AllianceBernstein Holding LP (NYSE:AB)
Morgan Stanley Financials Conference Call
June 12, 2013, 9:10 am ET
Douglas Peebles - Head and Chief Investment Officer of Fixed Income
Matt Kelley - Morgan Stanley
Matt Kelley - Morgan Stanley
Good morning, everyone. It's my pleasure to have Doug Peebles, CIO of AllianceBernstein's Fixed Income unit here with us today. Doug has been with the firm since 2008 and has obviously seen AllianceBernstein's Fixed Income through both the worst case and in its strong period of growth. So he is very topical for you guys to hear from Doug today, especially given what's going on in the fixed income markets and he has some pretty unique insights on asset allocation as well.
So, Doug, thanks for joining us today.
Thanks, Matt, and good morning, everybody. Just one correction. I have been here since 1987. Just feels like since 2008. So I am going to quickly go through some slides here, talk about, first starting with a big 10,000 foot AllianceBernstein discussion and then head right into fixed income. We will have some time at the end for questions and I don’t mind if you all have questions like while I am speaking to go ahead and ask. That’s fine with me.
In terms of AllianceBernstein, we have set out four key metrics in terms of what initiatives are we working on and we have highlighted each one of those on this display. The first one is about performance. In the investment management industry, if there is one thing that matters more than any other thing its performance and so that should always be first and foremost in our slides and the initiative was to improve investment performance and deliver for our clients.
We have some examples of up here on how we have done that. There are ways in which to look at this. I will show you direct performance slides for fixed income in a moment. But within the world of retail, there are a variety of different awards that are given out and in 2013, our funds have done extremely well in this space. It is not just one or two funds. It's nine funds across 15 different categories across the world.
We are particularly proud of our fixed income business in Asia, where we have won 16 awards but its not just Asia. We won 13 awards in Europe and three awards in the United States. I am very pleased to report that its not just fixed income funds that have won these awards, we have also won awards in the U.S. Small and SMID Cap as well as our Technology funds. So we have seen a good first quarter of performance across a broad array of our equity services and there are several services, the ones that are highlighted here who have continued to do well throughout the one, three and five year periods.
In terms of my group, the fixed income group, we do have now 90% of AUM in services that have outperformed there in these over three years. That’s a consistent level of performance that we are very proud of. We don’t take anything for granted but that’s something that we continue to strive for.
Then the second and third are really very related, particularly in today's marketplace. Diversify our business across channels, geographies and client bases, and develop new initiatives and new innovative products and services to meet the needs of clients. I think we give ourselves pretty good marks on this. In terms of sales strength, we have had significant sales strength in both Americas and in Europe. Over the previous several years, we have received most of our sales prowess in the Asian region.
This diversification, I think, that is very beneficial to us. There are a lot of different things going on in the world. There is still a big need for income in the fixed income world and that is not just in Asia. In particular, I think Europe, with the problems that they are going through, is going to be a marketplace where there has going to be a need for income for a long, long period of time.
Another thing I will mention here, which we are quite proud of, we have made pretty big investments for the sell side of our business in Asia developing the research platform in Asia and according to all of our metrics we are succeeding in that space and well ahead of plan. So that’s something that’s very exciting. In terms of new products, we have highlighted here our Muni High Income and Inflation Services which have just garnered their three-year track records in the [fortiac] space and we are doing quite well in the stars column for Morningstar which is very important.
A newer equity service for us, Select Equity, both long, short and long-only, has gathered a significant amount of assets over $2 billion in two years. That’s very exciting for us as well as launching a RIC service, a fund-of-fund service for our private clients, primarily for our private clients today in the [fortiac] space.
Then the operating results speak for themselves. We have reduced expenses a lot in this last quarter for revenues, which is something we are proud of. Our real estate plan is well on track and we have increased our operating margin to just under 22%. So, all-in-all, pretty good news as it relates to the first quarter for AllianceBernstein.
Now getting into my space. The fixed income space. We put forth in our group a set of initiatives. The first one shouldn’t surprise you, given what I mentioned on the last slide, that our relentless focus on investment performance across all services, this business doesn’t work unless you have good performance. Our crown jewel, if you will, at the moment continues to be the Asian retail space, particularly ex-Japan. We need to retain our focus on that so that we can retain our leading market share in that space.
So the first thing is don’t screw up what's working very well. Then the third one would be to build upon strong momentum in the European institutional space. The European institutional space is very exciting right now. Most European fixed income investors had really, during the course of the last decade, moved most of their exposures into government bonds, peripheral bonds in particular, and if they diversified out of government bonds, they moved into financials. The corporate space in Europe is dominated by the financials and what happened in the height of the crisis was the sovereign problems and the financial sector problems became two sides of the same coin.
So there is a tremendous desire for diversification for those institutional fixed income investors to globalize. So stop being so home region buyers, which they have been in Europe, and globalize and diversify away from just European financial sector credit exposure. We have benefited very nicely in that environment and I think that that will continue. We are a global firm. We are a global credit manager, very strong in credit and so there has been a lot of interest in that space. So we think that that will continue.
One area that I think that we have been punching well below our waist and we have made a specific target is the U.S. retail market. We have this very dominant market share in Asia. We don’t have nearly the same market share in the United States and we want to change that. We have been working on that for several years. Its bearing fruit in terms of our market share. But still we have plenty of growth left to come in that space, both in the tax exempt and the taxable space for the U.S [fortiac] funds and then I feel similarly as it relates to European retail.
In the U.S. Institutional space, one of the strengths of AllianceBernstein fixed income is global fixed income investments. So of the two things that I would say really highlight the strengths that we have, is credit in any form, investment grade or noninvestment grade and global fixed income investment. We have seen more U.S. institutional clients moving to go global. We have seen it in the state pension space. We have seen it in the private sector space as well. We should be well-equipped to do well in that arena.
Then because there is still very low interest rates around the world and a desire for income, we think it is important to come up with a couple of new services as clients wishes evolve. One of which is something that we have been out managing for a little while but we have created a specific fund for this which is in the nonagency residential mortgage-backed securities space.
Then the last item is very interesting because there has been significant changes in the world of fixed income in terms of liquidity available in the market place, right. Post-2008, the regulatory reforms, Dodd-Frank, Welker, the variety of different European rules have created a less liquid institutional market space for buying and selling bonds. Now that can be a two-edged sword. Its clearly going to increase the volatility in the fixed income markets. I don’t think there is any doubt about that. We are missing that over the past couple of weeks.
The other thing it is going to do, because the volatility has heightened, its going to offer a very, very fertile ground for alpha generation and in particular I think in the high yield space we are going to see bigger drops in bonds putting the security pricing into a stressed or distressed base even though the fundamental credit quality of those organizations probably don’t deserve from a pure valuation standpoint to be that stressed or distressed. We want to create products to take advantage of that. So these are the initiatives that we are focusing on.
Let me start with performance. What I have listed here are flagship services in the institutional and in the Luxembourg as well as [fortiac] fund space and they are one, three and five-year absolute returns. Then the percentile rankings. Then we color coded the percentile rankings. So the first thing you should look at is the numbers and the numbers are just off the charts there, right. One, three and five year returns looking high single digits to teen returns over all three of these time frames. I just want to relish that for a moment because that’s not what they are going to look in the next one, three and five years, right. So we are not have those big returns.
For our business the color coding is equally important as the returns, right. The color coding suggest that green is top quartile, dark blue is second quartile. We want to see a lot of green and dark blue, right. There are 33 observations in this space, 32 of them fit in the top two quartiles, right. If I could cut and paste that, right, for the next one, three and five years, I would do it right now. But that’s what we are working on every day to ensure that we have that sort of a ranking.
Equally important is try to stay out. The grey, you will notice you don’t see any grey colors in these color schemes. That’s a good thing, right. Because we want to stay out at the bottom. We have one service that happens to be in the third quartile but anyway I think that what this does, it creates opportunities for us to compete in a very, very competitive landscape for all sorts of services around the world. So that’s very good.
Now the question I am asked more often than not is, while we are going to be in a rising interest rate environment and how sensitive is your portfolio of clients in that space. So I tried to lay this out. The conclusion is that our fixed income business at AllianceBernstein is actually more sensitive to credit markets than it is to interest rate markets, right. So what we have shown here is that not all bonds are created equal.
On the left hand side with the bar charts, we have shown the beta, if you will, of a variety of different fixed income sectors to the U.S. treasury market. So, not surprisingly, the Barclays U.S. credit market, which is essentially high-grade credits denominated in U.S. dollars have 0.8% beta to the U.S. treasury market. So about 80% of the returns of the credit market can be explained through the returns of the treasury market, right. So its not quite one beta, but it is pretty high.
Then we go down the list. This is 1994 to 2013 timeframe. You will notice that as we move out further to the right, the global indices only have about 0.5 correlation to U.S. treasuries. The Muni is even below that. Then when we get to emerging market debt, historically there is a zero correlation to treasuries and high yield is a negative correlation to treasury. So the bulk of our business, and we have color-coded the pie chart on the right hand side, is in those global services, 34% in global services, 12% in Muni's and the area that is most credit sensitive to us, 17% of our business is credit mandates for insurance companies who actually are in concerns with rising interest rate environment, right. They are offsetting their assets and their liabilities. So they are matching those. They are, generally speaking, agnostic to which way rates move.
So if you look at this whole picture, at least historically, we shouldn’t be terribly sensitive in our portfolio of clients to a rising interest-rate environment. I think that’s a very good thing because I am not going to stand up here and tell you that we are not going to eventually see a rising interest-rate environment.
So let me then focus on Asia. You can see, since 2008, we have grown our AUM in Asia quite substantially and even the first quarter saw a slight uptick. We have two main services that have garnered the bulk of those AUM in Asia. Services that we launched in the early-1990s and the mid-1990s, American Income Portfolio and Global High Yield.
The nice story about the 2012 and 2013 numbers is we have diversified away from those being basically the sole products that people are buying from us in Asia. So we started an Emerging Market Debt Fund that just celebrated its third year anniversary. Its just under $2 billion. We stared a RMB Income Plus Fund which is very unique in this space which is already above the $1 billion. We have launched domestically. So American Income and global high yield are less invert funds, offshore funds that are sold in to Asia.
We have recently started a domestic mutual funds effort in Taiwan. We have launched our two funds in that space. One is a fund-to-funds. So we are doing some asset allocation work for our clients in that space. We think that has some prowess in the future. Then we have also just raised, in a record setting for Taiwan, IPO in an emerging market corporate bond fund. I think, really, that highlights the brand that we have built up over in that space.
I had already touched on the awards that we have won in this space. But I do want to highlight that we won Large Bond Manager in 2013, the Fund House of the Year. So not just for fixed income, for all of retail. The Fund House of the Year in Taiwan, Hong Kong and Singapore. Nobody has ever done that before, right. So, again, I that highlights the brand and we are in good standing as it relates to that.
I now want to move into something Matt and I were talking about earlier which is really my answer to, well, aren’t people all going to just sell their bonds because we are moving into a higher rate environment. I think that perhaps this is a better way to look at that question.
We have titled this the old prescription. This is the way that the old asset allocation that we are all familiar with, 60/40. The only reason this ended up working out nicely is because stocks and bonds were negatively correlated, right. So what we really like in asset allocation is negatively correlated big asset classes to make up these two pieces of the pie. But instead of calling them stocks and bonds, I like to just call them return seeking for the historic 60% stocks and risk mitigating for what has historically been 40% bonds.
If we think in those terms, there are bonds like high yield, I just showed with a negative correlation to treasuries that actually are at risk mitigating than return seeking. So we have bonds in return seeking space in light blue just as we have stocks in risk mitigating space in green. So high dividend paying stocks. Very defensive stocks, right. You would think of those as risk mitigating not return seeking.
If we think about that, and add one other piece of the pie which is, I will call this alternatives, and the final turn is not 2-and-20 hedge funds but alternatives as things that offer you diversification and are not highly correlated to either of the return seeking bucket or the risk mitigating bucket.
My job, as the head of fixed income, is to find bond offerings for our clients that solve their needs in each one of these three major buckets. That’s what I am going to explain as we move forward. Particularly in this cyclical environment that we are in right now where the U.S. economy, we can argue how strong it is but it is certainly the strongest of all the major economies around the world and I would argue its even stronger than most of the developing economies around the world.
So, bonds as risk reducing, our view on that is that investors, and I mentioned this before, many state pension plans are now moving to globalize their fixed income exposure leaving behind that old home country bias. Whys should they do that? I will give you two reasons.
The first one is economic cycle diversification. On the left hand side, we have shown in hedged back to U.S. dollar returns, the ordinal ranking of each of the six biggest bond markets in the world over time. You will see that there is no pattern here other than the winners become the losers and the losers become the winners. If you can capture that through research which we attempt to do you can add a lot of alpha to portfolios. So that’s fertile ground for alpha generation.
On the right hand side is the beta which we have broken down, the return profile of two major indices, a domestic index in green and a global index, again hedged to dollars, in blue. We have shown that in periods when U.S. bond performance is positive, by going global you capture 94% of the upside. That’s pretty good. More importantly, right now, when U.S. bond returns are negative, which we would expect them to be, from time-to-time, as we move out of this environment, you only capture 65% of the downside.
So the right hand side, to me, is a proof positive that this is a better beta and the left hand side offers more alpha. Now, active managers have captured that alpha. This is a breakdown of the industry top quartile premiums of global mangers in blue and domestic managers in green. So look at 10 years. We are talking three, four times the alpha generation for going global than for being in domestic.
And I think more and more people are going to try to take advantage of that, in the returns seeking space, right, this is bond that are return seeking assets. How do we define return seeking assets? They are more highly correlated to the equity market. So this is not just a snapshot, one three, five, seven and ten year correlations between the U.S. high yield index and the S&P 500. Those are the green diamonds, 0.7, 0.8 correlations to stocks. That, in our book, define return seeking with a negative correlation to bonds.
Now, we are happy and were very proud about our high yield performance but we think that there is a better way in managing high income, which is multisector in nature. So not just looking at the U.S. high yield market but looking at all markets that provide return seeking opportunities in the world of bonds. We do it across a variety of different sectors, some of which, on the right-hand side, are actually more known for being investment grade markets, right. So it is important to have a platform that enables you to do that and I think AllianceBernstein does that very, very well.
Now because we are cyclically in a period of low interest rates and a fear of rising interest rates, we also think it is important to offer clients fixed-income opportunities in the alternatives area. Again not highly correlated to return seeking and not highly correlated to risk mitigating. We have done that in a solutions-based way for people who were looking for income and for people who are thinking about bonds from an absolute returns perspective.
The first one, as it relates to income, would be those residential mortgage-backed securities. These are the all defaulted, also in sub prime securities which still offer a lot of value. In our minds, the value offering in this space, which we have to do on a default adjusted basis is actually in a variety of different scenarios much, much higher than what traditionally would be seen as high income services like high yield and emerging market debt.
Again, on the right-hand side, you can see it does that with very low correlation to both the risk mitigating and the return seeking space, right. This is a market that is really off on its own. It demands a tremendous amount of research. We have built that research platform basically to mange the PPIP money for the United States government, which is a program that has come and gone. They are now offering that to third-party clients who are very excited about the ability to gain income and not be highly correlated with those other two areas.
Then we move over to unconstrained bond type of investing, right. So this is investing where people say, look I need to own bonds, I want some income but I don’t want to be subject to just data or risk of a rising interest-rate environment, right. So people who think about bond investing for income without a sensitivity to an index. So therefore it has the absolute return orientation, a very dynamic approach, the ability to go long or short, right. So not based upon a risk mitigating portion and because this can be moving into part return seeking assets, we like to utilize a tail hedge strategy on the back of this as well. So that if we have a two or three standard deviation move, we have some protection in the portfolio for our clients.
Again, this is a similar quote slide that takes a look at, instead of country return, sector returns. Just for a quick moment, look at the gap between the winners and the losers in this space. That’s a huge opportunity for alpha creation for our client base. We do it in a way that’s very uncorrelated to the other major sectors.
So I just want to end the last couple of slides on thinking about what is the needs that our client has and ways in which we go about solving those needs, right. So it is not just that people come to us and say, I need you manage a high yield portfolio. Some do, but more than not, we are seeing today people are coming to us and saying, you know what, I need income for my clients. They don’t make enough money if they keep their assets in the bank or they need tax protection or they need protection against inflation, right. And we have the opportunity in the variety of different channels to offer these to our clients. So what is important to us, performance, delivering for clients, be well-positioned for the bond pivot, right, or the rotation, as people are calling it and we see some nice opportunities to grow our market share in a variety of different spaces around the world.
So with that, I will open it up to any questions, Matt.
Matt Kelley - Morgan Stanley
Sure, we have one back there. Yes?
Thank you. That was an extremely interesting and educational presentation. Can I take you back up to the 50,000 foot level, particularly, given your time at the firm, since 1988, the firm has really gone through quite a transition for many, many years, being perceived as primarily an equity shop and now you have become a very stellar fixed income performer. Can you comment a little bit on that transition, particularly since it was being accelerated post-financial crisis and how from both an investment strategy point of view and also from an client education point of view, you have made that transition?
Right, so, again I joined the firm in 1987. I have been in the fixed income group since 1987. So just a little bit of confession here. It always sort of pissed me off that we were seen as an equity house because we did fixed income since I joined. We have been involved in fixed income. I would argue that we had a nice story to tell in the fixed income world. I think the story has resonated out, partially because we struggled a little bit in the equity space, right. But I think that’s the beauty of AllianceBernstein, right, that it does have these pockets of diversified investment arenas and it has diversified clients around the world as well.
So the transition was, we basically did the same thing in the bond space that we have always done, right. I think the fact that we struggled in our large cap equity performance, right, because the other capitalizations in the equity space we have done just fine. But the fact that we struggled there gave more mind share, if you will, to the to the fixed income group and basically it wasn’t just AllianceBernstein, it was the world's desire for bond solutions for a variety of different things, the primary one being income.
We have had, I think to tell you how many times I have given the two main pillars, go global and in your high income space, the multisector, right. It is just a better answer. We have said that time and time again. Look, most people, when 60/40 was the way, you thought about the worlds, we are like, whatever. With bonds, just keep them and if they are tax exempt, keep them in the then Lehman Aggregate, now, Barclays Aggregate and don’t worry about it.
You had a 30 year drop in interest rates. So they took care of themselves. Most people spent most of their time on the 60%. Now we were in a different world. So those stories started to resonate. I have a very nice Lipper trophy my office for 10 years, the best high yield portfolio return. Right, 10 years in high yield. Bull markets, bear markets, the best.
Now, that’s for two reasons. Number one, I think we have very good analysts and (inaudible) and traders but it is actually better mousetrap. Having the ability to go across those sectors is a better way to manage money and you know what happens, you tell that story for 27 years, you produce returns that generate the proof statement about the story and people start buying it. I think that more and more, the full asset allocation is going to get the mind share as opposed to just the equity unit. Not AllianceBernstein's equity unit, the equity portion of that.
We have a strong effort in that. Look, I also think that our equity returns are going to turn a corner, right. I think as we move out of a macro environment and into a micro environment and as we move out from very highly correlated equity returns. So each stock return is very closely to each other. It is very uncorrelated. Because that’s the cycle we are going into. I think our equity theme is going to do great.
Matt Kelley - Morgan Stanley
We can take one more and then we are going to have to go to break out after this but any other questions from the audience? I think they are probably asking to break out. So let's go to break out. Thanks, Doug. Thanks for your time.
Thank you, everybody.
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