Och-Ziff Capital CEO Discusses Q3 2010 Results – Earnings Call Transcript

Nov. 2.10 | About: Och-Ziff Capital (OZM)

Och-Ziff Capital Management Group LLC (NYSE:OZM)

Q3 2010 Earnings Call Transcript

November 2, 2010 8:30 am ET

Executives

Tina Madon – Head, IR

Dan Och – Chairman and CEO

Joel Frank – CFO

Analysts

Roger Freeman – Barclays Capital

Bill Katz – Citigroup

Cynthia Mayer – Bank of America/Merrill Lynch

Robert Lee – KBW

Marc Irizarry – Goldman Sachs

Operator

Good morning, everyone and welcome to Och-Ziff Capital Management Group's 2010 third quarter earnings conference call. My name is Feb and I'll be your coordinator for today. At this time all participants are in listen-only mode. All lines have been placed on mute to prevent any background noise. (Operator Instructions) I would now like to turn the call over to Tina Madon, Head of Investor Relations at Och-Ziff.

Tina Madon

Great. Thanks, Fab. Good morning, everyone and welcome. With me today are Dan Och, our Chairman and CEO and Joel Frank, our Chief Financial Officer. I'd like to remind you that today's call may include forward-looking statements. These statements reflect the current views of management about, among other things, assumptions with respect to levels of assets under management, future events, certain expense levels and financial performance, many of which by their nature are inherently uncertain and outside of our control.

Och-Ziff's actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these forward-looking statements. For a discussion of risks that could affect our results please see the risk factors described in our 2009 Annual Report. The company does not undertake any obligation to publicly update or revise any forward-looking statement whether as a result of new information, future developments or otherwise.

During today's call, we will be referring to economic income, distributable earnings and other financial measures which are not prepared in accordance with U.S. generally accepted accounting principles. Information about and reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are available in our earnings release, which is posted on the For Shareholders page of our website. Furthermore, no statements made during this call should be construed as an offer to purchase shares of the company or an interest in any Och-Ziff Fund.

Today's call is being recorded and is copyrighted material of Och-Ziff Capital Management Group LLC. Telephonic and webcast replays will be made available later today. You can find the details for both on our website at www.ozcap.com. With that, let me turn the call over to Dan.

Dan Och

Thanks, Tina. Good morning, everyone. We appreciate you joining our call today. This morning I'll review our year-to-date investment performance through October 31 and assets under management as of November 1. I'll spend a little time reviewing our investment process and share our current view on capital flows. I'll also update you on the investment environment as we see it.

We continued to generate positive risk-adjusted returns for our fund investors with low volatility and low coalition to the equity markets regardless of market conditions, both during the third quarter and year-to-date. Our performance was a function of our adherence to a consistent disciplined approach to investing and managing risk. Our ability to invest across multiple strategies and geographies enabled us to be nimble in adjusting our portfolio allocations as market conditions changed. This was particularly evident in the month of October.

We have a long-history of generating profits for our fund investors because its diversified model enabled us to capitalize on opportunities across global market without excessive exposure in any one area. We deployed additional capital and increased our exposures without adjusting our risk parameters or changing our approach to evaluating new investment ideas.

Our consistency and discipline combined with our deep and long-standing investment expertise in each of our strategies are important elements of our competitive differentiation. Our fund investors play a significant value on both the preservation of capital during periods of market decline and the generation of competitive performance in rising markets.

They've realized that in order to produce non-volatile, non-correlated returns. We must – must be hedged and managed exposures at all times, not just in down markets. However, they also understand that we seek to generate competitive returns for them, regardless of market conditions or other factors. They therefore take a long-term view in placing capital with us and typically evaluate our annual investment performance rather than focusing on any specific month or quarter.

Within this context, our fund investors evaluate us based on our ability to consistently identify investment opportunities and strategies that perform within our risk tolerances, effectively manage the risk and liquidity of our portfolios and maintain a high degree of ongoing transparency in communications with them about our investment process and portfolio compositions.

Let me now turn to our business results, starting with assets under management. As we announced this morning, our assets under management as of November 1 totaled $27.2 billion, increasing $4.1 billion or 18% from $23.1 billion on December 31 of last year due to $2.4 billion of capital net inflows and $1.7 billion of performance-related appreciation.

These amounts include $300 million of net inflows on November 1 and $600 million of performance-related appreciation in the month of October. We believe it is most meaningful to evaluate year-to-date net inflows in order to measure the trend in our asset growth. As I had said previously, month-to-month capital flows can vary, sometimes significantly and therefore not the best measure of this growth.

On a year-to-date basis, we believe that we have received a significant share of the new capital inflows to the hedge fund industry and to absolute return managers in particular. Consistent with what we have seen throughout this year, our net inflows from July 1 to November 1 came from a combination of new and existing investors that would diversify by geography and type.

We continue to see particular interest from pension funds, private banks, corporates and other institutions including international pools of capital. We also continue to see interest in similar product platforms with longer-term lock-ups such as our real estate funds as well as our three-year offering.

These have experienced strong growth in assets under management year-to-date. As always, we seek to offer innovative investment platforms that meet the requirements of our fund investors and in turn further align our interest with them. The market environment over the last six months has again set to reinforce the importance of manager selection institutional investors.

We continue to believe that capital allocations to alternative asset managers will become significant as these investors increasing seek non-volatile returns to enhance the yield and diversity of their portfolios. As I've said before, we believe our performance track record combined with our strong culture as a firm, the transparency we offer our fund investors and our robust infrastructure clearly differentiate us a manager of choice.

Now, a quick update on our fund's investment performance. Year-to-date through October 31st, our master fund was up 6.7% net; our Europe Master Fund was up 6% net; our Asia Master Fund was up 9% net; and our Global Special Investments master fund was up 10.5% net. These returns were generated with one-fifth the volatility of the S&P 500 Index. Our year-to-date performance was primarily driven by our credit related strategies in the U.S. and Europe, long/short equities and convertible arbitrage in Asia and private investments.

Our performance as always reflects our intense focus on generating returns for our fund investors within our risk to allowances. As economic conditions have improved and uncertainty in the U.S. and Europe has declined relative to the first half of the year, we have been seeing new investment opportunities and have deployed capital accordingly.

During the third quarter, we increased our exposures in the OZ master fund and long/short equities globally and in merger arbitrage, reducing cash to 9% from 20% as of the end of the second quarter. Due to our ability to diversify among strategies and geographies, our low use of leverage and our stringent focus on risk management, we believe we are and will continue to be well positioned to generate strong risk-adjusted returns. With that, let me now turn the call over to Joel.

Joel Frank

Thanks, Dan. Today I will review our 2010 third quarter results and how we are thinking about expenses going forward. For the 2010 third quarter, we reported a GAAP net loss of $94 million or $1.04 per basic and $1.05 per diluted Class A Share. As always, a discussion of our GAAP results is contained in our press release for your reference.

Now, let's turn to the details behind our 2010 third quarter economic income, beginning with revenues. Management fees totaled $107 million, of which $105 million was attributable to the fund segment and $2 million to other operations, essentially unchanged from the 2010 second quarter as our assets under management remains at approximately $25.3 billion from April 1 to July 1.

From July 1 to October 1, our assets under management increased to $26.3 billion due to approximately $750 million of performance related appreciation and approximately $200 million of capital net inflows. Our average management fee remained at approximately 1.7%. This is a blended rate that includes the effect of our non-fee paying assets.

Now, let me turn to the 2010 third quarter expenses. Comp and benefits totaled $23 million during the third quarter with 19 million attributable to the fund segment and $4 million to other operations. Of the total, salaries and benefits were $19 million, essentially unchanged from the 2010 second quarter with 16 million attributable to the fund segment and $3 million to other operations.

Third quarter comp and benefits also included $3 million of bonus expense, which was essentially all attributable to the fund segment. Total salaries and benefits were 18% of management fees in the third quarter. We expect this ratio to be approximately 16 to 18% for the fourth quarter.

Now, turning to non-compensation expenses. Non-comp expenses totaled 21 million in the third quarter remaining essentially unchanged on a sequential basis with 20 million attributable to the fund segment and 1 million to the other operations. Non-comp expenses totaled 20% of Management fees in the 2010 third quarter. We expect this ratio to be approximately 19 to 22% for the fourth quarter of this year.

Our 2010 third quarter effective tax rate was 25% compared to 20% in the second quarter. The sequential increase in this quarterly rate was principally due to the expected flow of our annual revenues and expenses through our legal entity structure. We estimate that our full-year effective tax rate will be in the range of 20 to 25%.

As I have said previously, our 2010 full-year effective tax rate is subject to variables, which won't solidify for the fourth quarter of this year. As a reminder, these include the amount of incentive income we earn, the resulting flow of revenues and expenses through our legal entity structure and the effect that changes in our stock rate may have in the reduction for vesting RSUs.

As a result of these factors, our full-year tax rate very potentially by substantial amount from our estimate. Our 2010 third-quarter distributable earnings were 52 million or $0.13 per Adjusted Class A Share. As you saw in our press release this morning, our dividends for the 2010 third-quarter will be $0.10 per Class A Share. As is typical, we use cash to fund items related to the operation of our business.

The most significant of these were withholding taxes to be paid upon the vesting of RSUs and principle repayments on our variable rate borrowings. As Dan mentioned, we're always looking at ways in which we create innovative, new platform and structures that are appealing to our fund investors. To further align our interest with theirs, these are offerings that fee structures that are reflective of the liquidity characteristics of the underlying investments and of the longer lock-up period.

As we have disclosed in our 10-Q filings, incentive income for these assets is typically collected on a multi-year basis rather than annually. For example, our single product platforms of our private equity fee structure and our 3 year offering plus 20% incentive at the end of a 3-year lock-up period.

On a combined basis, these assets totaled 12% of our total assets under management as of September 30. These assets are important, because they have longer lock-ups and therefore, further increase the stability of our overall asset base.

In this environment, we are pleased and institutional investors want to plays capital with us for a longer time period. We believe that creating new product offerings that are responsive to fund investors requirements, emphasizes the importance we plays and maintaining a stronger line with them and in turn enhances our competitive positioning.

In closing, I would like once again to emphasis the relationship between the stability of our assets under management, the consistency of our investment performance earnings power of our business. These factors are key drivers, our competitive differentiation and thus our abilities continue to attract at a rate – a capital at a rate that we believe is at the high end of the range for the hedge fund industry.

Growth in our assets under management drives growth in our revenues and in turn growth in our earnings. As I have said previously, the scalability of our business complements dynamic. We expect growth in our management fees will more than offset any increase in our expenses overtime and the resulting margin expansion flows straight to the – our distributable earnings.

With that we'll be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question will come from the line of Roger Freeman from Barclays Capital.

Roger Freeman – Barclays Capital

Yes. Hi. Good morning. Can you talk a little bit about the three-year lockup and kind of the mix within the pipeline that would be subject to that versus other assets? Thank you.

Dan Och

Well, we don't know the mix within the pipeline because, as you know, unless and until investors actually commit, we don't know what tranche they're going to. As Joel said, if you combine all of the longer term products in a three-year lockup structure, as well as everything that is more private equity related, it's a total of 12% of assets. This is something that we're very excited about. I mean, if you realize what happened here, starting in the middle of 2009, which was a timetable where there was some concern as to whether institutions would want to be investing in hedge funds, we were approached by a number of institutions with the concept of their permitting for three years, rather than our shorter – our two year and other structures.

So we're very, very pleased. Obviously, these are long-term, high-quality investors and we think this is an example of the competitive differentiation that Och-Ziff has shown with institutions.

Roger Freeman – Barclays Capital

Okay.

Joel Frank

And then let me just add that when Dan talks about private equity, it's not private equity-type assets necessarily. It's just a structure for longer term characteristics of the assets themselves. And to add to what he said, the majority of all this capital is new – is new capital.

Roger Freeman – Barclays Capital

Okay. And can you update us, Joel, if you don't mind, on the AUM mix within the master fund? You mentioned cash was down to 9%. Maybe talk about the other areas and also by client type, please. Thank you.

Joel Frank

Sure. So long-short equity is about 30%, convertible arbitrage, 18%, structured credit, 15%, private investments, 10, other credit 11. Cash, you know is 9, as we've said and merger arb is 7%. And then on – in terms of investor type, pension is about 24%, fund to fund, 23%, foundation, 17, corporate and institutional, about 10, affiliated is around 9, family office around 8 and private bank around 9 as well.

Roger Freeman – Barclays Capital

Okay. And then lastly for me, can you talk about the fourth quarter dividend, how you're thinking about it in terms of the (inaudible) share and what needs to be re-invested into the company? Thank you.

Joel Frank

Well, as you know, we always pay out the majority of our distributable earnings and that's what we'll continue to do.

Roger Freeman – Barclays Capital

Okay. Thank you.

Operator

Your next question comes from Bill Katz from Citigroup.

Bill Katz – Citigroup

Hi, good morning, everyone. Just in terms of the 12% disclosure this morning, could you just let us know what that was maybe at the beginning of the year just to sort of frame the mix? And then from a modeling perspective, are there any changes in terms of the economics related to the change in the time horizon?

Joel Frank

Well, at the beginning of thank you, it was zero and so now, it's at – it's grown to 12% in terms of those particular assets. The majority of the assets relate to the three-year tranche which is basically just a timing difference in terms of the fact that once we go through this first three-year cycle and collect incentives, then there will be some incremental collection of incentive every year. And again, this is the majority of new additional capital.

Bill Katz – Citigroup

Okay. And maybe if you guys could just talk a little bit about – you mentioned very broadly what you see in the (inaudible), a couple more sentences on the dynamics where you're seeing it, non-U.S., U.S., the master fund. You mentioned you see the new product. What kind of products are you seeing the most demand for?

Dan Och

Well, to this point in the year, as you can see from the allocation of the assets, the majority of the demand has been in the master fund. We have recently begun to see more interest in some of the regional Funds. Obviously, that would mean the European and the Asian Fund and we think that's consistent with what we're seeing across the investment world, right? Investors in general seem to becoming a little bit more comfortable over time with taking risk, with focusing a little bit more closely on some of the differentiated products but arithmetically to this point in 2010, the majority of the demand has been in the master fund.

Bill Katz – Citigroup

Okay. Thank you.

Operator

Your next question comes from the line of Cynthia Mayer from Bank of America/Merrill Lynch.

Cynthia Mayer – Bank of America/Merrill Lynch

Hi, good morning. I think just to get a little more color on the flows, in terms of the pension fund flows, do you have a sense of what pension funds are allocating away from in order to put money into hedge fund products? Is it long-only equity or is it other forms of alternatives?

Joel Frank

Well, there are probably three trends going on and it depends on the individual pension fund, but there are three areas in which a pension fund can allocate. Number one, they can allocate from the alternatives bucket and that's traditionally where most of the allocations have come from. Number two, we're starting to see some discussion. And we think it's been more discussion than actual allocations, but some discussion about allocating from the equity allocation. Clearly, that would be a good thing in that those allocations are substantially larger overall than the alternative allocation.

Longer term, there's been some discussion that especially with the interest rates as low as they are about the potential misuse of allocations from the fixed-income side. Our view is that if we continue to generate very strong returns with very little downside and low volatility – look, we don't manage to any one quarter or any one – any month or any short-term period of time, but the fact that the returns we spoke about were generated with one-fifth of the volatility does not go unnoticed. And ultimately, we believe that if we can continue to generate the returns with that type of control and risk management, it's appropriate for any of those allocations. And that is where our focus is on perform, perform, perform.

Cynthia Mayer – Bank of America/Merrill Lynch

Okay. Can you maybe also talk a little about the retail side of the flows because as I understand it, you're on a couple of the big platforms. What are the trends there? Has that been slower to pick up than the institutional? What do you see looking ahead to next year?

Joel Frank

Well, on an absolute basis, the growth has been good. Obviously, you see that in some of the numbers for the private banks. And I know Dan may want to talk about what he sees for next year.

Dan Och

Look, we've been slow and selective about joining those platforms. We please – we’re pleased with the partners that we've selected and the collective flows have been strong. And we think that it creates a large opportunity going forward as well.

Cynthia Mayer – Bank of America/Merrill Lynch

Okay. And then maybe just among all the different channels, you're getting flows from, I think in the past call, you said you were marketing more than usual. Where do you – where are you focused in terms of marketing right now?

Dan Och

Well, we definitely did not say that or certainly did not mean to say that, because we're not marketing. As I said, our marketing is that performance in risk management infrastructure and transparency. And we have made no changes nor do we intend to make any changes in that.

Cynthia Mayer – Bank of America/Merrill Lynch

Okay. Sorry if I misunderstood that.

Dan Och

That's all right. Sorry if we misstated.

Operator

Your next question comes from Robert Lee from KBW.

Robert Lee – KBW

Thanks. Good morning. First, Joel, maybe just to clarify something, try to understand the three-year lockup product. It's a three-year initial lockup, 20% performance at the end of three years and then it kind of resets on an annual basis like a traditional investment?

Joel Frank

Well, yes, against recent and annual basis, then they reset to another three years depending on what the structure is, but generally you're correct.

Robert Lee – KBW

Okay. Dan, I'm just curious if you think about some of the changes taking place with investment banks and book rule and what not. It's obviously has been in the headlines, different firms having to exit different top [ph] businesses and understanding that's kind of where you got your start. Are you seeing any opportunities or does that kind of present any opportunities for the firm, not so much in terms of assets, but in terms of entering kind of these strategies, new platforms, seeing that some of these organizations kind of have to unwind businesses and good people get – have to find a home?

Dan Och

Yes. It does. I mean, there's a general trend and you're correct and you've been reading about it. But there's a general trend towards a reduction on the proprietary side on the banking and investment banking side of the industry. And so in terms of flow and availability of people and opportunities within businesses, I think you're correct about that trend.

Robert Lee – KBW

Okay. And if may I could be – maybe to talk – ask a question on the marketing, understanding what you focus your marketing on and how you present yourselves. I mean, I'm just curious maybe how though you've kind of changed other that your organizational structure or approach to distribution over the last – as the world's become more global as institutions have started to demand more transparency and things, I mean, how have you – maybe bring us up to speed on how you kind of invested in your kind of marketing and client service infrastructure and maybe how you changed the structure a bit, if you have, over the last couple of years?

Dan Och

Well, it's been evolutionary. Most of the increase has been on the client service side. The transparency is a very simple process. What our client service people do is consistently ask our clients, what's important to you? What are you most interested in? and generally, once two or three clients ask for something, we assume others are interested as well and then we figure out a way to add it.

We've – international, which is one thing you mentioned, is not new to Och-Ziff. We've had a very substantial investing presence in Europe and a very substantial investing presence in Asia. I think it's helped build our reputation within financial circles. But we've certainly increased our client service and client contact capabilities and our ability to respond to what's interesting clients. And so that group is larger but it's been an evolutionary fashion.

Robert Lee – KBW

Okay. And maybe just one last question, I mean, understanding that your net inflows have been pretty strong. And it may be hard to categorize this but I'm just curious that to the extent you do have some investors either redeeming part or some or all their capital. Is there any kind of underlying trend there you discern to the extent you do have some redemptions? Obviously, people need money for different reasons but I don't know if you had any sense that there was any kind of consistent themes, even a modest level of redemptions you may be seeing.

Dan Och

No. I think from an industry perspective in general, there were redemptions from the fund to funds industry. And there were redemptions from the endowment and foundation side having to do with liquidity issues that was really from an industry perspective. I also think it's pretty clear that those redemptions were relatively large beginning late '08 until sometime around the middle of 2009. And you've seen the quarterly trends. Obviously, we do not know what the fourth quarter will be. But we're hoping for a continued decline in that trend.

Robert Lee – KBW

All right. Great. Thanks for taking my questions.

Dan Och

Thank you.

Operator

Your next question comes from Marc Irizarry from Goldman Sachs.

Marc Irizarry – Goldman Sachs

Great. Thanks. Dan, can you just talk a little bit about the strategies I guess, a, that contributed to the strong year-to-date performance for you guys thus far? And going forward, where do you see – it looks like you certainly have increased your exposures and you've taken the cash down pretty significantly. Where do you think the opportunities to deploy capital are over the coming quarters?

Dan Och

Year-to-date, the performance has been reasonably well diversified. You know, we've been profitable in all geographic regions. The credit areas were more profitable than the long-short equity area, at least until very recently. But in general – and merger arbitrage was quite slow during most of the year, but it picked up recently. In terms of what you referred to in terms of the recent differentiation in the investment posture, I do want to remind you – and I think this is one of the things that institutions like about Och-Ziff.

We did reduce the cash position from 20% to 9%. But we're still generating these returns with a very, very conservative posture as we've always done and that's important to us and our risk-management processes and very important to our investors. And all that occurred there is when we invest, it's a combination of from the top down, where do we see opportunity and where do we see risks and uncertainty?

And from the bottoms up, what type of idea flow are we seeing in our different investment disciplines? At the margin over the past two months or so, we've seen a little bit more clarity in terms of the overall economic situation. We have seen substantially more opportunity in some of the investment areas, hence the modestly more invested position.

Marc Irizarry – Goldman Sachs

Okay. Great. And then just in terms of your flows – I might have missed this but how much of your flows year-to-date have gone into the three-year tranche?

Joel Frank

Well, that whole – the whole category was 12%, the majority of which is the three-year tranche.

Marc Irizarry – Goldman Sachs

Okay. And then how do you – and then has – as you develop more of a mix of longer term, locked-in capital, how's your – what is your compensation philosophy? What's implied sort of in terms of compensation there? I mean, how do you attempt to sort of balance the locked-in comp versus – does this mean maybe more increase in RSU grants or how should we think about the compensation philosophy?

Dan Och

Look, the compensation philosophy is the same it's always been. We value all the members of the team. We haven't really changed our model. And we'll pay bonuses based on how well the firm does, the economics of the firm and take into account the competitive environment, which we've always done.

Joel Frank

A key, Marc, on this three-year structure to remember is that once we get three years into it, since it's not as if we've raised the money once and then three-year ends and then we do it again. It's a constant rolling process. So once we get three years into it, it becomes largely irrelevant to the process and to the economics.

Marc Irizarry – Goldman Sachs

Okay. Great. Thanks.

Dan Och

Thank you.

Operator

Your next question is a follow-up from the line of Cynthia Mayer.

Cynthia Mayer – Bank of America/Merrill Lynch

Hi. Just to clarify on the longer dated products, on the management fees, are you billing on committed capital like classic private equity or are you billing on the value of assets like typical hedge funds?

Joel Frank

Remember, the majority of the capital is in the three-year tranche. So it's like a typical hedge fund is how we building on that received.

Cynthia Mayer – Bank of America/Merrill Lynch

Okay. And just on the most recent flows in 3Q in October, can you give us a sense of what proportion were from outside the U.S. and I guess what proportion were to longer dated products?

Dan Och

I mean, we generally don't break it down that way. It's really a mixture across the board.

Cynthia Mayer – Bank of America/Merrill Lynch

All right. Thanks.

Operator

There are no further questions in the queue. I would now like to hand the call back over to Tina for closing comments.

Tina Madon

Thanks, Fab. Thanks, everyone, for joining us today and for your interest in Och-Ziff. If you have any questions, please don't hesitate to contact me at 212-719-7381. Media inquiries should be directed to George Sard or Jonathan Gasthalter at 212-687-8080.

Operator

Thank you all for your participation in today's conference. That concludes the question – I'm sorry – that concludes today's conference. You may now disconnect. Have a wonderful day.

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