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Executives

Dan Cataldo - Treasurer

Tom Faust - Chairman and CEO

Laurie Hylton - Chief Financial Officer

Analysts

Michael Kim - Sandler O’Neill

Ken Worthington - JPMorgan

Jeff Hopson - Stifel Nicolaus

Daniel Fannon - Jefferies

Bill Katz - Citigroup

Robert Lee - KBW

Cynthia Mayer - Bank of America Merrill Lynch

Eaton Vance Corp. (EV) F4Q2012 Results Earnings Call November 20, 2012 11:00 AM ET

Operator

Greetings. And welcome to the Eaton Vance Fourth Quarter Fiscal Year 2012 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Dan Cataldo, Treasurer for Eaton Vance. Thank you, sir. You may begin.

Dan Cataldo

Good morning. And welcome to our 2012 fiscal fourth quarter earnings call and webcast. With me this morning are Tom Faust, Chairman and CEO of Eaton Vance; and Laurie Hylton, our CFO. We will first comment on the quarter and then we will take your questions.

The full earnings release and charts we will refer to during the call are available on our website, eatonvance.com under the heading Press Releases.

Today’s presentation contains forward-looking statements about our business and financial results. The actual results may differ materially from those projected due to risks and uncertainties in our business, including but not limited to those discussed in our SEC filings. These filings including our 2011 annual report and Form 10-K are available on our website or on request at no charge.

I’ll now turn it over to Tom.

Tom Faust

Good morning. October 31st marked the end of our fourth quarter and fiscal 2012. I’m pleased to report that fourth quarter net inflows of $2.2 billion enabled us to realize positive net flows for the fiscal year as a whole and to finish the period with $199.5 billion of assets under management, a new end of year record for Eaton Vance.

The 5% annualized internal growth rate we achieved in the fourth quarter is the fastest we have grown since the second quarter of fiscal 2011. Also well below our 10% organic growth target it’s certainly encouraging to be on a rising growth trajectory as we enter fiscal 2013.

In the fourth quarter, we had adjusted earnings per diluted share of $0.53, up 23% from the preceding quarter and up 13% from last year’s fourth quarter. This is the second highest quarterly earnings in company history, exceeded only by the $0.55 of adjusted earnings per diluted share in the third quarter of fiscal 2011.

Fourth quarter 2012 earnings benefited from approximately $0.02 per diluted share of performance fees recorded for the period. Laurie will discuss the quarter’s financial results in more detail in a few minutes.

As I continued with my review of the quarter, please refer to the tables in the press release and the PowerPoint slides on our website.

Fourth quarter gross sales of $14.4 billion were up 32% from the prior quarter and up 30% from the year ago quarter with each of our primary investment areas, equity, fixed income, floating-rate income and alternative experiencing sequentially improved sales.

We funded two large institutional mandates during the quarter, a new $2.1 billion Global Macro Absolute Return sub-advisory relationship and a $900 million centralized portfolio management assignment for Parametric in Australia.

Net flows for the quarter were positive in taxable and tax-free fixed income, floating-rate income and alternatives. We saw reduced net outflows from equity, largely due to lower net withdrawals from our large cap value franchise.

The $2.7 billion of large cap value net outflows for the quarter included the termination of $1.5 billion sub-advisory relationship. For the full fiscal year, we saw $11.9 billion of net outflows from our large cap value franchise, which finished the year with $13.8 billion of managed assets.

Given much improved near-term performance still favorable long-term performance in the significantly reduced tax-advantaged assets, we don’t expect large cap value to incur anywhere near the drag on our fiscal 2013 flow results as we experienced in fiscal 2012.

Our net flows for the first quarter of fiscal 2013 are certainly shaping up well. The institutional pipeline is strong and retail flows are improving. Those of you who follow the monthly strategic insight mutual fund flow data would have noticed that in August we moved into positive flow territory where we’ve remained through September and October and now into the first half of November. We do believe these improved trends should be sustainable into 2013.

Our optimism about next year flows are seems in part from how well our products and capabilities both legacy and new aligned with current investment trends and evolving investor needs. I would highlight five areas here.

The continuing investor appetite for income, our renewed investor focus on tax efficiency with higher investment taxes now pending in the U.S., growing acceptance of alternative as a mainstream asset class and increased appetite for global investment strategies, and finally, increased demand amongst sophisticated investors for low cost engineered alpha-enhanced data strategies, risk and tax management solutions, and portfolio implementation services. In each of these areas we believe we are well-positioned.

Looking first to income strategies, Eaton Vance has long been recognized as a market leader in floating rate bank loans, tax advantage municipal bond, high yield, global income and U.S. government income strategies. In total, we managed about $85 billion in income assets representing approximately 42% of our total managed assets.

Our income capabilities were significantly enhanced when Kathleen Gaffney joined us earlier this month as Co-Director of Investment Grade Fixed Income. Kathleen had been with Loomis Sayles for 28 years, where she co-managed the Loomis Sayles bond fund and also managed or co-managed a number of other mutual funds and institutional accounts, including core-plus, multi-sector and high yield mandates. Kathleen is well-known and well-respected in the industry, and we are very excited to have her join our team.

At Eaton Vance, she will be responsible for managing investment portfolios that draw upon the analytical resources of our entire income team. In fact, we recently filed for SEC approval of the new Eaton Vance bond fund to be managed by a team led by Kathleen. Overtime, we believe this and related offerings have the potential to become major additions to the Eaton Vance income strategy line up.

Now that the U.S. election is behind us, there is a lot more clarity on where investment taxes are headed, which is up. Eaton Vance is long and recognized as a leader in tax-managed investing.

We are market leaders in active tax-managed equity and tax advantage municipal income strategies, and Parametric is the market leader in benchmark-based tax-managed equity strategies.

In total, we manage about $81 billion in tax-managed equity and income assets representing more than 40% of our total managed assets. With tax rates on the rise we expect to see a growing focus on tax efficient investing in 2013. No firm is better positioned to benefit from that than Eaton Vance.

Another area where we are well-positioned is as a manage of alternative investment strategies that seeks to provide returns largely uncorrelated with stock and bond market performance. A range of alternative strategies are now gaining increased acceptance among investors.

In 2010, our Global Macro Absolute Return Fund emerged as a market leader among absolute return strategies offered in a mutual fund format. That fund is now complemented by a number of newer Eaton Vance absolute return funds, as well as commodity and currency funds. Our $8.1 billion of U.S. mutual fund absolute return assets represents over 20% of total category assets as tracked by Lipper.

Recently, we have started to achieve sale success for absolute return strategies in the institutional and sub-advisory markets, where our managed assets have grown to $2.5 billion from literally nothing a year ago.

Also playing to our strengths is increased demand for global investment strategies, while Eaton Vance is not traditionally been known as a global manager that is certainly changing. I would highlight three major drivers of our development as a global manager.

The first is our global income team, and the global macro emerging market debt and currency income strategies they manage, which now total over $10 billion in assets. Over the past several years, we have developed a sophisticated global income investment expertise and the critical infrastructure to support income and currency investing around the world.

The second core element of our global investment capability is Parametric’s emerging market equity discipline, a $16 billion franchise. This rules-based engineered strategy has achieved superior long-term performance, using an approach that Parametric is now applying to a number of different asset classes.

The third element of our global strategy came to fruition on August 6th of this year when we closed the previous announced transaction to acquire 49% of Montreal-based global equity manager Hexavest Inc. and entered into a distribution arrangement with Hexavest for all markets outside Canada. We are very pleased with how our partnership with Hexavest is beginning and the business momentum may continue to exhibit.

During the quarter, we launched four Hexavest advice mutual funds for U.S. distribution and are preparing to launch four Ireland-based Hexavest funds for the international market.

While we suspect it may take some times to gain traction with the new funds, we are seeing lots of interest and good progress in the institutional channel. From the close of the transaction through October 31, Hexavest had over $700 million of net inflows and saw assets under management increased from $11 billion to $12.1 billion.

Our deep pipeline of new opportunities gives us encouragement that Hexavest will see strong business growth in our fiscal 2013 as they begin to benefit from partnering with Eaton Vance’s power house distribution organization.

Also on the acquisition front, we announced last week that our subsidiary Parametric is acquiring the Clifton Group, a Minneapolis based provider of futures- and options-based portfolio implementation services and risk management solutions for institutional investors.

As of September 30th, Clifton managed $33.4 billion of overlay and funded assets managed on behalf of approximately 180 institutional clients. The acquisition is expected to close on or about December 31st of this year and is subject to certain customary closing conditions.

Clifton has been providing overlay services and risk management solutions to institutional investors for over 25 years, and is a well-recognized brand among large institutions and consultants.

The three Clifton’s three principals, Chief Investment Officer, Jack Hansen; Senior Portfolio Manager, Tom Lee; and Managing Principal, Kip Chaffee will all become Parametric shareholders and will continue in their current roles under long-term employment agreement to be entered into at closing. Clifton will operate as a division of Parametric with no changes in personnel or location expect as a result of the transaction.

Those of you who have followed Eaton Vance over the years are probably familiar with the success Parametric has enjoyed and the important role that has played in the growth and evolution of Eaton Vance.

When we acquired a controlling interest in Parametric in September 2003, they had $5.2 billion in assets under management, primarily in their tax-managed core product. Nine years later, Parametric manages over $53 billion across the range of engineered alpha-seeking strategies, option strategies and customized tracking strategies, including tax-managed core.

The Clifton acquisition adds a number of complementary capabilities and product offerings to Parametric. We view the Clifton acquisition as a major step forward in positioning Parametric as a market leading provider of portfolio solutions for sophisticated institutional family office and high net worth investors globally, with capabilities encompassing rules based engineered alpha and enhanced beta strategies, risk management, tax management, portfolio implementation and centralized portfolio management services.

With $87 billion of pro forma assets under management, Parametric is quickly emerging as a power house provider of portfolio of solutions. Today’s challenging markets require investors to work their portfolios harder and smarter to optimize exposures, balance risks, control costs and maximize risk adjusted returns.

It is the mission and focus of Parametric to help clients achieve these objectives. As they expand their capabilities through the Clifton acquisition and continue their internal development, we see great growth opportunities for Parametric for many years to come.

Although Eaton Vance is often thought of as a traditional asset manager, the large and growing position of Parametric inside Eaton Vance certainly blurs that characterization. Different from the rest of Eaton Vance, Parametric’s portfolio managers are not engaged in making predictive judgments about markets or individual securities.

Instead, the rules-based engineered strategies seek to provide diversified market exposures, often coupled with value-added risk management, tax management and volatility capital trading.

Because Parametric strategies are generally offered at lower price points and competing traditional active those managers, the relentless fee pressures seen across our industry affect Parametric differently, sometimes working to their advantage.

In closing, I want to comment that we entered 2013 with a growing optimism about our business. Yeah, the economic and market environment remain uncertain. Yeah, we expect our large cap value strategy to remain in net outflows. But with the rate of outflows there is abating and growth in other Eaton Vance strategies is increasing.

The hiring of Kathleen Gaffney opens up new growth avenues for our income business. The Hexavest transaction positions us for accelerated development of a global equity business and the Clifton acquisition should help Parametric stay on its accelerated growth trajectory. Everyone likes to be on a winning team and we see Eaton Vance is set for lots of wins in 2013 and beyond.

I’d now like to turn the call over to Laurie, who will discuss our fourth quarter financial results in more detail.

Laurie Hylton

Thank you, and good morning. In our press release this morning, we reported adjusted earnings per diluted share of $0.53 for the fourth quarter, compared to $0.43 in the third quarter and $0.47 in the fourth quarter fiscal 2011.

As we noted in the release, the adjusted earnings we report differ from GAAP earnings and that we back out changes in the estimated redemption value of non-controlling interest in our affiliates that are redeemable at other than fair value.

As you can see in attachment two to our press release, these adjustments totaled $0.08 in the fourth quarter of fiscal 2012 and $0.07 in the fourth quarter of last year. There were no adjustments made in the third quarter of this year.

Our operating margin was 34% in the fourth quarter, up from 32% in the prior fiscal quarter, reflecting a 4% increase in revenue on an operating expense base that was largely unchanged. This quarter’s operating margin of 34%, compares to 35% reported for the fourth quarter last year.

Last year’s higher fourth quarter margin was driven by a reduction in the final accrual rate for annual operating income-based bonuses, which was an adjustment we did not have this year. Based on preliminarily forecasting, we currently anticipate that margins will be in the 32% to 34% range as we move into fiscal 2013.

In the fourth quarter, revenue increased 4% over the preceding quarter, reflecting a 2% increase in average assets under management and an increase in our total effective fee rates of 63 basis points from 62 basis points. Year-over-year, revenue increased 4%, reflecting a 4% increase in average assets under management with no significant change in our total effective fee rate.

Breaking down the sequential increase in quarterly revenue a little bit further, investment advisory and administrative fees rates increased by 4%, reflecting the 2% increase in average assets under management. And an increase in our effective investment advisory and administrative fee rates to 52 basis points from 51 basis points in the third quarter.

The 1 basis point increase in our effective investment advisory and administrative fee rates sequentially can be largely attributed to performance fees of $3.7 million recorded in the fourth quarter fiscal 2012.

Excluding the effect of these performance fees, our fourth quarter effective investment advisory and administrative fee rate would have been largely unchanged to 51 basis points.

Distribution and service fee revenue increased only modestly sequentially, largely consistent with the increase in average assets subject to those fees.

On a year-over-year basis, fourth quarter investment advisory and administrative fees increased by 6%, reflecting a 4.5% in average assets under management and a modest increase in our effective investment advisory and administrative fee rate. Again, the increase in our effective fee rate largely reflects the contribution made by performance fees in the fourth quarter of fiscal 2012.

We continue to see decline in distribution and service fee-related revenues year-over-year, which reflects lower managed assets and fund share classes that are subject to those fees.

Although, the share class trend has an adverse effect on revenue, the profit impact is much smaller due to offsetting declines in distribution, service and deferred sales commission and amortization expense. Changes in our business mix will likely continue to put modest pressure on our effective fee rate going forward.

Equity assets, which represents 58% of our total assets under management a year ago dropped to 56% of total assets under management at October 31, 2012, largely as a result of the net outflows experienced in our large cap value franchise.

We’ve also seen a mixed shift in recent quarters from fund assets to lower revenue yielding separate accounts, with separate accounts increasing from 40% of total assets under management a year ago to 43% total assets under management on October 31, 2012.

Given the breakout of flows we see in the pipeline, we anticipate that our effective investment advisory and administrative fee rate will likely be in the 50 basis points range in fiscal 2013 before the effect of the pending Clifton acquisition.

Our effective fee rate will drop once we completes the excess Clifton acquisition and begin consolidating into our financial statements, an entity with approximately $33 billion of assets generating an average of about 8 basis points of revenue. It’s important to note that although Clifton has low effective fee rate, its operating margin is consistent with that of Eaton Vance.

Operating expenses in fourth quarter were largely unchanged from the third quarter and up 6% from the fourth quarter of last year.

Compensation expense is up 2% sequentially, primarily reflecting increases in sales and operating income based incentive.

Gross long-term sales and other inflows, which drive sales based incentives were up 32% in the fourth quarter compared to the third, while pre-bonus adjusted operating income which drives operating income based incentive was up 10% for the same period.

Compensation expense was up 19% in the fourth quarter fiscal 2012, compared to the same quarter last year, driven primarily by a 5% increase in headcount, increases in both sales and operating income-based incentives and last year’s fourth quarter adjustment in the accrual rate for operating income-based bonuses.

Gross long term sales and other inflows were up 30% year-over-year and pre-bonus adjusted operating income was up 10% for the same period.

Distribution expense was up marginally both sequentially and year-over-year, reflecting increases in Class A share commissions and Class C share distribution fee, partially offset by a decrease in intermediary marketing support payment.

The decline in marketing and support payments is driven by a decrease in the amount of average managed assets that are subject to those arrangements. Given flat or rising fund assets, we would anticipate seeing upward pressure on intermediary marketing support expense going forward as new arrangements are added and existing arrangements are renegotiated to higher levels.

Quarterly service fee expense increased 1% sequentially, consistent with the 1% increase in service fee income. Service fee expense decreased 5% in the fourth quarter, compared to the same quarter a year ago, consistent with the 6% decrease in service fee income and reflecting long-term shift to low or no low to fund share classes. The impact of the shift is also seen in the decrease in amortization of deferred sales commission, which declined 2% sequentially and 38% year-over-year.

Quarterly fund expenses decreased 4% sequentially, primarily reflecting decreases in fund subsidies and non-advisory expenses borne by the company on funds for which we have paid an all in fee. Fund expenses decreased 9% year-over-year, reflecting decrease in assets and sub-advised funds in which we pay a sub-advisory fee and lower fund subsidy.

Other expenses were down 6% sequentially, largely reflecting a decrease in professional services. Other expenses were largely unchanged in the fourth quarter fiscal 2012, compared to the fourth quarter of last year.

Equity in net income of affiliates of $1.8 million in the fourth quarter of fiscal 2012 included a $1.9 million contribution by Hexavest, which represents our 49% share of Hexavest’s earnings from the date of acquisition on August 6th. The $1.9 million is net of tax and the amortization of intangibles.

Non-operating income for the quarter reflects net investment gains and other investment income of $5.5 million, compared to $1.9 million in the third quarter fiscal 2012 and a net loss of $2 million in the fourth quarter of last year.

As seen in attachment three to our press release, $1.2 million and $800,000 of net investment income was allocated to non-controlling interest holders and our consolidated funds in the fourth quarter and third quarter fiscal 2012, respectively. While $300,000 of net investment losses were allocated to non-controlling interest holders in the fourth quarter of last year.

Investment portfolio, net gains and losses contributed a positive one penny to earnings per diluted share in the fourth quarter fiscal 2012 had essentially no impact in the third quarter and reduced earnings by one penny in the fourth quarter of last year.

Non-operating income also includes income associated with the company’s consolidated CLO entity, the majority of which is attributed to other beneficial interest holders in structure.

The residual CLO entity contribution earnings were approximately $1 million in the fourth quarter fiscal 2012, combines the company’s management fee and the net returns on our $1.9 million investment in the entity.

The residual contribution to earnings can be calculated by subtracting the non-controlling interest attributed to other CLO beneficial interest holders provided in attachment three, from the total non-operating income contributions during the period.

As seen in attachment three to our press release, fluctuations in non-controlling interests been largely driven by the performance of our consolidated CLO entity and the non-controlling interests value adjustments related to our subsidiaries whose non-controlling interests are redeemable at other than fair value.

Non-controlling interest value adjustments in the fourth quarters of fiscal 2012 and 2011 related to adjustments in the estimated redemption value of the non-controlling interest in Atlanta Capital, based on an annual termination of enterprise value on October 31st of each year. There were no significant non-controlling interest value adjustments in the third quarter of fiscal 2012.

Our effective tax rate was 34.1% in the fourth quarter of fiscal 2012, down from the 35.5% reported in the third quarter and 45.5% reported in the fourth quarter of last year. Excluding the effect of consolidated CLO entity earnings and losses, which are substantially allocated to other beneficial interest holders and therefore not subject to tax and calculation of our provision, our effective for the fourth and third quarters of fiscal 2012 was 36.1% and 38.2%, respectively.

Our effective tax rate for the fourth quarter of fiscal 2012 reflects a 2% benefit relating to the amendment of certain tax returns and the effective disqualifying dispositions of incentive stock options in the quarter.

We current anticipate that our effective tax rate adjusted for CLO earnings and losses will hold steady between 38% and 38.25% for the remainder of the fiscal year, not, but actually for the next year, excuse me.

One note on future stock-based compensation expense, as discussed on previous calls, there has historically been a degree of seasonality in our stock-based compensation expense to drive recognition on grant date of the full accounting cost of stock options awarded to retirement eligible employees.

As a result, we saw elevated stock-based compensation expense in the first quarter each fiscal year as new grants were made. We have this year modified our stock-based compensation plans such that we should not see significant seasonality going forward. We would anticipate that our run rate on stock based compensation going into fiscal 2013 would be somewhere in the neighborhood of $13 million for the quarter.

At this point, I would like to turn the call over to Dan to provide some commentary on our balance sheet and liquidity.

Dan Cataldo

Thanks, Laurie. We finished fourth quarter with $462 million of cash and equivalents, down from $600 million at the end of the third quarter. The reduction reflects the initial $192 million payment made upon the closing of Hexavest on August 6th. In addition, we estimate that we use $65 million to $70 million before calendar year end on the close of the Clifton Group acquisition.

Total investments of $487 million at October 31 were up $201 million from July 31. $181 million of this increase reflects intangible and other assets acquired in the Hexavest transaction, with the balance of the increase reflecting net new seed investments in the quarter.

Excluding outside shareholders $20 million interest in consolidated funds, our seed capital portfolio now stands at roughly $265 million. Seed investments in the quarter included funding of four new Hexavest funds that Tom mentioned earlier as well as additional investments in the Atlanta Capital Select Equity Fund.

During the third quarter, we used $30 million to repurchase 1.1 million shares of Eaton Vance stock at an average price of $28.31 and in October, we raised the quarterly dividend 5.3% to $0.20 per share. This marks a 32nd consecutive annual dividend increase.

For the full fiscal year, our strong cash flow enabled us to acquire the 49% stake in Hexavest. We paid $88 million in dividends to shareholders and repurchased $107 million worth of Eaton Vance stock.

Going forward, we will continue to use the company’s strong cash flow to invest in support of our business growth and return capital to shareholders. Our $300 million untapped credit facility in excess of the capital market available based on our investment grade credit ratings of A minus and A3 give us ample financial flexibility.

Operator, that concludes our prepared comments. We now are ready to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Michael Kim with Sandler O’Neill. Please proceed with your question.

Michael Kim - Sandler O’Neill

Yeah. Good afternoon. And first, can you just talk about the potential for further AUM related to the CPM mandate at Parametric? I think previously you’d talked about sort of $2 billion to $2.5 billion win, so does that suggest there is still a further sort of $1 billion to $1.5 billion of assets to come?

Tom Faust

I think you’re basically on the right track and just for those not familiar with what we are talking about. CPM refers to centralized portfolio management, which is a line of business of Parametric where -- what they do essentially is act as a quarterback as just on top of account relationship where different managers or sub-managers feed their portfolios to Parametric for centralized trade execution and centralized reporting to the clients. That’s a business that Parametric has been in for a while in the U.S. in support of the retail managed account business.

And they’ve recently started pursuing this on an institutional basis and Michael, the opportunity that you are talking about is in Australia, where we funded a part of that as I mentioned in the fourth quarter and have since funded the balance of that in November.

Michael Kim - Sandler O’Neill

Okay. And then second, I guess one of the dynamics that you’ve talked about in the past is sort of looking at holding periods when thinking about the profitability per dollar of AUM over time. So can you just talk about sort of client turnover rates at Parametric and then any early insight in the trends at Clifton. Just wondering, if the holding periods are long enough if you will to kind of offset some of the lower fee rates particularly for the overlay accounts?

Tom Faust

So Clifton is an institutional manager. Essentially, all of their revenues are based on institutional licenses. Those tend to be our long-term relationships. They don’t have the same velocity of client relationships as we typically experience on our retail business or is typical of retail asset management.

I would say however that their assets are subject to flexibility and that if a client takes off a position because they, for example, are using Clifton and a Clifton-based overlay to add equity exposure in a simple cost very quick liquid way, they may over time take that position off. They may transition to an active manager.

So there is some variability. The clients often use Clifton on a fairly short-term basis to add or subtract market exposure where that’s ultimately replaced by a more alpha driven manager. However, over time their assets have been relatively stable on a relatively stable growth trajectory.

There is a dynamic of variability to their assets and flows but is not so much driven by churn of clients, the same kind of dynamic that exists in U.S. retail. It’s actually based on how existing continuing clients use them and how the positions they have might go on or off at various times depending on what kind of market exposure they are looking to express synthetically.

Michael Kim - Sandler O’Neill

Thanks for taking my questions.

Operator

Our next question comes from the line of Ken Worthington with JPMorgan. Please proceed with your questions.

Ken Worthington - JPMorgan

Hi. Good morning. First question on the alternative bucket, looks like returns over the last couple of years have not been great if you compare it to either the returns of the S&P or bonds. You are winning some big institutional mandates. So I wanted to see what your thoughts were on returns in performance and then when you sell to the institutions, what are they expecting from these products?

Tom Faust

Yeah. So our target and our absolute return strategies, in general, is cash or LIBOR plus a spread and that spread will vary depending on the strategy. For example, in global macro, we offer a couple of basic versions of that with different amounts of underlying -- different risk levels, different leverage level, different exposures to the market.

What we think of it is the base version of that is looking to add something like 300 basis points or so of alpha or excess return to the benchmark and what we call the advantage version of that strategy, approximately one and three quarters, but two times that same amount. So, these are absolute return strategies where the target is cash or some cash substitute like LIBOR plus a spread where we’re not trying to beat an equity benchmark. We’re not trying to beat the fixed income benchmark and we’re trying to beat the cash benchmark.

And what’s appealing about these strategies and our particular approach to institutions and particularly variable annuity sponsors is not only the potential to earn return, but also the potential to earn return that is potentially less volatile than stock and bond market returns and also relatively uncorrelated with those returns.

Ken Worthington - JPMorgan

Okay. Perfect. And then as a follow-up, election is over. Is the market ready yet to look at tax-managed products, and if so, kind of can you set forth your strategy to take advantage of your brand in this area over the next year like. Is it close-end funds that you need to launch, you launch new open-end funds. Do you kind of market the existing product suite, anything you can give me in terms of your strategy here as we look forward out of year?

Tom Faust

Part of that question is easy to answer. Is the market ready for this? I would say no, the market is not ready because we don’t know what the tax rules are going to be in 2013 and beyond. So right in the real short term, maybe over the next couple of weeks or it could be three or four months or six months, whatever it takes them to figure out.

And so the world, how things are going to work in terms of the taxation of investments in United States. Until that’s resolved, there is no great opportunity. But I think we and most people think that we’re certainly on the verge of some truly significant changes. Some of those changes may make an element of tax efficient management, less important.

So, for example, if the tax rate on dividends goes up and dividends or tax are the same as interest then the tax advantage dividend part of our business, which is a relatively small part, either is transformed or goes away or something happens to that, that probably adverse. Most of our business in tax-managed product is focusing on either the generation of tax fee income that would be our immunity and tax advantage income strategies or focused on either reducing or deferring capital against taxes or related to that, actively generating capital losses.

So, it’s a little hard to say depending on where the market, sorry, where the tax rates go, what’s the new rules are going to be, our experience in -- I think this might be helpful. Our experience in 2003 when the last time the U.S. tax rates changed materially, what happened then was capital gains rates came down, which I think in hindsight you could say was a significant deterrent to growth of our tax-managed lineup including the Parametric part of that.

But what it did at the same time was created this opportunity for tax advantage, their dividend strategies based on the qualified dividend treatment. We don’t know what’s going to happen next as there might continue to be some favorable treatment for dividends that seems to be a critical issue that’s not yet determined.

But I do think that the negative effect that we saw in 2003, when capital gains tax rates went down will logically be reversed when capital gains tax rates move up. I think the expectation was that we are probably looking at, instead of a 15% rate probably something in a range of 20% plus rate of 3.8% on top of that for households with income over $250,000 or perhaps the numbers are not 23.8 or perhaps they are 28.8, something in that range.

But I think it’s going to be a big enough change that high income tax payers in United States very much across the board will be looking for new solutions. They will be looking for a different way to invest. And we believe that our lineup of tax-managed mutual funds which have been around since the late 90s calling active strategies. We believe that our lineup of municipal and tax-managed income fund and we believe that Parametric benchmark based passive tax-managed strategies will all be there and set to benefit from this increased attention on investment tax effects.

We don’t know exactly when that will happen. We don’t know exactly what the final rules will be but we are quite optimistic that that on balance this will be a positive for our tax and tax sufficient investing business.

And that we’ll see much more focus on this on financial advisors. We’ll see much more focus on this among family offices and the kinds of conversations that have in the past led to growth in our assets in these areas will increase very significantly as we -- as people start to figure out what the new rules are and how they should adjust their portfolio of management to take better advantage or to minimize the harm from these changes.

Ken Worthington - JPMorgan

Okay. Great. Thank you very much.

Operator

Our next question comes from the line of Jeff Hopson with Stifel Nicolaus. Please proceed with your questions.

Jeff Hopson - Stifel Nicolaus

Okay. Thanks a lot. You may have mentioned this, but the fee rate kicked up, curious if you can kind of drill down into that. I’m wondering about the timing of the lumpy slow. So, did those occur later in the quarter and just the $1.5 billion I didn’t hear you, which category did that come out of?

Tom Faust

The $1.5 billion, Jeff, that was out of the large cap value franchise, sub-advisory mandate, which actually was lower than average fee on large cap value asset. Laurie, you want to…

Laurie Hylton

We did talk a little bit about the uptick in the effective fee rate for the quarter and that largely related to roughly $3.7 million performance fee that was earned by our subsidiary Parametric in the fourth quarter. And we didn’t have the similar fee earns either in the third quarter of this year or the fourth quarter of last year.

Jeff Hopson - Stifel Nicolaus

Okay.

Tom Faust

And then in terms of the timing of the flows just to give you a sense that $900 million in Parametric overlay assets came in at the beginning of the quarter. And the funding of the global macro sub-advisory mandate came in towards beginning of October. So, end of the quarter beginning of the last month of the quarter.

Jeff Hopson - Stifel Nicolaus

Okay. One follow-up if you don’t mind. So, fixed income as a category at least by our data sources, didn’t seem to change that much and yet your numbers were down. Can you drill into that as far as the flows in fixed income taxable or I guess…

Tom Faust

Generally, there’s going to be two drivers on the taxable fixed income side of our flows. And this is for the most part activity that will take place in our funds and that will be in the high yield area. So I said two, actually one and taxable is going to be high yield. In fixed income, the two drivers that moved the numbers the most in total will include munis. So, I would look to flows in those two asset categories in the fixed income.

Jeff Hopson - Stifel Nicolaus

Right. I thought high yield was up. It looks like redemptions were up. Did you have a little bit of leakage in any particular fixed income product?

Tom Faust

No that stands out. I know high yields was not quite as -- flows are not quite as robust. This quarter they’ve cooled a bit but they’ve still been -- still among our better selling fund products.

Jeff Hopson - Stifel Nicolaus

All right. Okay. Great. Thanks.

Operator

Our next question comes from the line of Daniel Fannon with Jefferies. Please proceed with your questions.

Daniel Fannon - Jefferies

Hi, thanks. Tom, I guess just to build upon your -- or expand upon the comments you made on the institutional pipeline building, can you talk about the make up in November as you look into next year. Is it much different than what we’ve seen in this past quarter?

Tom Faust

Not dramatic changes. I touched on earlier one of the things that we’ve seen which is the funding of the centralized portfolio management mandate in Australia. That’s a piece of November business that has already funded, that’s very analogous. It’s actually the same client is funded to $900 million last quarter. So that’s not exchanged.

One of the things that we are seeing -- starting to see is development of a significant pipeline related to the Hexavest acquisition closed in August. We’ve been working together now about three months and we are starting to see some -- see some traction. We had a U.S. institutional win that round about yesterday, not a huge size, but significant size.

There are some other Hexavest opportunities some of them are legacy things that Hexavest had been pursuing prior to the transaction. Other ones are things that have been quiet new and the things that have developed as a result of our partnership on the distribution side.

So, Hexavest is a new part of our flow story. You may have picked up in the last table that our flow reporting for Hexavest is a little complicated. If it’s in our Eaton Vance fund, we’ll include it in our consolidated flows. If it’s not, if it’s a direct account where either it’s directly distributed by Hexavest or directly or distributed by Eaton Vance in a separate account form, those are not going to be included in our flows.

But on all that business, we earned 49% of Hexavest. We owned -- we got half the management profit. And also on the Eaton Vance distributed products, we will earn a distribution management fee on, which we expect to get some profit on that as well.

Daniel Fannon - Jefferies

Okay. And then, I guess on the expense side, the guidance is up 32% to 34% in terms of margins to make sure is helpful. Should we expect kind of the seasonal pick up in 1Q in terms of expenses to the low end of that potentially to start the year given the systems of the seasonal aspects or can you give us some guidance around the direction that would be helpful?

Laurie Hylton

No. I don’t think we’re going to see the same level of seasonality that we’ve seen previously. We’ve talked a little bit and when I made my comments earlier about stock-based compensation and the fact previously we’ve had a first quarter bump that’s related primarily to social retirement eligible.

And we’ve made some adjustments to our plans that going forward we won’t have that same level of seasonality with our stock-based compensation. I gave primarily a guidance that we’ll be looking at roughly $30 million a quarter in terms of stock-based compensation looking far more ratable over the course of the year.

So, I wouldn’t expect in terms of other expenses. Obviously, you have a slight February second quarter. First quarter, I wouldn’t expect we would see a significant drop in relation to the other quarters in the fiscal year.

Daniel Fannon - Jefferies

Okay. Just so the $30 million compares to what last year?

Laurie Hylton

I don’t have that in front of me.

Dan Cataldo

It is generally the seasonality on the stock options was $2 million to $3 million, Dan.

Daniel Fannon - Jefferies

Okay. Thank you.

Dan Cataldo

Of extra expense that was incurred in the first fiscal quarter that will go away.

Operator

Our next question comes from line of Bill Katz with Citigroup. Please proceed with your questions.

Bill Katz - Citigroup

Okay. Thank you. Taking up on that last question, can you maybe flush out why you expect margins to be flat to possibly down given the momentum in the volume? Thank you.

Laurie Hylton

Just to caution the spend are going to be down, I think we’re mostly looking at flat. I think we’re looking at the -- we anticipate bringing Clifton on at margins. They’re relatively similar to ours at this point. Obviously, there will be some amortization of intangibles that we’ll have to deal with, but we’re pretty much looking at flat margins going forward.

Bill Katz - Citigroup

Sales relative to the fourth quarter 34%?

Laurie Hylton

Well, the fourth quarter 34% also have $3.7 million of performance fees, which we touched on earlier.

Bill Katz - Citigroup

Right. Okay. And then second question is just when you mentioned you leveraged the tax-managed platform. Tom, what are your thoughts about the fact that the markets are basically flat for the last decade and ETFs are around today they were around last cycle so to speak and the relative impact that might have on the leverage to tax management platform?

Tom Faust

Yeah. It’s certainly a different environment for capital to gain generation versus where we were in the late 90s. I won’t say it’s the same. Every marks that doubled off the bottom people have made a fair bit of capital over the last now 3.5 years of market recovery. So, it’s not like we’re sitting at the bottom of an equity return cycle, income markets are also quite significantly off the bottom.

Regarding ETF, ETFs are quite formidable competition to tax efficient mutual fund, but they don’t offer really any competition to Parametric tax-managed core strategy. The goal with tax-managed core is to replicate an index on a pre-tax basis and to outperform on an after tax basis by systematically harvesting tax losses that can be distributed out to the investor. And if you probably know you can’t do that in a mutual fund, you can’t do that in ETF. And there is no way to push out tax losses in those vehicles.

So in many ways the growth of ETFs provides really a perfect entry, a perfect counter marketing for Parametric’s tax-managed core strategy. If you like a particular strategy and it delivered in a passive form at a low cost, you can do that through an ETF in which case you will not get any tax losses pass through or potentially you could enter into an arrangement with Parametric where at similarly low cost not necessarily the same.

But also very low cost you can get close tracking to that same benchmark, but based on active tax management you can generate on a consistent base, it will depend on what the market is doing. But you can generate over time tax losses that can be used to offset gains on other part of your portfolio.

Bill Katz - Citigroup

Okay. Thank you. Thank you very much.

Operator

Our next question comes from the line of Robert Lee with KBW. Please proceed with your questions.

Robert Lee - KBW

Thanks. Good morning, everyone.

Tom Faust

Yeah. Good morning.

Robert Lee - KBW

First question just on your non-U.S, you have before Hexavest Board on one of your game plan there responsibility is to market that kind of outside Canada and the U.S. and as you mentioned building some usage products. But could you try to bring us up to speed on where your non-U.S. initiatives are in terms of your footprint and how you are thinking about you expansion of your business outside the U.S. whether it’s from both a distribution and a kind of investment management perspective?

Tom Faust

Yeah. So, investment management, let me just touch on that first and then I’ll talk about distribution. Three main legs today of our international investment capability, the first leg is our global income team here in Boston that runs our Global Macro Absolute Return strategies that runs our emerging market debt fund or our gross like currency, strategy, there I think $10 billion or $11 billion in assets under management.

We also have in Boston an equity group focused on investing in global dividend stocks, global income stocks relatively small, I think that’s maybe $4 billion or so in assets. The second major element of our global investment capability is Parametric emerging market equity capability, which I think is about $16 billion in assets, one of their flagship capabilities.

And then the third piece -- third major piece is now Hexavest about $12 billion in assets, 49% owned by us where we have distribution rights or where we have distribution responsibilities in all markets outside Canada. Flipping over to the distribution side, we have a team in London. I would say maybe 20 people in London. We’ve got a handful people in Singapore.

We are in the process of converting our Australian position from our third-party marketer to an internal team. Those are the places physically where we have our presence. As we built out our international distribution over the last few years, it’s become very clear that to be successful in global distribution, we need global investment capabilities. And so one of the reasons for the Hexavest transaction is to provide products that feeds our global distribution network.

So, we want to have people on the ground around the world, because we see opportunities to sell bank loans, to sell income strategies of all types including global income in the right environment to sell U.S. equities. But one of the bread and butter capabilities that we need to be successful in that market is global equities and Hexavest gives us the ability to do that.

And my comment specifically about some of the things we’re doing in Australia. Australia is a particular focused for Parametric in the development of their both a centralized portfolio management opportunity as well as a tax-managed business. Australia, I think as far as we know unique or nearly unique among non-U.S. market has a tax code or tax treatment of investment that is probably similar to ours, but also imposes tax at a low rate, but taxes on what we would think appear as tax free qualified retirement saving.

So, part of the opportunity that Parametric is looking to exploit over the next 12 to 18 months is building out a larger on the ground presence in Australia. Right now, they’ve got -- I think it’s just one or might be two people direct employees of Parametric in Australia. But take a look for that to grow to exploit this opportunity they see both in centralized portfolio management and tax-managed core investing there.

So, we really view the growth of Parametric and now the addition of Hexavest or a family has really being cornerstones of our growth outside the United States. We certainly think that the development of our -- of a broad based capability in international income investing, ultimately will over time payoff in growth outside the United States for income based strategies as well.

Robert Lee - KBW

All right. Maybe as a follow-up question, is the business that’s really been talked about that much clearly, but could you kindly give an update on the kind of retail managed account business, I mean it’s kind of been bounce from that between from modest inflow, I guess this quarter had modest outflow and can you just give us a status update on what you see happening in that marketplace and what your thoughts are about growing that going forward?

Tom Faust

Yeah. So, this is a market that was -- I think as your comment suggest was a growth area for us and a growth area for a number of managers with which we compete maybe -- I guess, prior to the market correction 2008, this was viewed as a growth market and it’s been less of a growth market since then.

I think we’ve done better than most and the key to that is probably been our TABS acquisition that we made at end of 2008. That team has a very strong reputation, a great track record. And a lot of -- and a big falling in the retail managed account market that’s a key part of their business and it’s also part of their business as they were able to grow pretty substantially in 2012.

A component of that growth has been what we called the laddered muni, which are munis that are similar to a laddered municipal bond or any kind of bond separate account. But done in a retail managed account structure, that’s been a nice growth product for us. One of the other interesting things about retail managed account this year has been that if you look at our large cap value business, which is down from over $33 billion 18 months ago to about $13 billion and change at the end of October.

Somewhat to my surprise, one of the areas where we found the assets to be the stickiest was in retail managed accounts that continues to be a pretty major part of the remaining business of large cap value. And we’ve been encouraged that relative to some other prices like sub-advisory and certain types of mutual fund business but that’s proven to be relatively sticky.

But our view of the growth of retail managed accounts I think is modest. There could be certainly opportunities, part of the growth we potentially see related to the change in the tax law is for Parametric in the retail managed account business. That when we bought Parametric back in 2003, very much part of our plan was for that business to grow in retail managed accounts. And we were able to achieve that though, when the market turned over and with tax rates being low is certainly that’s not been particular growth focus for them retail managed accounts.

But if taxes go up and I think what they certainly are that that’s an area, where I think we’ll likely see more focus in my last response to Bill Katz’s question talked about the competitiveness of Parametric tax-managed core versus ETF from a tax perspective. Retail managed account is an excellent application of that, an area that we expect to see a nice growth there assuming that tax rates go up as we expect.

Robert Lee - KBW

Great. Thanks for taking my question.

Operator

Due to time constrained, our final question will come from the line of Cynthia Mayer with Bank of America Merrill Lynch. Please proceed with your questions.

Cynthia Mayer - Bank of America Merrill Lynch

Hi. Thanks a lot. May be just a follow-up on the margins for the 32%, 34% guidance, I guess this is not seasonality that really accounts for the range. What would move you from one end to the other and maybe just what kind of market assumptions underpin that? Thank you.

Laurie Hylton

I think generally going forward, as we think about our forecast and we generally look at some very modest equity market, generally in the 5% range in equity products, we haven’t really seen too much market in terms of our fixed income as we’re forecasting. I think in terms of what might drive the 32% to 34%, we are working through our budget cycle right now and are contemplating some investment in invested management systems in 2013.

And it will be a question how those actually rollout and how quickly we’re able to do, get some of those projects executed. But it would mostly be time related and very basic operating expenses. So, I would imagine it will be somewhere in that roughly 33% range going into the first quarter.

Tom Faust

So, I would say just beyond the discretionary decisions we’re making in terms of investments in IT and other things that ultimately it’s -- what does the market do and what our sales do, they’re going to determine where in that range or any range we’re likely to be. So, if the market goes up that has a positive impact on market on margins, if the market goes down that has a negative impact on margins.

If sales go up in the short run perversely that has a negative impact on margins, because we have sales base. You can also imagine a scenario though where the market is going up and growth sales are relatively weak, where we get a doubly positive impact on margins. But typically it doesn’t work that way. Typically if the market is going up and strong, we’re selling more and so that’s a market impact -- positive impact of on margins is somewhat offset by the sales based negative impact on margins.

So, I would say its a little bit discretionary decisions we are making. But mostly its going to be where is the market do and what to do our sales do that are going to determine we are in that range. And I know people like the model what the numbers are, but it’s something that unfortunately given the dependence of our business on revenues that are tied to stock market performance and cost that are tied to sales success, we can’t be quiet as precise in our estimate as maybe sometime people would like.

Cynthia Mayer - Bank of America Merrill Lynch

Great. Thanks.

Operator

Mr. Cataldo, we have reached the end of the question-and-answer session. I would now like to turn the floor back over to you for closing comments.

Dan Cataldo

Okay. Thank you. Thank you all for joining us this morning. And we wish you all a safe and Happy Thanksgiving. And look forward to talking to you in February. Good bye.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation. And have a wonderful day.

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