just update us on how models are contributing, if at all, today.

Yes. That's a great question. One main area of focus is increasing the availability of our ETFs in various channels. As you noted, getting access is different across channels, such as wires versus RIAs, along with accessing model providers and professional ETF buyers. We believe we have a great opportunity, especially if we can elevate some of our ETFs to a level of scale that matters in certain channels, like wirehouses, which need certain asset levels for access. We always focus on some model providers and professional buyers, and see that as a tremendous opportunity. Almost all our product development has been concentrated either on the ETF side or global fund side, alongside retail separate accounts. Our focus here has been expanding offerings, particularly in fixed income where we have constructed several frameworks to capitalize on that. That's another area where we see growth potential.

Great. And then just a follow-up question on inorganic activity. I was hoping you could elaborate on the types and size of opportunities that you're evaluating. Talk about your process in sifting through these properties and remind us of your criteria and hurdle rates. Does the transaction need to be accretive day one or within the first 12 months? How are you thinking about that?

Yes. When we speak about inorganic, we're covering a wide range; those that can add meaningful scale, those that can add capabilities that are quite additive to our current offerings, and expanding from public market offerings into private markets. We keep ourselves open to various opportunity sets and evaluate primarily what best fits strategically and what brings financial benefit and creates long-term value. We consider factors like accretion and the impact on our growth rates. While I don’t have specific hurdles to share, we assess various elements as we choose between alternatives. The good news is, with our current net debt being minimal and steady cash flows, we have flexibility to evaluate different types of opportunities. Great. Now thank you, and I want to thank everyone today for joining us. As always, if you have any other questions, please reach out. Thank you very much.

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