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Eaton Vance Corporation (NYSE:EV)

Q3 2014 Results Earnings Conference Call

August 20, 2014, 11:00 AM ET

Executives

Daniel C. Cataldo - Vice President and Treasurer

Thomas E. Faust - Chairman and Chief Executive Officer

Laurie G. Hylton - Chief Financial Officer

Analysts

Bill Katz - Citigroup

Ken Worthington - JPMorgan

Michael Kim - Sandler O’Neill

Dan Fannon - Jefferies & Company

Cynthia Mayer - Bank of America Merrill Lynch

Chris Shutler - William Blair

Andrew Donnantuono - KBW

Operator

Good morning, my name is Kirk and I will be your conference operator today. At this time, I would like to welcome everyone to the Eaton Vance Corp Third Quarter Fiscal Earnings Call and webcast. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer. (Operator Instructions).

Mr. Dan Cataldo you may begin your conference.

Daniel C. Cataldo

Thank you, and welcome everyone to our third quarter fiscal 2014 earnings call and webcast. Here this morning are Tom Faust; Chairman and CEO of Eaton Vance Corp and Laurie Hylton, our CFO. We will first comment on the quarter and then we will take your questions.

The full earnings release and the chart we will refer to during the call are available on our website eatonvance.com under the heading press releases. Today’s presentation contains forward-looking statements about our business and financial results. The actual results may differ materially from those projected due to risks and uncertainties in our business including but not limited to those discussed in our SEC filings. These filings including our 2013 Annual report and Form 10-K are available on our website on request at no charge.

I’ll now turn the call over to Tom.

Thomas E. Faust

Good morning. Eaton Vance had adjusted earnings per diluted share of $0.63 in the third fiscal quarter, an increase of 21% from $0.52 in the year ago quarter and a new record high. On a sequential quarter basis, adjusted earnings per diluted share increased 7% from $0.59 in the second quarter of fiscal 2014. The strong earnings comparisons reflect solid revenue growth, good control over discretionary spending and lower share count.

In the third quarter, we were again active on the capital management front, taking advantage of what we view as an attractive purchase range for our stock. We repurchased 2.5 million shares of stock for $93 million in cash essentially matching what we did in the second quarter. Through the first three quarters of fiscal 2014, we have repurchased and retired 6 million shares for a total of $228 million. With $547 million of cash and short term debt securities held at July 31, we have ample ability to continue an active share repurchase program while maintaining financial strength and flexibility.

We ended the quarter with $288.2 billion in consolidated assets under management up 7% from a year ago and up roughly 1% from the end of the prior quarter. Net flows for the third fiscal quarter were negative $2 billion. Outflows in the quarter were concentrated in three areas, floating rate income with net outflows of $1.4 billion, high yield with net outflows of $1.1 billion and large cap value equity with net outflows of $1 billion.

After several quarter of strong net inflows, retail bank loans flows turned negative in the third quarter consistent with overall industry trends and reflecting the decision by one of our largest advisory program partners to reduce their allocation to the bank owned asset class.

Without the associated $1.5 billion of withdrawals, net flows into our floating rate income strategies would have been positive in the third quarter as continuing strong institutional flows more than offset weakness in retail.

Although no one has more experience with retail loan funds than Eaton Vance, we struggle to understand the accelerated redemptions being seen today in the loan category. Loan prices are stable, credit conditions are benign and yields remain quite attractive in relation to other fixed income, sorry other floating rate instruments. Unlike holders of the fixed rate instruments, investors in floating rate bank loans do not face a loss of principle value as interest rates rise, and like investors in foreign bonds, floating rate bank loans price in U.S. dollars are not subject to currency risks.

Those seeking to explain loan funds outflows may point to a liquidity concerns, the idea that the loan asset class is not sufficiently liquid to support wide spread fund withdrawals. Throughout our 25-year record as a bank loan manager and nearly 14 years of experience managing daily liquid loan funds, we’ve always been able to meet withdrawal demand as they arise including during periods of significant financial distress.

While there could be no absolutes with this or any other asset class, we are confident that we have the pieces in place to continue meeting our funds liquidity needs through good times and bad, attesting to the continuing attractiveness of banks loans as an asset class, our institutional flows remains solidly positive.

In the third quarter, we closed on a new $500 million collateralized loan obligation entity and had 900 million of other net inflows into institutional loan strategies. Although we can’t predict when sentiment will again turn positive for retail loan fund products, we remain bullish on the bank loan asset class and our prospects for growth there as a proven industry leader.

In parallel with the weakness in bank loan fund flows, flows into high yield bond funds industry wide have also turned decisively negative in recent weeks. Our high yield bonds have seen only modest net outflows about $100 million in the third quarter. During the quarter we did lose $900 million high yield sub advisory relationship as the sponsor decided to bring management in-house.

Despite this disappointing account loss, we continue to maintain a large and vibrant high yield business under the direction of long time group leader Mike Weilheimer. At July 31, our high yield assets under management totaled $6.4 billion. As I mentioned, large cap value equity was the third major source of outflows in the quarter with $1 billion of net withdrawals. This represents a slight easing of the pace of outflows from the first half of the year and comes amid the transition in leadership of our value team to Eddie Perkin following the retirement of former lead manager Mike Mach in June.

As those who follow the company closely will know Eddie joined the Eaton Vance management as Chief Equity Investment Officer at the end of April, following a successful career at Goldman Sachs asset management. Although Eddie is just getting started as head of EVM’s Equity Group, I am pleased to report that early investment performance is very strong.

For the first three months of Eddie’s tenure, the Class I shares of our large cap value, focus value, focus growth, core stock, dividend builder and balance funds are ranked in the top quintile of their respective Morningstar categories.

For the year to date through the end of July, all of these funds and a number of other EVM managed equity funds rank in either the first or second quintile of their peer groups. With new leadership and renewed energy and focus our EVM equity business is turning the corner and positioned for improved business contribution.

2014 is also proving to be a strong performance year for many of our income and alternative strategies. For the year-to-date through 7/31 the Class I shares of our bonds, government obligations, short duration government income, diversified currency income and global macro advantage funds all rank in the top quintile of their Morningstar peer groups.

Performance has been particularly strong for our national municipal funds with our high-yield muni, national municipal income, AMT free municipal income, muni opportunities and TAS long term funds all having top decile class share performance rankings for the year-to-date.

Relative to many national and state-specific peer fund our muni strategies that have benefited from having little or no exposure to Puerto Rican credits. With seven national and 14 single state muni funds having atleast one class of shares rated four or five stars by Morningstar, we see our muni bond fund business is offering significant near term growth opportunities.

Flows into Eaton Vance Municipal income funds turned modestly positive in the third quarter, a notable improvement over the preceding four quarters. Global income is another area where we are seeing better performance and improved flows. This franchise includes our global macro absolute return, diversified currency and emerging market income strategies, which in total represent almost 9 billion in managed assets. While net flows were negative in the quarter in the range of $375 million, that’s a significant improvement from the $2.6 billion of net outflows in the first half of the fiscal year.

Another area of improving flows is parametrics emerging market equity strategy. Net inflows in the third quarter were almost $400 million, up from $200 million in the second quarter and less than $100 in the first quarter. The stronger flows are being driven by favorable relative investment performance as evidenced by our flagship funds excellent long-term record and five-star overall Morningstar rating.

At period end, parametrics EM assets totaled just over $22 billion. To round off the discussion of flows, I want to give you an update on the four emerging investment franchises identified last quarter as having significant potential to contribute to our future growth. You may recall that these are our two Richard Bernstein sub advised funds, the Parametric Clifton defensive equity strategy, latter municipal bonds, separate accounts and a multi sector income strategy.

During the third quarter, total assets in these four franchises grew $1.4 billion or 31% to $7.7 billion. The Eaton Vance Richard Bernstein Equity Strategy and All Asset Strategy Funds were introduced in October 2010 and September 2011 respectively. The funds are sub advised by Richard Bernstein Advisors and lead man is Rich Bernstein the former long time market strategist that met all ends. Both funds compete in large and growing asset classes, employ a distinctive top down investment approach and have gained broad intermediary acceptance in a relatively short time.

In the first nine months of fiscal 2014, the funds have had over $700 million of net inflows, installed managed assets more than doubled to $1.5 billion. This September we plan to launch a third fund sub advised by RBA, The Eaton Vance Richard Bernstein Market Opportunities Fund. The new fund will employ the same type down macro driven approach of the current funds but with a broader investment mandate, it includes the ability to hold both long and short positions.

The Parametric Clifton and defensive equity strategy applies the transparent rules based equity options over overlay to a portfolio of equity and cash investments. Institutions are using defensive equity as a low cost alternative to hedge funds and other hedged equity strategies seeking to generate alpha from a systematic program of writing put in call options. When we purchased Clifton at the end of 2012, assets in the strategies were approximately $560 million just over a year and half later defensive equity assets have grown to $2.1 million with a strong pipeline of new business opportunities.

Our Laddered Municipal Bond separate account product was developed by our TABS group in New York, and in less than three years managed assets have grown to over $2.8 billion with half of that growth coming in the last nine months. Sales continue to accelerate and the market opportunity here remains enormous.

Over $1 trillion of municipal bonds are today held directly by individual investors with little of no portfolio over sight. As the potential pitfall of holding unmanaged municipal bonds become apparent to more and more investors and advisors, we see big growth potential. We have the early lead in this market and don’t intend to relinquish it.

Our multi-sector income strategy is the lead managed by Kathleen Gaffney who joined Eaton Vance as co-head of investment grade fixed income in October 2012 after 28 years with Loomis Sayles. Eaton Vance bonds fund was introduced at the end of January 2013 as a mutual fund vehicle for the multi sector strategy.

Over the life of the fund in the last 12 months, the fund ranks among the top performer in its Morningstar category with its class I shares beating the peer group average by over 750 basis point on a one year basis at July 31.

In the third quarter, assets increased from 637 million to 1.25 billion, a 97% increase in just three months. As the strategies track record continues to build the fund is gaining broader acceptance on intermediary platforms. Over the coming months we also expect to start funding institutional separate account mandates, a huge untapped opportunity for this franchise.

I want to close with an update on our exchange rate of managed funds or ETMF imitative. As many of you know, ETMFs or proposed new type of open end fund that seek to provide the performance and tax advantage of exchange traded funds to active investment strategies while maintaining the confidentiality of portfolio trading information.

Unlike ETFs, ETMFs would not disclose their portfolio holdings on a daily basis. ETMFs would be brought and sold on an exchange utilizing a new trading protocol called NAV base trading. Our navigate fund solutions subsidiary hold the series of patterns that we seek to commercialize by licensing them to fund sponsor by Eaton Vance and other fund groups. Since our last earnings report we have continued to work towards regulatory approval and commercial loans. On July 30, we filed registration statements for 18 initial ETMFs to be offered by Eaton Vance.

While we can’t predict the outcome of the regulatory process, we remain confident that if approved, ETMFs have the potential to transform our actively managed strategies or deliver the fund investors in the U.S. with potentially quite significant financial implications for Eaton Vance.

With that, I’ll now turn the call over to Laurie to discuss the quarterly financial results in more detail.

Laurie G. Hylton

Thank you and good morning. Tom summarized for reported adjusted earnings per diluted share of $0.63 for the third quarter of fiscal 2014 compared to $0.52 for the third quarter of fiscal 2013 and $0.59 for the second quarter of this year. This represents an increase of 21% as compared to the third quarter of last year and an increase of 7% sequentially.

On a GAAP basis, we earned $0.63 per diluted share in the third quarter of fiscal 2014, $0.18 in third quarter of fiscal 2013, and $0.59 in the second quarter this fiscal year. AS you can see an attachment II to our press release, adjustments from reported GAAP earnings in the third quarter of last year include non-recurring cost associated with retiring 250 million of our 6.5% senior notes due in 2017, a charge to settle the state tax matter, instruction cost associated with the closed end fund offering.

We’re pleased to report that our third quarter operating results were strong in every respect. Operating income increased 10% year-over-year and 5% sequentially on revenue growth of 5% and 4% respectively. Prudent cost management and lower variable compensation cost drove our operating margin up to 35.7% from 33.9% in the third quarter of last year and 35.4% last quarter. On the strength of those operating results, adjusted net income increased 17% year-over-year and 4% sequentially. Adjusted earnings per diluted share increased 21% year-over-year and 7% sequentially, reflecting the growth in adjusted net income and a decrease in outstanding shares as a result of stepped up share repurchases over the last several quarters.

Revenue increased 5% year-over-year reflecting a 6% increase in investment advisory and administrative fees, partially offset by modest declines in distribution and service fee revenues. Looking specifically at investment advisory administrative fees, the 6% increase year-over-year reflects a 10% increase in average assets under management offset by a decline in our effective fee rate.

The decline in our effective fee rate from 44 basis points in the third quarter of last year to 43 basis points this quarter can be primarily attributed to the growth in lower fee implementation services mandate and the corresponding increase in implementation services asset as a percentage of total assets under management.

Revenue increased 4% sequentially, primarily reflecting the impact of having three additional days in the third quarter compared to the second, and a 2% increase in average assets under management. We feel the day count drag on both revenue and our effective fee rate in the second quarter each year as more than half our investment advisory and administrative fee revenue and all of our distribution and service fee revenue is calculated on the basis of the number of calendar days in the quarter.

Day count drove our effective investment advisory administrative fee rate up from 42 to 43 basis points sequentially. Performance fees did not materially affect effective fee rates for any of the periods presented contributing 928,000 in the third quarter of fiscal 2014 compared to 952,000 in the second quarter of fiscal 2014 and 850,000 in the third quarter of fiscal 2013.

We anticipate that our effective investment advisory and administrative fee rate for active equity strategies will remain at approximately 65 basis points. Fixed income strategies at approximately 45 basis points

Floating rate income strategy is at approximately 55 basis points, alternative strategy is in the low to mid 60s and implementation services is at approximately 10 basis points for the remainder of this fiscal year. As always, our future overall effective fee rate will be impacted to the extent that there are meaningful changes in product mix.

Shifting from revenue to expense, operating expenses were up 2% year-over-year reflecting low single digit percentage increases in our largest expense category including compensation, distribution related expenses and other discretionary spending. Operating expenses increased 3% sequentially reflecting similar single digit percentage increases in the same categories.

Compensation expense increased 2% year-over-year primarily due to increases in base salaries and benefits and stock based compensation, partially offset by decreases in operating income basis and as in sales base incentive compensation. The increases in base salaries and stock based compensation were driven primarily by a 7% increase in average head count and retirement during the third quarter of fiscal 2014 respectively.

The decrease in operating income base incentives reflects adjustments to operating income base approval rate across the company, while the decrease in sales based incentive compensation primarily reflects the decrease in compensation eligible retail sales.

Sequentially, we saw a 3% increase in comp expense driven by similar increases in base comp and benefits and stock based compensation partially offset by decreases in operating income based incentives. The sequential increase in base salaries and benefits primarily reflects the additional number of payroll dates with headcount growth related to permanent employees limited to 1%.

As in the year-over-year comparison, the increase in stock based compensation primarily reflects retirements during the third quarter of fiscal 2014 while the decrease in operating income base incentives reflects adjustments to accrual rates across the company.

Distribution service fee expense increased marginally both year-over-year and sequentially reflecting the increase in assets under management subject to these fees. Fund related expenses were up 14% year-over-year and 11% sequentially primarily reflecting an increase in sub advisory expenses driven by growth and sponsored funds managed by unaffiliated sub advisors.

Other operating expenses were up 4% both year-over-year and sequentially primarily reflecting increases in information technology spend related to investment management systems project partially offset by a decrease in recruiting and legal professional services.

Net income and gains on seed capital investments contributed roughly a penny to earnings in the third and second quarters of fiscal 2014 while reducing earnings by approximately $0.02 in the third quarter of fiscal 2013.

When quantifying the impact of our seed capital investments on earnings each quarter, we take into consideration our pro rata share of the gains, losses and other investment income earned on investments and sponsored products, with accounted and for as consolidated funds, separate accounts or equity method investments as well as the gains and losses recognized and derivative yields to hedge these investments. We then report the per share impact net of non controlling interest expense and income taxes.

Equity net income of affiliates decreased sequentially primarily reflecting a decrease in net income and gains recognized on sponsored products accounted for under the equity method. Our 49% interest in Hexavest, which is reported net of tax and the amortization of intangibles in equity and net income affiliates contributed approximately $0.02 per diluted share for all periods presented.

Excluding the affects of CLO entity earnings in markets in all periods presented and the state tax settlement in the third quarter of fiscal 2013, our effective tax rate for the third quarter fiscal 2014 was 38.5% compared to 38% in the second quarter of fiscal 2014, and 37.7% in the third quarter of fiscal 2013. We currently anticipate that our effective tax rate adjusted for CLO earnings and losses will be approximately 38% for the remainder of the fiscal year.

In terms of capital management as Tom mentioned, we repurchased 2.5 million shares of nonvoting common stock for approximately $92.6 million this quarter. When combined with prior quarters repurchases this brought both our average diluted share count and shares outstanding down by 2% sequentially.

Even with the significant increases in share repurchases, we finished the quarter holding just over $540 million of cash and short-term debt securities and approximately $260 million in seed capital investment.

Our outstanding debt consists of $250 million of 6.5% senior notes due in 2017 and $325 million of 3.625% senior notes due in 2023. We have a $300 million line of credit, which is currently undrawn.

Given our strong cash flow, liquidity and overall financial condition, we believe we’re well positioned to continue to return capital to shareholders through dividends and share repurchases. With our stock trading and what we view as attractive range. We expect to continue to be active repurchasers as we move into the fourth quarter.

This concludes our prepared comments. And at this point, we’d like to take any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Bill Katz from Citigroup. Your line is open.

Bill Katz - Citigroup

Hey, guys. Thank you and good morning everyone. Just Tom, you mentioned that on the retail side, I guess maybe you sound a little confounded, my words, about what you're seeing there. And I appreciate that. What was the reason that the distributor gave you for the allocation shift? And then what might be the risk of other distributors following suit? Seems like it always seems to be some consistency across the distribution platforms around those kinds of things?

Thomas E. Faust

Just to clarify, Bill, you’re asking about bank loan funds.

Bill Katz - Citigroup

Yes, I apologize, yes, yes.

Thomas E. Faust

Okay. So I think as you probably know platforms or advisory programs are increasing part of the mutual fund business where there is centralized decision making to some degree anyway with respect to asset allocation changes. So what happened in the quarter to us was that one of those -- one of the largest platforms, I think the largest in terms of exposure to our bank loan strategies, made an asset allocation change. They didn’t speak directly to me. I don’t think they would typically give a lot of color on the reason for the change. It was not a complete withdrawal, but it was a meaningful reduction in their exposure to us. We understand that the reallocation was not to another bank loan manager but it was from bank loans to some other asset class whether that’s stocks or bonds or alternative I can’t really give you any color on that.

As I mentioned, this is our – this was our largest single platform exposure. We certainly have other large investors in our bank loan strategies, but nothing of a similar character that’s of a similar size.

Bill Katz - Citigroup

Okay. And then maybe a second follow-up question just staying on the flow discussion for a moment, this is a combined question; just looking at the supplement for Hexavest, it seems like the flow story there has slowed in aggregate. Maybe you can just update on what might be driving that dynamic? And then on the implementation services, that too seems to have slowed of late. Is that just timing lumpiness or is there anything else going on there just in terms of penetration of that opportunity set?

Thomas E. Faust

So, I’ll just take those in the sequence you ask. First on Hexavest, flows there’s there have definitely slowed. Hexavest is just to remind people is a top-down global equity manager with about $17 billion in assets under management, which we owned 49% interest, they’re based in Montreal. So it’s a relatively small team. I think 40, 50 people focused on a global equity strategy.

They have historically been relatively strong performance -- performers during the periods of market weakness. They have been relatively cautious on the markets over the last couple of years, obviously that’s been position that hasn’t helped their relative performance. So they are in a mode where they’ve lagged their benchmark for the last couple of years.

They’re not losing business, because people view them as a defensive manager. But they’re not in a position to attract significant new flows, because they are relatively weak relative performance. They do have a pipeline. There are ongoing discussions with major prospects. But we would expect the growth rate there likely to be moderate until they start showing improved relative performance, which based on their current positioning would likely be during a period of weaker market conditions than we’ve seen over the last year and a half or so.

In terms of Clifton’s implementation services business, as you mentioned there is a lumpiness to that business. What we report as flows reflects really two things. One is client’s gains and loss. And the other is allocation or shifts and exposures or changes in position sizes for existing clients.

The second of those factors that changes in exposure by existing clients, is largely driven by factors that have nothing to with Clifton or the services they provide, just simply how much cash were they holding or how they’re using Clifton within their portfolios. That have some noise in it and it’s quite hard for to predict.

The first factor which is net clients gain, there’s a very positive story. Clifton is well ahead of their projections for their business for the year-to-date. Not only in defensive equity which is one of the growth strategies that we’ve highlighted, but also in their core overlay services business. So they continue to grow and add quite significant new clients. They are in the process of expanding their sales force. They’re well ahead of budgets in terms of new sales and new revenue acquisition for the year-to-date. So, that acquisition is certainly going very well and with growth substantially ahead of plan.

Bill Katz - Citigroup

Thank you, one last one. Thank you for taking my questions this morning. As you think about counterbalancing your platform with the four emergent segments that you see some very good growth of low numbers versus a bit of recovery for the legacy business how do you think about marketing spend and what might be the impact on G&A as we look forward?

Thomas E. Faust

I don’t think we see significant changes. Most of our sales and marketing expense tense to be commission based. Sales incentives we pay and so it will go up or down with the volume of gross sales and to some degree with the mix of sales among different products. But we don’t see a significant change in mix of sales or rate of sales, expenditure relative to the volume of sales activity.

Bill Katz - Citigroup

Okay. Thanks guys, appreciate it.

Thomas E. Faust

Thank you.

Operator

(Operator Instructions) And your next question comes from the line of Ken Worthington from JPMorgan. Your line is open.

Ken Worthington - JPMorgan

Hi. Good morning. Maybe to follow-up on Bill's and the sales force, can you talk about maybe how you’re positioning the overall sales force? You just mentioned that Hexavest is expanding its sales presence. Can you talk about how the sales team is evolving as you're growing both bigger but also adding new products? Are you growing the team, are you trying to get into not just new clients but maybe new channels as well? What are you doing on the sales side?

Thomas E. Faust

Yeah. The biggest change over the last year for us is the one that you touched on, which is the change at Parametric. As you may know prior to the acquisition of Clifton Group at the end of 2012, Parametric’s institutional products were represented by Eaton Vance institutional sales team. When we acquired Clifton we made the decision to move to a separate sales force for Parametric in the North American institutional market where the initial sales team were the members of the Clifton team.

We have added to that team over the last year, pretty aggressively, initially there were a total of three sales client service and consultant relations people, over the last year or little over a year that’s grown to I’d say, probably about eight people, four sales -- four field sales people, but backing that up with the consultant relations people and client service people.

So, three to let’s say eight or nine people on that team with the expectation for continued growth. On the retail side, the biggest change over the last year has been the addition of our wealth strategies group, which is a -- I’ll say five person or six -- I think six person team based here in Boston, but focused on strategies for high net worth investors in the retail channel, both drawn from Parametric, but also from Eaton Vance.

So those are the two major changes really focusing on growth opportunities we see for Parametric now combined with Clifton on the institutional side, plus wealth strategies, opportunities we see within retail for both traditional Eaton Vance strategies, as well as Parametric strategies.

Ken Worthington - JPMorgan

Great. Thanks. And then as a follow-up just on tax managed investing. To what extent is that seem becoming more visible with your customers. I’d like to talk beyond Parametric, as Parametric is doing quite well, but you got a big business beyond that. We saw a kind of muni sales turn positive, that maybe an element of it. Are you seeing it on the core equity franchises well? Or is performance still just not good enough even though its getting better to kind of bring those clients in, but I really want to know just thematically is tax managed investing picking up and if so to what magnitude?

Thomas E. Faust

Yeah. So I think three part to our tax managed franchise. One is Parametric which is a range of index replications strategies where given a benchmark or given an index, they will, with a high degree of tracking, seek to match that on a pretax basis. And then through separate accounts they are actively managed to harvest losses, they’ll look to outperform an ETF or non-tax managed strategy on an after tax basis by systematically harvesting tax losses.

That’s a big business for them. It’s one of their foundational businesses. When we first acquired Parametric in 2003 that was their dominant business, and that has continued to grow. Sales are strong as you might imagine we and others are aggressively making the case that in an environment where capital gains, taxes are in a range depending on where you live in the U.S. 25% to 33% for high net worth investors that there is a significant demand for tax efficient strategies and particularly strategies that can systematically throw off capital losses.

There are challenges to that business, one is that in a -- what has been a pretty strong equity market, the opportunities to realized capital losses maybe more limited than in an up and down market. But we’re dealing with that and continuing to deliver the high tax efficiency that we see.

So number one is the Parametric another equity strategies. Number two, which you touched on is munis where we are going gangbusters in terms of our muni separate account business in the form of our latter strategies where assets have grown from essentially zero to $2.8 billion over the last three years with very strong current growth. Also as you mentioned, our muni fund business, which is a very important business for us over $20 billion in muni fund asset turned positive inflows in the current quarter. And we’ve got a very broad lineup of high performing strategies. We’ve traditionally offered funds that have the high end of peer group in terms of current yield and we also have the differentiating feature today that our funds have.

As a general rule, little or no Puerto Rico exposure, which has become a hot button issue among investors in the muni sector. I think as many people are probably aware Puerto Rican bonds are tax free in most if not all states through the U.S. so they’re frequently held in size in state specific muni funds. Our fund as a role have limited exposure to that and that’s benefited our performance and it’s been a key differentiating feature that our sales guys are certainly pointing out to potential investors.

And then third piece for our tax managed business is based here in Boston, which is that Eaton Vance actively managed, tax managed equity funds. We’ve seen a little improvement there, but not much and I think it’s for the reason that you cited, Ken which is that performance while it’s better, it’s still not to a point where we can compete on a performance basis with other managers. I would also add that this group, the heyday of us raising assets in tax managed equities within the late 90s and certainly since then, the awareness and the competitiveness of ETFs and index funds versus equity strategies has grown and people’s broad recognition of the tax advances of the exchange rate structure are significantly greater today than they were in the late 90s.

So we don’t have great expectations for recovery there. We certainly believe that as our equity performance improves we will see improved flows in tax managed aggregate active equities, but we really see that the primary growth opportunities there is primarily on the Parametric side and on the muni side.

Ken Worthington - JPMorgan

Great. Thank you very much.

Operator

Your next question comes from the line of Michael Kim from Sandler O’Neill. Your line is open.

Michael Kim - Sandler O’Neill

Hey, guys. Good afternoon. First just as institutional fixed income investors continue to migrate in favor of more flexible mandates. Just wondering how that dynamic potentially sets up for the multi-sector bond strategy as you increasingly market that capability to those investors? I know you mentioned expecting to fund some mandates here shortly, but just any additional color on sort of the opportunity set there would be helpful? Thanks.

Thomas E. Faust

Yeah. We certainly see that as a big opportunity. We observe the same thing that income investors have migrated from core fixed income to core plus to increasingly we’re seeing interest in multi-sector which is moving out a little further on the risk spectrum, which is broadly where our Kathleen Gaffney's multi-sector income strategy operates.

We certainly expect to be more active there. Kathleen’s track record at Eaton Vance dates back to end of October of 2012, so we’re coming up on two years of that working with the team here, when she came to Eaton Vance she brought with her a big Rolodex of contacts in the industry, but many took appropriately a weight and see attitude. She is coming to a new place and working with a new team. But we’d like to think that as we hit the second anniversary of her being in the new location, working with the new team that given the really tremendous investment success that we’ve achieved, that we will start wining some institutional mandates and that can become a significant increment to the growth of that franchise.

And so, we’re quite excited, quite thrilled with how successfully that’s going as I mentioned retail assets approximately doubled to $1.2 billion or so in the most recent quarter. We certainly view that as really just getting started and since the big opportunities from here both continuing in retail but also institutionally. And I might add institutional opportunities we see not only in the U.S. but potentially also around the world.

Michael Kim - Sandler O’Neill

Okay. That’s helpful. And then, in terms of capital management, seems like you’re seed capital portfolio continues to vintage. So just wondering, looking forward, are you looking to recycle that capital into newer strategies or might there be an opportunity to remain proactive on the share repurchase front with some of that excess capital if you will?

Thomas E. Faust

We certainly see opportunities to continue the repurchase program. We have a handful of things that might be uses of seed capital in our traditional fund line up. I might tell you also that, we filed registration statements for 18 new ETMFs and if and when those get approved, they may also be a source of seed capital, but I guess we don’t from where we sit today see major changes there and expect that the primary use of our free cash flow will be to return to shareholders as oppose to expanding our seed capital activity.

Michael Kim - Sandler O’Neill

Okay. Thanks for taking my questions.

Operator

Your next question comes from the line of Dan Fannon from Jefferies. Your line is open.

Dan Fannon - Jefferies & Company

Thanks. I guess just following up on the bank loan comments, and just want to characterize the institutional demand was very strong this past quarter and it seems per your commentary that’s continuing. I guess is there any change in the redemption trend or is that -- I’m just looking at your – we see the growth sales in aggregate and the growth redemptions, it seems like the redemption pickup is all retail. Is the gross sales acceleration all coming institutionally or is that the right way to think about it?

Thomas E. Faust

I think that’s right. We are -- I’d say, we are in a -- if you put aside the $1.5 billion of withdrawals that we had from this program reallocation that I talked about, that mostly hit in I want to say the first half of June. Since then flows have been relatively stable in bank loans. We are seeing more redemptions than we would like. Gross sales are lower than we would like. But my own view, what do I know? My own view is that this will pass. And if you ask investors why are they redeeming bank loans? I don’t think people can you really great reason. And my guess is that as the world evolves and there become other things to worry about that we will see lessening of bank loan redemption.

Whether or not we’ll see a pick up in sales? I think as maybe another matter. There was a huge pickup as I’m sure you’ll recall in the first half of last year when there was a big surge of fear that the rates were going up and how does the income investor protect themselves or herself from loss of principal value in a period of rising interest rates. Bank loans seem like a great solution. Rates went up. Rates have been drifting down. My guess is that the next time that there’s any kind of an upward shock in rates than we will again say a pickup in retail demand for bank loans. I don’t know when that will be. I suspect somewhere out there in the next several quarters that will happen, but we certainly can’t forecast that. We don’t foresee that over the next couple of quarters.

So our presumption is that we will see continued retail outflows, I’d like at a moderating pace through the balance of the year and we’d like to think to be offset largely by continued institutional demand. Let me just repeat my statement that I made in my prepared remarks, which was that, if you take out that $1.5 billion reallocation that we would been positive in bank loans for the quarter. Can’t guarantee we’ll be positive next quarter, but we certainly see the prospect for improved net flows because we don’t anticipate anything like that in terms of single assets reallocation by any of our current bank loan clients.

Dan Fannon - Jefferies & Company

Great. That's helpful. Just thinking about the fee rates in aggregate going forward, and if I look at your emerging franchises page which has the four funds that are gathering momentum and just looking forward beyond what you said for next quarter but thinking out a little bit further and where you're seeing some redemptions versus where these funds are inflowing, is it reasonable still to assume a stable fee rate in aggregate going forward based on these types of products growing versus where you're seeing redemptions today?

Thomas E. Faust

I think as of long-term trend I would expect average fee rates for us to be moving down over coming quarters and coming years. I would say the same for our industry. We are -- our business as it grows and matures has become more competitive and that shows up principally in lower fees. We face those same pressures as everyone else. An additional dynamic we have is that Parametric which is – which is currently and has been the fastest growing part of Eaton Vance is a lower fee business than most of the other things that we do. I would expect Parametric to continue to grow faster than the rest of the Eaton Vance and that put additional pressure on us.

So I think within asset classes, I would say we would see perhaps small downward pressure on fees consistent with overall industry trend. As our mix grows more in the direction of Parametric and particularly more in the direction of implementation services we could see additional fee rate declines.

We don’t necessarily view lower fees as a bad thing. We want to provide good value to our customers. If we can operate effectively with attractive margins at a lower fee rate that’s business that we’ll take any day. One of the things that most attractive to us about our Parametric franchise particularly as it is grown and now encompasses the former Clifton business, is while its low fee it is still a very nicely attractive business in terms of margin.

So there’s a tendency to think sometimes that low fee equates to low margin in our business. If the business is operating efficiently, if it’s the kinds of strategies the kinds of thing that Clifton does or that the Parametric has done away from Clifton, we think we can earn very attractive margins and very attractive rates of returns at low fee rates.

Dan Fannon - Jefferies & Company

Great. Thank you.

Operator

Your next question comes from the line of Cynthia Mayer from Bank of America. Your line is open.

Cynthia Mayer - Bank of America Merrill Lynch

Hi, good morning. Question on comp, you mentioned I think you made an adjustment to operating income basic rules. I just wondering if you could give some color on what drew the change, is that flow related or performance related or related to a particular part of the business. And also maybe a little bit on the likely impact of the change? So should we assume 3Q is representative of incentive based comp going forward?

Laurie G. Hylton

Yeah. I think, Cynthia, the adjustments that we made were sort of minor adjustments across all of our subsidiaries as we were looking ahead to where we anticipated we were going to be making payouts at the end of the fiscal year. As you know operating income is up, but we want to ensure that we were making some rationale decisions around a given where we anticipate we’re going to paying out at each of the subsidiaries, and therefore made a decision to bring things down modestly this quarter. To that end we do anticipate that the numbers you’ve seen in the third quarter will likely be representative for what you would see in the fourth keeping in mind that the other significant component of variable compensation obviously is driven by sales, so that gets push around to the extent that there is an uptick in sales in the fourth quarter.

Cynthia Mayer - Bank of America Merrill Lynch

So then, I guess with the new fiscal year, would you reset that again?

Laurie G. Hylton

We do look at the accrual rates at the beginning of each fiscal year. I think there might be some modest changes, but I wouldn’t anticipate anything significant in the first quarter.

Cynthia Mayer - Bank of America Merrill Lynch

Okay. And then just the follow-up on the fee rate discussion, which is if you look at the floating rate maybe moving a little bit more to institutional versus retail. Would that effect the overall fee rate for floating rate or our CLOs and other institutional products sort of similar fee rate?

Thomas E. Faust

Somewhat lower on average, but not grossly so.

Cynthia Mayer - Bank of America Merrill Lynch

Okay, great. And then if you guys have ending share count, that would be really helpful? I'll call back and get that if you prefer?

Laurie G. Hylton

Just hold on. Ending shares were $118.7 million.

Cynthia Mayer - Bank of America Merrill Lynch

Great. Thanks a lot.

Laurie G. Hylton

You’re welcome.

Operator

Your next question comes from the line of Chris Shutler from William Blair. Your line is open.

Chris Shutler - William Blair

Hey, guys, good morning. With the multi-sector bond fund, I think, Tom, you said that you're making progress getting onto with a retail distribution platforms. Maybe just a little bit more color there to the extent that you can provide it?

Thomas E. Faust

There’s not a whole lot to say. That market tense to have requirements in terms of asset size, manager tenure, track record. And what’s been remarkable about the success we’ve achieved with our bond fund in the multi sector strategy is that we’ve really raised a lot of assets and gathered a lot of interest and attention really without having those things. So we began our fiscal year at the end of October with I think $75 million in assets in the strategy, that’s now $1.2 billion or $1.3 billion something in that range. I can’t point specifically to you know we’re going to get on XYZ platform on a particular day, but I understand generally how things work which is that as a strategy proves itself overtime and its assets grow that can be a logical step. So I don’t want to over promise that that’s about to happen tomorrow, I would couch that more as we would anticipate as the strategy matures and as assets grow that presents additional growth opportunity that today we really haven’t been able to take advantage of.

Chris Shutler - William Blair

Okay. And then secondly on the global macro absolute return obviously good to see the outflows there moderate a bit, but it does look like performance is still of a challenge even in the short term, so just any update there and how you see the flow outlook going forward? Thanks.

Thomas E. Faust

We’re having a pretty good year in performance, and I think we’re up about 4% for the I shares of our global macro strategy with LIBOR roundly zero, we think that’s pretty good. That’s our benchmark, we try and have performance of 300 to 400 basis points over our benchmark on an annual basis, that’s consistent with the historical performance record of this strategy relative to many peer fund and the global macro category and there are not a lot and they vary pretty significantly but relative to our peers we think we’re doing quite well.

So I think what happened to us in flows was that 2013 was a year in which a lot of asset classes had very high returns, like made a lot of money in stocks. We had modestly negative returns, gross returns were a few basis points positive, net returns were negative with generally in the range of zero to 1%. That didn’t really excite people, when equities are going up 30% why do you need to diversify into a global macro or similar types of esoteric strategies.

We have done a couple of things since then. One is returns are better. We’re making money. And the other is I think we’re in a period of maybe a bit more cautious environment for equities and other asset classes and the principal reason for investing in global macro three or four years ago is the same today, which is it being a source of diversification and potentially non-core related returns. We have in our global macro strategy very little exposure to U.S. equities, very little exposure to global equity, very little exposure to global interest rates and very little exposure to the movement of the dollar versus established currency box like the euro and the yen. That’s a pretty special asset class that provides that level of diversification.

But with that diversification people want return, and we didn’t deliver that last year. But we feel like with returns being in a positive and acceptable range, that we expect not only to see the outflows to continue to diminish, but I wouldn’t give up hope of within not very many months that this becomes a growth business for us again.

Chris Shutler - William Blair

Great. Thank you.

Operator

The next question comes from the line of Robert Lee from KBW. Your line is open.

Andrew Donnantuono

Hi this is actually Andrew Donnantuono filling in for Rob. Thanks for taking our questions. Just firstly, just a small one, could you just tell us how maybe we should be thinking about performance fees in fiscal fourth quarter. I know historically there’s been a little bit of a jump there relative to you know fiscal two and three, you know if not quantify that if you could just kind of give us a sense of how we should think about performance fees in the upcoming quarters?

Thomas E. Faust

Performance fees are, I guess you’d say notoriously hard to model because performance and access performance is hard to model. I think you’re right that the fourth quarter has been a period when we’ve seen generally a little bit of an uptick in performance fees. We have a major account that is a parametrics account that has a performance fee component that’s relative significant. The fees are as I remember the performance fee is on a rolling three year basis, periods is not done but we’re ahead of the benchmark, so we could see an uptick in performance fees in the fourth quarter but its not something as I said to be terribly meaningful to the company as a whole.

Andrew Donnantuono

Okay. Great, thanks and then just kind of shifting gears to just a very high level question, just trying to get a sense of as you’re kind of cumulative institutional pipeline maybe outside of some of the emerging franchise businesses that you’ve highlighted. You know would you characterize kind of where you’re sit now versus recent quarters, you know as far as institutional pipeline goes and maybe where you have seen if any kinds of spikes in RPF activity of late, any color you might have there would be very helpful.

Thomas E. Faust

Yeah so our visible pipeline and by pipeline we mean this is a one not funded business, is roundly $3 billion or so. That’s a range of different areas that includes bank loans, it includes emerging market equities and includes a fair bit of growth at traditional Clifton’s strategies both defensive equity and overlaid business there are some institutional cash management in that to recall that we started an institutional cash management business in 2013 and we’re building a pipeline there and expect to see some of them hit maybe in the fourth quarter it might extend into the early part of fiscal 2015. But the places where we’re seeing the activity or probably the obvious ones bank loan being high on that list, emerging market equities, multi-sector high yield, I guess those are probably the ones I would highlight as being most significant.

Andrew Donnantuono

Okay. Thank you.

Operator

We have no further questions at this time. I’ll turn the call back over to you, Mr. Cataldo.

Daniel C. Cataldo

Great. Thank you and thanks for joining us this morning and we look forward to reporting back to you at the end of our fourth fiscal quarter in November. Thank you.

Operator

This concludes today’s conference call. You may now disconnect.

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Source: Eaton Vance's (EV) CEO Thomas Faust on Q3 2014 Results - Earnings Call Transcript
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