Waddell & Reed Financial's CEO Discusses Q4 2012 Results - Earnings Transcript

Jan.29.13 | About: Waddell & (WDR)

Waddell & Reed Financial, Inc. (NYSE:WDR)

Q4 2012 Earnings Call

January 29, 2013 10:00 a.m. ET

Executives

Henry J. Herrmann – Chairman & CEO

Nicole McIntosh – Director of Investor Relations

Michael L. Avery – President

Thomas W. Butch – Chief Marketing Officer

Daniel P. Connealy – CFO & SVP

Michael D. Strohm – COO

Philip J. Sanders – Chief Investment Officer

Analysts

Robert Lee – KBW

Bill Katz – Citigroup

Michael Kim – Sandler O’Neill

Jeffrey Hopson – Stifel Nicolaus

Roger Freeman – Barclays Capital

Daniel Fannon – Jefferies

Marc Irizarry – Goldman Sachs

Mac Sykes – Gabelli & Co

Matthew Kelly – Morgan Stanley

Jason Weyeneth – Sterne Agee

Cynthia Mayer – Banc of America Securities – Merrill Lynch

Operator

Good morning. My name is Jody, and I will be your conference operator today. At this time, I would like to welcome everyone to the Wadell & Reed Financial’s Fourth Quarter 2012 Earnings Conference Call. [Operator Instructions]

Thank you. I would now like to turn the conference over to Hank Herrmann, Chairman and Chief Executive Officer of Wadell & Reed. Please go ahead.

Henry Herrmann

Thank you, Jody. Good morning. With me today are Mike Avery, President; Tom Butch, Chief Marketing Officer; Dan Connealy, Chief Financial Officer; Mike Strohm, Chief Operating Officer; Phil Sanders, Chief Investment Officer; and Nicole McIntosh, our VP of Investor Relations.

Nicole, would you read the forward-looking statements, please?

Nicole McIntosh

During this call, some of our comments and responses will include forward-looking statements. While we believe these statements to be reasonable based on information that is currently available to us, actual results could materially differ from those expressed or implied due to a number of factors including, but not limited to, those referenced in our public filings with the Securities and Exchange Commission.

We assume no duty to update any forward-looking statements. Materials relevant to today’s call, including a copy of today’s press release, as well as supplemental schedules, have been posted on our website at waddell.com under the Corporate tab.

Henry Herrmann

Thank you, Nicole. Good morning again everyone. As we end the year, I would like to review some of firm’s important successes. Despite the political and economic uncertainty that overshadow much in the past year, we reported solid operating results, improved our operating margin and increased our earnings per share. Our strong capital position allowed us not only to pay us special dividend of Wadell per diluted share in December, but also increased by 12%, the rate of our regular quarterly dividend beginning next month’s payment.

Fourth quarter earnings per diluted share from continuing operations were $0.61. This represents a 33% compared to same period last year. For the year, we earned $2.25 per diluted share or 12% more than the $2.01 per diluted share earned in 2011.

At $83 million, our operating income this quarter hit a new high and increased 34% compared to fourth quarter a year ago. Our operating margin expanded further reaching 27.5% during the current quarter. Full-year operating income of $302 million rose 6% sequentially while operating margin increased from 25% in 2011 to 26% in 2012.

Sales of $5.1 billion during the quarter were up slightly compared to the fourth quarter of 2011. Outflows $165 million compared to $42 million of inflows collected during the same period last year. Sales for the year were $21.9 billion, 8% below 2011’s record high. Inflows for the year were $2.3 billion compared to $5 billion during 2011.

Looking at the contribution of each channel during the quarter, our Advisors channel had sales of $1.1 billion during the current quarter. And as noted in this morning’s press release, this marked the channel’s second highest quarterly level ever. Sales for the year were $4.1 billion. Net outflows were $75 million as redemptions increased in what appeared to be a year-end push by investors by locking capital gains prior to the much anticipated rise in tax rates.

Average productivity per advisor continue to increase reaching $44.3 thousand during the quarter, a record’s high. Continued improvement in productivity is a combination of improved recruiting, more focus on supporting advisors and clients’ growing use of fee-based advisory products.

Our Wholesale channel had sales of $3.5 billion and outflows of $77 million during the quarter. Like our Advisors channel, probably for the same reason, redemptions increased into year-end.

A broader number of products selling in volume continued with approximately 40% of sales to fixed income, 30% of sales to assets strategy and 30% to everything else. A product line enables us to offer our clients a number of solid options to meet their ever-changing preferences.

Sales from our Institutional channel were $652 million and outflows were $13 million during the quarter. Institutional client interest remains high for products such as large cap and mid cap growth, core equity and more which recently high yield.

We’re also seeing growing interest from foreign investors for U.S. equities. It should be noted that January to date has seen a meaningful moderation in redemptions and a sharp improvement in sales volume. At this time, it is still too early to tell how sustainable the improvement is.

The inflow of funds maybe due in part to investors reinvesting funds withdrawn at the end of 2012, but it’s also possible that investors have found renewed confidence in the equity markets.

I want to finish my prepared remarks by noting another major milestone for the company. In January, assets under management grow to $100 billion mark in the first time in our company’s history. This is particularly notable since the last time the S&P was at current levels, our assets under management were about half where they are today.

Operator, at this time, I would like to open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Robert Lee from KBW.

Robert Lee – KBW

Thanks, good morning everyone.

Henry Herrmann

Good morning Rob.

Robert Lee – KBW

Just a quick question. It looks like in the, just the very thing within the sales mix in the quarter that may have driven the underwriting distribution fee revenues and I mean understanding sales generally have been solid, but it seems like there is a pretty good pop there. I do know if you had more VA sales or something that maybe drove that a little higher than where it’s been running.

Henry Herrmann

We’re all looking around shaking our head. I don’t think there was anything special.

Robert Lee – KBW

Okay. And Hank, I think maybe I think you touched on it I apologize it. I’m just summing your prepared remarks, but you maybe just update us on the institutional pipeline, I know previously you’ve been seen more active, been more interesting in things like core or not, but have you seen that activity pickup is more like actual RFPs and final some things or any kind of pipeline you could talk to?

Henry Herrmann

And we’ll let Tom respond. I may at common.

Thomas Butch

Hey Rob, it’s Tom. Yeah, search activity remains really strong. We had a great deal of interest that did not abate in the fourth quarter. And yes, it has manifested itself in RFP activity and some finals presentation. As Hank indicated, large cap core continues to be very favorably received and we’re in the early stages I would say of taking the high yield product which has been so successful on a retail basis to the institutional market. So I hope that’s instructive. I would say that search activity was very strong throughout the year and as you know as a sort of leading indicator of hopeful business activity down the road.

Robert Lee – KBW

All right that was it. Thanks for taking my questions.

Operator

Your next question comes from the line of Bill Katz from Citigroup.

Bill Katz – Citigroup

Okay, thank you, good morning everybody. Just on the flows, I guess from a big picture perspective and certainly appreciate with the fact your assets have doubled on that comment. If I look at your flows over the last several quarters now, your net flows have been basically a wash and I’m sort of curious, do you need to step up the ad spend to get the message out to maybe sort of reaccelerate growth. And then I have a couple of follow-ups.

Henry Herrmann

I’ll let Tom go first and then I’ll respond.

Thomas Butch

I would say, first of all, that part of the net is just you have a much larger denominator and you have redemption rate which is a function of just being bigger. And so, we went through a phase where a hugely substantial portion of that which we were taking it on a gross basis was becoming net and as you grow, some of that is just a natural maturation of the business wherein the redemption rate attaches to a higher base of assets and therefore you have some leveling of your net.

Relative to investment in marketing activity in the aggregate, I don’t know that advertising, and I’m not sure Bill that specifically what you mean is where I would say that we’ll get the totality of leverage. Certainly we’ve continued to expand the sales force over time. We have ramped up our marketing spend over that period of time and we have done a lot of internal things to support the wholesale activity in the field by way of marketing resources, product resources and the like. And so we continue to build into our capability and I think suspend trajectory has been appropriate to the task in hand.

Relative to the need to grow the top line of sales, we’re acutely attuned to that and I think the aggregation of all those things I just talked about really informs that effort and we continued to be very actively out in the market and I think the other thing it’s really important is relationships with distributors which I think trumps sort of marketing spend for advertising and we continued to invest very heavily in that part of our business too. I hope that’s helpful.

Bill Katz – Citigroup

Certainly.

Henry Herrmann

Bill its Hank. In my commentary opening remarks, I think I did say something we spent that we’re sort of significant reduction in redemptions and a very substantial improvement in gross sales in the first month here. I’d be a little bit reluctant to extrapolate too much from the fourth quarter, of course, we rely of unusual things going on there related to the things I mentioned taxes and so forth and sentiment. You bear in mind that previous three quarters were substantially positive net flows. And based on what’s going on right now in January we’re again in very substantial positive flows. Other than that, I think Tom did a great job answering your question.

Bill Katz – Citigroup

Okay. I was looking more of the last few quarters. In terms of what you’re seeing year-to-date, I’m just doing some fast math on your performance year-to-date and your assets at the end of the year and what you’re saying now and not coming up with substantial net flows, but where are you seeing the new business this year? Is it fixed income or is there moved to equity or just replacing some year-end tax selling?

Thomas Butch

Bill its Tom again. We’ve seen a significant increase in the appetite for our equity products and we have not seen a concurrent diminution of the appetite for the fixed income products that had been working, which is to say, the sales are broad based and in that sense encouraging. And I think importantly, the response to asset strategy in the month of January similarly been very favorable.

Bill Katz – Citigroup

Okay. All right, thanks for taking my questions.

Operator

Your next question comes from the line of Michael Kim from Sandler, O’Neill.

Michael Kim – Sandler O’Neill

Hey guys, good morning. Just to kind of follow-up on the recent step-up in flows thus far this quarter. I know you talked about some tactical drivers likely playing somewhat of a role, but just assuming investors do continue to get more comfortable moving up the risk curve. How do you see your flow trends kind of playing out as you look across your products that assuming that dynamics?

Henry Herrmann

I’m not sure I understood the thrust to your question. Were you talking about product by products specific guess about what our flows might be or?

Michael Kim – Sandler O’Neill

Well just which strategies you think are in the best position to maybe see a step-up in demand assuming retail investors kind of get more comfortable moving up the risk curve?

Thomas Butch

Well, we’ve been saying for a while Michael that we think that that step up has an intermediate place in allocation or products. So for example, asset strategy, our balance product and our global income allocation product would fill out that allocation bucket. And then if you get into equities, generally our mid cap growth, small cap growth and we hope our core equity fund which is have a lot of success institutionally. We hope we can transfer that success to a greater extent than has been the case to the retail marketplace.

So it’s hard to and as Hank indicated in the opening remarks, it’s hard to extrapolate from 28 days experience where it is all going to go. As I indicated before, the stuff that was working toward the end of last year is working. The appetite for the stuff which had been sidelined a little bit by the investor disaffection for equities seems at least so far to have recaptured some flow.

Henry Herrmann

And so I, it’s Hank, I have a prejudice that says if there is going to be return to equities its going to be more narrowly focused returns than maybe we’re seeing it for a while. And so I’m thinking that we’re going to see a renewed interest in products other than the ones that have been doing well for us in equity products that have really strong records where I think people have moved away over the past few years and a little less exposed than it should be.

So I’m thinking large cap core for reasons I said I think has active stock pickers, we will continue to outperform S&P in this sort of new index fund solutions. Science and tech is a very big product for us historically outstanding record, great year last year, more or so this year. And other product I think is going to do particularly well. Mid cap core, mid cap growth rather is another product where we have a very strong record. I think it’s underweighted relatively and has been leading the market up here in the last couple of months and I think it might be more interest generated there and so forth.

So I think this is going to be a broadening in products that have more narrow exposure than just buying the index and I think that’s going to unfold as year goes on.

Michael Kim – Sandler O’Neill

Okay, that’s very helpful. And then maybe a question for Dan, can you give us any color on some of the moving parts within the comp line for the fourth quarter or so? Just curious if there were any meaningful true-ups that impacted the number and then just kind of any guidance looking out into the first quarter just given the typical step-up related to salary increases and payroll taxes.

Daniel Connealy

Okay, thank you. There weren’t really much going in the fourth quarter that changed it. There were some modest movement of we had some variable comp attached to how the market goes. So month-to-month that can vary. Fourth quarter didn’t have anything unusual adjustments. So we would think that comp would be up a little bit just due to raises and few headcounts. So last quarter was $43.3 million this one would be probably north of $46 million that’s where I would put it.

Michael Kim – Sandler O’Neill

Okay. And then just a follow-up on underwriting and distribution but on the expense side, I guess in the tax you kind of called out some lower incentive payments on investment products in the Advisors channel. Can you just give us some color on that change and whether that’s kind of sustainable going forward?

Daniel Connealy

Well always in the fourth quarter we have to make adjustments because we’re assuming at what level it will payout, say, fees to the Advisors because it’s their annual volume that determines how much they make. So there was a modest downtick there in that adjustment. So that helps the quarter.

There are also effects in the Wholesale channel as wholesalers start achieving above goal part of their compensation is equity compensation and that’s of course spread over four years and that would happen toward the end of the year. Offsetting that, there really weren’t too many negative offset, so I think it benefited from those two things at fourth quarter.

Henry Herrmann

Well I kind of, this is Hank, I’d also point out that something we’ve talked about with almost everybody over the last two years, a year-and-a-half or whatever, there was books and records expense and we were anticipating that most of that would be behind this by the end of the third quarter. And that case was entirely behind us but it was mostly behind us by the end of the third quarter.

And that had two effects, one, somewhat lowered the expenses in indirect U&D and it also had, I think somewhat of a positive benefit in the fourth quarter in terms of growth sales in the Advisors channel because, our Advisors were less bogged down filling out papers and more able to go back and touch base with clients. And so we had pretty strong revenue gain third quarter or fourth quarter impart at least because of that. So I hope that gives you pretty good idea of what’s going on.

Michael Kim – Sandler O’Neill

Yeah. That’s great, thanks for taking my questions.

Operator

Your next question comes from the line of Jeff Hopson from Stifel.

Jeffrey Hopson – Stifel Nicolaus

Okay, thanks a lot. Curious one in terms of any sense of what you’re hearing about investor psychology and maybe more important Advisor psychology. And then maybe for Tom, what – would you say the wholesalers are out there advocating of equities versus fixed income? I know Hank had something out early in January that suggested that equities are going to outperform bonds etc. how far are you going with that? How adamant are you with that message at this point?

Henry Herrmann

I’ll only take the first part and then Tom get second point. I’m not sure exactly I understood your first question; tell me again, the first part of your question.

Jeffrey Hopson – Stifel Nicolaus

The investor psychology and the Advisor psychology.

Henry Herrmann

All right. I think even I talked a long time and I think I’ve always said that the Advisors channel is a little slow when the market makes a shift. And I still think that’s the case. So I don’t think our Advisors channel especially in the classic channel is a good lead indicator. Having said that, there has been some improvement in interest in equities in the channel, but bear in mind that most – a good portion of whatever we’re generating there is what I would call wrap products which presents different portfolios in case. So I don’t have this clear look on it, but I would just say as maybe is used to go, but I would just say that the Advisors channel will be slow to come to the party if there is going to be a shift in investor sentiment toward equities.

Jeffrey Hopson – Stifel Nicolaus

Okay.

Thomas Butch

And Jeff, I’ll tag along a little bit on the Wholesale channel relative to that and then answer what I think I understood your second question to be. I think the sharpness if you will the suddenness of the shift in favor of actively managed equities has been somewhat surprising. And the numbers obviously don’t lie the industry data suggest that that shift began really right at the beginning of the year and so far has carried forward.

Relative to Advisor and investor psychology I guess the numbers don’t lie to a certain extent and I don’t process to be a proxy for all of that. I would only say that I think in the aggregate it’s a little bit behind the numbers and that while I think there is a growing interest in equities, I don’t think it’s a chest pounding interest from what I hear anecdotally from our sales desk in our wholesaler, so there is a little bit of seaming disconnect there.

Relative to the question about how aggressively the wholesales are out telling the equity story, I would give you a couple of things. You’re right, that we did publish a piece and have been talking about equities very actively in the market for sometime. The very fact of the scale of the asset strategy fund and its portfolio positioning in the recent past has been a manifestation of our firm’s position on equities and the wholesalers by just by virtue of the breaths of its holding and they’re continuing to market, it have been telling that story which now of course transfers to a broad span of products.

The other thing I would make known to you as I’m sure you already know is that we’re not selling any abstract, each of the firms into which we take our product as its own perspective on the market which it publishes for its financial advisors and a great many of them, not unlike us, in the piece we publish have been very, very favorable with the equities. And so selling process is both what we believe what we’re good at and what the firms are telling their advisors. So I think that’s a long way of saying we’re actively promoting equities, but not to the exclusion of certain of other of our products which have been working well which are well accepted unless we think are still constructive stories itself.

Jeffrey Hopson – Stifel Nicolaus

Okay, great. Thank you.

Operator

Your next question comes from the line of Roger Freeman from Barclays.

Roger Freeman – Barclays Capital

Hi, good morning. Just, Hank coming back to the January trends and relative to the redemptions and software inflows in December, would you say that the January so far looks to be an offset or more so than what you saw negative in December. I’m just trying to get whether there is an indicator there or whether that are something more than just ploughing capital gains back into the market?

Henry Herrmann

The answers of the net inflows are substantially more than the outflows in the fourth quarter.

Roger Freeman – Barclays Capital

Okay, great. All right. And then, on the asset strategy front, I just to that last question, are you still about 80% equities, 10% goal like last quarter that shifted it all.

Michael Strohm

Yes.

Henry Herrmann

That was Mike saying yes.

Roger Freeman – Barclays Capital

Okay. And then in, the number of advisors went up a bit first time in a year. Just curious if there is anything to that and just your outlook maybe for this year, do you expect that to grow?

Thomas Butch

We certainly hope it will. I think if you look at the several quarters, it’s moved in a very narrow range and that suggest over the fact that we’re probably near a bottom in the total number and obviously we’re aggressively in the market seeking to find the right people. So we would hope to grow at this year.

Roger Freeman – Barclays Capital

Okay. And in the number of advisors on the choice platform go up in the fourth quarter and what were some of the movements in there in terms of people coming from the outside or departures or upgrades?

Thomas Butch

It did grow modestly quarter-to-quarter by seven advisors, so at the end of the quarter with 179, 14 and 7 out during the quarter.

Roger Freeman – Barclays Capital

Okay. All right, thanks a lot.

Operator

Your next question comes from the line of Daniel Fannon from Jefferies.

Daniel Fannon – Jefferies

Good morning. I guess just a question on expenses and maybe your outlook for the year in terms of your operating budget and things were on ad spend and what not, how we should think about from a modeling perspective.

Thomas Butch

Well, I think, we talked about compensation as far as controllable expenses, somewhat controllable as G&A and we think that’s probably just going to go up modestly in the first quarter. And it’s a little early to predict what’s going to happen for the full year. We don’t see a whole lot of great changes. We do have some changes that are growing as more and more of the sales are in certain class shares, we have dealers service cost and as that goes up with the AUM and it’s mainly in the wholesale. So those pressure G&A a bit. And we’re in the middle of some IT improvements and as the year goes on, that could contribute to a little more costs in that area as well.

Henry Herrmann

This is Hank. Still a very uncertain environment out there as far as I’m concerned and as a result of that, we continue to have sort of a pretty careful reign on headcount growth and I would expect that to continue at least through the first quarter and then we’ll take a look and if the environments clearly changed maybe we’ll make some adjustment. For the moment, we’re being pretty careful about costs.

Daniel Fannon – Jefferies

Great, thank you.

Operator

Your next question comes from the line of Marc Irizarry from Goldman Sachs.

Marc Irizarry – Goldman Sachs

Great, thanks. Hank, just on the comment on substantially more inflows than outflows that you saw last quarter. Did you see the pickup in the areas where you saw there were sort of capital gains related tax selling that you see sort of the bigger pickup there or is it sort of a broader based pickup that you’re seeing this year relative to what you saw at the end of the year last year?

Henry Herrmann

I just look at it on a daily basis, I haven’t seen the month’s total. So I’m going to give you my gut feel and that is that has been spread out. High yield is still quite popular in munis and in corporate that’s continued. Asset strategy fund had seen pretty significant net flows, but also have been a pickup in flows of the other products I mentioned.

Marc Irizarry – Goldman Sachs

Okay.

Henry Herrmann

So, I think your question is a good one. Seems like the numbers at the end of the month I’ll figure out the answer better.

Marc Irizarry – Goldman Sachs

Okay. Well we’ll wait and figure out that big question there. And then on the, just in terms of the capital and balance sheet, how should we think about your priorities in terms of you’re maybe buying back stock here and I don’t know if there is a view on equity. How we should think about the share count going forward and just use of capital?

Henry Herrmann

Okay. We’ll stick with what we’ve always said and that is we’ll at least offset restricted share grants dilution with share repurchases. So that’s, I don’t know 1.5 million shares and maybe to add higher and then we have to offset the $0.01 in the quarter negative impact from the sale of Legend and so I think I’ve said that’s our intention to take the cash from the transaction and reinvested in the stock. So we’ll continue to do that as you know we materially raised the dividend we paid out of special and still end of the year with $500 or so in excess cash and based on what’s going, we’re continuing to going on presently. Our cash generation is still pretty solid, excess cash generation. So I don’t see any change in the plan. We’ll at least make our commitment in terms of dealing with the restricted share grants and something untold happen and for some reason we had a big decline in share price as I’ve said in many times in the past we might consider adding more than that.

Marc Irizarry – Goldman Sachs

Okay, great. Thanks.

Operator

Your next question comes from the line of Mac Sykes from Gabelli & Co.

Mac Sykes – Gabelli & Co

Good morning gentlemen. Just to get some more color on IV (ph) which obviously had a strong year in 2012. In terms of what you’re seeing now, what is resonating with investors? Is it the one-year performance, the global nature, as to like attribution trades, maybe some combination, just trying to get a feel of why you’re seeing some migration back to the fund?

Henry Herrmann

You’re cutting out a little bit on, could you ask us one more time, I don’t knew the time right echoed.

Mac Sykes – Gabelli & Co

I apologize. So I just want to get some more color on IV, what’s resonating with new investors or investors now. Is it the one-year performance? Is it that it’s globally – its global nature or the historic attribution trades or some combination of both? I’m just trying to understand what maybe driving if that’s what flows there now?

Daniel Connealy

I think you provided the answer in your question. I do think it’s all those things. I do think there is credibility, if you look at the advisors survey research that we do, we have strong credibility at IV as a well-diversified manager and that certainly helps us take or as reflective of our ability to take a very strong span of products that have performed well across market circumstance.

I think also for your point as the market has reenergized around equities at least for now we’re also very credible there and it gives us the opportunity to tell additional stories over time. I don’t think its one-year performance of our products. Certainly there appears to have been a sharp reversal in investor psyche when the one-year numbers or when the year ended and investors took notice of what had transpired in the equity markets, but I don’t think we’re in any sense driven by one-year numbers. Our five year numbers are very strong. Reputationally I just think it’s the combination of high-quality wholesaling terrific product performance and rep read and just greater salience in the market having now been at 10 years. I think people rely on IV to be able to fill product needs across the span of market circumstance and across asset classes. So it’s been a function of a long build in that regard.

Henry Herrmann

I might ask Tom to comment on kasina.

Thomas Butch

Kasina is one of the research firms which whose research we use that looks at advisor perceptions and does what we believe to be the largest annual survey of financial advisors and their perceptions at firms and relative to what I just talked about in terms of perception of our performance, perception of our wholesaling, perception of our investment process, perception of IV’s product breath and its ability to bring products across market circumstance and its latest survey we faired well. And so that’s reflective of what advisors are thinking about IV and I hope that’s helpful to your question.

Mac Sykes – Gabelli & Co

Yeah, I appreciate that. Thank you very much.

Operator

Your next question comes from the line of Matt Kelly from Morgan Stanley.

Matthew Kelly – Morgan Stanley

Hey guys, thanks for taking my question. So just quickly following up on asset strategy, I’d be curious to get your thoughts on conversations with the advisors or some of the brokerage platforms now that the one-year performance has been crystallized as a strong number. Three year is more challenging, five year is quite good as well, but in terms of what advisors are looking for volatility versus performance, how are they squaring those up now that you have the strong one-year?

Thomas Butch

Well I guess it’s a really great question in one sense. In another sense, I think we’ve been telling the story so relentlessly for so long that I don’t think the story has changed relative to your question about volatility versus perceived lack thereof. It’s hard to know whether there has been a C change in sentiment but I think the fund’s long-term ability to perform well across market circumstances and its provenness in that regard is something that we continue to go back to and which I think maybe transcends near-term sentiment. And so I think really the one-year number was merely an affirmation of the strategy that the investment, the portfolio managers pursued and its success. And but I think investor acceptance doesn’t peg to that, but more of the experience that the team has delivered over much longer period of time.

Daniel Connealy

It’s a complicated question that you’re asking because I think it’s important to step back and look at the bigger picture. I think it’s important for all of us to remember that the average investor is still impacted by the global financial crisis that was just the beginning of which was just four years ago, if I market it August of 2007. And in that period of the crisis where a large percentage of everybody in this industry shareholder base is in the baby boomer generation that’s a group that would just from demographics have been mindful about preservation of capital during this last four to five year period anyway combined with having to navigate through a crisis compounded by anxiety that was manifest as recently as just a couple of months ago.

It wasn’t that long ago that our shareholder base financial advisors were anxious about the – whether or not the U.S. would be able to stabilize its economy and we got people that are bombarded every night with fears of a fiscal cliff and what the implications of that are as it pertains to not only the investment world but their individual portfolios. And that fear or anxiety at the moment has been dissipated to a large extent.

In that same period of time, just a couple of months ago, people were anxious about the sovereign credit crisis in Europe this time last year. That was what dominated the headlines, it’s hard to believe now, but that was what was driving people’s anxiety this time last year and as recently as a couple of months ago. And with actions taken on the part of the ECB and other leaders in Europe, at least for the time being, that crisis has seen anticipated.

The other issue that was driving people’s anxiety as recently as just a couple of months ago was what would happen to China in the flows of scandals, leadership change, decline in GDP and was it or not the second largest economy in the world was headed for a hard landing which those anxieties have been dissipated on the back of better numbers coming out of China in the fourth quarter, early January, smooth transition of leadership etc.

And if you think about how humans reacted to the crisis, they sort the safety of fixed income investments as a way to preserve their capital and as a way to best assure themselves of having the floor of income that they believe that they needed. And if you think about the last three year period or so, that was not a bad debt. If you look at the three-year annualized returns of fixed income funds that was a good place to be. And that it did provide the safety that they required and the returns over the last three-years even in conservative bond products has been pretty good, at least good enough to meet their return on expectations, but here as the conundrum that the financial advisors find themselves in and that was evident at the end of last year, where they’re now facing a situation where these issues have dissipated.

The returns in fixed income have been fairly good, but without the tailwind of declining interest rates environment from here and more likely the prospected interest rates were wise on the back of slightly better economics in the U.S., Europe and China, they’re now anxious about what are they doing with their fixed income investments, if I cannot get more than just to carry on the bonds and the underlying funds. And so I think some of the anxiety that financial advisors are going through now is I rent the fixed income for safety and that turned out to be a good bet. How do I meet my shareholder’s expectations going forward if the whitening’s to not be in the declining interest environment and even if interest rates stay where they are, I’m not likely to be better to carry on the bonds that are in the portfolio and how do I meet my client’s returns from here.

And so I think what we see is people going through that (inaudible) and in some cases, they’re beginning to rethink the wisdom of having disproportionate amount of their portfolios in the fixed income and as Hank pointed out, they’re looking at the performance of equity funds and going back through the algebra of well let’s say, maybe I can get to the return expectations that my client still need without a heavy dependents upon one asset class and I think we’re seeing that and witnessing at the very beginning of it. Is it necessary need a big rush from fixed income to equities quickly? No it’s probably more measured and thoughtful, but I suspect that that’s what were at the beginning.

Matthew Kelly – Morgan Stanley

Okay, thanks. That’s helpful color. Just one quick follow-up from me then, just in terms of trying to extrapolate what asset strategy flows kind of look like, is it fair to assume given the strong one-year last year that investors who bought into the asset strategy fund towards year-end 2011, early 2012? They might have exacerbated the kind of pre-fiscal cliff capital gain selling into year in the last few months. And if that so, are you seeing them kind of reengage if they did do that into that fund?

Daniel Connealy

Well, I don’t know. I mean rarely do people call you up and explain to you why they’re redeeming your fund. They’re more than happy to tell you what they’re buying it, but they rarely tell you why they’re redeeming it. So it’s hard for me to answer that question. I think it’s better to think about asset strategy in the context of its tenure, in others words, this is the fund has had a good track record for now 16 years. And it represents the culmination of everything we do as an organization.

And people that have had confidence in us, the strength of our wholesalers to go out and tell a story if you will based on our methodology, how we invest money, I think those people who have listened to that story and have confidence in us as an organization and have stayed with that or quite frankly the people that were trying to appeal to anyway and sure, I mean people who have short-term time horizons or have expectations that are misplaced, sure, I mean they’re going to redeem in the quick period of time and but I think what is important if you look at the building assets of our organization which is based on having people that our portfolio managers, analysts thinking over a long period of time and not fixated on quarterly, weekly, daily performance.

And having a strong group of wholesalers advisors telling a story that’s based on process and history and trying to teach people how the market works, how the world works as opposed to what is the hot fund to run to, I think that’s our story. And I think that story has a lot of legs to it and you’re right about one thing is that when you – if you tell people – there is always a group of people that you can tell them and you can tell them and you can tell them, but until they see it show up in the numbers that seems to be the last piece of creditability that they need before they now listen to you. Just like talking to my kids. So I think there is always going to be a group of people like that, but as long as we stay focused on fundamental analysis, process based on thinking about the world in the context of where growth comes from over a long period of time and as long as we do a good job, helping our wholesalers and advisors understanding that’s the worry so that they can repeat it to their clients then we’ll continue to do very well.

Matthew Kelly – Morgan Stanley

Thank you very much for taking my questions.

Operator

Your next question comes from the line of Jason Weyeneth from Sterne Agee.

Jason Weyeneth – Sterne Agee

Thanks. I just want to follow-up on some of the comments about the distribution margin. If I look at the advisor channel distribution margin, it was positive in the fourth quarter. I think in the past you’ve talked about that likely peaking at slightly negative. Just wondering if improve productivity of the advisors sales force and more fee-based advisory sales if that something that’s changed and we can now think about that as running at roughly breakeven or slightly positive going forward?

Henry Herrmann

Hi it’s Hank. I think over the long period of time I’ve talked about normalized the advisor channel U&D margin some place between 0 and minus 5. I haven’t changed my view on that. For the moment, we’re a little on the high side of that. We may stay that way as long as the market helps, but I don’t see it going into positive territory. I don’t see a material rise from here.

Jason Weyeneth – Sterne Agee

Thanks.

Operator

Your next question comes from the line of Cynthia Mayer from Banc of America.

Cynthia Mayer – Banc of America Securities – Merrill Lynch

Hi, good morning.

Henry Herrmann

Good morning.

Cynthia Mayer – Banc of America Securities – Merrill Lynch

Maybe just a follow-up on the question on the wholesale channel that margin also improved and I hear you that some of it was incentive I guess, which came down. But if you normalize for that what do you think it would have been and just looking ahead to this quarter, where the sales are improving and the net flows are improving, should we expect that to sort of revert to the norm in the past in quarters where you’re selling well?

Henry Herrmann

I’ll ask Dan respond and then I might have a comment.

Daniel Connealy

I do believe so yes. I think that we never said that we expect our wholesale channel to have a distribution margin that’s much better than just the market and that sort of where it’s been. It does improve over time the scale though, so the more we can grow the assets in that channel and more likely the margin will improve because the pass-through fees, the 12b-1 fees tend to drive that number towards 0, the larger they get.

Cynthia Mayer – Banc of America Securities – Merrill Lynch

Okay. And I guess just one more question on distribution which is, seems like you highlighted and I guess this isn’t totally distribution. You highlighted the move to allocation products in asset-based fees in the Advisors channel is helping revenues and I assume the margin. So understanding I think you said 37% of the distribution revenues are from asset based fees last year. How do you expect that to trend and is there a handy way to think about its potential contribution to the margin if it keeps trending?

Thomas Butch

Well, relative to the trend, I think it continues to grow at a sort of moderate rate that is the rate of growth of the asset allocation products. It has grown, as it has in many broker dealers, it has grown over the last several years, I think we probably see a leveling of it at some point not too far out. And relative to how you model that, I think that sort of the basic guidance.

Henry Herrmann

Yeah, I think that that product in the advisors is up to about 8 billion. So that’s a formidable part of their asset base, that’s why we don’t see it growing that much faster, but it could be and certainly that has advantageous effects on our margin because that’s a higher based fee. So that’s helped a lot.

Cynthia Mayer – Banc of America Securities – Merrill Lynch

Okay. And then maybe just a couple of questions on asset strategy, I think you said 80% equities, I think you guys are often views having more emerging markets exposure than competitors, but emerging markets are down this year and asset strategies up over 4%. What’s your current emerging markets exposure and how constructive are you on emerging markets? Is that fair to think of you guys is having more emerging markets exposure at this point?

Henry Herrmann

Cynthia this is Hank, Mike stepped out. I’ll give you the overview here. No, we do have emerging market exposure but its sort of back door and we don’t own a lot of specific emerging market stocks rather we own a lot of in terms of themes in emerging markets and I think that’s the way you should think about it and yet if you just thought about it that way asset strategy fund is over weighted there and has been over weighted there for a considerable period of time. Its awfully, awfully difficult to put money to work in specific stock names in emerging markets for a variety of reasons, one, that not a lot of cap value there, two, in a lot of the publicly traded institutions are really in extension of the governments of the countries they’re in and that’s not always the best recipe for an investment strategy.

So much more likely we’re theme related and at the moment there hasn’t been a material shift in that. We continue to be focused in that area on raise of the middle class and greater wealth construction in a very, very large universal population that just coming into what I would say a more mature economy. Mike just came back. He probably heard half of what I said and disagreed but I’m not going to let him talk.

Michael Strohm

I agree with whatever the Chairman said.

Cynthia Mayer – Banc of America Securities – Merrill Lynch

Okay. Thank you.

Henry Herrmann

Give it, go ahead Cynthia, ask Mike and see if he wants to respond little differently than I did.

Cynthia Mayer – Banc of America Securities – Merrill Lynch

I just asked what your emerging markets exposure is, if it’s fair to think of you guys as more emerging markets than some other similar funds and whether you’re still constructive on it? So I thought the answerer answered it.

Michael Strohm

Well, I’m going to give – it depends on how you look at an answer. People, if they look at the fund just based on the geographic location of the securities that we own, you would come to the conclusion that 80% equities at this is the developed market fund, if you look at the fact that half of our equities are in U.S. domiciled companies. About a fourth are in European domiciled companies and only a fourth are in companies domiciled in Asia. So if you look at it that way you would come to that conclusion.

What we tell our clients and the financial advisors is, because that’s usually the way they ask the question, but what we tell our clients advisors is the correct way to look at the allocation of securities and the portfolio is and I think I heard of the end of Mr. Herrmann’s answer, so I think I’m just going to just repeat what he said, but if you look at the companies and the portfolio, regardless of where they’re domiciled they produce a product or service that appeals to the emerging middle class. I mean that’s why they’re in the portfolio, whether they are financial service companies, whether they are entertainment companies, health care companies, energy related companies, the point of the exercise that we’ve gone through now for 10 years is to think about where growth in the world is occurring and based on the humans that are enjoying rising prosperity and which are the global local companies that satisfy the needs of aspirational purchases that are made by a newly prosperous group of people.

If you just think about the number of people in China, India, Indonesia alone, just those three countries that represents over a third of the world’s population, you have about 700 million people that are at the magic number of having discretionary income that for the first time perhaps allows them the benefit of making purchases in health care, entertainment, education, financial services, technology, property consumption goes up, protein consumption goes up, transportation becomes more sophisticated. And for us, regardless of the issues that occur on the developed world, whether it’s the U.S., Europe, Japan, what we have focused on as an organization for a long time is the likelihood of that 700 million is going to grow to 1 billion in just the next three to five years.

And on the strength of that alone that’s a lot of upside for the revenue, earnings generating capability of the companies that we have not only in the asset strategy fund, but throughout the funds in the organization.

Cynthia Mayer – Banc of America Securities – Merrill Lynch

Great. Maybe just one more, the high yield, its over $7 billion huge inflows last year, are you comfortable with the size of that or would you ever consider closing it? Thanks.

Henry Herrmann

Repeat the question, Cynthia.

Cynthia Mayer – Banc of America Securities – Merrill Lynch

The high yield fund is over 7 billion according to strategic insight. Are you comfortable with the size of that or would you ever consider closing it? Thanks.

Henry Herrmann

Well we would consider closing it, but at the moment I’m comfortable with it.

Operator

Your next question comes from the line of Patrick (inaudible).

Unidentified Analyst

Good morning guys. I just have a quick follow-up on market question on capital. You mentioned offsetting the dilution from the Legend sale, would you imagine that happening kind of immediately after you receive the cash or would you spread it over multiple quarters do you think?

Henry Herrmann

No comment.

Unidentified Analyst

Okay. Thank you.

Operator

Your next question comes from the line of Jeff Hopson from Stifel.

Jeffrey Hopson – Stifel Nicolaus

Okay, thanks. So just a follow-up on the – sales growth sales improved considerably, what’s the short-term effect on I guess the underwriting ratio? Do you still have the same effect that you did a few years ago of that hurting the margin or we had a size in terms of assets that that really doesn’t flow through? And then on the institutional side, in the fourth quarter, can you give us a sense of the flows maybe by some of the different sectors, the traditional institutional versus some of the other platforms and things that you have in that line?

Henry Herrmann

I’ll take the first part, Jeff. I think you’re right. We are of the size that a big uptick in sales volume would not have the pronounced effect that it did when this channel was much smaller. I would have some modest effect.

Jeffrey Hopson – Stifel Nicolaus

Okay.

Henry Herrmann

That haven’t changed what I’ve said in the past year, you know that the perfect world for us is strong asset market action and middling sales. And the terrible scenario is very strong sales and disappointing market action. And we’ve been sort of, the fourth quarter we’re sort of in the middle of that. So far in the first quarter we got a little bit more better sales, but good market action too. So directionally it’s a three-part equation and I failed elsewhere.

Jeffrey Hopson – Stifel Nicolaus

Okay thanks.

Thomas Butch

In terms of the question on institutional, little less than half was in sub-advised and the rest what you would call traditional.

Operator

That concludes today’s Q&A session. I will now turn it back over to the presenters for closing remarks.

Henry Herrmann

We thank you all for tuning in and appreciate your questions. Look forward to talking soon, take care.

Operator

Thank you. That concludes today’s conference call. You may now disconnect.

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Waddell & Reed (WDR): Q4 EPS of $0.61 beats by $0.03. Revenue of $302.8M beats by $1.78M. (PR)