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Waddell & Reed Financial Inc. (NYSE:WDR)

Q3 2011 Earnings Call

October 25, 2011 10:00 am ET

Executives

Henry J. Herrmann – Chairman of the Board, Chief Executive Officer

Nicole McIntosh – Vice President, Investor Relations

Daniel P. Connealy – Chief Financial Officer, Senior Vice President

Thomas W. Butch – Executive Vice President, Chief Marketing Officer

Michael L. Avery – President, Chief Investment Officer

Analysts

Cynthia Mayer – Bank of America/Merrill Lynch

William Katz – Citigroup

Michael Kim – Sandler O'Neill & Partners L.P.

Robert Lee – Keefe, Bruyette & Woods

Craig Siegenthaler – Credit Suisse

Roger Freeman – Barclays Capital

Jeffrey Hopson – Stifel Nicolaus

Marc Irizarry – Goldman Sachs

Macrae Sykes – Gabelli & Company

Daniel Fannon – Jefferies & Company

Operator

Good morning. My name is [Stephanie] and I will be your conference operator today. At this time, I would like to welcome everyone to the Third 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 conference over to Hank Herrmann, Chairman and Chief Executive Officer of Waddell & Reed. Please go ahead, sir.

Henry J. Herrmann

Thank you, Stephanie. Good morning everyone. With me today are Mike Avery, President; Tom Butch, Chief Marketing Officer; Dan Connealy, our Chief Financial Officer; Mike Strohm, our Chief Operations Officer; and Nicole McIntosh, our VP of Investor Relations. 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 corporate tab.

Henry J. Herrmann

Thank you, Nicole. Early this morning we reported our third quarter results. Net income for the quarter was $39.8 million, or $0.46 per diluted share, which represented a decline of 20% compared to the previous quarter and 2% compared to the same period last year, earnings per diluted share declined at a similar rate.

Operating income of $75 million declined 5% compared to the June ended quarter and improved 26% compared to the same period last year. This quarter’s operating margin of 25.2% was essentially flat compared to the previous quarter and showed good improvement compared to last year’s third quarter margin of 23.5%.

Importantly, operating margin remained near multi-year highs. Assets under management finished the quarter at $77.5 billion, a 16% decline compared to the end of the June. The decline in asset level was entirely attributable to market erosion as we generated positive inflows during the quarter. Keep in mind when building models the most of the market pressure came during the month of September.

Quarterly inflows of $1.3 billion helped by the win of a large sub-advised mandate in July. Flows were positive in equities, fixed income and money market asset classes. By channel flows are positive in wholesale and institutional, while slightly negative in Advisors. Assets levels have recovered from the steep losses incurred in September and now approximately 85 billion in AUM’s.

Gross daily sales volume in October is up slightly from September’s daily average and net flows are essentially flat. Through September as noted in our press release, relative investment performance declined on a one and three-year basis. Extreme volatility cause our rankings to swing up and down abnormally with risk-on/risk-off market moves.

Recently, relative performance has improved. The Advisor channel had sales of $867 million in the quarter compared to $1 billion during the previous quarter. The client gross sales push flows into negative territory for the first time this year nonetheless our Advisors ability to retain assets during the period of client market uncertainty once again prove the valuable asset for our company.

The redemption rate during the third quarter was essentially unchanged sequentially at 10% remaining par below the rate of redemption experienced by the rest of the industry. Gross sales of $4 billion in our Wholesale channel declined slightly compared to the second quarter, inflows were at positive $515 million. Flows decreased sequentially in for quarter, but remained positive in each of the three months.

Our institutional channel has a strong quarter with sales of $1.6 billion and net flows of $900 million. Business in this channel remains healthy due to steady stream of inflows from advisory relationships and solid performance underlying the various strategies available on the platform.

Our overall assets have shrunk nearly 16% during the quarter, flows remain positive at $1.3 billion. Our organic growth rate of 5.8% during the quarter remained one of the best among our peer group of publicly traded asset managers and again, ahead of the industry’s estimate of the 2% rate of decay.

Given our firm’s larger percentage of equity assets relatively this was a strong endorsement for the quality of our product in our distribution team. Strong market sentiment overhang seemingly have cleared up recently, most notably economic double-dip worries however there remains significant uncertainty surrounding Europe’s struggle to find solutions to their sovereign debt crisis. Volatility is likely to remain until we get greater clarity.

The breadth and performance of our product line and intensity of our distribution efforts have helped to moderate the dimensions and impact of outflows. As soon as the market uncertainty continues to clear up, we believe we’re well positioned to resume better than industry average growth. Operator, at this time I would like to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Cynthia Mayer of Bank of America.

Cynthia Mayer – Bank of America/Merrill Lynch

Hi, good morning.

Henry J. Herrmann

Good morning.

Cynthia Mayer – Bank of America/Merrill Lynch

Looks like your comps are quite a bit in the quarter and what’s below your prior guidance. I'm just wondering if markets bounce bank would you expect that to go back to the previous comp range and would you in any way restore what you had there was that a reflection in performance?

Daniel P. Connealy

Cynthia this is Dan. And what we do each year is as the year-end approaches assess what is the likely pay off and in bonuses not only for the PMs but for management. So as we entered the quarter we had quite a busy year under our belt and it just appeared that the rate that we were accruing which was the cash paid out last year was unlikely to be paid up this year. That could change yes Cynthia, so it’s hard to guess what that would be in the fourth quarter. But we didn’t believe, we have to restore the amount that we took the accruals down or we wouldn’t have made that adjustment.

Henry J. Herrmann

Cynthia it’s Hank. I just add now that obviously there is lots of uncertainty, which is why I plugged in the uncertainty comment in my formal remarks. I would just say that it could go up, but it could also go down. And so I hate to leave you with that thought, but that’s the reality. We were accruing at last year’s level up until this quarter. There was a little catch up in it and then a little bit of and you know where we are now kind of thought obviously if the market continues to go up about 10% a month that probably go up from your lips to guys [there].

Cynthia Mayer – Bank of America/Merrill Lynch

Okay and may be you said this, but did you mention how flows are for this quarter?

Henry J. Herrmann

Let Tom respond to it, I did touch on it but let’s have Tom elaborate.

Thomas W. Butch

Flows are essentially flat for the quarter, the net flows are flattish and for the distribution channels of Advisors in wholesale were modestly, wholesales modestly ahead, institutional modestly ahead and Advisors is modestly down. So the experience is essentially flattish that the daily sales rate is uptick and that the net experience as I said is essentially flat.

Henry J. Herrmann

I would just say that the stronger market environment has led to improving trend in inflows a last couple of days have been especially strong.

Cynthia Mayer – Bank of America/Merrill Lynch

Great thanks a lot.

Operator

Your next question comes from the line of Bill Katz of Citigroup.

William Katz – Citigroup

Hey thanks. Good morning everybody. Just sort of coming back to the flow discussion little bit, if you break it down a little bit further, I’m sort of curious of what’s being going on with the Asset Strategy fund in particular. It looks like that lost the star last quarter in a relatively volatile environment if you will. If you see the situation where that goes into redemptions and offset things going on possibly elsewhere, just trying to get a sense of how was that product sold into the channel I guess is it performance driven as this has to return, has volatility overlay?

Thomas W. Butch

The Asset Strategy fund for the month of October specifically is in net redemptions, and for the quarter, was positive. I would say that the negative flows that we have seen to the extent, that we have seen them are really concentrated in a handful of days where they were material outflows that the fund has been in outflow over the past many weeks. As to how the fund is sold, it is sold as a flexible mandate, which has the ability to move across asset classes as it seized it, and we moved into a period of extraordinary volatility in the market where with risk-offs across most asset classes as was reflected in those asset classes that really dominated sales in the quarter. And so I think what we have seen is a moderating trend of outflows generally speaking, but fund is doing outflows for the month of October.

William Katz – Citigroup

Okay. And then Hank just sort of stepping back a little bit, given the friendship nature of that fund in the concentration, I know you've been diversifying the sales a little bit. What gives you the confidence that you can continue to put up above average organic growth so to try and understand that the factors as we go onto 2012?

Henry J. Herrmann

Well, I'm guessing that uncertainties will sort of get impressed broadly speaking, and if that’s not the case, we’re not going to have any growth, and I'm not sure anybody else will either. I continue to think we have a strong line up of product and I think that includes as a strategy front. And I continue to believe that the environment is choppy as it is, makes a little difficult for anybody to draw too many comparisons to anything.

I will say that when the environment appears to be clearing up Asset Strategy fund performs exceptionally well, flows improve and I don’t expect any change in that. Big [advisor] is that the uncertainties clear up. I think in part is occurring which is why we’ve seen the rally we have and that is basically putting away for now the double dip worry, but the two other worries out there still that are important in Europe is one and China is another, and our view is that at some point Europe has got to clear up and the issue was China in soft landing, hard landing or whatever our view is more on keeping sort of a soft landing idea, but again, that has to get cleared up too.

Our best sort of place broadly speaking through out the whole complex and those kind of thoughts, and just my view that as this unfolds we’ll be in a good position to gain share. That of course is not touching on the distribution systems that we got in place a bit have done extraordinarily well in selling various products at various times, just to reiterate and I don’t think we had it in this release, but over 50% or so of gross daily sales are coming from products other than as a strategy fund, which is a continued improvement in what we’ve been seeing for quite a while.

Unidentified Company Representative

Bill, if I may just tag on to that. I did want to make sure that you knew that it was positive strongly in Q3 I focused my comments on October. In the fact that as I noted earlier, we’re modestly positive in October with its being negative I think, speaks the quality of the product line and the things that are happening across the product line. We saw very good inflows in the third quarter across the standard fixed income products that we offer and those are certainly continuing very strongly in the quarter, and across a span of equity and specialty product we continue to have good reg of sales and Hank indicated about half of the sales are coming from outside Asset Strategy. So, were we having this conversion sometime ago and Asset Strategy were in net redemption’s, I’m not sure that at that time, as I’m sure at that time, we would not have had the offset of all the positive other product sales that are happening. And I think the ongoing efforts to broaden the platform of products that are selling really are showing their benefit as we’re in this period.

William Katz – Citigroup

Hey, just one last one, thanks for taking my questions. Some of your peers is sort of hunted down a little bit on some of the G&A line if you will, beyond conversation, just to be clear, if you strip out the $1.8 million so far write-off how you think it about G&A in a go forward basis? Thanks.

Henry J. Herrmann

Look. Bill, I think that yeah, you should strip out the $1.8 million pressure on the G&A comes from also a dealer service cost. More and more of our distribution partners are requiring dealer service cost and so that has been somewhat of a pressure, they probably won’t be easing too much. But I think if you stretch, pullout that $1.8 million, that would be a good estimation. We're always looking to keep G&A within lines. We’re in the budget process now, and we’ll be looking for prudence throughout the whole company.

Thomas W. Butch

Well, I would just add the same sort of thing we’re talked about in the past. We’re going to manage G&A in the indirect distribution in keeping with what we think the likely revenue trend is going to be. And you know when you have a quarter like we just had, it’s not possible, because it adjusts so quickly, but we certainly are going to keep the uncertain environment in the back of our mind as we plan for next year.

William Katz – Citigroup

Okay. Thanks for taking my questions.

Operator

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

Michael Kim – Sandler O'Neill & Partners L.P.

Hi, guys. Good morning. First, I think in the past for the Asset Strategy fund investors were maybe more focused on performance relative to the S&P, but now just with competition on the rise for multi-asset strategies, do you feel like performance versus peers is becoming more important as it relates to driving sales for that product?

Henry J. Herrmann

Yes. I mean the short answer is, yes. And I think we've always looked at the peer group as the parameter for the context of selling. Yes.

Michael Kim – Sandler O'Neill & Partners L.P.

Okay. And then, just in terms in the institutional business, what the new winds had funded this quarter. Do you feel like you’re starting to maybe reach somewhat of a tipping point where you've got the scale and depth of product and performance to really start to see the growth of that business start to ramp up?

Henry J. Herrmann

Well, it's always going to lumpy and I do think growth has been ramping up on a growth sales basis for sure. The tougher part is forecasting redemption’s for the moment. I don’t have any idea of any meaningful redemption’s. Pictet continues to be in redemption’s, but that’s been true here now for six quarters or so. And I think that maybe easing up some just because a large cap growth performance has improved so much.

However the bigger question is, what can we do in the sub advised line up, what products that we have that look like they are going to gain traction and how are we doing with the platforms that are important in that arena, and I take a positive spin on that. I have mentioned in the past that I think large cap core is a great opportunity, the numbers at competitive basis continue to be outstanding relatively. We’ve got a lot of interest and we could take a lot of assets there if they want to come our way.

So I'm enthusiastic with that, I'm also enthusiastic about the improvement large cap growth. I believe for quite a while that’s one of the best places to be in the equity market and I think performance numbers come around a little bit for that whole category, it’s going to perk up some additional interest there and focus on domestic rather than diversify thing that’s been going on for the last couple of years. Those kind of long (inaudible), the other thing I would add is that, I know we are in a number of important searches, we have forgot an indication that we won an important mandate, however it’s not been funded until it’s funded, I'm reluctant to say other than we’ve won it, and it would be meaningful when it heads. So I think that, that’s going quite well.

Michael Kim – Sandler O'Neill & Partners L.P.

Okay. And then, just finally in terms of capital management, any change in thinking as it relates to buybacks beyond offsetting dilution. I know you kind of stepped it up a bit this quarter, but just given the environment and the recent decline in the stock price?

Henry J. Herrmann

We don’t like to elaborate too much, because it is a side being picked off and I’ve said that before in the conference call off late again, but you know its obvious that we’ve gone beyond what we indicate it was likely and I would suspect will keep picking at a way at it, picking our spots. Assuming this stock would get more depressed I think that would encourage us to do more.

You know the other capital management side of it is, you know what we’re doing I guess if I look we have $440 million of cash, we’re trying to decide when to deploy it and how for the moment, you know the dividend issues are something that we look out a little closer to year end and other than that nothing really different or changed.

Michael Kim – Sandler O'Neill & Partners L.P.

Okay. Thanks for taking my questions.

Operator

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

Robert Lee – Keefe, Bruyette & Woods

Thanks good morning everyone.

Henry J. Herrmann

Good morning, Rob

Thomas W. Butch

Hi, Rob.

Robert Lee – Keefe, Bruyette & Woods

A quick question on kind of the, they made the new product front. Yeah, I know may be the year or so ago you rolled out a product extension if you will for Asset Strategy. Is there anything and I know you have a fairly broad product line, but is there anything when you look out there and seeing that a lot of sales are going into you know Asset Strategy type products or kind of dividend oriental products or anything that you have some new things on the drawing board that you know are thinking about or may be seeding or how do you think about, you know kind of the needs of tweak product line somewhat?

Thomas W. Butch

Rob this is, Tom. You referenced the Asset Strategy in opportunities fund, which was the derivation of Asset Strategy that has a little over $400 million in it. We’re talking about a lot of things, there’s nothing eminent. Certainly the market is thirst income oriented products and not necessarily just fixed income, but income generally is something we’re thinking about. And so, that has been a focus of our conversations as has been the categories where we really have salience like Asset Strategy, and are there other opportunities to create new products off of those?

And I'll turn it over to Hank for further comments.

Henry J. Herrmann

Well, I think Tom really touched on one thing I just elaborated. Obviously, we recognize the importance of income, trying to figure out what the right product is to introduce in for that environment still something that’s reflecting us. Obviously, lot of facts out there with dividends, yields that way exceed what’s going on in the credit markets and their own bonds, and that is an opportunity, we haven’t seen for years and years, we have a dividend income fund as it stands, we're trying to figure out a way to better tap that retention.

Robert Lee – Keefe, Bruyette & Woods

Okay, great. And maybe just one question, looking the subadvised business, and is it possible, I think it would be helpful just for me to try to get a little bit better sense of the strategy mix, within that you have a lot of success in the subadvisory mandates, but I believe a lot of it’s not Asset Strategy related, maybe just a little bit of a sense of and maybe it’s the core product, but just kind of within your subadvisory mandates, what are the products that have the current asset mixes is and what's some of the – where some of the product sales have been there?

Henry J. Herrmann

Okay. So this was little bit of the top of my head but small cap growth is a very important product in the sub-advised category. Good flows for a long period of time, no recent wins but small cap growth is one area where is a little bit capacity constrained.

Large cap growth has been important there, core product has been very important there. We recently had a meaningful win in our SMid growth portfolio and that’s kind of a look at it like the most, at the top of my head I can’t think what I'm missing. I would say that, I want to say okay where is the best potential, I think large cap growth and large cap core are the two for the moment I think that got more going forward.

Robert Lee – Keefe, Bruyette & Woods

Okay. And I mean it’s within the sub-advised, is assets strategy meaningful chunk of those sub-advised assets or is it really been kind of these other strategies mostly?

Henry J. Herrmann

It’s an important win particularly say last 18 months has been important. But is it dominant percentage of all the assets, no. I will let Tom to talk.

Thomas W. Butch

Well, we had an Asset Strategy placement on a large insurance platform, as Hank indicated over the last year or so it’s 18 months, and the flows into that had been very good. The issue when getting Asset Strategy into more kind of mandates is the fact that for lot of living benefits we focus lot on hedging, and the ability to hedge that product can be reasonably complicated.

Robert Lee – Keefe, Bruyette & Woods

Okay. That was it. Thanks for taking my question.

Operator

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

Craig Siegenthaler – Credit Suisse

Thanks. Good morning everyone.

Henry J. Herrmann

Good morning.

Craig Siegenthaler – Credit Suisse

After stripping out the G&A charge and I’ve heard your kind of questions to whether your response to earlier question but it’s still up a lot and that’s maybe up about 6% sequentially, 30% year-over-year, what drove the kind of increase in kind of core G&A over the last year?

Henry J. Herrmann

Well in this quarter, in addition to the one-time loss that we discussed, legal costs were little higher, in addition we were not in the segment of developing systems to capitalize lot of cost. So some of the costs they normally might be going into capitalized software were expense because we are in the development phase on project too and the dealer’s service costs as I mentioned just seems to hedge up.

Craig Siegenthaler – Credit Suisse

Got it. Then looking at your supplemental table where you look to kind of average AUM in fee rates; in money market theory, it’s really low we know why it delevers. I’m just wondering relative to that 2.7 basis point fee rate where is the normal money market, the core money market fee rate?

Henry J. Herrmann

The normal fee rate is really pretty healthy around 40, but we haven’t seen that in some time, so we’re dealing about one basis point weaving all the cost over that. So that depending on where money market flows are can swing a bit.

Craig Siegenthaler – Credit Suisse

Got it, and if I can say just as one more; your U&D margin, if I look at the ratio of expense to revenues went down a little bit this quarter. Their denomic is kind of where sales are tending, where AUM is trending. (Inaudible) outlook on this margin into the fourth quarter based on kind of what you saw at the end of September in the first few weeks here in the fourth quarter?

Henry J. Herrmann

Well the U&D margin has being pressured a little bit starting in July for about a year, because we’re having to redo a new books in record system for the Advisors, so that’s going to be running probably in terms of one-time cost somewhere about $1 million per quarter. I’d previously thought it would be 750, but our actual came in a little higher in this first quarter. So I would say that that is one reason for that percentage to hedge up.

Craig Siegenthaler – Credit Suisse

Great. Again, thanks for taking my questions.

Operator

Your next question comes from the line of Roger Freeman of Barclays Capital.

Roger Freeman – Barclays Capital

Hi, good morning. I guess I just want to ask another question on the Morningstar rating, the Morningstar loss on Asset Strategy. So just kind of thinking back to the progression, I believe I’m correct looking back, it went from five to four stars last summer. There were some underperformance relative to benchmarks at that point in time and then you actually outperformed again. But here we've lost another star and I was looking at their rating methodology and it looks like, they propelled I think 50% rating on the 10 year and 30 on the five and 20 on the three, and that’s five to three year, that’s kind of an issue here, is that a way to think about, thinking about that and what you have to work through to get that star back up?

Thomas W. Butch

I think you stated the formula correctly.

Roger Freeman – Barclays Capital

Okay. Can you talk at all to for Asset Strategy in particular growth versus net sales, I'm just wanted to – I’m curious whether, it's really more of a selling issue than a redemption issue on that one?

Thomas W. Butch

What period are you referring to?

Roger Freeman – Barclays Capital

Well, this quarter, this part quarter or even just... Yeah.

Thomas W. Butch

So quarter magnitude for the third quarter, $2 billion-ish in growth out of $1.7 billion in that.

Roger Freeman – Barclays Capital

Okay. And if you would just versus the second quarter where’s the pick up and where was the biggest out; was it in the growth?

Thomas W. Butch

For the second quarter, the growth was – for the third quarter the growth was up slightly from the second down a little bit from the first.

Roger Freeman – Barclays Capital

Okay. And then two other questions; comp, you commented about I think you said there was a little bit of a catch up as it changed the accrual; just thinking about sort of run rate level for the fourth quarter and how much catch up was there in the third quarter?

Thomas W. Butch

Roger, that’s pretty hard to predict because as I say it will depend on the bonus accruals primarily. That’s probably the major lever we have to use, and as the quarter progresses and we see how the markets were doing and how our performance is going that will depend. So I’m sorry we can’t be more helpful than that.

Roger Freeman – Barclays Capital

Well, I guess maybe I have been asked well enough. I mean is it just as you right you think about in fact as you make an adjustment on the third quarter but part of that is sort of catching up the accrual earlier in the year, so is there any way to talk, I mean is it a notable amount in sort of the catch up portion rather than just changed to your run rate?

Thomas W. Butch

Again that was an estimate based on the nine months and we may have a different picture as we look at 12 months. So it’s very hard to interpolate that.

Roger Freeman – Barclays Capital

Okay. And then I guess the Advisor versus Wholesale channels, I think you commented that recently the wholesale was, its up, advisor down any comment about why there is a little bit of difference there on selling?

Thomas W. Butch

I’m sorry; I don’t understand your question, one more time please.

Roger Freeman – Barclays Capital

I think you said the wholesale was up I think that was a comment about October up modestly and advisor channel down modestly.

Thomas W. Butch

Yeah, let me discuss through those again. We’re talking about on a daily sales basis. The Advisors channel sequentially September to October is up a bit on a daily sales basis. I stated, I think that the Advisors channel was down, but it’s so modest that it’s hardly worth noting, because the Advisors channel has been extremely steady throughout each of the quarters of this year in terms of growth sales.

Roger Freeman – Barclays Capital

Okay all right thanks.

Thomas W. Butch

And that sales effectively too.

Operator

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

Jeffrey Hopson – Stifel Nicolaus

Okay, thanks. Tom, it sounds like Asset Strategy had a few days of you know stronger outflows, [capitalization], but given the under performance more recently in your mind, how would you say the flows are holding up. I mean, it certainly hasn’t been a dramatic outflow situation, but can you comment on that?

Thomas W. Butch

I would just sort answer your question, with your question, Jeff a little bit. I think you stated it pretty well. I’ve stated earlier that we saw a couple of days amid the most volatile market conditions. Where there were outflows spikes and while the fund has been an outflow for the last few weeks. I think as we indicated earlier, they’re manageable and moderating and so, I think the story has been one were amid the volatility we saw some outflows of a magnitude that was meaningful for two or three trading days. We had other days where there are outflows; we had days where there are inflows. So there’s not great clarity. I would say that the fund has performed very well recently and to the prior question, it’s certainly competitive generally with its peer group at this point and in a long-term basis, certainly competitive with its peer group. But even if you look at short-term performance, year-to-date performance to the extent that there was a gap it has been substantially closed with some of its largest peers. And so again, I think we'd like to think that if the volatility were to moderate, a great confidence in the fund and we may have critical part of our sales picture and something that remains extremely marketable.

Jeffrey Hopson – Stifel Nicolaus

Okay.

Henry J. Herrmann

Jeff, this is, Hank.

Jeffrey Hopson – Stifel Nicolaus

Okay.

Henry J. Herrmann

I just want to point to something I mentioned in the opening remarks and that is that we had an organic growth rate of 5.3% or 5.8% in the quarter. You know as well as I do that 85% of our assets are equity. You go around and see how that 5.3% or 5.8% looks relatively. Yeah, it’s been a tough environment, no question about it, but we still, what I consider have put some pretty extraordinary results as it relates to flows in production in the quarter, it gives in the background. So I know I’ve put my CEO hat on when I said that, but I don't want people to overlook it.

Jeffrey Hopson – Stifel Nicolaus

Okay. And it sounds like the sales of other products have been fine. So at this point, there is no concern or any concern that what’s happening to that Asset Strategy is having any influence on the sales of other products?

Thomas W. Butch

I think, Asset Strategy over its life has done nothing, but create a halo for other funds to have the opportunity to be sold, and I don’t see that being other than a positive influence on the totality of the fund family.

Jeffrey Hopson – Stifel Nicolaus

Okay. Great, thank you.

Operator

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

Marc Irizarry – Goldman Sachs

Great, thanks. You know, you guys called out that diversification beyond Asset Strategy that now half of the flows or half of the gross sales are coming from outside Asset Strategy. Can you just put into context during the quarter on a net basis what the net outflows were from Asset Strategy and how much of the flows may be in October on a net basis what that mix looks like of Asset Strategy versus other products?

Thomas W. Butch

Just to restate, the fund was in positive net flows for the third quarter on the magnitude of about $300 million. So, that was front end related to the front end of the quarter not surprisingly given that the volatility was at the back end of the quarter substantially. And October in that redemption’s I’m not totally current on the number, it’s less than $200 million.

Marc Irizarry – Goldman Sachs

And then how about the other funds in aggregate are you seeing enough traction with fixed income and other products that those are flow positive?

Thomas W. Butch

Yes. Because as I indicated, for the quarter if Asset Strategy is say plus, minus $200 million net negative and we’re modestly net positive for the quarter, the aggregation of the rest of the funds is net positive.

Marc Irizarry – Goldman Sachs

Okay. Great and then the outlook for shale spacing obviously you’ve mentioned the competition is picking up, are you expecting that you’re going to sort of revisit some of your, some of the distribution channel in terms of maybe you had some first-mover advantage on the shelf with the product and now there is more competition. So you’re expecting may be to revisit some of those channels where you had some first-mover advantage?

Henry J. Herrmann

Not sure what you mean by revisit in that context.

Marc Irizarry – Goldman Sachs

I mean do you think that the recent under performance is going to lead I think increasing discussions about with the gatekeepers in terms of the volatility of the product, the performance of the product relative to new entrants into the market?

Henry J. Herrmann

Thank you for that clarification. We’re obviously in frequent contact with all of the gatekeepers. We’ve got a great link to keep them upraised of what’s going on with the funds. I would say that those conversations have remained normal than the contact has remained normal. One of the things that, the fund is very well known for is its transparency, not only with the gatekeepers, but with the users of the product, and that is very well recognized in industry data that we look at and so, I would say generally, that the conversations have been normal. They have been within the routine of due diligence that happens on those platforms and that all of the communication that normally transpires with the fund continues unabated, and I think that’s very well appreciated by the gatekeepers and by the client base of the product.

Marc Irizarry – Goldman Sachs

Okay, great. Thanks.

Operator

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

Macrae Sykes – Gabelli & Company

Hi, good morning gentleman. Can you compare this experience that we’re seeing now with [IV] versus the months after the flash crash just in terms of conversations with investors and flows, just to give us parallel example.

Henry J. Herrmann

I don’t have the flows right in front of me. I’d say it’s more relevant to compare it to the 2008 period than to the flash crash, and I think speaking not just for IV, but for the industry as a whole, and we’ve had a great many financial advisers in here recently. I think the experience is when our people are extremely risked averse maybe even more than in the aftermath of the last market crash. And so, we're well aware of that and certainly, we believe we have a product range that can work within that context.

It’s specifically you’re talking about the Asset Strategy fund, so though it got a lot of a claim in the period you referenced, the experience in the fund itself at that time relative to sales was if I recall correctly, not substantially affected by that event. I think the difference between that and this is that there are great overhead, there are substantial in the minds of financial advisers and clients, concerned on a macro level and I think the risk-aversion reflects that. So, I guess that's what I would say the difference is in terms of our business it’s more affected today by the macro events that are overhanging the market than it was by that transitory event to which you’re calling attention.

Macrae Sykes – Gabelli & Company

Okay. And then, you mentioned that sort of the risk-aversion, I mean for a fund that is such an important part of what the all complex, just curious while in the risk controls it’s been more effective in mitigating the absolute decline during the quarter.

Michael L. Avery

Mac, this is, Mike. Let me...

Macrae Sykes – Gabelli & Company

Hey Mike.

Michael L. Avery

… take that one. As Tom mentioned, we’re fairly transparent on what we're doing and why and so we have been communicating with our shareholders and the wirehouses where we’re on the platform for some time about the cost of derivative structure products and the impact that has on performance. As you know, markets have been highly correlated, I would say since the global financial crisis going back to September of 2008, and in the time periods where markets are highly correlated, and I don’t need just securities within say the S&P 500, I mean markets across the globe are more highly correlated than they have ever been if you look back as far as 1926.

And when markets are highly correlated it’s a indicator that there is stress, it’s an indicator that the financial system from time to time is unstable and in periods like that industries will try to find ways to defend their portfolios or take defensive action. When that happens, it raises the cost of derivative securities, derivatives as you know are not cost free, there is a price that you pay for owning that security and if we look at say 5% out of the money puts one month have a premium of about 2%.

But if you keep rolling that forward every month, I guess to be very expensive insurance if you will in order to protect yourself from a cataclysmic outcome over the next 12 month period of time and that is such a deterrent on investor performance that we have made the decision as we have communicated to maintain a large growth exposure to the equity market, primarily because the equity market looks most attractive on a valuation basis.

If you look at several things, the correlations of markets as I mentioned and what happens when those correlations unwind when as Mr. Herrmann spoke to you get at least in the short-term resolutions as to the one or two issues that’s causing that correlation to begin with.

We've had, since the global financial crisis, three, maybe four primary issues that the entire investment world has centered upon. The most recent one is the expectation as to how the sovereign credit issue is going to be resolved. And that's what's driving the correlation at least recently. If you get some resolution to that in the next couple of days or more likely weeks or months, those correlations will go back to something close to normal, in which case you’re going to want to be in equity securities and without a hedge position on, as is indicated in the last, just two weeks.

Most of the market performances that you all are talking about, I think accounted at least 10 or 11 questions on Asset Strategy in some way, focusing on the period from, I would say August, into the beginning of August to the end of September. If you look at how markets have moved from that period of time relative to last two weeks, you can see that in the last two weeks, the markets have almost retraced what they gave up during at a week period of time.

So they have a hedge position that is costing you quite a bit of performance when you can’t always anticipate when investors will be satisfied with the outcomes for some near-term resolution, that gets pretty tricky. And I think that in this presence quite a few of the questions that we have heard. Yeah, it's true, you’re going to get people that are newcomers to our fund and may not be happy with the outcome from their most recent purchase, but if you think about how the history of this fund, and how this fund has been managed; this is a fund that has now a 17-year history. My team has been responsible for it for the last 15 years when it was a fairly insignificant fund.

I think that people are focused on is that the team stays focused on long-term performance; not weekly, monthly quarterly or even yearly performance. This is a fund that’s sold to people who are interested in how to meet their three to five year goals and are comfortable with the idea that the portfolio managers have access to all of the major asset classes, stocks, bonds, cash, currency derivatives, precious metals as a way to mitigate systemic risk over a long period of time.

And I think most people that we’ve talked to continue to be very happy with how the fund is managed, what we’re looking forward to and why. So to a long answer to your question and based on again just to sum it up how highly correlated, the more highly correlated markets are the more expensive derivatives are going to be, and you have to make a decision as to how much downside there is in the market in order to justify putting those on. If you get a big swing in the market to the upside, there is going to be some very unhappy portfolio managers who have heavily hedged their positions.

Macrae Sykes – Gabelli & Company

I appreciate that Mike. And just one follow-up, and I can appreciate your focus on transparency, especially with your investors. And I guess in terms of your China growth story, what gives you the confidence there just given the results of a big issue in transparency just with the earnings and growth et cetera?

Michael L. Avery

Well, I understand your question. I think that in developing markets, you have company’s regulators who are going through you know how to become develop market, so you have that issue. Number two, I think that you always have problems associated with transparency in any market, it is not exclusive to just China or the emerging markets; the developed markets have their own transparency issues, sovereign nations have their own transparency issues, which has resulted in the uncertainty that the market is dealing with as we speak.

Just to back through some of those, I mean if you think about why there is this European sovereign crisis to begin with, it had to do with the lack of transparency on the part of the weak government in terms of how they were satisfying the terms of the mastery tree and it turns out that with the help of investment banking firms, they were able to do that in a way wherein essence they were cheating, so that happens.

Certainly as it pertains to companies; somebody is intending to defraud their shareholders or hide results, corruption is not specific to any one people group and so that’s going to occur. I think that as it pertains to the Chinese though, I think one of the things you got to remember is that the transparency among the Chinese is fairly good, primarily because the cost of not being truthful, the cost of not being what’s coming in that culture has very strict penalties.

And I would say that our experience given that we have the benefit of having Chinese nationals on our staff who are expert in the accounting has helped us to avoid a number of the accounting mishaps that have occurred and that’s been a real plus to us as an organization to have a group of people that can be on the ground who can talk to Chinese CEO, CFOs in their native language and understand the accounting because that’s what they were trained in. So I think that’s helped us a lot.

As an organization we are still optimistic about the so called developing markets, the emerging markets being a source of growth. I think what we all lose site of because of where we sit that five out of seven humans on the face of the globe live in areas that are euphemistically called developing or emerging markets where 10% of that group or 500 million people are just now entering emerging or – are just now entering or in middle class for the very first time and that number is likely to go to a billion people or one out of five in the so called emerging markets are going to be in a economic category called middle class, again for the very first time. That is a lot of humans who for the very first time will be buying Coca-Cola products or Apple iPhones or BMWs or Volkswagen or enjoying entertainment that’s provided by the developed market countries. So that continues to make us very optimistic on a secular basis in spite of some of the short term mishaps that Mac you alluded to.

Macrae Sykes – Gabelli & Company

Okay thanks, Mike, appreciate it.

Henry J. Herrmann

Some might gamble in Asia to take hold, some might do that.

Operator

Your next question comes from the line of Dan Fannon of Jefferies & Company.

Daniel Fannon – Jefferies & Company

Hi good morning. I guess just looking at your outlook for the choice platform and hiring advisors, I guess has that changed at all given the recent volatility in the market or kind of give us an update there?

Henry J. Herrmann

I’d be happy to. At the end of the quarter we had about 134 advisers on the platform compared with 116 prior quarter. Assets were about 2.2 billion. I think on a prior call earlier this year I said, we had recruited 55 last year and it would be my hope that we would at least do that again this year, it’s my expectation that we’ll end with more than that number. Actually the activity has picked up quite a bit over the last few months both due to external factors and our product being better at it as time has gone on and so, I would say that the outlook is very constructive at this point.

Daniel Fannon – Jefferies & Company

Okay. It’s helpful and then, I guess just generally in terms of the institutional business and the sub advised management that you’ve addressed couple of times just curious if there is any seasonality to that business as we think about going into the fourth quarter also factoring in the market that we might see less fundings or less activity and might be pushed towards next year or you just kind of get a sense for that business.

Thomas W. Butch

I have never absorbed seasonality aspect in terms of do wins. There is some seasonality in some parts of the business because of our 1K contributions, which might have some influence, but broadly speaking I would say pretty hard to measure and after you redone, the impact wouldn’t be that large.

But there is that element of seasonality. Since you brought up that subject, I'm going to lighten Nicole’s – little bit here because she has had a couple of questions about sub-advised assets under management. So as of 9.30 sub-advised assets were at 17 billion – 7 billion excuse me I misspoke.

Daniel Fannon – Jefferies & Company

Okay great, thank you.

Nicole McIntosh

Just for a point of clarity that sub-advised assets, the assets that we’re managing excuse me that are managed for us by someone else and that is used by the analyst in forecasting the sub-advisory expense line. Not to be confused with the sub-advised assets that you find in institutional where sub-advisors or someone else.

Operator

Your next question comes from the line of Roger Freeman of Barclays Capital.

Roger Freeman – Barclays Capital

Hi just one quick follow-up on the comments that you made a couple of questions ago on the Asset Strategy kind of very helpful thanks. Just the derivative – use of derivatives in hedging there hasn’t been any change in your approach using derivatives since the last year on the flash crash with the attention that you got around on.

Michael L. Avery

Well, Roger, this is Mike. I would say that the flash crash incident had no impact on any of our hedging strategies

Roger Freeman – Barclays Capital

Okay that’s all thanks.

Operator

There are no further questions at this time. Presenters do you have any closing remarks.

Henry J. Herrmann

I think so. We appreciate your time very much and look forward to talking to you at the end of the year. Take care.

Operator

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

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