Cohen & Steers, Inc. (NYSE:CNS)
Q2 2014 Earnings Conference Call
July 17, 2014 11:00 a.m. ET
Adam Johnson – SVP and Associate General Counsel
Matt Stadler – CFO
Robert Steers – CEO
Joseph Harvey – President and Chief Investment Officer
Adam Beatty – Bank of America Merrill Lynch
John Dunn – Sidoti & Co.
Mac Sykes - Gabelli & Co.
Ladies and gentlemen, thank you for standing by and welcome to the Cohen & Steers’ second quarter 2014 financial results conference call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (Operator Instructions) As a reminder this conference is being recorded Thursday, July 17, 2014.
I’d now like to turn the conference over to Mr. Adam Johnson, Senior Vice President and Associate General Counsel. Please go ahead, sir.
Thank you. Welcome to the Cohen & Steers second quarter 2014 earnings conference call. Joining me are Chief Executive Officer, Bob Steers; Executive Chairman, Marty Cohen; our President, Joe Harvey; and our Chief Financial Officer, Matt Stadler.
Before I turn the call over to Matt, I want to point out that during the course of this conference call we may make a number of forward-looking statements. These forward-looking statements are subject to various risks and uncertainties and there are important factors that could cause actual outcomes to differ materially from those indicated in these statements. We believe that some of these factors are described in the Risk Factors section of our 2013 Form 10-K, which is available on our website at cohenandsteers.com. I want to remind you that the company assumes no duty to update any forward-looking statements.
Also, the presentation we make today contains pro forma or non-GAAP financial measures, which we believe are meaningful in evaluating the company’s performance. For disclosures on these pro forma metrics and their GAAP reconciliations, you should refer to the financial data contained within the press release we issued yesterday as well as in our previous earnings releases, each available on our website.
Finally, this presentation may contain information with respect to the investment performance of certain of our funds and strategies. I want to remind you that past performance is not a guarantee of future performance. This presentation will also contain information about funds that have filed registration statements with the SEC that have not yet become effective. This communication does not constitute an offer to sell or the solicitation of any offer to buy these securities. For more complete information about these funds, including charges, expenses and risks, please call 1800-330-7348 for our prospectus.
With that, I’ll turn the call over to Matt.
Thanks very much, Adam, and good morning everyone. Yesterday we reported net income of $0.49 per share compared with $0.34 in the prior year and $0.43 sequentially. Revenue for the quarter was a record $78.4 million compared with $77.8 million in the prior year and $72.8 million sequentially. The increase in revenue from the prior year's quarter was attributable to higher average assets resulting from market appreciation and net inflows into open-end mutual funds, partially offset by net outflows from institutional accounts. Average assets for the quarter were a record $50.7 billion, compared with $50.2 billion in the prior year's quarter and $47.7 billion sequentially
Our effective fee rate for the quarter was 57.7 basis points, up from 57.4 basis points last quarter. The increase was primarily due to the continued shift in the mix of our assets under management towards open end funds. Operating income for the quarter was $29.7 million compared with $28.6 million in the prior year's quarter and $27.6 million sequentially. Our operating margin decreased slightly to 37.8% from 37.9% last quarter. The decline was primarily due to higher G&A costs associated with the marketing for our real asset strategies. Bob will provide some color on the Real Assets Institute in his remarks.
Pre-tax income net of non-controlling interest was $33.9 million for the quarter compared with $25.2 million in the prior year's quarter and $30.6 million sequentially. With respect to average assets under management, our AUM totaled a record $52.3 billion at June 30, an increase of $3.3 billion or 7% from March 31. The increase in assets under management was attributable to market appreciation. At June 30, our U.S. real estate strategy comprised 52% of the total assets we managed, followed by global and international real estate at 19%, preferred securities at 11% and global listed infrastructure at 11%.
Assets under management in institutional accounts totaled $25.7 billion at June 30, an increase of $1.2 billion or 5% from the first quarter. The increase was due to market appreciation of $1.8 billion partially offset by net outflows of $521 million, the majority of which were from a large cap sub-advised relationship. Subsequent to quarter-end, this relationship terminated its account. If you annualize second quarter flows, institutional accounts had a 9% decay rate. Encouragingly, we recorded net inflows of $129 million from advisory accounts, most of which went into global listed infrastructure portfolios. This represents an 8% annualized organic growth rate for advisory accounts.
Our open-end funds had record assets under management of $16.6 billion at June 30, an increase of $1.5 billion or 10%. The increase was due to market appreciation of $966 million combined with net inflows of 515 million which included $56 million of net inflows into our real assets fund, bringing its total assets under management to $171 million. It is notable that we have recorded net inflows into open-end funds in 19 of the past 21 quarters. If you annualize second quarter flows, open end funds had a 14% organic growth rate. Assets under management in our closed-end funds totaled $9.9 billion at June 30, an increase of $524 million or 6% from the first quarter due to market appreciation.
Moving to expenses. On a sequential basis, expenses increased 8%, primarily due to higher employee compensation and benefits, G&A and distribution and service fees. The compensation to revenue ratio for the quarter remained at 33%, consistent with the guidance provided on our last call and therefore the increase in compensation and benefits is proportionate with the increase in revenue. The increase in G&A was primarily due to higher travel and entertainment and marketing expenses associated with our Real Assets strategies.
And finally, the increase in distribution and service fee expense was consistent with the change in the average assets in our open end mutual funds. On a sequential basis, non-operating income net of non-controlling interest increased $1.2 million. The increase was primarily due to higher returns from our seed investments. With respect to the balance sheet, our firm liquidity totaled $192 million compared with $177 million last quarter. Stockholders' equity was $250 million compared with $231 million at March 31, and we are still debt free.
Let me just briefly discuss a few items to consider for the second half of 2014. With respect to compensation and benefits, we expect to maintain a 33% compensation to revenue ratio. We expect G&A to increase slightly in the second half of the year versus the first half of the year, primarily due to our ongoing investments in the education of the marketplace on the merits of real assets strategies. And finally, we project that our tax rate for 2014 will decrease to approximately 35.5% from 36.5%. Previously, we projected non-operating gains for 2014 which due to accumulated capital loss carry-forwards would have resulted in no associated tax expense.
Based on second quarter results and our revised forecast for the rest of the year, we are now projecting a higher amount of non-operating gains. The cumulative effect of this change in estimate was reported in the second quarter, resulting in an effective tax rate of 34.6%. We expect that our effective tax rate will approximate 35.5% for the remainder of the year. And with that I would like to turn it over to Bob Steers.
Thank you, Matt, and good morning. By almost every measure, we were pleased with the results and the momentum achieved in the second quarter. Evaluating our core metrics, which are investment performance, organic growth, the Real Assets Institute which is our marketing initiative to educate on real assets, and the development of new products and markets. The outcomes have been outstanding and the momentum shift to real asset strategies is now palpable.
Starting with investment performance, absolute and relative returns for all of our strategies were strong in the second quarter and for the latest 12-months. Including MLPs and commodities as core strategies, seven of nine teams outperformed their benchmarks in the second quarter and all nine teams outperformed for the latest 12-months. By any measure, our teams have been delivering strong and consistent alpha. And in recognition of our listed infrastructure team's long-term track record, Morningstar has recently awarded this fund a 10-year five star rating.
Next, I would like to update on our real assets multi-strategy teams and our main marketing initiative, the Real Assets Institute. First, our decision to enhance our real asset investment capabilities by bringing in-house active management of commodities and resource equities has worked very well, as has the addition of Vince Childers as our Real Assets Portfolio Manager and Strategist. This portfolio which includes as core allocations, real estate, commodities, resource equities and infrastructure, has outperformed its benchmark by over 300 basis points over the latest 12-months, with strong alpha generation from each of the individual sleeves.
Our major marketing initiative, the Real Assets Institute, is off to an excellent start aided by market leading returns real asset strategies this year. We have now conducted institutes in five cities and received outstanding feedback followed by accelerating inflows. As a result of this initial success, we are planning to increase the number of institutes this year and are already booked well into next year. In addition, we have been invited by other distributors to book events in their systems as well.
There is no doubt that there is strong interest in learning more about liquid real assets and how to implement real asset strategies, especially in the current economic and capital market climate. As you already know, asset flows in the quarter were generally strong. Importantly, we are seeing a surge in demand across the full range of real asset strategies as well as with preferred securities. What's encouraging is that the investor interest is broad-based and includes institutional investors globally as well as in the wealth management channel.
Specifically, retail net inflows totaled $515 million which as Matt mentioned, represented a 14% annual organic growth rate with our preferred securities and U.S. REIT funds leading the way. It's also important to note that our real assets fund had inflows of $56 million in the quarter, which was up from $4 million in the first quarter. Likely a reflection of good investment performance and the impact of our marketing initiatives. As I alluded to earlier, we are seeing a broad increase in RFP activity and mandates won in our institutional advisory channel.
Net inflows in the quarter excluding sub-advisory accounts were $129 million or an 8% organic growth rate. While we are pleased with the net inflows, equally important when considering future growth is the breadth and diversity of the new mandates. In the quarter, multiple, global listed infrastructure accounts were funded from non-U.S. pension funds totaling in excess of $100 million. And we also won our first institutional multi-strat real assets mandate, which is expected to fund in this quarter. What's becoming increasingly clear is that institutions around the globe are interested in implementing liquid real asset strategies as a complement to other alternative investments.
As evidence of this, our pipeline of unfunded mandates is as full as it has been in years and thus far in July, over $300 million of previously awarded mandates have been funded. The sub-advisory channel was the only weak segment in the quarter experiencing net outflows of $650 million. $506 million of the outflow came from a single large cap value relationship and as Matt mentioned, subsequent to the end of the quarter, the client informed us that they plan to terminate the remainder of the account which is approximately $960 million. While the loss of such a large relationship is disappointing, looking ahead we don’t foresee any additional accounts to be at risk and our outlook for future sub-advisory flows is now positive.
As one example, in Japan strong investment performance and investor demand for U.S. REITs have substantially reduced outflows and in fact we are now seeing early signs of positive flows. Also supporting our positive outlook for sub-advisory flows in Japan and elsewhere is the potential for new product launches which I will address in just a minute. Looking forward we have numerous new product and marketing initiatives in the pipeline. To began, Todd Glickson has joined Cohen & Steers as our Senior Vice President overseeing global marketing and product solutions. Todd was previously managing director in charge of product development and strategy at Principal Investors.
Turns to funds. In addition to the MLP open end fund which we launched in January, this quarter we went live with our active commodity long short fund, and we are now in the process of getting it approved for sale in the major broker dealer networks. In connection with our plans to grow the DCIO channel, we expect to have two new CITs, one each for U.S. and global real estate to complement our existing global listed infrastructure CIT.
We also plan to add more R and Z non-revenue share classes to our core open end funds. Lastly as I said, over the next six months we expect to sub-advise three new funds in Japan. One with our current partner and the other two with two new distributors. As you may recall, diversifying our asset base in Japan has been an important strategic objective of the firm. The three new fund strategies are expected to focus on U.S. REIT preferreds, global preferreds and global listed infrastructure.
Also in preparation for these new growth opportunities including institutional pension accounts, we are in the process of upgrading our license for operating in Japan and will be expanding our staff and office space in Tokyo. Based on what we are seeing in our markets, it feels like all of the pieces are in place for significant future growth. Strong absolute and relative returns for the real asset class has captured investors attention. The increased investor acceptance of global listed infrastructure and active commodities as important real asset strategies across channels and around the globe, is providing multiple additional avenues of growth for us.
In addition to the growing acceptance of our expanded real asset portfolio, new venues at home such as DCIO along with new partnerships in Europe and Asia will help to compound our opportunities to grow. As always, our focus will remain on execution.
With that, I would like to turn the call back over to the operator and open it up to questions.
(Operator Instructions) Our first question comes from the line of Adam Beatty with Bank of America. Please proceed.
Adam Beatty – Bank of America Merrill Lynch
First, just a question on, I guess, around G&A spend and some of the build outs that you are doing. Firstly about the Real Assets Institute and then also what you just mentioned about Tokyo. What is the time horizon for this? What kind of -- are you expecting kind of a higher run rate level in future years or is it more of a onetime spend? If you could just give some details around your plans there it would be appreciated.
Sure, Adam, thank you. So with respect to our expansion in Japan, which will be a combination of office space and personnel. We expect that to occur very late in the fourth quarter to early first quarter of next year. And we don’t really expect that it will be meaningful. So I will be guidance with our fourth quarter call on 2015 but as of this point we don’t think it's going to be a significant change to any run rate.
Adam Beatty – Bank of America Merrill Lynch
Great. Thanks very much. And then just maybe stepping back, there seemed like a couple of moving parts lately on the sub-advisory front. One client going away and it sounds like some new ones coming on. Any takeaways from that in terms of, especially I guess the ones that went away, does it reflect a certain sentiment or shift in sentiment amongst your clients? And then maybe on the inbound, obviously folks are starting to recognize the validity of your approach in certain areas. Maybe some takeaways from that as well?
Adam, it's Bob. It's actually not quite as confusing as perhaps as we have made it sound. In the sub-advisory channel there has really been two dominant issues. One has been investment performance and our large cap value which, ironically, for the year-to-date and latest 12-months were top quartile if not top decile there. But we had this one extremely large sub-advisory relationship who has taken money out previously and now terminated. And that’s done. The other has been, flows in flows out in Japan. And as I mentioned, we are not going to predict flows but we feel between the current funds that we sub-advise and the new launches, we are very optimistic about, at some point in the near future having a positive sign on those flows. Again, we are not predicting but that what it feels like.
The other sub-advisory relationships are all significantly smaller and generally focused on real estate and so on, and they are going fine. And not that dramatic either way. And so our sense is just as retail flows have been strong, institutional flows this quarter were solid. As I mentioned, we have had some significant fundings since the end of the quarter and the pipeline is very full there. That feels very good. And I think following this quarter and the termination of the large cap value relationship, the sub-advisory channel is going to be much simpler and directionally will be following the other two channels.
Adam Beatty – Bank of America Merrill Lynch
Great. Thank you very much for the detail. Appreciate it. Just one last one. On sort of real assets and competition in that area. I think there have been some other folks, other firms lately coming to the table in terms of similar offerings. Do you see yourselves as having a competitive lead or other advantages in that area and how do you see that shaking out in the future?
Well, I think having more competition come in is both a positive and a negative. I think the more voices educating the market -- there has been a lot written in the last year or two about, in liquid alternatives the first step and the most important step is to fill the knowledge gap as to what is a liquid alternative and so on. And we have a similar knowledge gap, for us we think it's an opportunity in that space. But the more voices out there, I think real assets gains a larger piece of the asset allocation pie. That said, when it comes down to competing, it will come down to investment performance. It will also come down to the fact that, as I mentioned, really three out of four of our core sleeves, we have very long-term track records in real estate at 25 years. As I mentioned, global listed infrastructure, we now have a ten-year 5 star rating. There is no shortcut to that.
Our commodities team which has only been with us for about a year and half but previously had a tremendous eight year track record. And so I think to compete well, you have to perform, you have to educate the market. And that’s why our Real Assets Institute, which is not the only initiative we have to educate and promote the real asset allocation, but it's an excellent opportunity to become sort of the go to guys, the trusted advisor in the real asset space. And that’s why we think that this is the time to devote investments and time to educating the market. And I think that’s going to be a significant component for success whether it's in real assets or any of the alternative asset classes.
Our next question comes from the line of John Dunn with Sidoti & Co. Please proceed.
John Dunn – Sidoti & Co.
Just on the Real Assets Institute. I know this is probably a hard question to answer, but do you guys have any expectation about the timeline from when you go to Chicago or whatever city, and you start to see a ramp up? Is it a multi-year process or something less than that? Just a sense of how you think that might play out at this point?
You know, it's hard to predict. We frankly had expected it would be a longer, a slower response curve if you will. But I think the combination of the fact that real asset strategies, real estate infrastructure, real estate, have been market leaders this year. It has been a great wind to our back. So as I mentioned, in the first quarter we had virtually no -- $4 million inflows into real assets, our real asset fund. Second quarter that went to $54 million-$55 million and growing. And we think these, as we go around the country and having these seminars with retail and institutional investors, the effect is -- it's not linear, it's a compounding effect. So I think as long as the environment is pushing investors to think about inflation, interest rates maturing cycles and real asset strategies continue to perform, I think we will see more immediate results.
On the other hand if market conditions change, that could be stretched out. I think you have to think about this as a multi-year process too when you look at, say in the wealth management channel, some of the recommendations for how much of a portfolio should be in real assets. We are looking at 5% to 11% recommendations and yet investors are much much lower than that in their portfolios today. So that reallocation process is not going to happen overnight. It's going to take place over a period of time and that’s one of the things that makes us so excited. You can say the same thing about institutional portfolios. If you look at how the real asset targets are changing, they are going from 10 to 20, in that sort of magnitude. And they are too in that market. It is a multiyear process.
And if I could just add, I would encourage you not to look at our real assets fund as the benchmark for that because these institutes are not designed to sell a fund, they are designed to educate the market. And there is lots of ways for us to win. We can win by the flows into the turnkey real assets fund going up. But as we are seeing, we are winning in even bigger ways and getting individual sleeves from large institution. And so the way to measure this is really our overall real asset flow is not an individual fund.
John Dunn – Sidoti & Co.
Right. Thanks for all your comments on distribution. But just on the DCIO channel, what's your strategy there for getting flows there?
Well, we had mentioned previously that last year Matt Gannon joined us. Very successful and experienced leader in the DCIO marketplace. And we have worked together to put together a comprehensive business plan that ranges from making sure that we have, whether it's in our mutual funds, CITs, whatever the vehicles are, that we have the appropriate vehicles and structures for the large medium and small segments of the DCIO marketplace.
We are in the process of adding several senior national accounts people there to develop the relationships with record keepers and others and we are in the process there. And again, many of these institutes are aimed at gatekeepers including those involved in the DCIO marketplace. Now lastly, we are also going to, which is somewhat new for us, is add personal for direct sales in the DC marketplace and heretofore we have not had a significant effort in direct sales in our institutional group.
(Operator Instructions) Our next question comes from the line of Mac Sykes with Gabelli & Co. Please proceed.
Mac Sykes - Gabelli & Co.
Good morning, gentlemen, and congratulations on the record assets. It's terrific. Just three questions. One, just a technical one. The LCVC rate, is that below the aggregate for the firm on the outgoing assets?
Mac Sykes - Gabelli & Co.
Okay. And then on the Japan fund. The other relationships that you will be developing, are those on par with your distribution capabilities with the current provider?
Yes. They are both leading distributors in Japan.
Mac Sykes - Gabelli & Co.
Okay. And knowing a little bit about the Japan market, would you expect a step inflow with decent velocity of flows once you launch one of these products, or could we see a more gradual effect?
You know in Japan I think you have to be very cautious. It was years before our flows with our current partner really ramped up. On the other hand the window is open for new fund launches and there has been some significant successes there. So we are very optimistic but we are really -- we are really not going to try to predict flows. I just think that we have got great income oriented strategies that are proven in the Japanese market and we are going to be delivering them through three of the leading distributors in Japan. So we are in a very good place and we are very optimistic about where the flows are going to go.
Mr. Johnson, there are no further questions at this time.
Thank you. Thank you for participating everyone. This concludes the earnings conference call.
Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Have a great day everybody.
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