AllianceBernstein Holding LP Presents at Bank of America Merrill Lynch 2012 Banking and Financial Services Conference (Transcript)

| About: AllianceBernstein Holding (AB)

AllianceBernstein Holding LP (NYSE:AB)

Bank of America Merrill Lynch 2012 Banking and Financial Services Conference

November 13, 2012 01:45 PM ET


Peter Kraus - Chairman & CEO

Seth Masters - CIO


Unidentified Analyst

Some more questions, couple of polling questions, so please help us out and grab one of those recorders and give us your opinion. This is the first industry question which is one that's been a big one in the industry lately, which is “When will investors rotate back into actively managed equities? In January, sometime next year, next two years, never; let us know what you think. I suppose there is a chance that your answer would be one something other than that like, over the next five years, but let us know.

And then we will also ask an Alliance specific question for fun, oh I am sorry first, we’ll ask an expansion upon the last question which is “What will it take to get investors back as actively manage equities? You think it takes better market? Do you think it takes a worse bond market, tougher, need for higher returns or maybe higher dividends; one of those? Sorry we don’t have an “other” in this case.

And by the way, we’ll assemble the answers and look at them just before Q&A. And then the last is just an Alliance specific question which is “Well I just had a mix shift is now 24% or so active equity, I believe” and so interesting strategic questions. Should it rebuild this equity, should it go with the emphasis on bonds, or one of the other possibilities including just remain as broad as possible. So let us know what you think and when we’re done.

Okay, so now the presentation I guess probably most of you know Alliance pretty well, but just briefly you know just following for years, I'd say one of the things its notable about it is retail institutional and high networks as well as a global footprint, Alliance is probably, covers one of the broadest swaps of asset management among the public companies. And as most know, it’s had its challenges, many from equity underperformance but also some positive trends recently.

Earlier this year at some point it actually touched 400 billion, I think, which was a level not being since about 2008, but has rebounded 2009, which rebounded help us strong fixed income sales, great retail channels sales particularly from overseas and it spread, as I said, really offers a lot of possibilities.

So with us here today is Chairman and CEO Peter Kraus. Peter has been in Alliance nearly four years and that has led a number of initiatives including streamlining, introduction of a lot of new products including the popular low volatility strategies and also with him is Seth Masters, CIO for asset allocation strategies and Seth has been at Alliance-Bernstein for 22 years. So with that, I'll turn it over to Peter Kraus. Thanks very much.

Peter Kraus

Thanks a lot Cynthia. So I look forward to your answers myself particularly on slide three, but thanks a lot. It's a pleasure to be back at the BoA Merrill financial services conference. So it's a good time when we're here to update all of you on how we have executed our growth strategy throughout the year. So we're going to try to do that. I'm as Cynthia said, coming up on my fourth anniversary at AB and so I thought I'd use this presentation to share a bit of a report card with all of you on what we've accomplished during my time at the firm.

It's no secret that AB has had a lot of work to do over these four years. We've also had to invest for growth in a number of areas at a time when assets and revenues were declining and we were losing ground in institutional equities, the traditional growth engine of the firm that certainly has been our challenge. Yet even with all these challenges that we faced, we've been able to pivot our businesses to be better positioned for our clients. We are on a stronger financial footing and we're facing a much better and brighter future.

Business leaders in our firm like Seth, who have been instrumental in our ability to make this shift, deserve a lot of the credit. So let me take you through what’s happened at firm wide level over the past four years, before I hand it over to Seth to share his successes when the allocation strategies.

Seth Masters

So, I know you need some time to read this slide, I'm not going to give it to you, but you know what's on it. So I'm going to get started. So state of the firm, it's no exaggeration to say that I came into a firm that was in the midst of a traumatic reversal of fortune in 2008. After several years of unprecedented successes, because over of the over-exposure certain large cap financial stocks and companies that were subject to financial leverage going into the financial crisis, our global growth and value investment performance declined precipitously.

It was exaggerated by how large our asset bases had gotten in these two strategies and also by the fact that we had underinvested elsewhere in innovation and growth, particularly in our valuable retail franchise. The good news was that our fixed income strategies were performing extremely well. The bad news was we weren't leveraging that strong performance, on top of all that we overbilled, overspent in the boom times. We're also in the throes of the worst financial crisis since the great depression and we needed to put a plan in place immediately to stabilize the organization prioritizing initiative that would ultimately input AB back on a path of growth, so here's what we did.

You've seen its action plan, we followed it very since. Those of you who follow AB on a regular basis will recognize these four focus areas. We'll update you on what we've accomplished in each of these areas on each quarterly earnings call and whenever we add investor conferences like this, you get a sense of our progress.

First, we've had to address our investor performance issues by supporting our strong fixed income platform and evaluating our research and investment processes and equities. We also needed to invest from growth in areas where we saw the most long term promise and more important, where we could anticipate and meet clients’ needs.

That meant we’re invigorating our retail franchise building out, our emerging growth areas across products and regions and innovating for our clients with new services and new ideas.

And we had to address our cost structure by taking a hard look at headcount, space and all of that against prevailing business trends. This slide is going to look even more familiar to some of you; it sums up all we've accomplished in the past four years in executing on that strategy. I think we’ve achieved quite a bit, especially considering the difficulties of all the markets we've seen and the pressures we've been under as a firm and frankly as an industry over the past four years.

We have delivered consistent fixed income, outperformance and made headway in equities. We've launched new equity services that meet our client’s evolving needs even as we've remained committed to core equity growth and value services. We've innovated for our clients with newest offerings across channels and asset classes.

We are not only re-invigorated our US retail business, we are now on the map in a major way in Asia and growing in Europe as well. In four years of declining market volumes, our leading US self-side business has been able to gain share, add talent, and successfully expand into Europe and now in Asia.

We steadily enhanced our private client offering. We've also built a strong business and reputation in the defined contribution space in both the US and in the UK. You’ll hear a lot more from us on these two areas from Seth in a moment.

Finally we are steadily improving our operating leverage through an ambitious global real estate consolidation plan and other expense initiatives. While our work is by no means done and we made significant meaningful progress, in the time we've been executing our long terms strategy, we have more to go. Most importantly, we've positioned our business over the past four years to be there in a better way for our clients. That will pay dividend and will improve substantially in all of these areas; sales, profitability, financial strength for the long term. So let’s look at where the business stands today.

Large cap equities which represented more than half of our total assets and nearly two thirds of our annualized fee base at the end of 2008, half of the assets of two thirds of the fee base has clearly contracted significantly during these past few difficult years.

At the same time, our investments to build out in other areas have paid off. We've achieved growth in every area beyond large cap equities and are a much more diversified business today. Asset tender management in these services have increased by 61%, almost two thirds, in the time we've been executing our strategies in annualized fees, they generate have increased 75%. The 527 million in incremental annualized fees we now earn from these strategies replace about 75% of the fees we've lost as result of the client in large cap equity.

And we believe large cap equities will come back as markets become amenable to core growth and value disciplines and our performance therefore improves. We have a long history of delivering for clients, though we've certainly disappointed recently. We may never be again as big as we once were in large cap equities, but we don't need to be. We're well positioned and growing in a number of areas that are important to our clients, and we've diversified the business and won't return to our over concentration of the past.

Asset allocation strategy which is (inaudible) business could be our greatest success story in this regard. It's a place where our clients increasingly want to be and where we've innovated with new offerings to meet their needs. In the past few years we've built a significant presence in this emerging space and our clients have responded. Asset allocation AUM has grown the most in percentage terms of all the targeted growth areas for the firm. Today it's about 12% of the firm’s AUM and the fees we realized from asset allocation services has nearly doubled since the end of ’08 to almost a $190 million on an annualized basis, Seth is going to take our array of asset allocation strategies which are designed to balance, taking a long term view for clients. With adjusting dynamically to respond to near term market challenges while at the same time managing clients risk. I'm excited about all we've accomplished for this business I can't imagine a more effective architect than Seth.

So without further ado I'm going to turn over to Seth.

Seth Masters

Well thank you Peter and Cynthia and it is a pleasure to be here today and I feel very excited to discuss with you our asset allocation services. A business that I am very passionate about and one where I think although we've come a long way very quickly, there is a long way yet ahead of us to go, and why is that, why is there this growing need for asset allocation in our view?

Well our industry, really since its founding has typically focused on slots and roles basically taking a capital structure and breaking it up into its component parts like equity and within equity, growth and value and large and small cap and then slicing and dicing portfolios into those constituent components or style boxes and then trying to determine which are the best managers in each of those boxes. The asset allocation decision has actually been secondary in terms of the way our business has actually been compensated in a way it's run its self and along the way, in fact most of the efforts been dedicated by the industry to manage a selection and to bring out who is the best manager in each box. Where does that asset allocation decision end up? Well ironically it goes back to the investor. And that in fact is a bit of a problem because investors over the last few years and especially since 2008 have recognized that they are meeting their goals and that they have incurred a lot of more risks than they were expecting.

They’ve discovered that fixing that problem requires revisiting this issue of them taking on implicitly the allocation of capital and their asset mix. And they can’t fix that problem, we're responsible for those framework. They actually have to have a better approach to asset allocation across the boxes, not just worrying about what's happening within each box.

And, what we see as we work with investors of all different stripes is that the precise goal or objective that investors are shooting for is very-very different for different types of investors. Individuals are trying to meet financial goals, like being able to send their kids to college or being able to retire at the age of 65. So define benefit plan, the goal is probably meeting your planned liability and especially if you are under underfunded that can be a huge challenge. We define contribution plan, increasingly the key issue is helping your participants achieve a dignified retirement and having that outcome be somewhat more concrete, more certain foundations and endowments, are trying to make sure that whatever spending policies they're committed to is something that they can sustain over whatever their horizon might be and so on.

So all of these actually incredibly varied objectives and in many cases, something that's required to future amount of study, but underlying those objectives, which you find are there really two key concerns, that investors know they have to get right and often needs help with. The first is, when you're trying to meet that objective, what is the strategy you're going to pursue, what is the policy over the long run which is going to give you the best side of meeting your strategic goal and managing your risk of not make them goal in the long run.

And the second big concern that people express is what’s the shape of the path that gets you to that long run outcome and I think 2008 is a good case study of why just reaching the goal by itself is not the only problem that shorter term or dynamic issue of how you get there, is pretty important as well.

And we've found a number of ways, to address the needs of different kinds of investors across a spectrum of different asset allocation services that draw on our abilities in this area. Our first group of asset allocation clients were our private clients and that’s because we've been managing money for private clients since 1967 and the vast majority, I would say about 90% of our private client really see us as their asset allocator and as a partner with them and helping to find and meet their investment objectives. So it’s a natural roll for us to allocation.

And we've designed and implemented an integrated approach to asset management for private clients that systematically manages not just asset allocation, but also their taxes and risk across each one of the about 30,000 individual client portfolios for which we have responsibility.

We’ve also done a lot of work to enrich what’s inside that private client solution. Our most important innovation over these last few years I think has been incorporating dynamic asset allocation into the private client channel and I'll give you a little bit more detail on that in a minute. But dynamic asset allocation which we also call DAA focuses on dynamically adjusting the exposures inside client portfolios to make sure that they remain in tune with the evolving risk and return dynamics of the market. So the result that we’re looking for in portfolios that were dynamically managed is more consistency of return. Essentially the same return with a lot less risk in the tails.

Another key area for us is the fund contribution. And in that case we have been building a differentiated presence for years now. We started by making some real breakthroughs in glide path design which is devising the asset allocations through time of target-date type services whose asset makes mix shift gradually over the lifecycle of an individual.

And then we introduced our own customized retirement strategies or CRS service which helps 401K plan to implement the target-date default design that's right for them that allows them also to improve the oversight quality of their the fund contribution plan and reduces cost, to basically make the fund contribution much more institutional, much more like traditional DB.

And we continued to refine our CRS offering and most recently we've implemented a lifetime income service which allows VC plans to actually offer a guaranteed income benefit that really makes VC in our view at parity with traditional DB but with a whole lot less constant risk for the employer.

And finally in the fund contribution arena, we've also taken the CRS concept for the UK as well as the US and we’re following (inaudible) CRS but also developing a new service called the retirement bridge which manages the timing of a new innovation.

So that's the third column on the chart, if you move over to the fourth column, inflationary assets is actually a relatively new area for us. And note that we don't know exactly when inflation might pick up around the world and we're not making a forecast that it will do that imminently but we do know one thing, whenever inflation does pick up, it will immediately become one of the biggest problems for the vast majority of investors, because rises in inflation tend to be bad for both bonds and stocks and therefore you really need from an asset allocation standpoint, some assets that actually benefits when inflation rises which is why we have now a value of services that provide that kind of inflation sensitive effect.

And last by no means least, our index business is also a growing area, and it's becoming an opportunity for us to add more value for clients. What we will focus on is that there's a big difference between what most people think of as indices which are the plain vanilla benchmarks like the S&P 500 and customized strategies that can provide risk control or be tailored to a specific client need. Most of our business is actually custom indices although we do vanilla indices as well and those are in fact higher value added to the client where we tend to be more attractive business for us as well.

So let’s delve into each of these five areas of asset allocation in a bit more depth, beginning with private client. As I said, we have made some very substantial enhancements to our private client offering over the last couple of years, and we've actually, essentially, renovated every aspect of the service. We introduced the AA or dynamic asset allocation in 2010 and now that allows us as I mentioned to modify our exposures to stocks versus bonds, US versus non US assets and interest rate exposures, currency exposures to smoothly reflect the risk and also rewards that we see in the marketplace as they evolve literally day by day.

In 2010, if you move to the bottom left, we also introduce alternatives which initially was an institutional type vehicle that was appropriate for the higher end of our private client business and it is a multi-manager funded fund that's very uncorrelated to equities of any stripe and actually also relatively uncorrelated with bonds and therefore quite attractive as part of an overall asset mix. In 2011 we also introduced real assets and other inflation sensitive services that cover bond exposure which again is important for helping portfolios withstand the ravages of inflation when it rises. And then this year, we've introduced another couple of innovations, we basically transitioned our clients in to strategic equities on the top right of the bar, which is a multi-style all cap portfolio that offers both greater diversification and also higher conviction than our historic equity side you did.

And finally we've run clients access through our alternative strategy by making our multi-manager fund the fronts offering available as a registered investment company or RIC which virtually all of our private clients can now access. So, let me just quickly go through the 2012 enhancement in a little bit more depth starting with the RIC.

So now that we do have a registered investment company, basically almost all of our private clients qualifies for access to an institutional quality alternatives vehicle which managed by one of the longest tenures, strongest teams in the business with an excellent long term track record at managing a hedge fund to fund.

This is a great diversifier for our clients and it allows our clients to access a wider variety of investment ideas that may otherwise could, I mean the ideas can provide very good returns while actually lowering overall portfolio risk because they will tend not to necessarily reflect what's happening in the stock and bond markets.

So, you see equities is also about harnessing more of our best ideas and doing so more risk efficiently. Now let me go through that in a bit more detail, because this is really something quite new and different for us and we think for the industry, so it’s truly integrated model where we are actually managing, all of the underline parts of multi-assets, multi stop portfolio in one envelope.

So before our traditional large US equity portfolio offerings for our private clients was strategic value and strategic growth, the upper left most green and blue circles on this chart and they were basically managed more or less as separate portfolios. Now we have and we had more equity piece parts than that and we're drawing on in fact six of those equity piece parts to put together strategic equity, the other four are active (inaudible) the pale blue circle, select equity the grey circle and also a smidge value and growth.

If you were to think of this the way most institutions do and buy each of those six pieces separately which is the classic way of putting together a multi manager portfolio, you would invest with over 200 individual stocks in the large cap space plus this mid-name and the portfolios of each of them would be constructed and optimized as a separate standalone piece without taking account of what’s going on in the other five. There will be no management therefore, of any risk concentrations that could result because multiple portfolios could hold the same stock or have essentially overlapping exposures for the same risk. And from a tax standpoint, if you have taxable clients in your tax managing, each of those portfolios would be tax managed as a separate piece part, not recognizing that sometimes some things that’s going on over here, could actually has far implications that could be offset over there.

So we thought about, is there a way to deliver a better result by integrating this. And we think there really is. The way we managed these equities today, is we incorporate all six of those component parts to deliver a multi-style and multi-cap portfolio that has value and growth and stabilizing components from active low volume plus equity, plus both large and smidge names, but we are only choosing the highest conviction names from each of the teams, whereas each of the teams to contribute the parts of their portfolios that have the that really have the juice. As a result, the number of holdings is about half of what it would be if you bought all the six parts separately and we are building that portfolio with the help of the underlying teams as one unit. So we are managing risk and we are managing taxes across the whole thing, not piece by piece. And we think this is a lot more efficient from a risk standpoint and actually allows us over time to deliver higher conviction and better returns. And let me give you a sense of how that works.

If you look at the S&P 500, the 35 holdings accounts for 25% of the index. If you look at our portfolio, our 35 holdings account for almost half of the whole portfolio. That’s a very high degree of active share. It means that we have a lot of conviction in those names. We are taking meaningful positions. But here is the interesting thing. From a risk standpoint, the ability of our team to manage risk has actually gone up because we have components that are still very complementary to each other.

The value team is looking for the stock that has the absolute cheapest prices, so a lot of pharma companies are on that list of stock we are holding in the top 30s that have a little (inaudible) for value. We have a lot of stocks we like because they have superior and we think underappreciated growth potential like for example American Electric and Biogen and the stability teams want predictable earnings, which avoids surprises and may also be for that reason undervalued like IBM Rexon and that is interesting because these ideas tend to diversify each other better than the sort of (inaudible) best value idea that diversify the rest of the value stocks. So that's we think a better way of running a portfolio comprehensively across multiple files and cap ranges.

So clearly the goal here is better consistency of results, better management of risk and still seeking high return and that's something we can do not just within an equity portfolio, we can also do that across assets, we have dynamic asset allocation tools and clearly in the last few years we've seen just how much of a roller coaster markets can be. And clients are clamoring for something that helps smooth that ride, that's what we seek to do with dynamic asset allocation or DAA. And the goal is to help keep clients invested for the long run by helping them manage the peaks and valleys. What you can see on this chart is we’re trying to pull in the tails of the distribution. Essentially you reduce short term risks and mitigate the extreme outcome but without sacrificing return. It's very easy to mitigate extremes by just deleveraging a portfolio but then you're moving your return down. We want to be able to mitigate extremes with the same return and since we launched the AA in early 2010, we think we've been able to deliver on that promise, and let’s see how DAA has worked since inception.

What you can see on this chart is that we've had to negotiate a very turbulent environment over the last couple of years. The changes are fast and furious as you can see in the blue line which shows the ups and downs of the global equity index and what we've done over that time is when we have seen opportunities to moderate risks because risks have become very elevated, up in the wake of Europe (inaudible) or other micro events. We pulled back on our equity holding and took our equity rate below norm as shown by the green bars pointing down, whereas when those periods when risks were actually abating and becoming more moderate and we thought you were well compensated relative to the risk you had to take, we've put more of the portfolio into risk assets, it’s shown like periods when the green bars are pointing up.

And here you can see how we actually performed. Managing volatility through DAA has allowed us to meet our key objective which is reducing volatility by a little bit more than 10%. We've also done that without a meaningful impact on returns, our expectations over time are, our expected impact on returns will bounce around zero, sometimes a little bit more, sometimes a little bit less, and what drives whether you're a little bit above, a little bit below is what the environment has been recently because you can see on this chart that when you are in weak market like the second quarter of 2010 or the third quarter of 2011, DAA has tended to deliver very good relative performance, as you would hope like during very weak markets from the markets down, that’s DAAs job is to mitigate that drawdown.

On the other hand during markets that have wobble to the upside, we will tend to lag as we can see by the events in the third quarter of 2010 and the fourth quarter of 2011. So, we think that this is exactly one of the kinds of tools that clients want and we've rolled this out for the vast majority of our clients in the private client business, we've rolled it out also for some clients and define contribution and insurance companies have also been very interested in this capability.

Let's move on now to the defined composition business overall. So, if you look at the opportunity in US (PC), the prime composition, the numbers are actually pretty staggering so for our industry as a whole, this is going to be I think the institutional growth engine over the next twenty years.

Ever since the pension protection act passed in 2006, there have been huge incentives for DC client sponsors to auto enroll their workers and there have been legal protection for client sponsors to fault of those workers into what's called the QDPIA, a qualified investment vehicle that is the default option and that's usually been a target base front.

This has led to a real bloom in the fund contribution and actually a huge institutional of the fund contribution. The net of which is that the share of US companies that are auto growing has gone from as you can see on the chart only about 14% 2003, to now 16% or more and a vast increase in the amount of the assets in DC that are going into that default options because all the new people who are being defaulted into plans, tend to end up in the default option and the people who roll out of a DC plan because they are changing jobs or retiring tend to have most of their legacy money in everything else.

So in the right hand side of the chart what you can see is the fund contributions universe is growing quite robustly and it's been virtually double from about $3 trillion in 20110 to about $6 trillion in 2020 and virtually all of that growth we anticipate is going to come from the default option which is again almost exclusively or dominantly target paid assets. This is a very-very rapid rate of change and a huge amount of money and so the question is how do you take advantage of this major trends, I think really will transform our industry. And well, our view is that we have been focused on having a better answer for what’s at DIA, what’s that target date default should look like. One that is better suited to being a major part like you have the assets of a typical plan in the future.

The way we do this is by having a customized target based structure, that’s unlike a traditional bundled target based fund, is able to evolve as plans evolve and as their needs change. Because this customized retirement strategies or CRS which is in fact, but it sounds like, it’s an open architecture target based portfolio which can be fully flexible. It’s designed to allow a client sponsor to choose whatever managers they would like, using a glide path as tailored to their needs and can easily evolve and using whatever other providers they feel are most effective and this allows us to leverage our asset allocation knowledge to design the glide path that helps individual participants through the lifecycle, and it also allows us to implement smoothly changes in that glide path, as well as any changes to the manager lineup that a client sponsor would like to have or changes to the plan design.

This we think really brings the DC plans into the institutional world, the same way they have been used to managing their DB legacy pension plans. And what we've seen is a very strong growth in the US and we've just launched in the UK and things look pretty promising there too. So by innovating this way, we have been able to grow the custom retirement strategies business from just say over $3 billion in 2008 to something a bit over $16 billion today.

We believe we are the market leader in this space. And we have also been able to launch UK a similar CRS service, which has literally just started this year and now has about $750 million in assets funded or in the process of funding.

In addition, in United States we also have a lifetime income solution which is up and running today and which we are very excited about. So lifetime income is the thing that people have always really wanted to integrate into the C-plans that has never been possible before. And we think that there were a number of stumbling blocks, one of the big ones being, you have to have a few part of the default option for target based fund which is well suited for that, because you don’t need to provide lifetime income to someone who is 30 years old and as they approach age 65, they need more and more of this, so it's a target based structure that lets you vary how much lifetime income you have, is actually the perfect kind of approach to use.

But you also can't use traditional insurance product inside that target based fund for a number of reasons, but one of them is almost all traditional insurance products are single insurer and large transponsers do not want to be saddled with a potential risk of having one insurer backstopping their entire DC program, when that insurance company might not be there in 20 or 30 years. So you have to design a new kind of insurance that is also compatible with having multiple insurance companies back it.

We spent a number of years designing this and launching it and now have this service up and running. We think it's really very transformational because this allows a DC plan to offer what amounts to a lifetime income benefit, equity pension and truly be at parity with what DB used to be. We think that will make the DC business really one of the ways that transponsers in the future will actually transition away from the DB model, which they now are desperate to do and our first big client as many of you know, was our UTC or UTX for those of you who look at the ticker and this has been very well received, we're very excited about continuing to build on that foundation.

So we are pretty excited about all of this, I still have to mention in the UK we are developing something called retirement bridge which is a way of managing the timing list that people have as they move basically from managing an asset portfolio while they're working to eventually annuitizing in retirement which you need to do in the UK and that actually is also something that's gotten a lot of very, very favorable mention including being cited by the UK government as really standards setter and they're thinking about how they want the UK fund contribution business to evolve.

So we think that our DC business really is again part of what makes our asset allocation business strong, it's taking advantage of the fact that we have insight into evolving needs that clients have and that we have tools to help them meet those needs and that's the same thing we've done in the inflation of the asset arena.

As I mentioned earlier, we don't really see that inflation is going to rise soon, but it could happen at some point, in the not too distant future because as you see on this slide, on the left hand side, the developed world is deleveraging and is awash with liquidity, a lot of which is spilling over into the emerging markets which actually have a fairly accommodative fiscal policy by and large and that excess money growth that we are in part responsible for is fueling inflationary pressures on the other side of the world, some of which come back to haunt us. Right now, because the global economy is so soft, those cycled pattern in the past decide but at some might they might and the key point about inflation protection is like the rain storms, you need to have the umbrella before the rain stops falling if you want to manage the problem.

So, what we have done on the efficient side is think about what are some inflation sensitive assets that investors might need in that kind of rainstorm and they really would need them. On this chart you can see the inflation sensitivity of different kinds of assets and as you can see, both regular bonds and stocks tend to have a pretty negative outcome in times when inflation is ripe, and they tend to drop two to one any rise in inflation. By contrast, assets like inflation response and especially natural resource stocks, commodity, features and goals can be very inflation sensitive. So, the point is to how essentially some part of a portfolio exposed to those pieces of a capital market structure that can benefit from inflation to shield the rest of the portfolio that's in assets like bonds and regular stocks.

And what we typically recommend is that whether you are in a traditional type asset allegation or in a core satellite type of asset allocation, you are obviously somewhere in the neighborhood of 5 to 15% of the portfolio to these real assets and exactly what the right answer is will depend obviously on client circumstances but the key point here is we need to have some to protect your portfolio, you don’t want too much because this is a form of insurance and there is an opportunity cost to protecting yourself from inflation, you don’t want to buy more insurance than you need.

Finally, our index business, we think is very distinctive and I think many people think of indexing as sort of a simple almost monetized business but there is one thing that sometimes gets forgotten in all of that. There are literally thousands of indices out there, thousands. That's a lot of indices to choose from and it’s really not obvious which is the right benchmark to use I mean in the United States, once upon a time, people would have assumed that the right index to use was DOW, right now, a lot of people assume it’s the S&P but interestingly a couple of high profile managers have switched recently from the S&P to a Russell or Chris or other competing indices and that’s just in large cap equities, in the US.

So figuring out what you are trying to do to achieve market exposure, is an active decision, there are pretty big differences year to year between the performance of different indices that are trying to describe same universe and just tracking one index doesn’t mean, you've actually managed your risk. Our clients in our index business tend to be large and sophisticated organizations but do have specific objectives and they need help basically understanding which type of index is going to help them meet those objectives best. So it really fits into this broad blue print of asset allocation when you think about that.

The way we do this is we really take the clients problem and work with them to understand where they fit along the spectrum from plains vanilla indices on the left hand side of the page. We just have to define which country you are looking at, and maybe which sector or capitalization range and then you can choose from a menu and by that we manage quite a lot of plain vanilla indices; I mean we do a pretty good job of that.

But where we get more and more interested, as you move towards the right, where there is more value added embedded in both the index selection and management and implementation. So you could worry about maybe exactly how you weight the components in the index. There is a lot of reasons why traditional indices can actually be quite misleading or unhelpful to many clients.

You could worry about factor exposures. There might be factor exposures in the index that you don’t want and you want to basically work around and it could actually be beta exposures that you want to incorporate into your index management. For example like having an indexed version of dynamic asset allocation or some other stop lock type mechanism that might be based on indicators like volatility in the markets. And we think that all of these custom index solutions really are extending the strengths of our firm, the same ones that make us very helpful as an active manager but those issues actually exist on the index side more than most people realize.

So what do we do overall when you think about everything I just talked about that (inaudible) allocation? What we are doing is we are delivering value for clients in a set of asset clauses of capabilities that they increasingly want to have, with basically differentiating for clients by approaching the two key issues that they face. One of which is what their long term target allocations first would look like. What risks, does it make sense for them to be in general and then from time to time, as the world changes, as their needs change, how should they tweak those exposures?

And I think we have done a pretty good job so far in beginning to address these broad concerns. And I am excited about the prospect of becoming better and better at that through time and look forward also to your questions about this and about the firm. So with that let me turn it back over to you Cynthia.

Question-and-Answer Session

Unidentified Analyst

Great, thank you. We just have a little bit of time left. So why don’t we, want to make sure audience gets a chance to ask questions, see if anybody has a question and if not, I have a question, and we’ll take a look at the answers here while you think of a question.

So rotation equity, sometime next year and even more think sometime over the next three years, I'd say given how long it's taken us a positive answer wouldn’t we? (Inaudible) And then what would it take, if we look at the next answer, another good year of equities and even more people believe negative fixed income returns and that in line with one of the things our strategists at Bank of America Merrill Lynch thinks Michael (inaudible) and then finally to the strategy question which people may or may not have answered, we build bad equity, okay…

Peter Kraus

We agree.

Unidentified Analyst

And focus on the high net worth which is really a very unusual and prized business and (inaudible) so remain as broad as possible.

So I don't know if there are any questions but maybe I'll just ask a quick question if there are none which is, the thread that I hear of going through everything you're talking about is customization and I'm wondering how you handle the pull between customization versus the efficiency of standardized offerings.

Peter Kraus

Right, it's a great point. Definitely customization can eat you alive if you don't think before you do it, of how it will scale. So good example of how we solve that problem is the way we customize dynamic asset allocation, we can have 30,000 separately managed accounts for our various private clients and basically we have every single possible asset mix you could imagine from clients with 30% equities to clients with 80% equities and also we have clients who are taxable and clients who are taxable and clients who are not.

What we're able to do was basically have a very small number of mutual funds that we can use in different combinations to allow our full dynamic asset allocation advice to work for every single one of those clients some of them are taxable, some of them are not and by doing that you make something that looks incredibly daunting, actually very scalable.

Unidentified Analyst

So building block of…

Peter Kraus


Unidentified Analyst

All right, well with that we're out of time. Thank you very much Peter and Seth.

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