Virtus Investment Partners' (VRTS) CEO George Aylward on Q4 2015 Results - Earnings Call Transcript

| About: Virtus Investment (VRTS)

Virtus Investment Partners, Inc. (NASDAQ:VRTS)

Q4 2015 Earnings Conference Call

January 29, 2016 10:00 AM ET

Executives

Jeanne Hess – Investor Relations

George Aylward – President and Chief Executive Officer

Mike Angerthal – Executive Vice President and Chief Financial Officer

Analysts

Michael Kim – Sandler O'Neill

Michael Carrier – Bank of America Merrill Lynch

Alex Blostein – Goldman Sachs

Steven Schwartz – Raymond James & Associates

Surinder Thind – Jefferies

Operator

Good morning. My name is Michelle, and I will be your conference operator today. I would like to welcome everyone to the Virtus Investment Partners’ Quarterly Conference Call. The slide presentation for this call is available in the Investor Relations section of the Virtus website, www.virtus.com. This call is also being recorded and will be available for replay on the Virtus website. At this time, all participants are in a listen-only mode. After the speakers’ remarks, there will be a question-and-answer period and instructions will follow at that time.

I will now turn the conference to your host, Jeanne Hess.

Jeanne Hess

Thank you and good morning, everyone. On behalf of Virtus Investment Partners, I would like to welcome you to the discussion of our operating and financial results for the fourth quarter of 2015. Before we begin, I direct your attention to the important disclosures on Page 2 of the slide presentation that accompanies this webcast.

Certain matters discussed on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not statements of facts or guarantees of future performance and are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those discussed in the statements. These statements may be identified by such words as expect, anticipate, believe, outlook, may and similar terms.

For a discussion of these risks and uncertainties, please see the Risk Factors and Management Discussion and Analysis sections of our periodic reports that are filed with the SEC as well as our other recent filings, which are available in the Investor Relations section of our website, virtus.com. We do not undertake any obligation to update forward-looking statements.

In addition to results presented on a GAAP basis, Virtus uses certain non-GAAP measures to evaluate its financial results. Our non-GAAP financial measures are not substitutes for GAAP financial results and should be read in conjunction with GAAP results.

Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in our earnings press release which is available on our website. For this call, we have a presentation, including an appendix that is accessible within the webcast through the Investor Relations section of virtus.com.

Now, I would like to turn the call over to our President and CEO, George Aylward. George?

George Aylward

Thank you, Jeanne, and good morning everyone. I’ll start today by providing an overview of the quarter, and reviewing some of the items that contributed to results. Mike will then provide more detail on the financial results and balance sheet.

Before turning to the results for the quarter, let me comment on the environment. Market conditions in 2015 were impacted by multiple factors including global concern over China, rapidly declining oil prices, and a long anticipated Federal Reserve rate hike. These events produce not only elevated volatility, but also contributed o muted to negative returns across the most asset classes. It was a difficult year, where positive absolute returns were hard to come by.

Following the weekend to the markets in September, fourth quarter market levels ended up, masking into quarter volatility. The impact of the market environment has meaningful influence on investor behavior and preferences as demonstrated in the industry flows.

As challenging as the environment has been, it presents opportunities for us as our product offerings include a significant number of quality oriented, risk-managed or solutions oriented strategies. In addition, we believe that this environment also presents an opportunity for active managers to demonstrate their value over passive strategies that have benefited from the generally up-moving market since 2009.

With that as a backdrop, let’s turn to fourth quarter sales in flows. We ended the quarter with assets under management of $47.4 billion, which represents a modest sequential quarter decline as net outflows slightly offset market appreciation. Total sales increased by 24% to $3.2 billion from $2.5 billion in the sequential quarter, reflecting higher sales in mutual funds, separately managed accounts and institutional. Mutual fund sales increased 36% to $2.5 billion from $1.9 billion sequentially due to higher sales in all asset classes, in particular international equity and fixed income.

Our fourth quarter open-end sales rate increased to 35%, which is generally above industry averages. In the fourth quarter, we had our best total net flows since the third quarter of 2014, as $700 million improvement in mutual fund flows was partially offset by lower positive flows in institutional and ETFs. For open-end fund, net outflows in the domestic equity and alternative asset classes improved sequentially, reflecting the lowest levels of redemptions for the former AlphaSector funds, since the first quarter of 2014.

Net outflows in these funds improved to $0.7 billion from $0.9 billion in the prior quarter. International equity net flows remain positive in the quarter and improved sequentially. Although the emerging markets asset class has been under significant pressure, our emerging market opportunities fund remained attractive to investors, given its strong relative performance. In January, we have generally seen a higher overall level of open-end sales that is trending to a slightly higher sales rate than in the fourth quarter.

Open-end net flows in January were negatively affected by a significant emerging-market reallocation last week at the same distribution partner who made a significant positive reallocation last April, which we mentioned on our first quarter earnings call last year. A fundamental element of our business model is offering investment strategies across product types and asset classes that are expected to perform well over time and are attractive in various market cycles and as investor preferences change.

We believe our multi-manager approach that leverages managers who specialize in individual strategies will generally outperform more broad-based managers. We are pleased that our relative performance continued to be very strong at December 31, with 19 of our rated funds having four and five stars. In addition, approximately 80% of our assets are in strategies that have beaten their respective benchmarks over the past five years. This performance demonstrates the strength of the institutional quality managers we offer including Newfleet Asset Management, Duff & Phelps Investment Management, Kayne Anderson Rudnick, and Vontobel Asset Management.

We continue to expand our collection of product offerings and managers with several new relationships. For example, we acquired a majority interest in a multi-manager ETF platform, now called Virtus ETF Solutions, which provides us with manufacturing capabilities for both active and passive ETFs. We chose Dorsey, Wright & Associates, a leading advisor to financial professionals, as the technical analysis provider for some of our rules-based strategies, and we partnered with Aviva Investors, a firm with a broad set of capabilities that is a leader in outcome-oriented solutions, to offer the Virtus Multi-Strategy Target Return Fund.

And we introduced Target Date Retirement Income Funds aimed at the defined contribution market by leveraging the expertise of Dimensional Fund Advisors. We believe that our lineup of investment managers has never been stronger and that our retail distribution approach of providing a single point of access to a diverse set of boutique managers distinguishes us in the marketplace.

Turning to the financial results, fourth-quarter operating income as adjusted and related margin were $19.4 million and 29%. Similar to last quarter, the results included a $4.6 million negative impact of a variable incentive fee, excluding which our operating income as adjusted and related margin would have been $24 million and 34%. Fourth quarter earnings per diluted share as adjusted were $1.37, reflecting the impact of lower average assets and a variable incentive fee of $0.33 per share partially offset by the lower share count.

Turning to capital and our balance sheet, cash and investments ended the quarter at $422 million and remained at a strong level of $50 on a per share basis. In the quarter, we returned $38.9 million of capital through share repurchases and dividend payments, with the fourth quarter marking our highest level of share repurchases to date. As a result of continued repurchases, our outstanding shares have declined by 6.4% from December 31, 2014, and 3.1% from September 30, 2015.

The quarterly dividend remained unchanged at $0.45 per share. We will continue to balance a meaningful return of capital with investments in the growth of the business. Now I will turn it over to Mike to provide a more detailed review of the financial results and balance sheet. Mike?

Mike Angerthal

Thank you, George. Good morning, everyone. Starting on Slide 7, assets under management, we ended the quarter with assets of $47.4 billion, which represents a decrease of 16% from the prior year and 1% from the prior quarter. On a sequential basis, the $0.5 billion decrease in assets is primarily attributable to net outflows of $1.1 billion and dividend distributions of $0.2 billion, that more than offset market appreciation of $0.9 billion.

The $9.3 billion year-over-year decrease in assets under management is primarily attributable to $6.3 billion of net outflows, $2.2 billion of market depreciation, and $0.6 billion of dividend distributions. The former AlphaSector funds accounted for $6.6 billion of net outflows in 2015. Excluding the former AlphaSector products, net flows were positive $0.4 billion for the year. At December 31, these funds had $2.7 billion of AUM or 6% of total assets.

Turning to Slide 8, asset flows. In the fourth quarter we had total net outflows of $1.1 billion, an improvement from $1.6 billion in the prior quarter. Primarily attributable to an improvement in mutual fund net outflows to $1.2 billion from $1.9 billion sequentially as net outflows in the former AlphaSector funds improved to $0.7 billion from $0.9 billion.

Total sales increased 24% sequentially to $3.2 billion reflecting sales increases of 36% in open-end mutual funds, 26% in separately managed accounts and 14% in institutional. Gross sales in open-end mutual funds were $2.5 billion, which represented an increase of $0.7 billion from the third quarter. The increase in sales was primarily attributable to international equity and fixed income. Mutual fund net flows by asset class were as follows. International equity sales increased 43% in the quarter, which resulted in net inflows of $38 million, compared with modest outflows in the prior quarter.

Sales of fixed income increased 28% sequentially to $0.5 billion. Net outflows were $0.4 billion, consistent with the prior quarter. Alternative strategies had sales of $142 million, an increase of 31% from $108 million sequentially. Net outflows were $0.2 billion in the quarter.

Sales of domestic equity increased slightly to $108 million sequentially. Net outflows were $0.6 billion, an improvement from $0.9 billion in the third quarter. ETFs had positive net flows of $35 million compared with $204 million in the third quarter. As a reminder, in the third quarter we introduced the Virtus Newfleet Multi-Sector Unconstrained Bond ETF, which contributed $131 million of net flows in the third quarter and an additional $23 million in the fourth quarter.

Institutional had positive net flows of $45 million in the quarter. Inflows are primarily attributable to additional flows on existing accounts. Institutional flows are always hard to project, but this quarter represents the fifth consecutive quarter of positive net flows in this product category.

Turning to Slide 9, investment management fees as adjusted of $60.9 million decreased 7% on a sequential quarter basis and 20% from the prior-year quarter. The components of the change in investment management fees are average assets and fee rates. Average assets under management of $48.5 billion decreased 4% sequentially and 17% compared to the prior-year quarter. The 4% sequential decline is due to a 4% decline in open-end funds.

The average fee rate decreased 1 basis point sequentially due to a 1.3 basis point decline in the open-end fund fee rate that reflects net outflows and higher fee products. The fourth-quarter open-end fund fee rate was 46 basis points, and excluding the negative variable incentive fee, it was 52.1 basis points. A quick note for modeling, the variable incentive fee will continue to have an impact for part of the first quarter.

Therefore, we expect the first-quarter open-end fund fee rate to be approximately 48 basis points and we expect it to be approximately 51 basis points for the remainder of 2016, all else being equal. The average fee rate on ETFs increased to 29 basis points from 22 basis points in the prior quarter. The higher fee rate is reflective of the full-quarter impact of the Newfleet managed fixed-income ETF.

Slide 10 shows the five-quarter trend in employment expenses. Total employment expenses. Total employment expenses, as adjusted, for the quarter were $34.4 million an increase of $0.9 million and $0.3 million from the prior quarter and prior year, respectively. The increase from the third quarter reflects higher sales-based compensation, due to the 36% increase in open-end mutual fund sales, as well as incremental costs associated with adding resources to support quantitative strategies, including the trend funds for which we took on additional responsibilities earlier in the year.

These higher incremental costs more than offset the benefit of lower variable profit-based compensation in the quarter. Given the volatile market conditions, we believe the best way to model employment expenses, as adjusted in the near term is on an absolute dollar basis. The first quarter will include incremental payroll taxes, which were $2.5 million in the prior year. Therefore, we expect employment expenses to be in a range of $36 million to $37 million in the first quarter.

The trend in other operating expenses, as adjusted, reflects the timing of product distribution and operational activities. Other operating expenses as adjusted, of $12 million in the fourth quarter included $0.8 million of discrete professional fees and fund-related expenses. Excluding the $0.8 million of discrete items, other operating expenses were unchanged from the prior-year quarter at $11.2 million.

We continue to expect other operating expenses, as adjusted, to be within a relatively tight range of $11 million to $12 million per quarter. We are focused on reducing discretionary costs, with the goal of being at the lower end of our range. It is important to note that certain of these expenses are tied to longer-term contracts and cannot be reduced in the short-term.

Slide 12 illustrates the trends of adjusted results. In the fourth quarter, operating income, as adjusted, was $19.4 million, a decrease of $5.9 million or 23% from the prior quarter. The decrease reflects $4.4 million of lower revenues, as adjusted, due to lower average assets and lower fee rates, combined with $1.5 million of higher operating expenses, as adjusted.

Our operating margin, as adjusted, for the fourth quarter was 29%, a decrease from 36% in the third quarter and 46% in the prior year. Excluding the negative $4.6 million variable incentive fee mentioned earlier, our operating income, as adjusted, and margin would have been $24 million and 34%, respectively. That fee had a $0.33 impact on our earnings per diluted share, as adjusted, which were $1.37 in the fourth quarter; excluding the fee, earnings per share would have been $1.70, all else being equal.

GAAP net income attributable to common stockholders was $6.6 million or $0.76 per diluted share. The quarter included $8.5 million or $0.97 per share of unrealized mark-to-market adjustments, net of tax, on the Company's investments and an effective tax rate of 60%. The rate was impacted by a $2.5 million valuation allowance associated with the unrealized losses on the Company's investments. Excluding the valuation allowance and the impact of consolidated sponsored investment products, the quarterly effective rate was 39%, consistent with prior periods.

We ended the fourth quarter with strong cash and investments, no outstanding debt, and $75 million of unused capacity on our credit facility. At December 31, 2015, cash and investments were $422 million, a decrease of 5% sequentially and 10% from the prior year. Cash and investments on a per-share basis remain strong at $50, compared with $52 at December 31, 2014, and $51 at September 30, 2015. Our seed capital investments totaled $274 million a decline of 1% sequentially. Our target range for the size of our seed portfolio remains $200 million to $250 million.

Working capital of $72 million decreased $35 million or 33% sequentially, primarily due to operating cash flows being more than offset by return of capital to shareholders of $38.9 million. That included $35 million of share repurchases, our highest quarterly level to date and an additional investment of $20 million in a potential CLO to be managed by Newfleet, bringing that total investment to $40 million.

The key metric we evaluate with respect to working capital is working capital to spend, and we have said on prior calls that we target a range of 50% to 75%. Given that the size of our seed capital investment is greater than the long-term target, we believe our current ratio of 26% is reasonable at this time. The $38.9 million of capital returned to shareholders in the quarter represented 326% of net income as adjusted, bringing the total year payout to 143%.

As we have consistently stated, the primary goal of our capital management strategy is to balance investments in the business with returning a meaningful level of capital to shareholders.

With that, let me turn the call back over to George.

George Aylward

Thanks. That concludes our prepared remarks. Now let’s take some questions. Michelle, can you open up the line please.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Michael Kim with Sandler O’Neill. Your line is open.

Michael Kim

Hi, guys. Good morning. First, can you maybe quantify the flow impact related to the EM reallocation you mentioned earlier? And then, just kind of more broadly, I'm just curious how you see EM ops flow trends, just in light of, like you mentioned, very strong relative performance versus maybe headwinds around sort of negative absolute returns and less demand for emerging markets funds more broadly.

George Aylward

Sure, I will take the second part first. The emerging markets asset class has been under incredible pressure, and in terms of absolute returns, that has driven a lot of behavior that you have seen with those strategies. We have been pleased at, given just the consistently strong performance of the fund managed by Vontobel, our Emerging Markets Opportunities fund, that we've actually been one of the few funds that have been maintaining relatively good flows over that period.

As a backdrop, I would say investors have taken steps away from that steps away from that asset class, and I think many of the firms in general either have an underweight or an equal weight. So as you look forward, generally emerging markets will have ebbs and flows of being underweight, then equal weight, and then overweight, and right now, obviously, it is on the more negative side. So obviously we look forward to the opportunity when the asset class in general is in favor and consistently we will be seeing previously, even when the asset class is in favor, we've been fortunate that the strong relative performance we have had makes it attractive in that environment and not just when the asset class is out of favor.

In terms of the reallocation, and again, as you know, we are not going to go into a lot of specifics, but there was one actually Friday of last week, and it was significant in terms of what you could see if you look at the flows in the fund, and it really was not dissimilar, except for directional to what we saw last April when there was a very significant large reallocation and it actually was at the same distribution partner. So as we've commented before, this fund is a very popular fund and does have placement in some of the platforms and models. So when there are different types of allocations in a very short period of time, specifically in a day or two, you can see that kind of rebalance. But again it was a significant number and, again, we have seen those before, several times over the last few years.

Michael Kim

Got it. That's helpful. And then, separately, one of your peers has started to grant equity to their underlying affiliate management teams, just as a way to maybe further incentivize growth. So, just wondering if you are considering maybe shifting some of the economics of your model as it relates to either existing affiliates or as you think about prospective deals potentially?

George Aylward

Yes, we like to think we have a really good alignment in our general structure where we try to align our affiliates to Virtus shareholders in terms of their compensation is highly tied to the contribution they make to operating income as adjusted, our non-GAAP measure. And we do utilize in those plans a further alignment by using Virtus equity so that there is as much alignment that we can be, but really allowing each affiliate to maximize their opportunities, given their specific expertise and their portion of the business. We will always continue to consider anything that enhance – for us, anything that can increase the alignment between the portfolio managers and the affiliates and our shareholders, absolutely we will always consider those things. But we think we have very good alignment right now.

Michael Kim

Okay, and then just one last one, maybe for Mike. I know you called out the $35 million of capital dedicated to share repurchases last quarter, but did you disclose the number of shares that were bought back? And then, just any updated thoughts on the outlook for ongoing buybacks, just in light of the stock's more recent pullback versus maybe incremental pressure on cash flows, just given continued market challenges?

Mike Angerthal

Yes. Good morning, Michael. Page 13, we disclosed the basic shares outstanding from third quarter to fourth quarter and that's a good indication of the number of shares that were repurchased in the period. So, you can get that. Certainly, we were pleased with having a decline of 6.4% of shares outstanding over the year and 3.1% in the quarter and we do consider multiple factors when we evaluate the level of repurchases and some of those that you mention, including operating cash flows and the position of the balance sheet, will go into that decision making going forward. And we certainly had the ability to be opportunistic when we did the increased share authorization last quarter that we talked about.

George Aylward

Yes, and just to add to that, as we have said consistently over many years, we always balance. We do think it's important to have a meaningful return of capital to shareholders and continue to invest in the future growth of the business in the form of future products, and we have a very strong balance sheet that allows us the ability to do both. So, we are pleased that we have the ability to seed some, hopefully, very interesting and attractive products, some of which are already seeing some early outcomes and at the same time reduce share count by 3.1% in a quarter, and then we end the quarter with $50 on a per share basis of cash and investments. And as you know if you adjust it for debt, it would still be $50 per share as we have no outstanding debt.

So, we're going to continue to do that balancing. We think both of those are important elements, and as Mike stated, the additional authorization last year on the program allows us that flexibility as we evaluate the various factors.

Michael Kim

Got it, okay. Thanks for taking my questions.

George Aylward

Yes. Thank you.

Operator

Our next question comes from Michael Carrier of Bank of America Merrill Lynch. Your line is open.

Michael Carrier

Hi, thanks, guys. Mike, maybe first one just on the expenses. So I hear you on the non-comp around that 11, 12 range on the low end. Just on the comp, maybe past the seasonal period of the 1Q in terms of what you guys have in terms of the flexibility that you can manage in a more volatile market backdrop versus what is going to be, I guess, stickier or less flexible in the model.

Mike Angerthal

Yes. I mean certainly the market volatility is something that we look at carefully, and that's why we were specific to just talk about how we are thinking about employment into the first quarter and thinking about it on an absolute dollar basis. So, I think looking out further, we will update our thinking in terms of the market conditions, but it is important to note that we have been very selective in terms of any headcount changes, and the changes that we called out were not in the base salary or the fixed portion of employment. It was sales base. So, we think we have the infrastructure in place and have the operating leverage to be in place as asset levels change, as some of the seed products that George alluded to in our capital that we think are in place and you will see the operating leverage on the upside. But employment line and the margin are impacted by the character of assets under management in terms of whether those are subadvised or internally managed, but I think we are well positioned in terms of the existing infrastructure.

Michael Carrier

Okay, that’s helpful. And then, maybe just shifting over to on the product side, so, I guess, two questions. Just given the recent rate hike and the backdrop in fixed income, just what you’re seeing in terms of maybe demand with Newfleet? And then on the product, maybe, launch side, it sounds like you guys still see a decent amount of opportunities. Given some of the ETFs that you guys launched, just recent kind of I don’t know feedback, and then from a pipeline, I know you guys don’t tell us all what you’re going to launch before you launch it, but just in terms of either the feedback in the level of opportunities that you see on the horizon?

George Aylward

Sure. So starting with the first part of the question, so in terms of fixed income, the longest awaited rate hike in the history did finally occur, and it created obviously a lot of uncertainty and hesitancy among investors in fixed income about, fixed income and how to access fixed income.

And some of those were valid and some of it was probably an overreaction to what is a long tradition of rates going up and going down and what those cycles are. Our view is it presents a great opportunity for Newfleet because fixed income is not an easy asset class, and for individual investors and financial advisors to try to navigate the complexities of what happens in valuations and in markets, given rate hikes, is very difficult.

And the multistrategy approach, multisector approach, that Newfleet takes where based upon over two decades of experience in understanding where to find the best value in different sectors, we actually think this is a great environment for having that kind of an approach and outsourcing that complexity to professionals that have a proven track record in that. And as you know, Newfleet has a wide suite of products, so again they will have it in terms of different durations and whether they are single strategies or multisector. I think on the last call I actually referred to one of their strategies, the low duration one, as being one in this environment that, all things being equal, would be a very attractive way to play it.

But we do think their very differentiated approach and their ability to find value in the different sectors that they have demonstrated over the years gives them a good opportunity in this market. But people are very hesitant about how to play fixed income in a rising rate environment, and then, again, now you start having questions about will there be a rising rate environment or is growth, expected growth or lack of growth, going to change all of that. Again, our view is that is why you should select a manager who is expert in that area and do it.

Turning to ETFs, and we did make the transaction last year so that we have the ability to manufacture and distribute ETFs, and we are approaching that in terms of abilities to offer both actively managed strategies where it is practical and reasonable as well as, for lack of a better term, smart beta types of products.

We have launched products already since that introduction. We have quite a few things in the pipeline there, and generally it gives us the ability really to, one, leverage some of the abilities we already have and utilize in open-end funds, but tailor them for where there might be a preference for an ETF type of wrapper. But it also opens up opportunities for us to do things with capabilities that might not be logical in an open-end fund. So, it's still early. We are very pleased. I think when we acquired it, it was about $70 million in assets under management. Now it is over $300 million, $350 million at this point. It’s still early, a lot of activity going on there, and we see that is a future growth opportunity for us as we move forward. And as we all know, ETFs are just increasingly becoming a more and more important part of a financial advisor's recommended investments for his or her clients.

Michael Carrier

Okay, thanks a lot.

Mike Angerthal

Thank you.

Operator

Our next question comes from Alex Blostein of Goldman Sachs. Your line is open.

Alex Blostein

Hey, good morning guys. Just a quick follow-up, a couple of income statement questions, just a quick follow-up on Mike's question. So I guess, Mike, to your comments earlier about thinking about employee comp more in terms of dollars in the near-term, does that extend beyond the first quarter, meaning 36 to 37 and you kind of said $2.5 million uptick, but then we should think about 33, 34 maybe dollar kind of run rate and the leverage you are talking about just works if the revenue environment improves? I'm just trying to understand the sensitivity in the model in the near term.

Mike Angerthal

Yes, we were specific for the first quarter, given the current market environment. Beyond that, we're going to be very selective in terms of any changes to the headcount and we will monitor the environment. As you know, the model – our model is variable in nature and we have variable compensation plans, but going beyond the first quarter is not something we could do at this point in this market.

Alex Blostein

Got it. Any sense of what percentage – given the current mix of business, what percentage of comp is fixed versus variable?

Mike Angerthal

We stated about 50% to 55% variable, and I think that still holds, and you saw the change this quarter in terms of the sales-based compensation, where we had sales increase 36% our open-end funds over the prior quarter and that has an impact. As you know, we pay our sales team at the time of sale, so those are the factors that will impact that row on a quarterly basis.

Alex Blostein

Got it. Another dynamic I was hoping to just run through is around distribution and underwriting fees and the expenses I guess associated with that. It looks like for the last couple of quarters, the fee rate of distribution underwriting I guess just as a percentage of open-end mutual fund assets has been coming down a little bit, so just compressing the overall margin on distribution. Is that something temporary, because it seems like that was the dynamic in the third quarter and the fourth quarter? Do you guys expect it to reverse or the second half of 2015 is more of the appropriate run rate for both the revenue and expense-line items, again as a percentage of mutual fund assets?

Mike Angerthal

Yes, it’s a good question. I mean you have seen us model and talk about that row as a percentage of long-term open-end mutual funds, and in there includes payments we make to our technical research provider for the trend funds. So you’ll see that trend down to – I think it has been around 25 basis points and I think that’s a good way to think about it going forward.

Alex Blostein

Got it, and that was on the expense front. But on the revenue front, the third and fourth quarter is also a decent run rate as far as the fee rate goes?

Mike Angerthal

I think that’s right.

Alex Blostein

Got you. Okay, thanks so much.

Mike Angerthal

Thanks.

Operator

Our next question comes from Steven Schwartz of Raymond James & Associates. Your line is open.

Steven Schwartz

Good morning, everybody. A quick couple, George, could you talk about maybe as an asset class volatility control, given December, given what has so far gone on in January. Is that something that may be comes back?

George Aylward

In terms of having products that have low volatility or help you manage through volatility?

Steven Schwartz

Yes, yes, the latter.

George Aylward

Yes, no, absolutely. I think this is in some ways a perfect environment for people to be reminded that volatility can have a significant impact not only on your statement, but on your psychological makeup when you check CNBC in the morning.

So we do think and we would characterize that in sort of either our risk-managed or our solutions-oriented products. So as challenging in this environment has been, we have actually had a lot of our products doing incredibly well during this period of volatility with markets being down 3% or 4% in one day and some of these less volatile products being flat. So, we do think that having products that help you address the uncertainty around volatility, particularly if you have a shorter horizon, are important and I would say we actually have a lot of those. Again, where we have always struggled is in when markets are – just simply do nothing but go up and up and up; our mix of offerings generally is not the most competitive in that environment. We are actually better in an environment like this.

Steven Schwartz

Yes, I guess what I am trying to get at is have you seen any substantial change in flows to those products yet?

George Aylward

I don’t know if I would say the word substantial, but absolutely, you are getting a lot more attention, and even in some of our very new funds where it is really early and you wouldn’t expect to be seeing flows, like in our Multi-Strategy Target Return Fund, which just was launched last July, and that is basically almost no – very little correlation to the markets, we have seen early inflows into that product in December. Last year, I think it was a little shy of $20 million and we probably had another $20 million in January, which is really unusual for such a new fund, but it is literally right in the sweet spot of what you are discussing in terms of a product that has very little correlation to the volatility in markets, and we are very hopeful that that will continue. But no, you are absolutely seeing a lot more interest in products that will sort of address that need.

Steven Schwartz

Okay, good. And then for Mike, could you – I realize it is not part of your operating income and it comes and goes, but could you discuss maybe what drove what was probably a bigger loss than anybody might have imagined on investment products in the quarter?

Mike Angerthal

Yes, the unrealized mark to market, I think I touched on that in my – on the seed portfolio. I think it was $8.5 million for the quarter. Yes, we have referenced the $277 million, seed portfolio, and there is a broad product set within that portfolio and given some of the volatility in the markets, you’ll see those – you see that come through in the negative mark. And I think we have had quarters of positive results and positive marks, but from our standpoint, the goal of the deployment of that seed is to gather third-party assets over time, and we look to the balance sheet and that’s really what – how we think about that. And that’s why you see those marks.

Steven Schwartz

Yes, understood, but was there anything in particular that led to the mark-to-market this quarter?

Mike Angerthal

I think we have got probably five or six significant products. I think certain of the alternative products that are uncorrelated to the markets had some energy exposure and I think that’s what – that is specifically what impacted the negative mark.

Steven Schwartz

Got it. Okay, thank you.

Mike Angerthal

Sure.

Operator

Our next question comes from Surinder Thind of Jefferies. Your line is open.

Surinder Thind

Good morning.

Mike Angerthal

Good morning.

Surinder Thind

I was hoping to touch base on the fee rate guidance. Any color around there? It appears to be down versus the guidance from last quarter. Any thoughts would be helpful.

Mike Angerthal

Yes. Good morning, Surinder. The guidance we gave may be 1 basis point or 2 different than the prior guidance that we gave, but it is important to note that we looked forward. In the second quarter, we expect to have no longer any impact from the variable incentive fee. So what we gave was in the first quarter there would be a partial impact of that fee, and I tried to highlight the partial-quarter impact with the – I think I touched on 48 basis points being the first quarter and then moving towards that approximate 51 basis points for the remainder of the year. So it’s just a partial quarter impact.

Surinder Thind

Okay, but…

Mike Angerthal

Having fee rate.

Surinder Thind

The negative variable fee does completely go away by second quarter, then? Is that correct?

Mike Angerthal

That’s consistent with how I described it, yes.

Surinder Thind

Okay, and then one other quick question, maybe some color around the recent launch of the DFA funds or the target-date funds. Why those products, why now, and how do they shape up competitively?

George Aylward

Sure, and that was we recently, at the end of last year, beginning of this year, launched a series of target-date funds and, as you referenced, it is partnering with and utilizing the capabilities of DFA. I think, as many people are aware and know, DFA is just an incredibly well-respected and thoughtful part of the industry, and they had developed a very differentiated approach to retirement, competitive in the target date arena with a focus not only on the accumulation of wealth, which many of the products focus in on, but really in the other side, the income in retirement piece of it. We thought it was a very compelling and a very differentiated approach.

We are very pleased that they partnered with us to make those capabilities available in the firms that we distribute through. So we do think that is a very interesting opportunity for us to take something geared towards retirement, but we would actually view these as much more than just a retirement product, and to be the provider of those capabilities into the intermediary distribution channel where we normally participate, and we just think that’s a great opportunity. It’s a big space and it is very competitive, but I think what DFA has developed and we are making available in partnership with them will be very differentiated and we are hopeful it will ultimately resonate.

Surinder Thind

Thank you.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Aylward for any closing remarks.

George Aylward

Okay, I just want to thank everyone for joining us today and we certainly encourage you to call us if you have any further questions.

Operator

That concludes today’s conference. Thank you for participating. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!