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Executives

Timothy Armour - Interim CEO

Robert Garvy - Chairman and Co-Chief Executive Officer, INTECH Investment Management LLC

Gregory Frost - EVP and CFO

Analysts

Ken Worthington - JPMorgan

Craig Siegenthaler - Credit Suisse

William Katz - Buckingham Research

Roger Freeman - Barclays Capital

Robert Lee - KBW

Michael Kim - Sandler O'Neill

Cynthia Mayer - Merrill Lynch

Michael Carrier - Deutsche Bank

Janus Capital Group, Inc. (JNS) Q3 2009 Earnings Call October 22, 2009 10:00 AM ET

Operator

I would like to welcome everyone to the Janus Capital Group Third Quarter 2009 Earnings Conference Call. (Operator Instructions).

Before the company begins, I would like to reference their standard legal disclaimer which also accompanies the full slide presentation located in the Investor Relations area of janus.com. Statements made in the presentation today may contain forward-looking information about management's plans, projections, expectations, strategic objectives, business prospects, anticipated financial results, anticipated results of litigation and regulatory proceedings, and other similar matters.

A variety of factors, many of which are beyond the company's control, affect the operations, performance, business strategy and the results of Janus, and could cause actual results and experiences to differ materially from the expectations and objectives expressed in their statements. These factors include, but are not limited to, the factors described in Janus reports filed with the SEC, which are available on their website, www.janus.com, and on the SEC's website, www.sec.gov.

Investors are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date on which they are made. Janus does not undertake to update such statements to reflect the impact of circumstances or events that arise after the date these statements were made. Investors should, however, consult any further disclosures Janus may make in its reports filed with the SEC.

Thank you. Now, it is my pleasure to introduce Tim Armour, Chief Executive of Officer of Janus Capital Group. Mr. Armour, you may begin your conference.

Timothy Armour

Thank you. Good morning. This is Tim Armour, Chief Executive Officer. With me this morning in Denver are Robert Garvy, the INTECH Chairman and CEO, as well as Greg Frost, our Chief Financial Officer. The three of us will handle different parts of this presentation.

I think where I'll start is sort of give you a broad headline of what we're going to present to you today, and I think I would characterize third quarter 2009 as a quarter of continued recovery for Janus Capital, with some really good news on the front for Janus and Perkins with strong performance and flows that resulted from that, as well as impressive contribution from our fixed income team. We have some offsets, and we'll speak about in a moment in terms of outflows at INTECH, as well as the expense drag from one-time charges for legal settlements and for severance.

So, if you will, turn to page two of the PowerPoint presentation we have and I'll begin with the first highlight that in 2009, our earnings per share reached $0.05 a share versus $0.10 in the previous quarter and $0.16 a year ago. As I mentioned, this reflects the earnings drag from $0.10 per share as a result of legal settlements and severance associated with the former CEO, and that was partially offset by a gain from the completion of the debt tender offer. If you normalize third quarter and you add it back the $0.10 one-time charge, that would put us at $0.15 for the quarter, which is well ahead of the previous quarter, and in fact, almost equal to the third quarter year ago of $0.16.

Total company net flows of minus $6 billion is a story of sort of several cross currents. If you look at the detail here, you see that net flows from Janus were plus 1.3 and Perkins 0.6, and it was offset by some pretty significant outflows on the INTECH side at $2.5 billion and we'll talk about that one in a little more detail in a moment.

On a summary basis, the assets under management at the end of September 30 were $151 billion, which is 14% up versus second quarter. On this theme of continued recovery of Janus, that's actually 55% higher than the low point we had in assets under management this year. So, what you are seeing is sort of a continued steady recovery in assets under management for Janus Capital.

Relative investment performance continues to be strong for Janus equity, Janus fixed income and Perkins, and while INTECH's short and intermediate term relative performance has been weak, in fact the long-term performance is actually quite good. So, we also successfully completed the capital restructuring, which gave us increased financial flexibility. Greg will give you little bit of an update of that in a moment.

If you would turn to the next page, and I'll go into a little bit of detail on the flows, I've summarized here that in the third quarter Janus and Perkins' long-term net flows remained positive, while INTECH experienced some outflows. The total company was up slightly quarter-to-quarter. I think in the upper left quadrant there, if you see the total company flows, that $8.6 billion positive offset by $9.2 billion negative, we ended up with just under $600 million negative net flows.

I think the real story is, if you decompose that and look at the various components, on the upper right-hand side you see Janus' long-term flows. At $1.3 billion net flows, the net flows were off 24%. Underneath that, it's a continuing good story. We had positive inflows of $1.3 billion making up that positive 1.3 in net flows, 65% of that flow $900 million came from our fixed income products.

To put this in a little bit of context for the marketplace, the market for mutual funds in the third quarter was up about 10%, the equity side was up 3% and fixed income was up 28%. Our bond side was up 78% and it reflected really sterling performance that I'll cover in a moment on the bond side.

Over 43% of our mutual funds posted positive net flows, and top contributors included overseas, our balanced fund and our short-term bond and flexible bond funds. So, annual organic growth rate was about 7%, just slightly below the organic growth rate for the industry.

On the bottom-left, you see the INTECH flows. They decreased remarkably, and there are sort of two stories. One is, there was a lot of rebalancing in US equities into fixed income and more passive portfolios, and so INTECH suffered from that. In addition, we had some continued underperformance of our Large Cap Growth strategies. It wasn't dramatic underperformance, but it was below the benchmark, and we try and stay above that benchmark. Bob Garvy will talk about that in a moment.

On the bottom right, you see the Perkins' story, which is a story of sustained above-par performance. This is the fifth consecutive quarter that Perkins has had positive net flows. The $600 million translates to an organic growth rate annualized of about 23%.

If you turn to the next page, page four, this break downs our flows by retail, international and institutional channels. I'll start with the retail channel on the left-hand side. You can see we have strong gross flows across all sub-channels, whether it was broker-dealer, investment-only retirement, the financial institutions or supermarket sub-channel, they all posted positive net flows. I think the biggest strength was really on our broker-dealer and supermarket areas.

Interestingly, on the supermarket side, we had 21 funds listed on select or guidance list with Schwab and Sidoti. Being on those lists really is a driver of sustained flows, and we are maybe overrepresented on those lists and it's really helping drive our flows in that area.

On the institutional area, in the middle, the story is a little bit more sanguine. Many pension plans have remained frozen. We're not seeing the level of searches in the category and increased redemptions as a result of continued underperformance at INTECH, primarily again on the Large Cap Growth and the broad Large Cap Growth strategies has resulted in a net minus $2.8 billion in that channel.

International, on the other side, saw a significant increase in flows, and if you see, up $500 million. This has been a good story for Janus. It's led by INTECH on the institutional side, but Janus and Perkins all had positive flows internationally during this quarter.

I would point out that over the last 19 quarters, 15 of those or almost 80% of the time, Janus Capital Group has had positive net flows internationally. Again, this diversified portfolio between retail, institutional and international is really sort of helping provide balance in terms of flows and revenues.

Turning to the next page, on page five, and this is a little bit of a summary of really what has been outstanding performance, long-term relative performance across the board. On the first bullet you see that 79, 88 and 86% of mutual funds are in the top two Lipper quartiles, above meeting in performance on a one, three and five-year basis for the quarter. If you then sort of step down and just look at the Janus equity mutual funds, it goes from 83 to 94 to 88 on a one, three and five basis.

In our fixed income, interesting, I mentioned that they had really outstanding performance, 100% of the Janus fixed income funds are in the top two Lipper quartiles on a one, three and five-year basis. The Perkins mid cap value and small cap funds ranked in the top 19 and 9% across one, three and five, and importantly, the large cap value fund from Perkins that we launched at the end of last year is now in the top 34%. So that's showing significant promise as well.

I would also highlight, if you are not aware, prior to joining Janus' Board and taking this assignment, I was at Morningstar and I can tell you that for a group of funds to have 64% of their mutual funds have a four, five star rating is just outstanding performance. That's a force distribution. No more than 32.5% of funds in the universe can be four or five star rated. So to have a 64% is really outsize performance across the board on a sustained base.

You can see on INTECH's strategies, weakness in the short term, but I point out that on a five-year basis 63% of strategies are outperforming their benchmark. We have a near term and intermediate problem with INTECH, but in the longer term, we're still serving our clients well versus the benchmark.

Then finally on page six, I put as the headline that 86% of firm-wide mutual funds are outperforming peers on a three and five-year basis. What this chart tells you, on the top half we have firm-wide mutual funds, on the bottom half we have just the Janus equity, but on the firm-wide mutual funds, in the middle, on a three-year basis, we have 88% that are above medium performance on a Lipper basis. I think this chart really tells the story of sustained investment excellence and it's something we feel quite good about that our team has really navigated the 2008-2009 market crises very well.

When we look at how we fare this time versus how we fared in the bear market in 2001-2002, we really see some of the improvements and enhancements we made to the investment team and to the process really kicking in. So, if I were to highlight to you where were we at the beginning of the bear market in 2001-2002 versus where we are at the end of September quarter, we had 27 analysts back in the 2000 period, today we have 35 equity analysts. We've also added nine junior analysts and 20 research associates.

Previously we were covering only 500 stocks, now we're covering in-depth 1,400 stocks. Our PM tenure is up dramatically. We went from 7.2 years in 2000 to 10.8 years, and the average years in the industry went from 9.5 up to 14.3. So we feel very good about sort of the strength of the team and continuity we have there. I think this outsize performance, if you look down at Janus equity mutual funds and you go over to that middle column on a three-year basis, there are few firms in the industry that can claim 94% of their funds are above medium performance on a Lipper basis across three years.

So we feel terrific about that. We also feel we have an enhanced investment risk management process that better understands the risk we're taking, both at the portfolio level and at the firm level.

So with that in hand on page six, I'd ask you now to turn to page seven, and I'll turn this over to INTECH Chairman and CEO, Bob Garvy, to talk in a little more depth about the story at INTECH because I think it defies a simple explanation. I think if you understand the details of this, you will have the confidence I have that INTECH will be able to sustain its performance over the long term.

So, Bob, if you will.

Robert Garvy

Thank you. Thank you, Tim. Well, as Tim has pointed out, the recent underperformance at INTECH coupled with a challenging investment environment led to substantial net outflows in the third quarter of 2009. Several of our investment strategies have underperformed their respective benchmarks over the one and three-year time periods. Large Cap Growth strategies have also underperformed over the five-year period.

When we look at net performance of INTECH, particularly in these Large Cap Growth strategies, over the three-year timeframe, the Large Cap Growth strategy is behind the benchmark by 163 basis points and over five years by 76 basis points. In Broad Large Cap Growth, we've underperformed by 316 basis points over three years and 171 basis points over five years, both of those net of fees. Broad Enhanced Plus is behind lesser amounts, 63 basis points over three years and five years 25 basis points behind the benchmark.

We're not happy with this kind of performance, but it is not severe underperformance. However, if it does continue, particularly in the Large Cap Growth strategies, obviously, this could result in greater levels of outflows going forward.

Large cap equity search activity has also significantly slowed among US plan sponsors in response to the global financial crisis as asset allocations are reassessed and as these institutional investors deal with a wide range of issues that have emanated from the global financial crisis.

On a positive note, search activity in global and international strategies is increasing at INTECH, particularly within the non-US institutional market segment. We continue to develop and implement further global and international alternative and solutions-based strategy to meet investor demand, and we remain focused on client and consultant service, efforts to educate and respond to investors. We brought in Andrew Klebanow, for example, in January of this year to head the client and consultant service effort at INTECH.

Turning to page nine, I want to point out that despite the shorter term underperformance, INTECH's firm-wide batting average continues to be strong across the one, three and five-year periods. The firm-wide batting average across our nine primary strategies was 72%, 83% and 92% for the one, three and five-year periods respectively as of the end of the quarter.

Our Global Core is outperforming its benchmark by 94 basis points and 110 basis points on a three-year and since inception basis net of fees. Also International Equity is outperforming its benchmark by 236 basis points since November 2006 inception. You can see in the table very strong batting average across our main strategies over the one, three and five-year periods.

So we can see that this underperformance is pretty much concentrated in the growth strategies. If you'll turn to page 10, we'd like to make a couple of observations for you. First of all, INTECH has experienced similar periods of underperformance, but over the long term has achieved targeted excess returns. While our short and intermediate term results are disappointing, all strategies are operating within a normal range of statistical expectations.

The risk management investment process that we employ has helped to moderate the magnitude of the underperformance, most of which, as I pointed out, has been concentrated in the Large Cap Growth area.

It's quite surprising that occasionally an investment process that is actually functioning normally will experience multiyear periods of underperformance. You see a table here on page 10. It shows that strategies with positive information ratios, that is real excess returns above benchmarks, will have at least one 48 rolling period of underperformance from peak to trough over various timeframes.

For example, a strategy with a 0.25 information ratio over 10 years has an 85% probability of posting a four-year period in which from peak to trough the performance was below the benchmark, and over 20 years that probability rises to almost 99%. Again, if you look at the bottom of that table, a 0.75 information ratio strategy, which ranks among the highest in the industry, over 10 years has more than a 50% chance of showing a four-year period of underperformance, while over 20 years it rises to 83%.

I might point out that our Enhanced Plus strategy, which over 22 years has an information ratio of 0.75, ranks in the first percentile of the evaluation universe of performance. Even with that kind of performance, over a 20-year timeframe, that strategy has been in place for about 16 years, there is an 83% probability of having at least one four-year period of underperformance.

So it's not surprising that even a normally behaving strategy will occasionally suffer these kinds of performance. Over the long term, relative performance remains positive at INTECH and consistent with our target expectations.

Turning to page 11, we do think INTECH is very well positioned for long-term growth. We are all quite familiar with the four Ps of institutional investment philosophy. That's a key one. At INTECH, our philosophy is based on a proven mathematical theorem, not a supposition or hypothesis or a conjecture. In terms of process, INTECH's risk-managed investment process has been consistently applied for over 22 years.

The people strength of the firm is very strong. Our organization has historically had low turnover compared to the industry. The only area in which we are suffering right now on a short-term basis and intermediate term and in moderate amounts is in performance. While our long-term relative performance remains positive and historically has been consistent with target expectations, we are disappointed in this short and intermediate term performance.

I'd add a fifth P that particularly with a strategy like INTECH's, patience is a virtue in this kind of circumstance. As long as this performance is modest and moderate, we are very confident that our performance will return to its historical pattern.

We continue to focus on the needs of institutional investors and our opportunities for growth. We are further developing and implementing our investment solution capabilities. We're leveraging our opportunities in global and international strategies by introducing additional applications. We continue our research and development for incremental improvements to our investment process and the engineering for the implementation of them. We are focusing on to diversify this classic portfolio theory into additional asset classes, and we would expect in the next year or so to be introducing applications in classes outside of domestic and international equities.

At this point, I'll turn the presentation over to Greg Frost to go over the financials.

Gregory Frost

Thanks, Bob and good morning. Janus recorded third quarter earnings totaling $0.05 per share compared to $0.10 in the prior quarter and $0.16 a year ago. As Tim mentioned, we had another noisy quarter a little bit and we kind of had the $0.10 net charge included in the current quarter numbers, which breaks down as follows. $0.05 relates to charges associated with the departure of the former CEO, $0.07 relates to legal settlements with former employee and we've recorded a $0.02 gain on the debt tender we completed in August, which I'll cover more in a little bit.

We mentioned the CEO charge last quarter, roughly $7 million as recorded in compensation and just over $5 million recorded in our long-term incentive line for the non-cash acceleration of unvested equity. On the legal side, I think everyone is aware of the trial earlier in the year that we went through, and during the third quarter, similar claim were made by former employees. Instead of going through the cost and distraction of another public trial, we decided to settle the matters out of court for a total of $20.5 million. We are not aware of and do not anticipate any additional claims made by former employees related to this matter.

Moving to the operation side, both average assets under management and revenue were higher in the quarter, given the obvious rise in the markets. Operating expense, as indicated on the slide, were up 29% in the current quarter. If we kind of exclude the charges that we discussed earlier, the increase was only roughly 8%, and this 8% rise was primarily caused higher variable expenses, namely compensation and concessions, offset by lower discretionary G&A spending.

Compensation did tick up at a higher rate than revenue this quarter, primarily result of Janus' continued strong equity and fixed income investment performance that Tim mentioned over the three and five-year periods, and as indicated on the prior slide, the noticeable improvement on a one-year basis.

As normalized expenses increased at a lower rate than the 14% increase in revenue, we certainly experienced a positive operating leverage in the business, given higher assets in a reduced, fixed and discretionary cost basis. Also, as noted on Q3 or noted on the slide, third quarter includes almost $3 million of cost from the JIF, JAD merger with another $2 million to $3 three million expected in the fourth quarter as we finalize the project. This is very much in line with what we have communicated to you all in prior calls.

Turning to the capital side, our successful capital raise in the July and the subsequent debt tender in August resulted in overall decrease of long-term debt of $360 million. We expect annual interest expense on a GAAP basis to decline approximately $16 million and decrease $24 million on a cash basis. Remember that the interest on the convertible debt is taken to the P&L at the market rate of straight debt or the approximated market rate of straight debt of roughly 10%, while the cash interest is obviously the stated coupon of 3.25.

As a result of being able to buy our outstanding senior notes at a discount, we realized a gain of $5.8 million in the quarter, and this is net of the write-off of previously capitalized bond issue cost. This transaction clearly was an important step for us in getting our credit metrics back in line with an investment grade company.

As I mentioned before, if we look at more normalized numbers, we did see margin expansion during the quarter given the rise in assets and our reduced cost base. We remained focused on managing expenses in this uncertain market environment, but we acknowledge that to grow the business, we'll have to make certain investments in the business as we move forward. Thus, although, I would expect some level of margin expansion if assets continue to increase down the road, it will be tempered by cautious investment in the business and our employees.

With that, I will turn it back over to Tim to wrap-up.

Timothy Armour

Thanks Greg. If you would turn to page 14, it's kind of a final slide in our presentation. I would summarize that we're delivering strong, long-term relative investment performance across all three brands. We think we have the key ingredients to be both successful and independent.

We're going to be a long-term winner in the money management category. We're gaining share and equity in fixed income markets through positive net long-term flows both at Janus and at Perkins. We're very confident that INTECH's mathematical investment process is well positioned for long-term growth despite current underperformance. We've been in this position before. We've turned it around and served our clients quite well. We have every confidence that will continue.

I would highlight I am the Interim CEO. I have been here about three and a half months. We are still in the midst of a CEO search. I would describe it as we're probably in the seventh inning. We are seeing truly excellent and impressive candidates. My hope is when we have this call after the first of the year, we will be introducing a new CEO to you. So I remain very, very encouraged by the quality of candidates that we're seeing.

We have an experienced leadership team. It's committed to growing the business, while focusing on controlling costs. We want to further establish a global franchise. I pointed out that the sustained strength we have there. We want to continue to invest and grow that part of our business.

We're dedicated to becoming a top tier firm in the advisory channel. We have significant momentum this quarter. It's part of our strategy of building out not only in the advisor and intermediary channel, but also in the institutional channel. We're going to leverage Janus, INTECH and Perkins strong long-term relative investment performance to further penetrate the institutional channel. We have real strength there and penetration on behalf of INTECH, and I think that's helping us penetrate that channel more broadly.

So I would wrap up and say, while we see a relatively, maybe uncertain and challenging market environment that we're in, we're more confident than ever that we're going to perform quite well. We feel we have the organizational stability. We have asset growth and momentum. We are going to focus on channel and geographic expansion. Greg pointed out that we're very mindful in sort of this environment we're in that we have to keep our powder dry that we're going to control operating expense and headcount. We're going to have steady margin improvement.

We will look to improve the quality of the franchise, whether it's improving the asset quality and the persistence, our penetration in the international markets, retirement markets, the institutional market. We see that are well above par performance is really a key ingredient for us to penetrating some of those markets.

So, with that, I'll pause here, and operator, we would welcome any questions from the audience.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Ken Worthington of JPMorgan.

Ken Worthington - JPMorgan

Hi, good morning. Maybe first for Greg, can you just flesh out your comments on the margin outlook and investment, maybe a little bit more details on what kind of investments you think you would make? How much they may actually weigh on margins and any other flavor would be wonderful.

Gregory Frost

You know, Ken, I won't go too much in detail. You know I would say this, I think all asset managers find themselves in a position today where they've cut back on their costs. We spent the better part of '09 kind of waiting for the market to stabilize a little bit, and now that we're here, at least it's what feels like a little more stable market, I think everybody is in the same boat, but we're looking ahead to 2010 and beyond and figuring out what are those growth opportunities in the business that we can invest in to generate top-line growth.

I'd be naive to think that we can do that without investments and I also would be naive to think that we can do it without the support of our employees. I think you're going to have to make some investments in this business. The magnitude and what that looks like in the future, I think, we can flesh out as we get further down the road with you. Suffice it to say, we are focused on the cost base. As Tim said, we're focused on margin expansion, but I do think it will be tempered by what has to be increased investments in certain parts of this business.

Ken Worthington - JPMorgan

As a follow-up maybe for Tim, we have seen some turnover in sales, I think the top three have left recently, maybe help us understand what's going on, any risk of further departures and the impact these departures are having on sales, if any?

Timothy Armour

Sure. The comment I'd make is Janus across the board has a pretty broad, deep, high-quality bench, and I think we're a target within the industry because we have really super people, and we had two of those three people that were sort of picked up by competitors because they are very talented. Their departure came after the leader of the group, Dominic Martellaro, decided to sort of take time and go on the beach. He didn't leave to go to another provider. He just wanted to stop traveling on airplanes. Having said that, we've been able to, without missing a beat I think, asked Robin Berry to step up and sort of play a more important role heading up the distribution and backfilled in that with John Ingram, who was within our sales organization, one of the more talented executives that has taken a leadership position, and then Drew Elder, who is handling sort of the platform, the domestic platform for sort of our larger client base.

So we never like to see people leave. I got to tell you that I feel extremely positive on sort of the talent we have in place and how well they are working together and we have not reduced our commitment to that intermediary channel. If anything, it's increased. My opinion is that if you look across the board, I get this question a lot about departures or turnover at Janus, just pause for a moment. We have not had a major departure out of the investment area in over two years. The engine room is running very well. I feel very confident across the board. I think sort of across the board the temperature of sort of the environment at Janus, it's a great place to work, we've got good people, we've got the right people on the bus and I'm encouraged looking forward about our prospects.

Ken Worthington - JPMorgan

Great. Thank you.

Operator

Your next question comes from the line of Craig Siegenthaler of Credit Suisse.

Craig Siegenthaler - Credit Suisse

Thanks and good morning. On the institutional landscape, and maybe, Robert, you could provide some perspective here, but it sounds like RFP activity is still weak for domestic equities. How much of that is a function of the client, which may still want to increase allocations to the bond or international equities or how much of that is a function of really relative performance here?

Robert Garvy

Well, I think that if we look at the industry as a whole, we can see that domestic equity searches are down anywhere from 50 to 75 or 80%. The major consulting firms have reported very, very substantial slowdown in activity, and in the first half of the year, the activity almost was close to zero. It's only picked up very recently. A large part of that, obviously, is a function of the global financial crisis, the asset allocation analysis, movement to passive, a whole raft of the things that have been occurring to cause that. Secondly, if you do have underperformance or weak performance in that type of environment then you can expect the activity in your area to be reduced as well, and we have recognized that reality as well.

Craig Siegenthaler - Credit Suisse

Do you expect the domestic equity searches start improving here, and if they don't, are you worried that the pond is getting little smaller here and it will be tough to kind of fight for market share?

Robert Garvy

No, I fully expect that as this crisis passes that we'll see a return to normalcy in the allocations to investment managers. We have very, very strong performance in a number of our strategies. The only real pocket of concern is in the Large Cap Growth arena. So I would expect us to participate in the increased activity that is likely to come and is starting to come now in the equity arena.

Craig Siegenthaler - Credit Suisse

Great. Robert, thanks for your thoughts.

Operator

Your next question comes from the line of William Katz of Buckingham Research.

William Katz - Buckingham Research

Good morning everyone. I just want to stay with, Robert, if you could. I've a couple of questions for your. Greg, one or two for you. In terms of the positioning of INTECH, just wondering can you size the portfolio between US and non-US and maybe large cap versus the rest of the company? And then the bigger question is there seems to be a very strong push to passive relative to quant, and I'm just sort of curious if there is more of a structural concern in your mind about the positioning the business?

Robert Garvy

Sure. The non-US based business of INTECH is about 18% now of our total assets under management. That is non-US based investors. They are spread across our global, our international, as well as some of our domestic strategies and we expect to see substantial growth in that non-US based investor client list in the next five years or so. In terms of the second part of your question, the movement to passive, that's kind of maybe a two-edged sword in some respects because we are a risk-managed manager and a number of our strategies are considered enhanced indexing. When you look across the searches that are occurring, even in many of these "passive searches," enhanced strategies are included in those. So we would expect to participate in those and remain confident that we'll be a major player in that area.

William Katz - Buckingham Research

Greg, I'm sort of curious in terms of reconciliation between GAAP and operating, are you including or excluding the JIF, JAG conversion cost in your assumptions?

Gregory Frost

I am including that in what I would call the normalized numbers, Bill. I mean, I think that's an investment that we consciously made this year. So it's in there. The only thing I'm "backing out" would be the severance cost and the legal settlements.

William Katz - Buckingham Research

So just so I understand then, in the fourth quarter you will have those expenses again, but in the first quarter of 2010, would that repeat or that would go away?

Gregory Frost

That would largely go away. We have a small piece of the project to finish up in the first quarter, but the bulk of the spending will occur in Q4.

William Katz - Buckingham Research

Then just last question on that. You've historically had sort of a goal of 50% plus incremental margin. Is that no longer the case in light of your commentary about reinvesting in the business into 2010?

Gregory Frost

I mean I stand by the long-term goal, but I think it's just that, it's a long-term. I think we find ourselves in the position where I think we were close to achieving that, if you kind of look at the normalized numbers Q3 to Q2, but we also know that we have to do some investments in the business to grow. That's our long-term goal and some years we'll hit it and some years you're not going to because you're going to have to make investments.

William Katz - Buckingham Research

Okay, thank you.

Operator

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

Roger Freeman - Barclays Capital

Hi. Just two questions. I guess I'm curious to get your thoughts on retail flows. Industry flows have turned negative. They've been negative basically in the last seven weeks, at least, domestic funds. Yours have come off each month, obviously, still positive and doing better than the industry. What do you think is really driving that market continuing to hit new highs, what turns that around?

Timothy Armour

I guess, the way I had comment on it, we've done a little bit better than the industry on some of those channels. I think one thing is going on in the retail market is, it's an unusually fixed income intensive market right now and that's not our sweet spot in terms of the number of our asset or the number of our funds. Having said that, we're still participating very well on the upside there. I said we had over 70% increase.

The other is, I just think there is still a lot of fear in the water. Bob characterized it in the institutional market. I think the same thing is going on in retail. What we can do is keep our head down and really focused on delivering excellent performance. I think as this market sort of improves and gets stronger and less worried, I think there is a going to be a flight to quality and those that deliver very, very good long-term performance. I also think that overseas we have tremendous performance. We've had both in our overseas strategies for domestic retail as well as what we're seeing in terms of potential in the retail business outside of the United States.

Again, I think its part of the theme of Janus, which is we want to have sort of a multi-asset, multimarket capability so that we're participating across three brands in multiple markets where we can find growth opportunities. I think across the board our performance on balance is really terrific, and I think that's the characteristic of the kind of firms I think that are going to do well in the coming market.

Roger Freeman - Barclays Capital

Got it. That's helpful. Then, I guess my follow-up, maybe for Bob, just in terms of the Large Cap Growth strategy, do you modify the models when they are underperforming or do they just sort of stick to the way they have always functioned? And then, also, inside of that study you showed, is that just a simulation that's run on that fund or are there other funds included in that? And also on large cap, has that one underperformed for a multiyear period in the last, I guess, 10 years?

Robert Garvy

Let's see if we can take three…

Roger Freeman - Barclays Capital

Sorry.

Robert Garvy

That's all right. In terms of the underperformance that we have experienced and our response to it, our process has been in place for essentially 22 years. It's a volatility capture strategy in which we're looking at volatility and correlation. While we have made small, marginal, incremental changes over the years, the basic process has not changed over this time. It's been consistently applied. The application of this methodology, however, is subject to changes in volatility in the market, and particularly sudden changes in the volatility of the market.

So you have a situation in 2008 and running into the first quarter of 2009 in which you have markets plummeting at very, very fast rates, and then subsequent to that, increasing and moving forward at very extreme rates. When you are sampling the volatility, obviously, that is going to create a lag in the response to this type of volatility. Sometimes the lag is favorable and it creates positive tracking area, other times its negative, and we are experiencing the negative side of that now.

So we don't make major changes to the process itself. It's based on a very sound methodology that we have a lot of confidence in and we fully expect it to return to its historical performance. You asked a question also about the large cap area and the significance of that and are we underperforming in the large cap area, Enhanced Plus strategy, which is the strategy that's our flagship and which we have substantial assets, the most assets in the firm really, that and Large Cap Growth remains in positive territory and has been in positive territory and we fully expect it to continue. I think you're going to have to remind me the third part of your question.

Timothy Armour

It was about the underperformance.

Robert Garvy

Yes, you asked about the underperformance.

Roger Freeman - Barclays Capital

Yeah.

Robert Garvy

In the 1990s, we had a period of underperformance in that large cap enhanced strategy, between '94 and '97. You refer to the table that we showed. That is a Monte Carlo simulation. If you have a strategy that over a long period of time has an excess return and a tracking error, the quotient of those two numbers is the information ratio. So, even with a positive long-term return and some tracking error around it, you can see that there are periods in which there will be extended underperformance. That's a statistical outcome. It's a Monte Carlo simulation using the 1,000 period sample and is standard statistical technique.

Roger Freeman - Barclays Capital

Got it. Thank you.

Operator

Your next question comes from the line of Robert Lee of KBW

Robert Lee - KBW

Thanks, good morning. A few questions. First, not to beat a dead horse, but at INTECH, can you size the – seem to think that that's where most of the outflow risk is, size the growth portfolios that are at risk as a proportion of total assets, and then I have a few other questions?

Robert Garvy

Well, we don't give guidance on specifics and our expectations about flows in that area. The institutional marketplace has always been very lumpy. Our relative performance, underperformance is certainly impacting net flows now. However, we do continue and we do see headwinds in the market. Plan sponsors have been slow to make rebalancing decisions, given the volatility that they have experienced. Liquidity has continued to be an issue in the equity market, and as a result, the search activity, as I pointed out, is down very dramatically from 2007 and the first three quarters of 2008 levels.

However, in the international markets search activity is increasing. We saw net inflows in that business in the third quarter of 2009. We continue to believe that our Global Core and our International Equity strategies will be engines for growth. I might point out in that regard that the Global Core strategy will reach its five-year track record at the end of December of '09, which represents another critical point for institutional investors, and since inception Global Core is outperforming its benchmark net of fees by 110 basis points annually.

Robert Lee - KBW

All right. Well, maybe I'll ask this a different way. The $47 billion roughly of assets at the end of Q3…

Robert Garvy

Yes.

Robert Lee - KBW

…in your strategies, how much of that is in strategies you think are most at risk?

Robert Garvy

Well. Our Large Cap Growth has about $10 billion in assets in it. That's where some of the underperformance has been focused. The Broad Large Cap Growth strategy has about $6 billion to $7 billion in it. There has been underperformance there as well. As we point out, the long-term performance here though is quite strong and the performance over the short and intermediate term is really quite moderate.

Robert Lee - KBW

Couple of other questions. I mean the first one is just for the geography on the income statement for you, Greg. Where is the $12 million of one-time expenses showing up? Is it partially spilt between long-term incentive and regular comp, is it all in place? I just want to get the geography down.

Gregory Frost

$7 million in employee comp, roughly $5 million in LTA.

Robert Lee - KBW

Maybe just talk a tiny bit about capital management at this point. I mean, you did the exchange, that's been moderated. At this point, is it really still just building capital for maturities out in 2011, 2012, or are you starting to in any way, shape or form rethink how you will deploy your cash volume going forward?

Gregory Frost

It's a fair question. I think we're going to always stand by our philosophy of making sure that we're deploying our capital, which gives our shareholders the best risk adjusted rate of return as we move forward. I think we were pleased that we can get the capital raised and the tender behind us. We're pleased that we find ourselves where we do today. I think going forward we're going to deploy the cash as we think will yield the best returns for our shareholders and that may include further opportunistic debt repurchases. I certainly like having a little more cash in the balance sheet in these uncertain times as well.

Robert Lee - KBW

If you guys could indulge me, one last question, I guess, mainly for Tim. I know you can't mention any specific candidates or whatnot, but I'm just curious when you search for a CEO, I mean are you focusing on individuals who really it's more about you think you have the right strategy now and just need someone who can execute on it, or do you think it's important for whoever you are looking at that they kind of bring something new to the table that they may have a different perspective on where maybe the company should head in the years ahead?

Timothy Armour

I think probably the headline answer to that is I think the strategy is right. We need to find the right person to pull the team together to execute it. When we put together a list of attributes we were looking for in the next CEO, strong leadership skills was at the very top of the list. We have a diverse portfolio of people and businesses, we're spread out across the globe, we have tremendous potential and I think we needed the right leader to come in and sort of execute on these strategies to make us a global player with excellent performance across all our strategies on a sustained basis and penetrate the markets we described.

I think we've got all the preconditions and the raw material to do that, I think we just need the right leader to help clarify this vision and get people to execute it and get on board. As I said before, I think we are seeing some really impressive candidates that I think will fit that bill very well.

Operator

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

Michael Kim - Sandler O'Neill

Hi, guys. Good morning. Just first in terms of INTECH, to what extent do you think the recent underperformance might represent somewhat of a headwind for you guys to kind of more broadly penetrate the institutional channel with some of your Janus capabilities?

Robert Garvy

Well, we're not happy with our recent performance, but the reality is that any investment process that is working normally will have periods of underperformance, and INTECH is not any exception to that. As I pointed out, we've seen similar periods of underperformance in the past in both the short and the intermediate term. Over the long-term, these strategies are providing levels of excess returns at low relative risk that are consistent with our targeted expectations.

So I think that institutional investors when evaluating money managers will take into consideration the process that's being employed, the people that are engaged in it, the philosophy that underscores it and the performance issue, particularly on a short-term basis, is probably an opportunity for acquisition rather than a significant headwind. We continue to be in searches. We have a lot of support from the consultant community and I expect us to be a significant participant moving forward as we have in the past.

Michael Kim - Sandler O'Neill

So that hasn't really impacted any of your cross-selling initiatives in terms of your Janus capabilities away from INTECH?

Robert Garvy

Well, no, I don't think that's a factor that is of concern to us at all. I mean, INTECH is a now a very broadly-based firm. We have multiple strategies in diverse markets. 10 years, 15 years ago, we were essentially a one to three product firm. We're much broader base now and I think we have multiple opportunities to expand our penetration in these markets.

Michael Kim - Sandler O'Neill

Then just to maybe kind of beat a dead horse here, but in terms of the outflows, specifically in the third quarter, were there any kind of outsized redemptions that we should be aware of, and then do you kind of anticipate any redemptions as you look into this quarter? I know it's early, but any help there would be appreciated.

Robert Garvy

Well, you know, I've already responded to a question in that regard. We don't provide any specific guidance in that regard at all. These flows tend to be lumpy. That's the nature of the institutional business. We can say if performance continues to underperform that they are likely to continue. If you look historically at money managers, the flows tend to lag the performance; that is during periods of good performance when it turns negative, positive flows will continue for a while. Typically, when there are periods of underperformance, the slowdown in positive flows with the negative flows are likely to lag to some degree the turnaround in performance.

Operator

(Operator Instructions). Your next question comes from the line of Cynthia Mayer of Merrill Lynch.

Cynthia Mayer - Merrill Lynch

Hi, good morning. In terms of the comp, you mentioned it picked up because of strong performance and I'm just wondering did any of that increase include a catch-up or is 3Q a good run rate?

Gregory Frost

Let's see. There may be a little catch-up in there, Cynthia, but I think the vast majority of the increase is from the investment group on their one, three and five-year numbers.

Cynthia Mayer - Merrill Lynch

Looking at your legacy Janus and Perkins flows, the sales went up in the third quarter, but the redemptions also went up. I'm wondering is there anything in there in terms of a trend we should think about other than industry trends away from domestic equity or seasonality or anything there that you think could carry through to 4Q?

Gregory Frost

No, I don't. I think, honestly, one of the things that did happen, to Bob's point, you know when you get good performance and then it changes, there is a little bit of a lag, my opinion is that we dropped out a very weak September quarter a year ago relative to our performance. In fact, our overall net performance actually improved a little bit. You can see that 94% on the Janus side. So I would not read into those numbers and those trends. The headline would be we're in a pretty good position. We have asset allocation shifts due to strong performance to the good and to the bad, and I think that's what going on. That's sort of the lumpiness you see in those numbers. It's not sort of a big client getting out or getting in on either side of that.

Cynthia Mayer - Merrill Lynch

Great. Thank you.

Timothy Armour

Let me, if I could, ask one more question after this?

Operator

Your next question comes from line of Mike Carrier of Deutsche Bank.

Michael Carrier - Deutsche Bank

Thanks. Just one quick question, and this is away from INTECH, just on the Janus side. When you look at the overall trends, redemptions have picked up, and obviously that's a little bit just mix of products being weighted towards domestic equities and those being out of favor. When you think about the performance that you are seeing in the institutional products and the fixed income products, obviously, they are pretty strong. So anything that you guys are doing or can do to kind of increase the exposure on the retail platforms. Then, I guess on the institutional side, for fixed income is it still a size problem, meaning you just don't have enough assets, so a lot of the mandates institutions are just nervous to allocate money into the products?

Timothy Armour

Mike, let me just clarify. Is your question about outflows on the Janus long-term flows?

Michael Carrier - Deutsche Bank

This is the redemptions.

Timothy Armour

Honestly, if you go back to page three, you'll just look at the redemption rates, the annualized redemption rates, actually they are coming down. Third quarter year ago we were at 31, third quarter this year we are at 24%. We were at minus $8.5 billion outflows last year at this time. We're at minus 4.6 this year. So, in fact, it's actually improving a little bit and the redemption rate is actually slowing down a little bit. On the fixed income side, buried within this asset management firm that's very equity-focused for Janus, we have this incredible performance capability in bonds, this has been a household secret. I think what we need to do is sort of tell that story better and we're getting a lot of interest in our fixed income, both on the institutional and on the intermediary side.

I think what you'll see is when I talked about sort of the increased level of investment, really one of the areas I'm talking about is the attention to the fixed income arena, it's really good ballast to the rest of the business. They are very persistent assets. They stick to our ribs a little bit longer and they have good characteristics that are very attractive to us. So I think part of our future going forward is a sustained quality effort against the fixed income arena. They've got 100% in the top Lipper quartiles of one, three, five and 10-year basis. That's a great story on the institutional side as well as the intermediary side.

Michael Carrier - Deutsche Bank

Yeah, I was just looking at the absolute level of redemptions just sequentially, but I hear you. Then just one for Greg, just given the comp level when you strip out the severance cost, any kind of color in terms of what's normal for the quarter versus what we've seen in the industry so far, first quarter, second quarter accruals were pretty low just given the environment, and obviously, for you guys both environment, and but also performance has been improving, so you just got to balance that. Any kind of color on what's the true-up versus what's just the normal for the quarter?

Gregory Frost

Yeah, like I said before I think the majority of it is going to be just kind of the normal increase from revenue and the performance numbers. I think all asset managers started out first and second quarter with pretty low bonus accruals across the board. I think everyone is kind of thinking about that as the market has somewhat stabilized, but the vast majority of the increase, like I said before, is going to be from the investment side.

Michael Carrier - Deutsche Bank

Okay, thanks, guys.

Robert Garvy

Thanks very much, folks. We've got some clients actually waiting to chat with us outside this room. So if I could, I would end the conference now. Thanks very much for your questions and your attention. We appreciate it.

Operator

This concludes today's conference. Thank you for your participation. You may now disconnect.

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Source: Janus Capital Group, Inc. Q3 2009 Earnings Call Transcript
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