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Waddell & Reed Financial, Inc. (NYSE:WDR)

Q2 2011 Earnings Call

July 26, 2011 10:00 AM ET

Executives

Hank Herrmann – Chairman and CEO

Nicole McIntosh – AVP, IR

Tom Butch – Chief Marketing Officer

Mike Strohm – COO

Mike Avery – President

Dan Connealy – CFO

Analysts

William Katz – Citi Group

Cynthia Mayer – Bank of America/Merrill Lynch

Michael Kim – Sandler O’Neill

Craig Siegenthaler – Credit Suisse

Robert Lee – KBW

Roger Freeman – Barclays Capital

Mac Sykes – Gabelli & Company

Jeff Hopson – Stifel

Mark Irizarry – Goldman Sachs

Operator

Ladies and gentlemen, thank you for standing by and welcome to the second quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator Instructions). Thank you. I would now like to turn the floor over to Mr. Hank Herrmann, CEO, to begin.

Hank Herrmann

Thank you Beverly. Good morning everyone. With me today are Mike Avery, President; Phil Sanders, CIO; Tom Butch, Chief Marketing Officer; Dan Connealy, Chief Financial Officer; Mike Strohm, our Chief Operating Officer; and Nicole McIntosh, our AVP of Investor Relations. And Nicole, would you read the forward-looking statements please.

Nicole McIntosh

During this call, some of our comments and responses will include forward-looking statements. While we believe these statements to be reasonable based on information that is currently available to us, actual results could materially differ from those expressed or implied due to a number of factors including, but not limited to, those referenced in our public filings with the Securities and Exchange Commission. We assume no duty to update any forward-looking statements.

Materials relevant to today’s call, including a copy of today’s press release, as well as supplemental schedules have been posted on our website at Waddell.com under the Investor Relations tab.

Hank Herrmann

Thank you Nicole. This morning we report our second quarter results. I would like to bring the following highlights to your attention. Net income of $50 million rose 46% compared to last year’s second quarter and 10% compared to this year’s first quarter. Earnings per diluted share of $0.58 rose against the comparable periods at a similar rate. Both net income and the earnings per share quarterly figures were the highest in the company’s history.

Also notable is the continued expansion of our operating margin. At 25.5% it beats the highest levels since fourth quarter of 2004. Assets under management reached $91.7 billion. Net inflows were $1.7 billion. Gross sales of $5.8 billion were $780 million below the previous quarter’s volume, having been negatively impacted by market uncertainty and some seasonal slowdown in our advisor’s channel.

Compared to the same period last year, sales rose 10%. While we are not immune to market sentiment fluctuations, at 7.6%, we again produced organic growth significantly above the industry and among the top names in our peer group.

As of last Friday, AUM’s were approximately $95.6 billion. Average daily sales in the Advisor and Wholesale channels for the month of July to date, are slightly below the second quarter run rate, but well ahead of last July’s volume.

Our Institutional channels are significantly ahead of pace, benefiting from $800 million in new sub advisory sales.

Turning to distribution channel specifics, Advisor had another $1 billion quarter in sales, while maintaining modestly positive net flows. Advisor productivity improved for the seventh consecutive quarter.

Wholesale continues to drive overall growth in AUM’s with sales of $4.2 billion during the quarter and net sales of $1.8 billion. We continue to make progress in diversifying sales toward a greater number of funds. This quarter marked the first time in four years that less than 50% of sales went to flagship rather than flagship as a strategy fund. I mispronounced fund. Actually, strategy fund was below 50%. Organic growth in the channel was 16.2%.

Our Institutional efforts yielded sales of $556 million during the quarter, approximately 28% below the two comparative periods. Redemptions increased primarily from Pictet related large cap growth withdrawals. I would note that on a year to date basis, the performance of our large cap growth product continues to improve with the strategy ranking in the 25th percentile of Lippert through last week.

As you note in our release, subsequent to the end of the quarter, we received approximately $800 million from our sub advisory efforts, principally in our large cap core product. We believe this early on for positive flows in this mandate and these types of sub advisory relationships will continue to help drive the growth in our Institutional channel.

Overall, our investment performance remained solid with 60% of our funds and 80% of our assets beating their Lippert peer group over the past 12 months. Longer term performance is similarly solid.

The quarter was obviously challenging on many fronts. The economy slowed. The European sovereign debt crisis intensified. US Congress continues to vacillate over the solutions to our debt dilemma. Despite consequent negative investor sentiment, Waddell & Reed was able to advance by offering solid investment choices for most any situation.

Operator, at this time, I’d like to open the call for questions.

Question-and-Answer session

Operator

(Operator instructions). Your first question comes from the line of William Katz with Citi Group.

William Katz – Citi Group

Okay, thank you very much. Just one maybe modeling question first then a bigger picture question. If you in the quarter here, you highlighted some comp true ups. Can you quantify the amount of the true up?

Hank Herrmann

Are you thinking about compensation?

William Katz – Citi Group

Yes.

Hank Herrmann

Well we had approximately $800,000 that was an adjustment in this quarter. It was due to the final vesting of stock that was issued four years ago and it related to our assumptions on attrition. So we had less attrition and we’re required when we make such a grant to assume what that will be.

We have modified our outlook going forward so that this should not happen again. So we are thinking that compensation for the next two quarters will probably be between $41 million and $42 million total, and that depends on what happens towards the end of the year as we look at performance for our PM’s to see how they’ve done against their peer group.

William Katz – Citi Group

Okay. That’s very helpful. Thank you. And then just in terms of the Institutional channel Hank; you mentioned the $800 million win. Sort of stepping back a little bit, can you talk a little bit about the dynamics driving the $800 million? You had mentioned it’s so early on. Where else could you see some of the growth?

Hank Herrmann

Well, it was a platform sale obviously. It will have flow, so I assume that it will grow for the same reason flows grow pretty much anywhere. The product is large cap core. If you took a quick glance at it, its performance level of the last few years, performance has been very, very solid. It’s I guess, measured against the S&P, it’s a 250 to 300 basis point ahead this year and probably that’s the same kind of number over the last three years.

What I see happening in the Institutional plans business and in the retail business is some move away from passive to active management. This is sort of taking share back if you will from index funds.

I don’t know if that was what you’re looking for, but follow up if you’ve got something else.

William Katz – Citi Group

Okay. Just one other questions and thanks for taking all my questions. In terms of free cash flow, just wondering if you could maybe prioritize how you’re thinking about reinvesting back into the business between further buy back beyond any kind of adjustment to drift or compensation versus dividend hike.

Hank Herrmann

Well no change in plan. We continue to manage to basically offset the share grants through repurchases and we sort of have been spreading it out through the year and I expect we will at least accomplish that much before the year is over.

The alternative for cash obviously is what we’re going to do about the dividend. I expect that the Board will consider how to treat the dividend in the October board meeting. Obviously at the present time, just looking at the balance sheet, we’re in pretty good position, but at the same time, there’s a certain amount of timid thinking, because of the uncertainty that we’re dealing with on the things I mentioned in my comments. But I do think it will be considered in October.

William Katz – Citi Group

Okay. Thanks for taking all my questions.

Operator

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

Cynthia Mayer – Bank of America/Merrill Lynch

Hi, good morning.

Hank Herrmann

Morning Cynthia.

Cynthia Mayer – Bank of America/Merrill Lynch

Maybe a modeling question to start it. It looks like distribution revenues and expenses rose in line in the quarter versus last quarter, so I’m wondering, do you see any operating leverage there ahead and drilling down, it looks like the biggest shift there was in indirect expenses in the advisors channel, or I should say the biggest shift within the indirect expenses was in the advisors channel, so is that kind of an ongoing trend. Are you investing a little bit more there or is that a one off?

Hank Herrmann

Well we are starting the re-papering of our accounts as we’d mentioned on previous calls, and that process began at the end of June. So for approximately the next 12 months, we will be putting in an effort to re-paper these accounts, prepare them for the SunGard platform that will assist us in compliance and many other ways.

So I think we’ve said that about $1.5 million per year, so starting with July, and ending next June, about $1.5 million in ‘11 and $1.5 million in ‘12, will be devoted to that process. So that is one item that I think you need to be reminded of.

So that is a headwind. On the other hand, a concrete to answer to a question that has too many variables in it, makes for me to remind you that you tell me what market action is and you tell me what happens to gross sales and I can give you a better answer.

At the moment, I do think that the point that Dan mentioned will not make it easier for sure for us to show any leverage, but if we have a strong market, given the size of the assets we have at the present time and so forth, we may be able to do that.

On the other hand, if you give me what Washington seems to be engineering – that’s a little joke – I suspect we’ll go the other way.

Cynthia Mayer – Bank of America/Merrill Lynch

Got it. And also just I guess to follow up on the big sub advisory win you just had. I wasn’t really clear whether you think that’s sort of a part of a trend that you’re getting a lot more sub advisory wins say this year than last year or if it’s somewhat seasonal. What can you see ahead in terms of sub advisory wins and can you remind us again of the pricing on those.

Hank Herrmann

Okay. In this particular case, the pricing is about 20 basis points. There is, I would also point out however, that in this particular relationship, a lot of the back office related chores are in the ballpark of the other person in the relationship. So the 20 basis points will have reasonable profitability in it regardless of the low rate, one.

Two, sub advisory business has been helping us a lot over the last couple of years. This becomes a little bit more important all the time. The $800 million of course, is, I probably have to say, I don’t expect to get one of those every week, but I do think – I do know, that there are other searches going on at the present time, which if we win them, could also have material first time contributions and also pretty steady flows

Again, I think it’s just an attitude of in some cases, Institutional type investors are looking for alpha a little more than they have over the past couple of years. We certainly have a long history of adding alpha and I think that the wind is at our back to some degree.

And again, it’s always about a beauty contest. You have to have the numbers, which we do, and you have to be able to tell coherently a pretty compelling story. I think we’re in that position. And then you have to have the portfolio managers who can tell the story effectively.

When I put that equation together and reflect backward, it’s always been a winning combination and given that the market looks like they’re interested in what we’re doing and that we are pretty strong on all the three bullet points that I think are important to win, I’m optimistic that it could lead to a lot over a reasonable period of time. I wish I could give you more help on a lot, but a lot is all I’ve got.

Cynthia Mayer – Bank of America/Merrill Lynch

Okay. No, that’s very helpful. And I guess last question is just on Pictet. Can you remind us how many assets are there at this point and also, since it’s out performing now, what length of time do you think it would take of outperformance to turn that around?

Hank Herrmann

Well, it’s been outperforming I think for three quarters now, so it may not take that much time. But it’s a guessing game, and presently, Pictet is about $1.1 billion to $1.2 billion.

Cynthia Mayer – Bank of America/Merrill Lynch

Thank you.

Operator

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

Michael Kim – Sandler O’Neill

Hey guys, good morning. First Hank, I think you’ve talked about how demand for the FS strategy fund has typically picked up during periods of kind of heightened uncertainty so just given kind of the flexible portfolio and the way that fund is marketed, just curious if you think that trend will play out again assuming the markets remain volatile and risk appetites kind of remain uneven.

Hank Herrmann

Well I think when there’s uncertainty, the fund does have certain positive characteristics that helps the flows. When it’s worse than uncertainty, I don’t think it helps anybody, and we’re kind of worse than uncertainty presently. However, we still had very positive flows in that FS strategy fund in the second quarter and so far in the third quarter.

Michael Kim – Sandler O’Neill

Okay. And then I think in June, the flows in the Ivy mid cap growth fund were actually higher than flows into asset strategy so even though it’s a much smaller portfolio, I’m just wondering how big the opportunity is for that fund and could this potentially be kind of another franchise fund for you over time.

Hank Herrmann

Yeah, given the mid cap definition, I don’t think it’s going to be a $40 billion fund, but it has lots of potential. So I don’t know, winging it. Be thrilled with $10 billion. That’s probably too aggressive.

Michael Kim – Sandler O’Neill

Okay. And then maybe just a final question for Tom. Just maybe an update in terms of where he stands on kind of further penetrating some of the wire houses or the regional firms that you guys have been focused on.

Tom Butch

Mike, our penetration remains relatively unchanged from last year with a couple of exceptions in either direction. Our focus continues to be driving greater flows in the wire houses. The mid cap growth phenomenon to which you referred was substantially a function of that.

We have a couple of very large firms that we are focusing on and we are much earlier in our evolution on those. So I would say that we continue to hold share in the wires where we have obviously built this business and are making good progress elsewhere. There’s certainly a lot of share still to take.

Michael Kim – Sandler O’Neill

Okay. Thanks for taking my questions.

Operator

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

Craig Siegenthaler – Credit Suisse

Thanks. Good morning everyone.

Hank Herrmann

Good morning.

Craig Siegenthaler – Credit Suisse

Just first on the mid cap growth fund, very strong results here in June, actually beat out the asset strategy fund in terms of flows. It’s more impressive kind of given the RAUM base here. I’m just trying to see, was there anything lumpy in the June number and I’m wondering if you can maybe tell us how this fund’s been trending kind of July 1st to date.

Tom Butch

I don’t know that I would really call it lumpy. This is Tom speaking. The fund gained a premier placement on one of the platforms that one of our large broker dealer partners. That should create sustainability in the flows. I don’t – I’m afraid I don’t have the July run rate in front of me, but it seems to me that it has certainly sustained what we saw in the prior quarter, and a note just sent to me would confirm that.

Craig Siegenthaler – Credit Suisse

Excellent. Second question, just more of a business management question, it looks like compensation is up about 23% from second quarter 2010 and revenues are up about 20% over that period. I’m just wondering how should we think about the trend in compensation going forward relative to revenues, relative to fund performance, earnings and other factors. And I realize there’s a little bit of an unusual in there too this quarter.

Hank Herrmann

Yes, there’s a couple of items you ought to think about We did have about one million shares were granted on April 2nd, so those will amortize over the next four years. They replaced shares that were completely vested and they were issued at a much lower price in the past. So that will be a steady increase in our equity compensation.

And secondly, this $800,000 that I mentioned was somewhat of a onetime thing, so as we adjusted our accruals. So again, I think compensation will be between $41 million and $42 million over the next two quarters depending on what happens to our assumptions on accruals for bonuses.

Craig Siegenthaler – Credit Suisse

Got it. All right. Great. Thanks for taking my questions.

Operator

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

Robert Lee – KBW

Thanks. Good morning everyone.

Hank Herrmann

Hi Rob.

Robert Lee – KBW

Hey, Hank I’m just curious. I mean understanding the size of AUM doesn’t necessarily – understand it’s a very scalable business and you know the size of AUM is not necessarily the right way to – always the right way to think of it but I look today, your AUM’s about $29 billion above its pre-crisis peaks. You continue to expand your distribution footprint, take on new relationships that at what point do you start to get to having to or feeling the need to maybe ramp up investment in infrastructure, whether it’s to properly service all the new relationships or even to step up expansion of your investment staff, which if memory serves me, has been relatively stable for a long time now.

Hank Herrmann

Well thank you. I feel like we’re ramped up. I deal with it every day to try to keep it from ramping too much Rob. Okay so investment staff, boy I don’t know, 50 to 80 over the last two years probably, but that’s my guess on head count. I’m looking at Mike and think probably about the same number?

Mike Strohm

That may be a little high. We’ve added 11 people over the last six to 12 months and in the 12 months prior to that was probably five, six, so that would be about what I’m thinking.

Hank Herrmann

It’s been a pretty meaningful increase in personnel since we had our voluntary separation plan in the fourth quarter in 2008. That whether it’s grown as much as AUM’s, I don’t know about that part, but we’ve been increasing the size of staff and I expect that we’ll continue to do that.

In terms of other categories like IT investment, it’s been significant over the last few years and it will likely continue to be that way. Then on the broker/dealer side of our organization, we’ve also been making material investments in our new platform choice and we’ve also been investing in support specifically for that activity.

So we’ve been ramping up quite a few places, and as we talked about, we’re going to have a ramp up in head count for two things; for one, books and records where we have to re-paper everybody and also we’ll be bringing in-house our – I’ve forgotten – OSJ function over the next year or so too. Those are all going to be meaningful investments.

Longer term basis, OSJ will allow for a lot more efficiency; will allow our managers out in the field to spend more time on driving sales as opposed to paper shuffling, and so that’s a good thing. But over the next year or so, it’s going to cost us some money.

Having said all of that, I’m counting of course on normal market action. If I get normal market action, I continue to think we will make modest improvements, sort of grinding higher – Mr. Connealy’s phrase – toward improving operating margin, toward that 30% goal.

Robert Lee – KBW

Okay.

Hank Herrmann

That was a long answer, but...

Robert Lee – KBW

I appreciate it and I apologize if you mentioned this earlier. I got on the call a little bit late. But in the traditional institutional business outside the sub advisory platforms where you’ve had a lot of success, I mean can you kind of update us a little bit on the activity you’re seeing there. Any kind of – been a lot of chatter about it may be getting better, but it doesn’t seem like it’s really come through at all. But just what are you seeing there; shift in tone or for your traditional active products.

Hank Herrmann

I would say it’s still a lot of chatter. I think there are some additional opportunities perhaps opening up but we’re not quite ready to talk too much about that. So the net of it all is that new wins in the traditional institutional business have been reasonable, but they’ve been pretty modest.

If you look at total institutional channel, we had pretty close to record gross sales. That’s split of course with sub advisory, but also traditional business.

Robert Lee – KBW

Okay. Great. I appreciate it. It’s all my questions.

Hank Herrmann

Thank you.

Operator

Next question comes from the line of Roger Freeman with Barclays Capital.

Roger Freeman – Barclays Capital

Oh hi, good morning. I guess just back on the sub advisory comments, what would you say the reason is that you’re seeing some increased demand for Alpha, sort of over passive. Are these pension funds or just sort of grappling with having to get better returns?

Hank Herrmann

Yeah, I think it has a lot to do with the valuation structure in the market as a whole. Some people are looking at the way things are priced one versus another and thinking that there’s opportunity to drive Alpha. I think a combination of index funds and ETS have caused the market to be kind of flat in the valuation perspective and the growth rates of the companies within those indexes are certainly not flat. So that’s the best explanation I can give you.

Roger Freeman – Barclays Capital

Okay, yeah that’s helpful. And then you’ve been talking for a while about this large mandate that you were working on and hopeful that some of it will come through and I guess this looks like one of those, and it sounds like you’ve got a few in the pipeline. If you aggregated all of that opportunity, obviously recognizing that you’re not going to get all of that, but is it in total multiples of what we’re seeing with this one?

Hank Herrmann

Thank you for that softball question. I can’t respond with any credibility, so I’m just going to flub it.

Roger Freeman – Barclays Capital

Okay. All right. The – I wanted to ask on the advisor channel what kind of trends have you seen in the past quarter around the choice platform in terms of additional interest or new folks that have come in from outside that have been attracted to that specifically.

Tom Butch

Hi Roger, it’s Tom. The choice channel into the quarter with about 116 advisors. 71 of them were people we’ve recruited from the outside. 25 are advisors from our traditional classic channel who have made the choice to transfer to Choice. We’ve had 26 hires here to date. The pipeline is probably at its best state since we started this.

Our managers are more comfortable with recruiting. I think operationally, we’re at a good place and we’re pretty confident that the pipeline looks pretty good at this point. So the assets eclipsed $2 billion on that channel in the second quarter and again, the momentum seems to be in its best place since we started.

Roger Freeman – Barclays Capital

And of the 26 hires year to date, is that mostly coming out of the independent channels or regional broker dealers? How would you characterize that?

Tom Butch

I’d characterize it as coming from what I would generally call full service firms, which would be warehouses and regional’s. The independents has to this point been a very small part of it.

Roger Freeman – Barclays Capital

Okay. Great. Thanks a lot.

Operator

Your next question comes from the line of Mac Sykes with Gabelli & Company.

Mac Sykes – Gabelli & Company

Good morning gentlemen. I was wondering if you could give us a little more additional color on European demand for US equities. Is it demand just coming from share gains due to performance or something else in terms of how people view US equities and what do you expect for second half?

Hank Herrmann

I’m not quite sure I understand where you’re coming from with the foundation of flows from European. The only European relationship that we’ve talked about is Pictet and that was in a negative flow position in the second quarter.

The flows into the third quarter have turned pretty neutral at this point in time, but other than that, I wish I had a lot more to say about European flows. We’re struggling trying to figure out how to have better foot penetration in foreign markets.

Mac Sykes – Gabelli & Company

I’m sorry. I was talking about sort of the pickup in sales there, just offsetting that due to the performance. You don’t see any shift in European demand at all?

Hank Herrmann

No.

Mac Sykes – Gabelli & Company

Just related to you specifically.

Hank Herrmann

No.

Mac Sykes – Gabelli & Company

And then Mike, gold has rallied this year but the gold equities have not. Could you just give us your thoughts on this dichotomy and how you’re positioning IVS within this attribution framework?

Mike Strohm

Well let me take the second question first. The fund is mostly equities. We do have exposure to gold bullion. We have very little exposure to fixed income investments. The dichotomy that you referred to, I suspect is to a couple of things.

One is the primary demand for gold in general is due to its characteristic as a currency as opposed to a commodity and secondly, and related to that, since there are a number of ways that people who see gold as a currency can invest it in through either physical, the ETF, gold futures, warehouse receipts, there is obviously a variety of ways that people can satisfy that demand.

Thirdly, I think that if you look at the companies that are primary businesses is precious metals, mining, they’ve been struggling, and some of them have been struggling in a rising gold price environment with rising costs associated with labor, energy, which are the two largest components of their variable costs.

So that would be answer. Again, we own gold bullion primarily because we see it as a currency, and as a currency, we think the demand will continue to go up in an environment that Mr. Herrmann has described as very difficult when governments, political leaderships, central bankers see paper currencies as something that can be valued in order to meet their political objectives.

Mac Sykes – Gabelli & Company

Great. Thank you.

Operator

Your next question comes from the line of Jeff Hopson with Stifel.

Jeff Hopson – Stifel

Okay, thanks a lot. I guess for Tom, in June the fixed high income product flows weakened consistent with the industry and there was an approximate rebound in, or pick up in flows from another fixed income product that previously had not gotten a lot of flows. So I guess the question is, was it luck that that picked up or are you guys just that good in terms of kind of bringing some visibility to a product that previously had not garnered as much interest.

Tom Butch

Jeff, with all due respect, how do you think I’ll choose between those alternatives? Our municipal high, which is probably the fund you’re referring to has had periods of very good flow. Maybe earlier in the year with just uncertainty around municipals, it wasn’t perhaps as strong as it had been but that’s the fund I think you’re talking about having picked up the slack.

And what I would say is despite what you described in June, a percentage of flows that went to the fixed income product, the modest relative to equities actually picked up a bit in the second quarter and the pie income fund turned in another good gross in that slow quarter.

Jeff Hopson – Stifel

Okay. And then in July can we assume that maybe fixed income is picking up a little bit and equity softening or anything there you can point to?

Tom Butch

I would say that what we saw in June looks pretty consistent with July so far.

Jeff Hopson – Stifel

Okay. Great. Thank you.

Operator

Your next question comes from the line of Mark Irizarry with Goldman Sachs.

Mark Irizarry – Goldman Sachs

Great, thanks. Question is for Mike. Can you just talk about capacity in asset strategy and also I guess there seems to be a lot of competition sort of entering this category so can you maybe just speak to that.

Mike Strohm

Well Mark, thanks for the question. There certainly is a lot of interest in global allocation or flexile allocation products and you’re right. There seems to be more people trying to introduce a product into this category.

I think it speaks to a couple of things. One, there are a couple of firms like ourselves who have done well in this space so that’s getting attention. Secondly, I think it speaks more to the underlying demand that investors have, whether they’re retail or institutional, in having a product that helps protect them on the downside.

I would say that the level of risk aversion on the part of all investors is exceptionally high and they see that global allocation products they can use either derivatives or have a lot of flexibility to change asset classes is a tool that perhaps will help them with their extreme risk aversion.

So I think that’s the primary driver for it, and it’s not just retail. It’s not just high net worth. It’s also the institutional area of where again, you see a renewed or an invigorated interest in this space because of the risk aversion characteristics that a number of the funds, not only ours, but that we compete with, have as characteristics of how they manage their money.

In terms of capacity, Mark I think you ask me this question every quarter, and I don’t know. I really don’t. We have been fortunate with this product for a long period of time. When we started, there was no interest in global allocation or flexible products or funds that allowed the portfolio manager to reallocate on their behalf and we started off with zero, and now the number has grown dramatically.

I think what has helped us is that from the very beginning we have tried to stay with large cap equities when we’ve had a large allocation in equities. I think that’s helped. And again, by virtue of the fact that we’re allowed to be in all the major asset classes, certainly a lot of capacity as it pertains to fixed income investments, a lot of capacity as it pertains to precious metals more than we have been able to tap into.

And again, if you stick to large cap equities, we can manage more assets than we’re currently managing. What the upper limit on that is, I don’t really know.

Mark Irizarry – Goldman Sachs

Okay. I’ll keep asking every quarter.

Mike Strohm

Okay.

Mark Irizarry – Goldman Sachs

Just if maybe you could talk about the mix of sales by channel. Are you seeing any differentiation in product by channel?

Mike Strohm

I think as noted in our public releases, the mix of sales in the wholesale reflected our ongoing efforts to further diversify away from asset strategy while maintaining our competitive position there and our results were certainly reflective of that. I mentioned that there was a very modest uptick in fixed as a percentage of total.

It’s much less a factor in the advisors business where a lot of those sales go to an asset allocation product so that new sales tend to go into what is effectively automatic allocation and individual fund selection at point of sale. Therefore, it’s probably a little less relevant than in the past.

Mark Irizarry – Goldman Sachs

Okay. Then maybe more specifically in the wholesales channel; if you look by type of door if you will. Are you seeing maybe the wire houses broaden out faster than maybe some of the other distribution points within wholesale?

Mike Strohm

Actually no. I think it’s reasonably consistent across all of our distributors. I don’t think there’s any one that is unduly concentrated to an extent much more material than another.

Mark Irizarry – Goldman Sachs

Okay. Great. And then just Hank, just quickly on your comment on broadening our penetration in foreign markets, how well are you to think about some sort of transaction or partnership with an overseas entity to sort of fulfill the aspirations to build your foreign exposure.

Hank Herrmann

I’ll let Tom address that, talk about that venture.

Tom Butch

Okay. We, late last year, created a partnership with a distribution organization that is effectively a start up with some people who had great success in the past in distributing products overseas and made a small investment in this organization and have been working with them to effect a strategy to take our products internationally.

The first step in that has been getting on the shelves of our existing broker dealers that serve non-resident citizens here in the United States. That’s a fairly substantial business in certain of the wire houses. We have accomplished that.

We are taking sales. We have three funds that are registered in Luxembourg; our asset strategy product, our large cap growth and our science and technology. At this point, the efforts are concentrating on the asset strategy product. We are very much in startup mode, but we’re seeing flows start to come in.

Mike Avery, myself and many others have been very involved in working with EMG, Emerging Managers Group, which is the name of this organization, to effect this strategy and try to get this off the ground. The folks who are running this have had long experience in virtually every overseas market and though we’re early in the process, we think that this will be incrementally beneficial to us and help us a) understand and b) ultimately penetrate these foreign markets.

Mike, I don’t know if you’d like to mention the Bank of China thing.

Mike Avery

Well I would just say that we’ve had some opportunities to visit with potential and existing clients outside the US, specifically in Asia, Latin America and there is interest in a product like asset strategy as well as believe it or not, portfolio managers who focus on the developed markets – Tom mentioned large cap growth, science and tech – outside of the US.

And I think the phenomenon that is helpful is that as a large demographic in Asia, Latin America, the Middle East, have rising prosperity, that the demand for financial services in general go up as more prosperous people look for ways to manage their wealth.

And not unlike European or US investors, they look to diversify their wealth and diversify their portfolios by increasing their investments in some other geography or some other part of the world and that phenomena is certainly beginning to play out in again, Asia, Latin America in particular.

So it’s very early days. We have, as Tom mentioned, put a lot of effort into it. So far, the flows have been very modest, but as we continue to rely on people who are better at this to help us get into those markets, as we put more in on educating what in many cases, is a very new investor, and as we continue to deliver a product and articulate what we are doing, I think we’ll continue to do well.

It’s fascinating to me as a portfolio manager that to talk to Asians about investing in the emerging middle class in Asia, initially that sounds like you’re trying to sell ice cubes to Eskimos, but they are very fascinated in that concept; in some ways, even more than in the US or in Europe. So it’s early. We have high expectations and we’ll see.

Mark Irizarry – Goldman Sachs

Great. Thanks.

Operator

Your next question is a follow up from the line of William Katz with Citi Group.

William Katz – Citi Group

Hi thanks. Just two follow ups. Thank you very much. First one, in terms of the other expense line, that jumped pretty significantly both quarter to quarter and year on year. Just sort of wondering if you could give us a little guidance about the outlook for that. Are you seeing anything unusual there? And then I do have a follow up.

Dan Connealy

Okay, thanks Bill. This is Dan. You’re speaking I think, about G&A specifically. There’s a couple of things that as we look at all the models that you gentlemen and ladies have put together that some have fallen short. That is in the service income line and in G&A. These are offsetting factors caused by dealer services revenue and costs.

So when we have a sale of a YI or an R share, it doesn’t have a 12B1, but it does have a service fee, so that’s why service fees went up higher than the number of accounts went up. And that also is pressure on G&A.

So in this quarter, dealer service fees were about $3.3 million and if you looked at that a year ago, it would be a smaller number. So that is a factor that will probably continue because it’s an asset based fee. If we have good markets, and these are popular share classes because they are low cost, would probably pressure G&A, but we have the service income as well, and we do make a margin on that so this is not something that’s not just a complete pass through.

William Katz – Citi Group

Okay. And then my follow up Hank, just trying to cut through your words a little bit more. When you talked about July looking a little bit soft relative to the second quarter trends, was that a gross sale and or redemption discussion or just one or the other.

Hank Herrmann

I didn’t follow. Ask me again Bill. I’m sorry.

William Katz – Citi Group

I’m sorry. In terms of the flow outlook into July, you mentioned things a little bit better than a year ago, but a little bit softer sequentially I guess relative to second quarter trends. Was that a statement around sales or redemptions or both?

Hank Herrmann

Sales.

William Katz – Citi Group

Okay. Great. Thank you.

Operator

At this time, there are no further questions. I’ll turn the floor back to management for closing remarks.

Hank Herrmann

I think Tom has something he wants to say here.

Tom Butch

Thank you Hank. I did want to clarify modestly one of my answers on the mid cap growth. It occurred to me as I was thinking back that there was a small lump relative to the total that came in. Let’s say it was roughly 25% of the total sales that came in when initially the fund was placed in this premier position at one of our broker dealer partners. That does change the go forward pieces, but I thought I would make clear that there was a lump but it wasn’t by any means the largest portion of sales. Thanks Hank.

Hank Herrmann

Beverly, I think that’s it for management. We appreciate everybody listening in and look forward to talking to you next quarter. Thanks for your time.

Operator

Thank you ladies and gentlemen for joining today’s conference call. You may now disconnect.

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