Earnings Call Transcript - VRTS Q1 2021

Operator, Operator

Good morning. My name is Carmen, 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. I will now turn the conference over to your host, Sean Rourke.

Sean Rourke, Host

Thank you, Carmen, and good morning, everyone. On behalf of Virtus Investment Partners, I would like to welcome you to the discussion of our operating and financial results for the first quarter of 2021. Our speakers today are George Aylward, President and CEO of Virtus; and Mike Angerthal, Chief Financial Officer. Following the prepared remarks, we will have a Q&A period.

George Aylward, President and CEO

Thank you, Sean. Good morning, everyone. I'll start today with an overview of the results we reported this morning, as well as a brief update on Westchester Capital Management, before turning it over to Mike to provide more detail on the quarter. So turning to the results, we are pleased with the very strong start to the year, continuing the momentum that accelerated throughout last year, and reflecting the benefits of our new partnership with AllianzGI. For the quarter, we delivered a significant increase in assets under management to nearly $170 billion; the fourth consecutive quarter of positive net flows, representing an organic growth rate of 10% over the past 12 months, our highest level of quarterly sales, which exceeded $10 billion for the first time; strong growth in operating profitability, with the operating margin of more than 10 percentage points over the prior year; a 32% sequential increase in earnings per share as adjusted to their highest level; and consistent return of capital to shareholders and debt reduction. We're especially pleased with our continued trend of broad-based sales strength and positive net flows. The foundation of that growth is our ability to provide a holistic set of building blocks, made available by effective and differentiated distribution with a demonstrated track record of driving growth. Our collection of differentiated managers, each with distinctive strategies, approaches to investing, and compelling investment performance offers a diversity of products and strategies that can appeal to investors and financial advisers across market cycles and changing investor preferences. Our results over the past year have demonstrated the value of our model and approach.

Michael Angerthal, Chief Financial Officer

Thank you, George. Good morning, everyone. Starting with our results on Slide 7, assets under management, at March 31, assets under management were $168.9 billion, up 28% from $132.2 billion at December 31. The sequential increase reflected the addition of $29.5 billion of assets from AGI on February 1, $4.7 billion of market appreciation, and $2.4 billion of positive net flows. AUM is diversified by product type, with open-end funds, institutional, and retail separate accounts representing approximately 43%, 25%, and 22% of AUM, respectively. In terms of asset classes, equity assets represented 63% of AUM, fixed income represented 21%, and multi-asset and alternatives represented 13% and 3%, respectively. Within equity, domestic assets were 73% of total, international and global were 21%, and specialty equity represented 6%. Domestic equity is relatively evenly split among large, mid, and small-cap assets. In addition, we had $3.4 billion of other fee-earning assets at March 31 that resulted from the AGI partnership. Turning to investment performance, we continue to generate strong relative performance across our strategies. As of March 31, approximately 72% of rated fund assets had 4 or 5 stars, and 96% were in 3, 4, or 5-star funds. We currently have 12 funds with AUM of $1 billion or more that are rated 4 or 5 stars, representing a diverse set of strategies from 6 different managers. In addition to very strong fund performance, 93% of institutional assets and 100% of retail separate account assets were beating their benchmarks on a 3-year basis as of March 31. And 93% of institutional assets and 93% of retail separate account assets were outperforming their benchmarks over 5 years. Also, 87% of institutional assets were exceeding the median performance of their peer groups on the same 5-year basis.

George Aylward, President and CEO

Thanks, Mike. So we'll now take some of your questions. Carmen, can you open up the lines, please?

Operator, Operator

First question comes from Jeremy Campbell with Barclays.

Jeremy Campbell, Analyst

Before I ask my question, I just want to clarify here. George, I think you mentioned, when talking about Westchester accretion, it was 6% on top of normalized 1Q. So is the math we take your $6.78, we add back to $0.85 of seasonal and then another month of AGI, so maybe something north of $8, as normalized, for the first quarter?

George Aylward, President and CEO

I'm not going to give you a number. Yes, but we did update based on our most recent earnings, which are the first quarter, and doing it on a run rate normalized basis.

Michael Angerthal, Chief Financial Officer

And I think the adjustments that you just outlined are appropriate to get to that level.

Jeremy Campbell, Analyst

Perfect. Great. And then, George, I know it's still really early, but the data suggests that your sales force might be getting some traction already in distributing the Allianz funds. Just kind of wondering how you'd characterize the early experience so far.

George Aylward, President and CEO

Well, I've been very pleased with the overall experience, and I know I can speak for pretty much everyone here and our sales force and marketing. So I've been incredibly impressed with the caliber of onboarding from AllianzGI. I mean they're a great firm, and I participated in some of the onboarding and the educational sessions for our sales force, which have been very extensive, and I would describe it kind of as best-in-class. So I think they've done a great job in terms of communicating their value proposition, and our folks, who are very used to bringing on new managers and new strategies, I think have absorbed that. So I view that as we're off to a good start. I think currently, for the funds that are currently sub-advised by AGI, I believe they were positive flows in the first 2 months, which I think, as you're sort of pointing out, is off to a good start to take on a new manager and a new set of strategies. So I feel very good about that. And going back to the whole strategic partnership, I think this sort of underscores the intent from our mutual intent, which was for the future growth of a business, which is why the deal is structured the way it is, is because both they and we are really optimistic about the future opportunity to grow the business, as opposed to just have it as a transaction.

Jeremy Campbell, Analyst

And then maybe just in that vein, George, I mean, this is a pretty unique deal, and now you have a structural blueprint in place since last summer. You also have an early case study showing solid sales for the Virtus pipes. Do you think there's potentially interest from other large players, maybe those with more institutional SKUs, to pursue a similar type of partnership structure with you or elsewhere in the industry on the retail side?

George Aylward, President and CEO

I would hope so. This is a well-structured partnership aimed at growing the business and achieving success together. The structure isn't suitable for someone looking to exit a business. I believe our structure provides mutual benefits and fosters good alignment. However, I cannot speak for other parties and their perspectives on what is in their best interest. I am open to discussing this structure with anyone interested in having the conversation.

Operator, Operator

Our next question comes from Mike Carrier with Bank of America.

Michael Carrier, Analyst

First, just with the AGI Partners closed, can you provide some context on the plan and probably timing just around offering those strategies throughout the Virtus distribution network?

George Aylward, President and CEO

Yes, it's already up and running. There was a lengthy period before the closing to secure the fund and client consent approvals. During that time, we did a lot of work to educate our team to ensure they are prepared to effectively distribute through their financial advisers upon closing. Additionally, these strategies are already well-known at the national account level. We also used this opportunity to enhance some of the resources that previously supported AllianzGI employees. It's off and running, and the funds managed by AGI for the first two months alone have already shown a net positive, which we consider a good start.

Michael Carrier, Analyst

Okay. Great. And for Mike, regarding the $138 million in revenue participation liability related to AGI, I want to clarify whether this will affect the adjusted income statement or if it is simply a cash flow item moving forward.

Michael Angerthal, Chief Financial Officer

Yes. And we recorded the consideration that's contingent this period. The accounting for that was based on the unique nature of the transaction. That amount does represent the full liability and the sum total of the payments that we expect to make, based on the assessed value at the end of the first quarter. We will assess those payments on each quarter point and update accordingly, and we'll update it going forward. But it will likely not have a P&L impact going forward, but we'll continue to evaluate that if there's any change. But the view is it's a contingent consideration and will flow through balance sheet items, and any P&L impact would be adjusted on a non-GAAP basis going forward.

George Aylward, President and CEO

Yes. And as Mike pointed out, the cash payments will be annually once a year, so you'll sort of see that in terms of liability, which will adjust based upon estimates of future revenue, but it will also then be adjusted for any future payment. So that liability will change over time for those reasons.

Operator, Operator

Our next question comes from Sumeet Mody with Piper Sandler.

Sumeet Mody, Analyst

For me on the comp ratio, excluding the $9.4 million of seasonal items, getting that core 43.3% for the quarter, how should we square that with the guidance of 44% to 46% that's been maintained? Can you talk about the decision to maintain that and any considerations? Why the first quarter came in below that range or future quarters might be 100 to 300 basis points higher, given the majority of those AGI funds are kind of splitting that net management fee kind of outside of those NFJ funds?

George Aylward, President and CEO

Sure. I will share a few thoughts and then Mike will elaborate. Regarding the ratio, several factors influence it, and one that is often underestimated is the revenue lift from market performance. In the first quarter, we saw a favorable combination of circumstances where equity markets continued to rise. We also attracted a significant amount of sub-advised assets, which do not incur employment expenses, and this occurred for two out of the three months. This adds some complexity to accurately assessing the quarter. As for the guidance and the range, as Mike mentioned, it is subject to variability and can be affected by numerous factors, including revenue and our profit and sales situation. Mike?

Michael Angerthal, Chief Financial Officer

Yes, I think that's right. As we look forward, we take into consideration the highest level of profitability that we've had. We look at the sales levels. We look at expected investments supporting the growth of the business. And I'd expect, all else being equal, perhaps to be at the low end of that range looking ahead. But certainly, it's subject to the markets, sales, profitability as the key elements.

Sumeet Mody, Analyst

Got it. And then one on capital allocation. You guys have been paying down in the kind of $12 million to $18 million range over the last few years. And the first quarter came in a little bit below the range. And then considering repurchases and net settlements, the new $138 million revenue participation liability, the increasing dividend, potential future acquisitions, how should we think about this change in capital allocation from here? And maybe specifically on the appetite for acquisitions, has that changed at all, given now you have 2 balance sheet items with the kind of high cash flow that you guys are bringing in and current acquisition costs, the zero net debt. So putting all of that together, A, how does the capital allocation strategy change, and then B, how does that impact your appetite for acquisitions kind of going forward?

George Aylward, President and CEO

Yes. Well, I don't think the overall strategy changes. I think the fundamental premise of the strategy was to basically make sure that we had flexibility to do all of these things in terms of investing in the growth of the business and returning to shareholders, and then always maintaining reasonable levels of debt. So we actually feel pretty good that, because of where we currently are in terms of our levels of debt, that even with some of those upcoming cash obligations that Mike highlighted, that the cash flow that we're generating is sufficient to really sort of address those and then still leave opportunity if we ever determine that an M&A transaction makes sense. So we actually feel like we have a lot of flexibility to continue to evaluate all of those opportunities at any given time. And as it relates to M&A, as we've said before, our growth strategy is not predicated upon continuous M&A. However, we will do M&A in those opportunities that we think will be incredibly additive or strategic in terms of either product capability or distribution access or sometimes in terms of scale. So we kind of feel very comfortable that, on a relative basis, we have that flexibility to do those. Mike, anything you'd add to that?

Michael Angerthal, Chief Financial Officer

Yes. No, I would just reiterate the upcoming payments that are obligations that we're considering in the next 12 months with the closing of Westchester in the first quarter, first revenue participation payment. So we're factoring all of those into our capital priorities.

Operator, Operator

Our next question is from Michael Cyprys with Morgan Stanley.

Michael Cyprys, Analyst

Maybe just coming back on the AGI side, I was hoping you could talk maybe a little bit about some of the distribution initiatives, how you plan to sort of expand distribution of those AGI products. You went through some of the actions you've taken just around educating the sales force. But as you kind of look forward, what are some of the actions that are coming down the pike? And what's the opportunity, would you say, on the institutional side? I know you spoke about some of the retail investor add, but what's the opportunity for expanding distribution of those AGI products on the institutional side, and how are you approaching that?

George Aylward, President and CEO

Yes. Just on the last piece, to clarify, so for AGI, we are not representing and supporting them on the institutional side, so we really are their U.S. retail partner. So our focus with them is bringing their very compelling strategies to the retail U.S. intermediary space, in particular, so it really is focused in on retail. So as we sort of look at what the opportunity set for AGI is, so again, the collection of products were very strong and very differentiated. They had very good access in many of the places that we're available. So our approach has been to take the great foundation that is already present with the products and the relationships that existed there, and then, using some of the resources that have that knowledge and experience, and then expanding it with ours to try to sort of leverage our additional relationships and more expanded sales access to sort of maximize that. So I think, where I think they did a great job with what they had, I think where we might be able to have some opportunities working collectively with them is to really find more and better ways to sort of position their products within some of the areas of access that we have greater access than maybe they historically had. The other thing I would point out for AGI is that we look at this as a very important strategic relationship. Included in that will be further thoughts around introducing other of their capabilities in the retail market. So this isn't a closed block of capabilities. We maintain a continuous dialogue with them about other opportunities because they have a lot of compelling capabilities that we might find opportunity for in future retail products.

Michael Cyprys, Analyst

Great. And just maybe a broader question on the institutional side, I think you had referenced a pipeline of mandates that have been won but not yet funded. Maybe you could just elaborate on some of the areas where you're seeing strength on the institutional side. Are you able to sort of elaborate on the pipeline and help quantify maybe how that stands today versus last quarter or a year ago? And just more broadly, on the institutional marketplace, maybe you could talk about some of the emerging trends that you're seeing amongst your client set and the products that you're seeing in demand and how your approach within the institutional channel is evolving to keep pace.

George Aylward, President and CEO

So regarding our focus on the institutional and pipeline areas, we see this as a significant growth opportunity and have dedicated more resources to it over the past few years. Recently, we have observed a consistent increase in new mandates, which marks an evolution from previous sporadic opportunities. Currently, the pipeline looks broader than before in terms of affiliates and strategies. However, as is typical in the institutional space, it can fluctuate at any moment. My comments were intended to highlight that we have multiple capabilities that are currently attractive. We also believe there are continued expansion opportunities, especially with non-U.S. clients, as many of our managers are not widely recognized outside the U.S. and have substantial potential once they gain visibility. Our strategies are designed to adapt within the institutional space, where most of our affiliated managers focus on differentiated, high-conviction, quality-oriented, or income-oriented strategies. We're working to find the best match between our capabilities and the market's interests. While institutional business remains unpredictable, it's encouraging to see a greater variety of capabilities across managers and asset classes. I am particularly pleased about the resurgence in fixed income, which had weaknesses last year but is showing improvement in some of our strategies. Our flexible product set is designed to adapt to market changes, so it has been reassuring to see strength returning in fixed income.

Michael Cyprys, Analyst

Got it. And then just the latter point just around your approach on the institutional challenges, anything to speak to there in terms of maybe how your approach to the channel, perhaps on the sales side, is evolving? Maybe you can remind us how you're sort of approaching the marketplace from a sales standpoint in terms of salespeople at the center versus at the individual affiliate franchises. How are you thinking about and approaching that?

George Aylward, President and CEO

Yes, I would describe our approach as affiliate-centric. Each affiliate is unique in terms of their position and the opportunities available to them. We offer shared resources to support these affiliates. In some cases, we engage in a wide range of activities, while in other cases, we provide specific support or systems. Our strategy is customized for each affiliate based on their strengths, as each has distinct opportunities, and we utilize a mix of resources to assist them.

Operator, Operator

Okay, and this concludes our question-and-answer session. I would like to turn the conference back to Mr. Aylward for his final remarks.

George Aylward, President and CEO

All right. Well, thank you very much. I want to thank everyone for joining us today and certainly ask you to call us or reach out if you have any other further questions. Have a great day. Thanks.

Operator, Operator

And thank you. This concludes today's conference call. Thank you for your participation, and you may now disconnect.