Pzena Investment Management Q3 2009 Earnings Call Transcript

| About: Pzena Investment (PZN)

Pzena Investment Management, Inc. (NYSE:PZN)

Q3 2009 Earnings Conference Call

29 October, 2009 10:00 a.m. ET


Greg Martin - CFO

Rich Pzena - CEO, CIO


William Katz - Buckingham Research

Marc Irizarry - Goldman Sachs

Hugh Miller – Sidoti

Tim Shay - J.P. Morgan

Roger Smith - FPK


My name is Lashae and I will be your conference operator today. At this time I would like to welcome everyone to the Pzena Third Quarter Earnings Conference Call. (Operator instructions) Thank you. Mr. Martin you may begin your conference.

Greg Martin

Lashae thank you very much. I am Greg Martin, Chief Financial Officer at the Pzena Investment Management and I would like to take this opportunity to welcome you all to our third quarter 2009 earnings conference call.

Joining me on the call as always is Rich Pzena, our Chief Executive Officer, and Co-Chief Investment Officer. Our third quarter earnings press release contains the financial tables for the periods we are going to discuss.

If you don’t have a copy it can be obtained at our website at www.pzena.com in the investor relation section. A replay of this call will be available for the next week at our website. From time to time information or statements provided by us including those within this conference call may contain certain forward-looking statements related to future events, future financial performance, strategies, expectations, competitive environment and regulations.

Forward-looking statements are based on information available at the time these statements were made and or management’s good faith belief as of that time with respect to future events and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements.

Such risks and uncertainties include but are not limited to loss of revenues due to contract terminations and redemptions, our ownership structure, catastrophic or unpredictable events, unavailability, our third party retail distribution channels, damage to our reputation or interpretation of and position relative to the market, fluctuations in the financial markets and the competitive conditions in the mutual funds asset management and broader financial services sectors.

For a discussion concerning some of these and other risks, uncertainties and other important factors that could affect future results, please see forward-looking statements and where applicable, risk factors in the company's Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 13, 2009. And in the company’s quarterly reports on Form 10-Quarter, as filed with the Securities and Exchange Commission.

In addition, please be advised that because of the prohibitions on selective disclosure, the company, as a matter of policy, does not disclose material that is not public information on our conference calls. If one of your questions requires the disclosure of material non-public information, the company will not be able to respond to it.

Before I highlight some of our financial results, I would like to draw your attention to some changes in the presentation and content of the financial information we have included in the press release.

As some of you may be aware from our last monthly press release, we have changed the classifications of our assets under management to better reflect the underlying behavior and composition of our client base.

Historically, we have broken down our assets under management into two categories separately managed and public biased accounts. In September, we began to group our assets under management in the institutional and retail accounts, which is more inline with how we actually view our business.

This change does not impact our results or financial position in anyway. As a practical matter the change involving classifying some funds that service only institutional investors from what we previously presented a sub-advised into our new institutional category. The assets under management data in the press release has been declassified for all periods presented.

We have also presented additional historical asset and revenue information in the back of the press release to assist you in understanding, analyzing the trends in these categories overtime. You will notice that we have also included non-GAAP income statements for that. In addition for removing valuation allowance and tax receivables being the accounting adjustments also different format from our standard GAAP statements.

What we have done is change the order of the income statement that better reflect the relationship between the operating company and the public entity. I will go into greater detail on these formatting changes and non-GAAP adjustment later in the call that the change in, income statement format have no impact on our non-GAAP results.

We reported revenue of 16.8 million for the third quarter of 2009. Operating income of 8.7 million, non-GAAP diluted net income of 5.3 million and non-GAAP diluted net income per share of $0.08 also in September we repaid the remaining principle outstanding on our bank debt and terminated our credit agreement.

I will review our financial result in detail in a few minutes. First I would like to turn the call over to Rich Pzena, who will discuss our view of the investing environment and how our position is relative to it.

Rich Pzena

Thank you Greg, perhaps the best thing I can do is to start with the obvious. We just completed the two best quarters in our history, it never fails to amaze me that investment cycles evoke such similar responses each time. Sure each one has its own special flavor and this one has the collapse of the global or near collapse of the global financial system and a near depression as its special marketing post.

But the similarities among the cycles are far more note worthy consider these cycles from a simple 2 phase plan, phase 1, as the economic cycle reaches its peak, investors pour money into what's has been working and momentum forces dominate the market, rational analysis is suspended and story not valuation drives stock prices, last time it was the internet bubble this time energy and all themes commodity captured the floor.

Phase 2, then just when it seems impossible often due to the extreme exaggeration of the trend coupled with the beginning of an economic slowdown the market reversed its course. Momentum stops valuation matters again and investors retrench. During this current cycle investor could actually point a new phrase to describe their response to the market.

They call it de-risking. Looked at through a behavioral science lens this phenomenon is simply a period of excessive greed that is followed by one dominated by extreme fear. What is interesting to note is that history shows that the periods of greed tend to be far shorter than the periods of fear, leaving value investors with long periods of time to ply their trade.

Again behavioral finance offers compelling logic to explain this imbalance. The negative effect of losses is far more powerful than the positive effect from gains. These cycles have been occurring for a long time and we see no reason to predict that they will end with this current one.

So it has always been important for us to be sure that our clients share our long term orientation. Otherwise they will be tempted to de-risk at the worst possible time. Since the market turned on March 9, our portfolios have risen approximately 100%.

So it may not be surprising to hear that the most frequent question we get today is did we miss it? The data clearly says no and I want to address this point first from the perspective of our portfolios and then offer some thoughts on how the value cycle impacts the outlook for our business. Let me start with some history.

For the past 40 years an investor who followed a naïve deep value strategy and brought the lowest price to books in title of the 1000 largest U.S. stocks that have earned 500 basis points per year of excess returns over the S&P 500 ending up with nearly six times more money than someone bought the index. Why doesn’t everyone just do this? The answer lies in the unfortunate reality that in order to achieve this spectacular return advantage, an investor must be willing to accept periods of painful underperformance.

During the past 40 years there were five periods when the deep value approach underperformed even its specialized Russell 1000 value index by as much as 25 percentage points over period of lasting as long as two years.

Everyone knows the return advantage is out there but because of these periods of pain very few investment firms are capable of the discipline and long-term horizon acquired to capture these returns. Most consultants and all of our clients know we are one of those firms. Our long-term record demonstrates that point.

Our longest running strategy is the inner value which states back to our firm inception in 1996 has generated more than 500 basis points of excess returns over the value benchmark and nearly 1000 basis points of excess return over the S&P 500 for the past 10 years.

The question though always is the same. Can investors swallow the periods of underperformance or mistakes as the disbelievers call them. This time our mistake was a large exposure to financials as we entered one of the worst financial crises in history.

We had already learned the lesson that too much financial leverage is dangerous for value investor, no matter how good their research is.

Accordingly, we modified our process 10 years ago to reduce our exposure to leverage and to try and rent vendor the inevitable downturn less painful. We executed that process reasonably well until the banks became cheap.

We debated whether we should apply the same anti-leverage rules to banks and regretfully we decided not to. Our logic at the time well obviously was proven to be wrong was one, banks were supposed to be leveraged its their business model.

Two banks have successfully navigated high leverage per decade in fact the failure rate for banks is about half the failure rates for non-banks in spite of their high leverage and three, the banking industry has always enjoyed a critical life relationship with the public sector that is well accepted and appreciated by both sides.

And so when we saw investors going to the Bloomberg machine to look up the value of a mortgage loan and applying that value to Citibank we thought that they completely missed the point.

A bank isn’t a balance sheet, a bank is on going business franchise with huge on going revenue streams available to offset losses. Well a high leverage of banks rendered our view incorrect and for the first time in modern history bank customers panicked covering the government and the management to have to intervene to raise massive amounts of capital to protect the franchises from collapse. As a result we suffered 12 months of significant under performance in our portfolios.

While we can say we get it now it doesn’t do us a lot of a good we lost that performance. The real question for potential investor in Pzena investment management is, where do we go from here? And to the lessons that we learned over time render it likely but the inevitable downturns we will experience in the future would be less severe.

In our first quarter newsletter this year we wrote that approximately five times price to normalized earnings our portfolio is at the cheapest level in our history although we make no pronouncements as to the timing of the bottom we believe that our portfolios are well positioned to participate once the upturn occurs.

Today after our portfolios have doubled and earnings have begun to recover the evaluations at approximately seven times our estimate of normal earnings. Other than during the bottom of this cycle our portfolios today are as attractively valued as there have been at any other time in our 14-year history.

We have found great investment opportunities in many different sectors. I mentioned earlier that value cycles tend to be long. Looking back to 1969 we have identified that we are in the fifth, two phase cycle as I described it earlier.

Phase one, the green phase ended in March. On average the prior fear phases as we like to call them the value cycles have lasted 77 months with a range of 58 for the shortest to 93 months for the longest, measured from the trough in relative performance of value strategies to their peak.

On average the prior value cycles have produced excess returns of 184% cumulatively above the S&P 500 with a range of 135% to 254%. So far this value cycle has lasted seven months and produced 51% of excess returns. Otherwise it has been sharper in the first seven months than in the early stages of the prior cycles. History tells us that we are in the very early stages of this value recovery. The reason that prior value cycles lasted so long I believe is the same reason this cycle will last a long time, mainly earnings recovery and momentum.

On businesses decline, companies respond by reducing their expenses. Often times quite dramatically and during the ensuing recovery the expense growth lags dramatically.

We believe that earnings momentum is likely to be quite strong for the years to come. Just like it has been in every prior recovery, as companies are reluctant to add expenses, even as the revenues return.

And the fifth cycle turns out to be quote, the new normal with sluggish economic growth as almost universally believed the results would be no different.

With almost uncanny unanimity Corporate America is planning for no to slow growth. And since companies are run by people who adapt to whatever environment is presented to them, we believe that profit margins will return to the same old normal even if economic growth to the new normal.

This view of two is quite consistent with past behavior. The last time we had a period of sluggish GDP growth and inflation of 1975 to 1982 corporate ROEs averaged 13.5% almost precisely their long term average.

We don’t expect this cycle to be any different. Now, let me offer some thoughts on how the current environment has impacted our business and how we are planning for the future.

Our AUM increased from $10.6 billion to $13.9 billion during the third quarter, reflecting both strong investment performance and net positive asset flows from institutional clients.

The best client to hire value managers is exactly at the most painful point in the cycle. While most investors prior to entering at a point like we saw this past March too scary we are encouraged both by flows that we have seen during the worst of this cycle and by the increase in search activity reflecting the continued strong institutional reputation that our firm maintained.

Our one year and ten year performance records are in the top profile among our peers while our 3 and 5 year numbers continued to bear the impact of our poor performance in the second half of 2007 and the first half of 2008.

The three year numbers should improve dramatically in the second half of next year powering any investment performance issues between now and then. So while encouraged we don’t expect asset growth to return to peak crisis levels during 2010 but we do believe that our reputation as disciplined value investors will lead to lasting out performance and improving business trends.

From our own business prospective we are preparing for what we believe will be an extended value driven cycle we are in the process of launching emerging markets value, a strategy that we have been incubating for approximately 2 yrs and which has performed quite well in this environment contrary to preconceived notions value strategies actually are more powerful in emerging market than they are in developed markets.

We are in a hiring mode adding one new analyst to our investment team this past quarter with the intention of adding several more over the next year as we take advantage of the rich talent pool that has been made available by recent industry dislocations. We are beefing up our sales force to help take advantage of opportunities that we think will arise for us outside of the United States.

In short we are positioning ourselves to take advantage of what we believe will be an extended value cycle. So while many market observers have labeled the past six months of junk rally, implying that its okay not to worry that you missed it since it won’t last very long we earned our excess returns over a broad array of extremely high quality companies.

Outside of financial services our portfolios are made up of companies with significantly higher historical profitability than the market and with significantly lower financial leverage. In other words despite our reputation as a firm focused on financials the truth is that we seek to buy extremely good businesses at low prices across many industries we’ve been able to do this do so this time too.

These opportunities continue to be available today. So while market pundits are counseling de-risking as their advice ((inaudible)) equities in general and value spreads in particular remain attractive despite the sharp run-off over the last seven months.

History suggests that we are still in the early innings of this value cycle and the next leg up will likely be driven by earnings increase in the context of a modest economic recovery. We continue to find high quality companies in sectors experiencing near term stress where we believe research and patience are the ingredients for long term out performance.

We believe that our clients understand this and that prospective clients will be attracted by our unwavering commitment to our discipline. I will now turn it over to Greg Martin, our Chief Financial Officer for a review of our third quarter results.

Greg Martin

Thank you Rich. I would like to start off by discussing our assets under management or AUM, our fee rates and revenues. As I mentioned earlier in September 2009, we reclassified our assets under management into two categories, institutional accounts and retail accounts.

Our institutional accounts are primarily comprised of foundations and endowments defined benefit and defined contribution plans for corporations and municipalities and fund which service institutional investors. While our retail accounts are generally open end mutual funds which cater primarily the retail clients.

Historical information has been reclassified for all periods presented. Our total assets under management during the third quarter of 2009 increased by $3.3 billion or 31.1% from $10.6 billion at June 30, 2009 to $13.9 billion at December 30, 2009. This increase is attributable to $2.8 billion in market appreciation and net inflows of $0.5 billion. Year-to-date our total assets have increased $3.2 billion or 29.9% due to the $3.5 billion in market appreciation partially offset by $0.3 billion in net outflows.

At September 30, 2009 the company’s $13.9 billion in the AUM consisted of $10.2 billion in institutional accounts and $3.7 billion in retail accounts.

During the third quarter of 2009, assets and institutional accounts increased $2.7 billion or 36.0% to $10.2 billion at September 30, 2009 from $7.5 billion at June 30, 2009 due to $2.1 billion in market appreciation and $0.6 billion in net inflows.

Retail assets increased $0.6 billion or 19.4% during the third quarter of 2009 from $3.1 billion at June 30, 2009 due primarily the $0.7 billion in market appreciation partially offset by $0.1 billion in net outflows. Our third quarter 2009 revenues were $16.8 million down 33.1% from $25.1 million in the third quarter of 2008 and an increase of 18.3% in the second quarter of 2009, which were $14.2 million.

The year-over-year and sequential changes in revenues were due primarily to changes in average assets under management. For the 9 months ended September 30, 2009 revenues were $44.7 million down 46.4% form $83.4 million for the 9 months ended September 30, 2008.

Reduction in revenues was due to declines in average asset under management. Average assets under managements were $12.2 billion for the third quarter of 2009 down 30.7% from $17.6 billion for the third quarter 2008 and an increase of 22.0% from $10.0 billion for the second quarter of 2009.

For the nine months ended September 30, 2009 average assets under management was $10.7 billion down 47.0% from $20.2 billion for the 9 months ended September 30, 2008. Our weighted average fee rate was 0.550% in the third quarter of 2009 down from 0.569% in the third quarter of 2008 and down from 0.568% in the second quarter of 2009.

The year-over-year and sequential decrease was due in part to increase in the average account size of our institutional clients. Our tiered fee schedules generally charge lower rates as account size increases.

Institutional accounts comprise 73.4% of total asset under management as of September 30, 2009 increasing from 69.7% as of September 30, 2008 and 70.8% as of June 30, 2009.

Weighted average fees for institutional accounts decreased to 0.630% for the third quarter of 2009 from 0.654% for the third quarter of 2008 and 0.651% for the second quarter of 2009.

The year-over-year and sequential decline in weighted average fees of institutional accounts arose in part as a result of the channels higher average account size, which typically lowers rates due to our tiered fee schedules.

Weighted average fees of retail account decreased to 0.346% for the third quarter of 2009 from 0.372% for the third quarter of 2008 and from 0.367% for the second quarter of 2009. The year-over-year and sequential declines in weighted average fees were due primarily to the fact that the temporary voluntary partial fee labor on the John Hancock Classic Value Fund.

Our share of this reduction expires May 2010. For the nine months ended September 30, 2009 weighted average fees increased to 0.559% from 0.551% for the nine months ended September 30, 2008 primarily due to the higher mix of assets in our global and lethal strategies.

Now let’s turn our attention to the remainder of the P&L. For the third quarter of 2009 our compensation expense increased $0.2 million or 3.3% from $6.0 million for the second quarter of 2009 to $6.2 million in the third quarter of 2009. Year-over-year compensation expense decreased $2.0 million or 24.4% from $8.2 million as a result of lower overall compensation levels and reduced variable compensation costs.

General and administrative expenses remain fairly consistent sequentially declining $0.1 million or 5% from $2.0 million in the second quarter of 2009. Compared with the third quarter of 2008, General and Administrative Expenses decreased $0.7 million or 26.9% from $2.6 million.

The year-over-year decline in general and administrative expenses was primarily a result of decreased professional fees and data systems costs arising from ongoing efforts to reduce overall operating expenditures.

Total operating expenses were $8.1 million for the third quarter of 2009 compared with $10.8 million for the third quarter of 2008 and $8.0 million for the second quarter of 2009. Year-over-year we have reduced our operating expenses by 25%. We expect expenses to be higher in 2010 as the industry recovers and we will pursue our expansion initiatives. Of course that in contingence are higher revenues next year.

Operating margins were 51.6% for the third quarter of 2009 compared with 57.0% for the third quarter of 2008 and 44.1% for the second quarter of 2009.

For the nine months ended September 30, 2009 the operating margin was 45.0% compared with 59.1% with nine months ended September 30, 2008. As I mentioned briefly earlier we have included non-GAAP income statements that in addition to adjusting for certain valuation allowance and tax receivable agreement items also different format from our standard GAAP statements. I would like a moment to walk through these changes.

Working down the income statements, the non-GAAP presentation begins to diverge from a standard GAAP format after operating income. On a non-GAAP basis, we have presented other income expense net of the interest of outside investors in our consolidated subsidiaries.

In the GAAP statements other incomes effectively grossed up by these outside interest, which are then subsequently deducted out in the non-controlling interest line.

We believe the non-GAAP presentation should simplify the other income expense line considerably. Because these outside interests are added to and then deducted from GAAP presentation so there is no bottom line change resulting from these non-GAAP presentation.

On a non-GAAP basis, adding the other income expense net of outside interest to operating income continued income before taxes and the income allocation to the operating company.

This number is then tax effective by the New York City unincorporated business tax leaving you with an approximation of the operating company’s net income. Approximately 86.6% of this amount is then allocated to the non-public members of the operating company. The amount remaining after this allocation represents the pre-tax income of the public entity.

This number is then taxed at the public companies cooperate effective rate to generate proforma net income. I will briefly discuss the valuation allowance and tax receivable adjustment at the conclusion of the financial discussion but we will focus remaining remarks on the non-GAAP information.

Other income expenses net of outside interest was $1.2 million for the third quarter of 2009 and consisted primarily of $1.5 million in income related to deposit performance of the companies investments in its own products offset by 23 million in net interest expense.

Other income expense net of outside interest was an expensive 1.6 million for the third quarter of 2008 and income of 1.2 million for the second quarter of 2009. The year-over-year increase in third quarter 2009 other incomes arose primarily as a result from the favorable performance on the company's investment in its own product in 2009 as well as the decrease in interest expense associated with our outstanding debt.

The effective rate for our unincorporated business taxes was 5.2% for the third quarter of 2009, 6.1% for the third quarter of 2008 and 5.4% for second quarter of 2009. The sequential on year-over-year fluctuations in its affective rate were driven by certain expenses that are permanently non-deductible for the UBT purposes.

While this rate will tend to vary from period to period we would generally anticipate it being between 5% and 7% in the future. The allocation to the non-public members of our operating company represented 86.6% of the allocable income of the companies third quarter 2009.

This allocation represented 90.4% of the allocable income for the third quarter of 2008 and 86.6% of the allocable income for the second quarter of 2009 but variance in the allocation percentages are the results of changes in the ownership interest of the company in the operating company.

The effective rate for our corporate income taxes not including UBT was 42.7% for the third quarter of 2009, 41.4% for the third quarter of 2008 and 42.6% for the second quarter of 2009.

We generally anticipate our corporate effective rate to be between 42% and 43% in the future. During the quarter ended September 30, 2009 we repaid the remaining $10 million principal amount outstanding on our term loans and terminated our credit agreements and the associated revolving credit facilities.

At quarter end our total debt was $16.0 million and our total cash was $19.1 million. This cash number includes approximately $0.6 million of cash held by our consolidated investment partnerships. There are no financial covenants in our remaining debt. As a result of the foregoing we recorded $0.8 of basic and diluted non-GAAP net income per share for the third quarter of 2009.

Now I would like to briefly walk through the valuation allowance and tax receivables adjustments net effect of which comprised the difference between our non-GAAP and GAAP results.

For the third quarter of 2009 the company recognized a $3.1 million deduction in its valuation allowance and a corresponding $2.4 million increase in its liability towards selling and converting shareholders due to its realized estimates of future taxable income.

For the third quarter of 2008 the company established evaluation allowance and wrote down its deferred tax asset by $62.7 million. It similarly reduced the liability for selling and converting shareholders by $53.3 million.

For the second quarter of 2009 the company recognized a $0.9 million deduction in valuation allowance and a corresponding $0.6 million increase in liability towards selling and converting shareholders also due to revised estimates of future taxable income.

Because the rules around valuation allowance are relatively prescriptive particularly with respect to the time period although most of these assets can be expected to be used in uncertain economic times we have conservatively limited our projections for three years.

We would expect on a quarterly basis to record adjustments to the valuation allowance and our liability towards selling and converting shareholders as we extend this growing three-year horizon out in subsequent quarters.

Because of the adjustments to the liability is generally left in the adjustments to the valuation allowance the net effect is expected to be positive although generally not material on a full-diluted basis.

Of course the ultimate amount of these adjustments will depend on our estimates of future taxable income and a level of our economic interest in the operating company. Net of the effect of the valuation allowance and tax receivable amounts I just discussed we reported $0.17 of GAAP basic net income per share and $0.09 of GAAP diluted net income per share for the third quarter of 2009.

The differences between basic and diluted earnings per share were generated by the adjustments to the company’s deferred tax assets and liabilities with selling shareholders. It had a proportionally greater effect on basic net income. And now we would be happy to take any questions.

Question-and-Answer Session


(Operator Instructions). And today your first question comes from William Katz from Buckingham Research.

William Katz - Buckingham Research

Rich I was curious you talked about expanding the business which is a common theme coming through most of the asset managers in the third quarter. Could you may be mention the expense growth rate if you will or how to think about margins incremental margins or the absolute level of margins again so it could be more of a market driven and then anyone climb in the near term?

Rich Pzena

Yeah, the magnitude, the way to think about those is we are going to add I would say the best desk let’s say four people to the staff which is going to be less than 10% of our existing staff, that would probably be slightly higher than average wages. So it’s going to add, the staff expansion is going to add about 10% to the run rate, of course we don’t get everybody added to the full year and then we are likely to experience some upward pressure in comps for existing staff and while it’s really hard to say where the market is going to go we will be competitive and so we are planning for expense growth but we are planning for expense growth at a significantly lower rate than we are planning the revenue growth and so we think that margins will expand next year and the incremental margins should be for our business should always be in excess of 50%.

William Katz - Buckingham Research

Yeah, that’s very helpful, thank you. My second question revolves around the fees if you will, I apologize for the analysis of this question but as anywhere more to build and presumably institutions would exceed retail based on your commentary about mainly the rolling three year return outlook. How should we think about break points from here, considering its every billion dollars you know how is that work against the fee rate?

Rich Pzena

It’s a difficult thing to model because at all times its all kinds of stuff going on and I think really what you have to do is look at what our average account size is, not average account size as generally been trending up, not independent of the marketplace. We have been winning bigger accounts and losing smaller accounts. So I think that actually has a big if not a bigger impact when you know the performance impacts. The break points, our average account size just to give you a rough indicator in the third quarter of ’09 was all the way back to where it was in the first quarter of ’08 and at the low point in the first quarter of ’09 it was about a third lowest. So that you can look at the weighted average fees rate and get some indications from that. I don’t know if that’s helpful to you. It’s hard, very, very hard to explicitly model that.

William Katz - Buckingham Research

Sure. Okay and then just a final question is as you look out into the pipeline for the institutional business it seems like you are getting a mixed read from the other asset managers in terms of what’s happening in the real time sense, you raised a very provocative way of thinking way of thinking about the equity markets. So how you counterbalance that versus what’s going on. So in other words you can may be give it up on the pipeline and to mention what happened in the third quarter as well because you obviously had some good flows there.

Rich Pzena

Well, the pipeline you know let me try and give it on a qualitative basis. If we were running flat out for five years prior to this crisis, we went from flat out to basically zero in search activity for the fourth quarter of 2008. Well, I would say we are nowhere near flat out. We are also not at zero.

We are in less than half the activity that we were at, at the peak. What we are seeing I think the way we are experiencing this is not that there is any search. We actually believe in the conversations that we have with our clients and our prospects and the consultants lead us to believe that there’s major way of thinking of asset allocation strategies and appropriate managers going on in many, many, many institutions and that has led to some search activity. I think it will lead to even a higher search activity in the coming years. For us I think the difference between what we are experiencing now versus what we experienced five years ago is that we are winning on a lower proportion of that and that is a bigger factor when whether or not their search activity. So what I will tell you is that’s hard to, that we are encouraged about is we still get included in almost every major value opportunity out there. Whether we get selected to be a finalist or whether we win the finals is with a much, much lower probability but there is activity and we will consider. Does that help?

William Katz - Buckingham Research

That’s very helpful. Thanks so much.


And your next question comes from Marc Irizarry from Goldman Sachs.

Marc Irizarry - Goldman Sachs

Rich can you talk a little bit about the emerging market value strategy, may be you can help size that product and also how much fee capital do you have invested in there already and where do you expect to see most of the traction, are you going to be getting on some retail managed account platforms there or is that going to be more a product with big marketing institutions?

Rich Pzena

Yeah, at this point we haven’t foreseen a retail strategy at all. In fact we’ve barely pursued institutional strategy so we just have some of our own fund capital a couple of million dollars invested in this. And we’ve begun to expose it for the institutional world and we are seeking a launch client. I will tell you that you shouldn’t expect that there will be significant assets in 2010. Our goal for 2010 would be and a success for us would be to find a $100 million institutional launch client and while we talked a lot about that, a lot of potential participants but we don’t have anything yet. So the scope of the opportunity we think is a $5 billion opportunity for us and I think that actually bringing some valuation discipline to an emerging market place will gain some traction especially given some of the research which is quite compelling on the efficacy of value in emerging markets. But at this time its complete speculation so my guess is if we had a $100 million in 2010 that will be success.

Marc Irizarry - Goldman Sachs

Okay, great and then just two questions regarding your institutional business. Can you talk about what if at all in fact you are hearing or may be seeing in your business from potentially a move towards passive from institutions and then also what’s the latest in terms of fees on the institutional side?

Rich Pzena

I will tell you that there is definitely a move towards passage, there is a move towards what I called in the, in my prepared remarks derisking and to many derisking means process that also means asset allocation that might be more away from equities. So I would tell you that there is swing between active and passive that goes back and forth and back and forth and they just are reactive to how everyone did and I think passive managers beat active managers in 2000, in the last couple of years and in 2009 our known value almost every value manager is beating the index or anyone who is a serious value manager is beating the index and my guess is that 2009 will be a year where managers beat their indices probably we don’t know what 2010 may be but its always wayward looking and I have watched in my 14 years or I will call my 25 year career pendulum swing between active and passive progress at times. But you are right its swinging towards passive. In my regard there is deep pressure to the extent that people are looking for more passive like or lower risk products. We are not experiencing any real key pressure on our basic products or concentrated on high octane value products but to the extent that we are interested in where the action is which is may be on more quasi passive the fees are lower in that than they are in the high octane product.

Marc Irizarry - Goldman Sachs

Okay, great and then just a quick follow up on the active passive discussion. When you sit down with your institutions or just broadly speaking when you talk about your strategies in particular, how defensible are they against a move towards passive I mean is there just you know is there a sort of clear cut avenue that you point to say that you don’t have this is the strategy that’s defensible against passive or how do you add your you know the question of the defensibility versus passive of your strategies.

Rich Pzena

Well, you know the only arbiter of whether active or passive is whether after fee returns. So you know the investment managers who can produce positive after fee returns against a benchmark have some case to make why they should be active. And there’s all kinds of investors out there and all kinds of institutions in it, while the pendulum might be swinging somewhat towards passive it doesn’t mean that I can’t even tell you the last time I even engaged in an active versus passive debate. The people that are talking to us are not thinking about us versus passive. So you know I never find myself in a position of having to justify it.

Marc Irizarry - Goldman Sachs

Okay, great. Thanks.


Your next question comes from Hugh Miller from Sidoti.

Hugh Miller - Sidoti

The first one I was just talking about the possibility of at some point reinstating the dividend now you’ve terminated the revolver you know any thought as to the potential for that with the current debt that you have now or would that be kind of a thing that you would look to do after you have paid down the sub debt in its entirety.

Rich Pzena

Well, Hugh the sub debt also contains the dividend restrictions which doesn’t allow us to pay dividends until we either pay off the sub debt or we renegotiate the terms with the sub debt holders. I am one of the sub debt holders so I am in a kind of an awkward position and I am really not the swing factor here anyway. I think I will answer the question in two different ways. If we have to pay off the sub debt before we can reinstate the dividend I think we will be able to do that in 2010 at least if we achieve our budget we will be able to do that in 2010. Do I think that the sub debt holders will allow us, will raise that restriction and allow us to repay the started dividend if we start paying down some of the debt I think the reasonable possibility and we are pursuing that.

Hugh Miller - Sidoti

Okay, great. I guess if you think about that on a go forward basis relative to the dividends you have paid in the past when you are at a point where you can reinstate that you have a sense of where that might be because ultimately you originally had a higher dividend level and then cut that ahead of cutting it entirely. So I guess any thoughts to that as you look forward.

Rich Pzena

Generally I would answer the question by saying that our business doesn’t require a whole lot of capital and so paying out a high percentage of earnings to our constituencies is what we were intending to do. Obviously some of the earnings have to be dedicated to paying down debt in the near term, there is some working capital in this business because we carry receivables as when you deal with institutions you deal in arrears and you have to wait to collect the money so between the needs for working capital or incubation or debt repayment and dividends you know the capital requirements aren’t high but we would aim to pay a higher percentage of our earnings as we possibly could.

Hugh Miller - Sidoti

Okay. And I guess as a follow up on your comment with regard to incubation obviously you talked about the emerging markets value that you are looking to launch you know one of the products I guess that you foresee as an opportunity for expansion of that platform on the horizon as we look into 2010, 2011 and beyond.

Rich Pzena

Yes, at this point we made the decision in our most recent planning session to defer any new incubations for a year because we have a lot on our plate you know we have a lot of capacity in our existing products and we are launching emerging markets and we are expanding our staff. So we see pretty substantial opportunity for growth without new products for the next five years. So I think the next things we incubate will be in 2011 and there’s all kinds of possibilities that we talk about every year but there’s nothing in 2010.

Hugh Miller - Sidoti

Okay, great. A question with regard to you know where we stand now on the fees in the retail and the institutional channels. Obviously there are tons of variables that will impact things with regards to you know a shift towards a more global with higher fees, average account sizes and the opportunities for newer mandates winning those, where do you kind of see things if you look out into 2010 and how we should be thinking about the fees relative to where they were in the third quarter.

Rich Pzena

Yeah, I think the third quarter is probably a reasonably good tag we have some temporary pressures that will abate next year. On the other hand we continue to be competing for pretty large mandates, larger than our historical average. So those are true conflicting pressures. So and my guess if you had to average it wouldn’t be very, next year wouldn’t be very different than what we just achieved.

Hugh Miller - Sidoti

Okay. And the last question is with regard to the comment you guys had made but I didn’t get you earlier on the waiver of fees through John Hancock Fund and the expiration of that, if you could just touch on that and any color would be great.

Rich Pzena

Yeah, John Hancock decided to voluntarily reduce the expense rate on the passive value funds effective in late spring and we agreed to share and that with a one year limit that expires in May of 2010.

Hugh Miller - Sidoti

Thank you very much.


Your next question comes from Ken Worthington from J.P. Morgan

Tim Shay - J.P. Morgan

Hi, its time Shay here, filling in for Ken. On the sub advisory relationships, how are the existing relationships there and what feedback have you been getting about the improvement in performance and if you are meeting their expectations.

Rich Pzena

Yeah, let me specifically talk about John Hancock and it is the lion’s share of our sub advisory business. The relationship on a scale of 1 to 10 has been a 10 I would say every year since we’ve been working with them. They are about the best partners you could ever hope to have as a distribution partner and hopefully they feel that way about us as investment partners and but we pretty much every year since the classic value fund has been launched we’ve been the number one or number two selling fund in their system and now that really hasn’t changed. The difference obviously is we had negative net flow, we had outflows but they continue to really like to tell their classic value story and so obviously they are very pleased with the recent investment performance. They described the market life now when, I will say, I will tell you that I am a lesser than expert on the retail side than I would feel on the institutional side but they described the market place still as one where retail investors are very cautious equities. Certainly our Morningstar rating, which had been two stars most of last couple of years and recently went to three stars, it’s not at the point where you would expect lots of new incremental flows. But nevertheless John Hancock’s features as in all of the presentations to their clients and we support them in that. So I hope that gives you a flavor is very strong.

Tim Shay - J.P. Morgan

Okay, that’s helpful. And then in terms of your gross trends going forward do you have any plans to try to grow the sub advisory distribution channel and are you actively seeking out any new relationships there?

Rich Pzena

We are not. We have I think 11 sub advisory relationships today. We pretty much cover the geography of the world with our products. We have tended to not want to distribute our high fee, low capacity products through retail because we want to preserve the extra fee for ourselves rather than share it with the distribution partner. So I think we are actually happy with our line up.

Tim Shay - J.P. Morgan

Okay. That’s all of my questions. Thank you very much.


Your next question Roger Smith with FPK

Roger Smith - FPK

You said you were talking about adding four people to the staff. Is that primarily to run or to work on the global and international side or are you working on building on the US side as well?

Rich Pzena

Well, all of our analysts are actually global analysts thus what’s driving the need is definitely from the global international side particularly as we launch emerging markets and we have additional companies that we have to research for our portfolio. So the incremental work is coming from outside the US plus people that we hire are really not specialized geographically.

Roger Smith - FPK

Fair enough. And then you talked a little bit about upward pressure in compensation. How should we think about that is that coming in the form of you know stock and cash, more cash, more stock, that kind of thought.

Rich Pzena

I wish I knew the answer to that question you know we obviously try to spend a lot of time seeing what’s going on the market place and being responsive. What we’ve obviously when we had a down turn in compensation it was disproportionately absorbed by the higher paid people and so if you think about our own specific issues we have a ownership concentration and very senior people here and we tried very hard to increase the equity stakes of the next generation. So as their comp rises we are doing everything in our power to make as much of it non cash as we can push on them and they are willing recipients I don’t mean to make it sound like it’s a struggle but so incrementally if you think the high end was the most disproportionately penalized and therefore we will pop that the most it might be more non cash than cash that’s I am just totally stress relating.

Roger Smith - FPK

And then on that whole war for talent are you noticing any sort of changes here that is getting more difficult despite the fact that a lot of people were available to work may be 6 or 9 months ago is it harder to bring in people today?

Rich Pzena

No you know its been hard for this whole 6 to 9 month period what at the risk of not being politically correct in the statement my sense is that the people that most funds that laid off people get a pretty good job but deciding who to lay off.

Roger Smith - FPK

And then if we just talk about the AUMs for a minute here I am guessing most of the client base is a U.S. based investor is investing in both U.S. and then global and then international stocks is there sort of looking at the AUMs it sort of looks like more of that focus is on the international and global product than the U.S. product is there anything going on sort of in the channel that is pushing investors one way or the other or is it just sort of their preference?

Rich Pzena

Well I think your actual original premise isn’t correct. A lot of the global and international money that we are getting is actually coming from outside the United States. And so what we are really experiencing is some acceptance globally as a brand and most of those people lets take the Australian market as a good example because we have a lot of business in Australia it’s a market its now the fourth largest private pension market in the world growing double digit and their local markets can absorb all of the money that use to be invested so they actively seek global asset managers. And we actively try to position ourselves just under that money so U.S. has been the slowest country going global in their thinking its been they have our domestic managers we have our international managers the idea that we should have one manager doing global is catching on slowly I would say the discussion in U.S. institutions about global mandate is orders of magnitude higher than it was two years ago but it’s a slow process.

Roger Smith - FPK

Great thanks very much.

Rich Pzena

You are welcome.


The next question comes from William Katz with Buckingham Research.

William Katz - Buckingham Research

My question had been answered but I did have one follow up in terms of your discussion about Hancock being happy with the relationship against the performance issues did you sort of dialogue or give me a sense of why they would ask for a fee concession then?

Rich Pzena

The board did the trust gives one to Hancock and so the performance is poor and your fees are high and for a lot of pressure we resisted, they resisted and in the end we decided to voluntarily go along with it because they asked for it we made we trendfully made it a temporary phenomenon a temporary agreement based on out performance returning our performance has returned so the fee waver is fired one that performs after one year.

William Katz - Buckingham Research

Okay that’s terrific thanks so much.


(Operator Instructions) and there are no further questions at this time Mr. Martin do you have any closing remarks?

Greg Martin

None really thank you all for joining us on today's call.


This concludes today’s conference call.

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