Cohen & Steers, Inc. (NYSE:CNS)
Q1 2016 Earnings Conference Call
April 21, 2016 10:00 AM ET
Adam Johnson – Senior Vice President and Associate General Counsel
Bob Steers – Chief Executive Officer
Joe Harvey – President
Matt Stadler – Chief Financial Officer
Adam Beatty – Bank of America/Merrill Lynch
John Dunn – Evercore ISI
Adam Grossbard – Sidoti & Company
Ann Dai – KBW
Mac Sykes – Gabelli
Ladies and gentlemen, thank you for standing by. Welcome to the Cohen & Steers First Quarter 2016 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions].
As a reminder, this conference is being recorded Thursday, April 21, 2016. I would now like to turn the conference over to Adam Johnson, Senior Vice President and Associate General Counsel of Cohen & Steers. Please go ahead, sir.
Thank you and welcome to Cohen & Steers first quarter 2016 earnings conference call. Joining me is our Chief Executive Officer, Bob Steers; our President, Joe Harvey; and our Chief Financial Officer, Matt Stadler. Before I turn the call over to Matt, I want to point out that during the course of this conference call, we may make a number of forward-looking statements. These forward-looking statements are subject to various risks and uncertainties and there are important factors that could cause actual outcomes to differ materially from those indicated in these statements. We believe that some of these factors are described in the risk factors section of our 2015 Form 10-K which is available on our website at cowenandsteers.com. I want to remind you that the company assumes no duty to update any forward-looking statements.
Also the presentation we make today contains pro forma or non-GAAP financial measures which we believe are meaningful in evaluating the company’s performance. For disclosures on pro forma metrics and their GAAP reconciliation, you should refer to the financial data contained in the earnings release and presentation materials we issued yesterday, available on our website. Finally, this presentation may contain information with respect to investment performance with certain of our funds and strategies. I want to remind you that past performance is not a guarantee of future performance. This presentation will also contain information about funds that have filed registration statements with the SEC that have not yet become effective. This communication shall not constitute an offer to sell or the solicitation of any offer to buy these securities. For complete information about these funds, including charges, expenses and risks, please call 1800-330-7348 for a prospectus.
And with that, I’ll turn the call over to Matt.
Thank you, Adam. Good morning everyone. Thanks for joining us today. Yesterday we reported net income of $0.39 a share, compared with $0.45 in the prior year and $0.13 sequentially. The first quarter included a non-cash expense of $1.9 million or $0.03 a share, associated with the accelerated vesting of certain restricted stock units. Excluding this item, earnings per share would have been $0.42. As a reminder, the fourth quarter included 11 million of unrealized non-operating losses, resulting from a change in accounting classification and other than temporary impairment on certain of our seed investments. In addition, the fourth quarter included a higher tax rate resulting from a full valuation allowance on the tax benefit associated with those unrealized losses. Excluding the non-cash expense on the accelerated vesting, operating earnings per share were $0.41 for the quarter compared with $0.47 in the prior year’s quarter and $0.41 sequentially.
Page five of the earnings presentation, which is available on our website, displayed the current and trailing four quarter trend in revenue and breaks out investment advisory fees by vehicle. Revenue was 79.7 million for the quarter, compared with 83.8 million in the prior year’s quarter, and 81.7 million sequentially. The decrease in revenue from last quarter was primarily attributable to lower average assets under management in closed end funds which paid fees in excess of our firm average and one less day in the quarter. Average assets under management for the quarter were 51.6 billion compared with 55 billion in the prior year’s quarter and 52 billion sequentially. Operating income was 30.3 million as adjusted, compared with 34.5 million in the prior year’s quarter and 30.4 million sequentially. Our operating margin increased to 38% as adjusted, from 37.2% last quarter.
Page six of the earnings presentation displays the current and trailing four quarter trend in expenses which decreased 3.7% on a sequential basis after adjusting for the non-cash accelerated vesting. Decreases in compensation and benefits and G&A were partially offset by an increase in depreciation and amortization. Excluding the non-cash accelerated vesting, the compensation to revenue ratio was 32.75% for the quarter, consistent with the guidance we provided on our last call. The decrease in G&A was primarily due to lower cost associated with hosted and sponsored events and lower fund organizational expenses when compared with the fourth quarter, which included the launch of the Cowen & Steers load duration preferred in income fund, partially offset by an increase in recruiting fees. The sequential increase in depreciation and amortization was primarily attributable to the write-off of certain fixed assets that were taken out of service in the quarter. We recorded a non-operating gain, net of non-controlling interests of 643,000 for the first quarter, compared with non-operating loss of 12.1 million last quarter. The non-operating results were primarily due to unrealized gains and losses on our seed investments. Our effective tax rate for the quarter was 38%, also consistent with the guidance we provided on our last call.
Page seven of the earnings presentation displays our cash, cash equivalents and seed investments for the current and trailing four quarters and reflects the portion of our cash and cash equivalents held outside the United States. Our firm liquidity totaled 186 million compared with 202 million last quarter and stockholders’ equity was 238 million, compared with 232 million at December 31st. We continue to remain debt free. In order to achieve greater transparency, consistency, and accuracy, beginning with this quarter, the assets under management tables in our earnings release now reflect distributions as a separate caption following market appreciation. And reinvestments are now classified as inflows; prior periods reflect these revised classifications. Prior to this change, distributions from our Japanese sub-advisory businesses were recorded in net flows and distributions from our mutual funds were recorded in market appreciation depreciation, net of reinvestments.
Total assets under management which could be found on page eight of the earnings presentation totaled 55.5 billion at March 31st, an increase of 2.5 billion or 5% from December 31st. Assets under management in institutional accounts totaled 27.9 billion at March 31st, an increase of 1.8 billion or 7% from last quarter and open-end funds had assets under management of 18.1 billion, an increase of 686 million from last quarter. Assets under management in closed-end funds remained at about 9 billion.
Page 11 of the earnings presentation displayed net flows by investment vehicles and for the quarter, institutional accounts recorded net inflows of 1.2 billion, representing an annual organic growth rate of 18%. During the first quarter sub-advised portfolios in Japan, reported net inflows of 864 million. Distributions increased slightly to 655 million from 583 million last quarter, and sub-advised accounts ex-Japan, recorded net outflows of 51 million. Bob Steers will provide some color on the level of activity and our institutional pipeline in a moment. Open-end funds recorded net inflows of 324 million during the quarter, representing an annual organic growth rate of 7%. Distributions totaled 133 million during the quarter of which 96 million were reinvested and have been included in inflows.
Let me briefly discuss a few items to consider for the second quarter and remainder of 2016. With respect to compensation and benefits, we expect to maintain 32.75% compensation to revenue ratio. We expect G&A to increase approximately 1% to 2% from 2015 which due to the management of our discretionary expenses is lower than the 4% o 6% we referenced on our last call. We project that our effective tax rate will remain at approximately 38% for 2016, and finally, with respect to non-operating income of the 63.2 million of seed investments at March 31st, 42.6 million have either been consolidated or classified as equity method. And as a result, any unrealized gains and losses will be recorded in non-operating income on the income statement. The remaining 20.6 million have been classified as available for sale and any unrealized gains and losses will be recorded in other comprehensive income on the balance sheet. The strategy breakdown for the 42.6 million of seed investments with the unrealized gains and losses will be recorded on the income statement are as follows: 14.7 million in low duration preferred securities; 11.4 million in MLP and midstream energy; 11.2 million in commodities and 5.3 million in global listed infrastructure.
And with that, I’d like to hand it over to Bob Steers.
Thank you, Matt, and good morning, everyone. The first quarter proved challenging in myriad ways as you all know, but the most notable were the rapid shifts in sentiment and volatility. The pessimism in the first sex weeks of the year which was fueled by $26 oil, negative interest rates, continued dollar strength and fears that Deutsche Bank could actually omit dividends on certain corporate preferred securities, resulted in a strong risk off market. By mid-February, U.S. REITs had declined by 9%. Thereafter, market sentiment again shifted abruptly. The dollar weakened, oil rallied at 46% off the lows, emerging market concerns eased and equities rebounded sharply. During this period, U.S. REITs went on a 15.5% tear and ended the quarter up about 6%.
Given the cross currents in the quarter, our relative performance was decidedly mixed. As we would expect in this environment, our active commodity, natural resource equity, and multi-strategy real-asset portfolios, posted solidly positive returns and materially outperform their benchmarks. However, our U.S. and global real-estate strategies and our preferred security strategy, underperformed their benchmarks in the quarter. As a result, over the past year, six of 10 core strategies outperformed their benchmarks. We remain confident in our process and as the markets normalize, that our relative performance will revert to more acceptable levels. And as a reminder, today, over 80% of our open-end mutual fund assets are in strategies rated 4 or 5 stars by Morningstar.
As Matt mentioned, flows in the quarter were strong and net inflows came in at 1.4 billion for 11% organic growth rate. It’s also notable that we achieved net inflows in each of our three largest business segments; wealth management, institutional advisory and in Japan. Only the sub-advisory ex-Japan channel experienced net outflows and they were a modest 51 million. Of course, our ultimate goal is to achieve net inflows in all four of these segments simultaneously. In the aggregate open-end funds net inflows were 324 million or a 7% organic growth rate, led by our five-star preferred securities and U.S. REIT funds which drew the bulk of the net inflows. Looking ahead at the Cohen & Steers Real Estate Securities Fund, was recently added as a focus fund by both JP Morgan Chase and Morgan Stanley Wealth Management, which should help bolster our domestic U.S. REIT open-end fund sales efforts going forward.
As you know, we began the quarter with a 1.35 billion institutional pipeline, and as expected, the advisory channel delivered 377 million of net inflows for 20% organic growth rate. Gross inflows of 699 million were the highest in four years, with a majority of the capital year marked for global and Asia focused real-estate security strategies. Our pipeline of awarded but unfunded mandates currently stands at 730 million, and notably RFP activity has doubled year-over-year with U.S. REIT, real asset multi-strategy and preferred securities activity especially strong.
Turning to Japan, we enjoyed our best inflows both before and after distributions in over five years. U.S. REIT funds continue to be among the best selling retail products in Japan, and we’ve been the top performing manager in that marketplace. Net inflows in the quarter were 864 million, derived mainly from Daiwa’s U.S. REIT funds. In addition, Daiwa will be launching their second REIT preferred funds for institutional clients this month. We also began sub-advising a corporate hybrid preferred securities fund for Shinsei Investment Management on March 30th. Shinsei is now our fourth sub-advisory relationship in Japan, alongside of Daiwa, Nomura and [indiscernible].
Before I open it up to questions, I’d like to refer you to the letter to shareholders in our 2015 annual report, which is intended to be an objective evaluation of the secular headwinds and also the opportunities currently facing our industry. We believe that its analysis and conclusions provide a roadmap and call to action for Cohen & Steers, as well as the serious commitment to our clients and shareholders. The simplest takeaway from the letter is that the asset management industry in its current form is no longer a growth industry for a majority of traditional active asset managers. Overcapacity, chronically poor investment performance, high fees, competition from passive strategies, growing barriers to entry for access to distribution and the rapidly growing cost of regulatory compliance, taken together will challenge future growth and profitability for most legacy investment managers. However, we’re convinced that asset managers who are focused on a limited number of historically inefficient markets, with strong brands and track records of consistent outperformance, will be among the relatively small number of big winners. The challenge will be to execute strategies that can deliver more for less by staying focused, developing talent, and embracing new cost efficient structures and technologies.
Going forward, we’re redoubling our focus on delivering outflow consistently which will entail additional investments and talent. As an integral part of this effort, we’re devoting time and resources towards deepening our bench of talent with clear succession planning throughout the organization. Because the cost of doing business will continue to rise and seed pressures will persist, we’re implementing strategies to more aggressively manage expenses and improve productivity. In contrast to our commitment to stay focused on real assets and alternative income strategies as the most effective way to consistently deliver outflow, we remain committed to supporting a highly diverse and global distribution platform to deliver our expertise and to those markets where these strategies are highly sort after.
To that end, we will continue to invest in expanding our business development strategies in the U.S., Europe and in Asia. Again, I would encourage you to take a look at our letter which can be found on our website. And lastly, in February, we announced that my partner Marty Cohen who’s been our Executive Chairman over the prior two years was transitioning to Board Chairman. So although technically that means Marty is not a full-time employee, he of course remains closely connected and involved, especially in strategic issues as Chairman of our Board.
With that, I’d happy to open the floor to questions.
Thank you. [Operator Instructions]. And our first question comes from the line of Adam Beatty of Bank of America/ Merrill Lynch. Please proceed with your question.
Thank you and good morning. Just a quick question on the lower expense guidance, you mentioned attention to cost and what have you. Does that reflect, you had previously been spending some money on some what I would call broader marketing efforts around the real asset institute and what have you. Do the lower expenses reflect any sort of completion of initiatives like that or is it more sort of cost cutting around the edges? Thanks.
Yeah, Adam it’s couple of things, one, broader is a lot of little things which don’t really accumulate in and of themselves but when you aggregate, they are meaningful. So I think in overall discipline and - top has been helpful. With respect to the conferences though, we have not eliminated them, but now that we’ve got a couple of years of history behind us, we’ve targeted them in a more cost effective way and that’s translated into an overall save as well. So they’re still ongoing but they are more efficient and cost effective.
That said, Adam, as Matt mentioned, over the past six months as part of our strategic planning process and again I think, some of our conclusions and strategies are contained in the letter to shareholders. We are bringing a meaningfully different view and cultural shift internally on even in an environment where we think we can sustain organic growth and top bottom line growth. Given our outlook for the industry, I think extreme discipline is required on everything from IT and marketing and compensation and so forth. And so, we tried to reflect that in the first quarter and we want to sustain that mentality going forward.
So you’re really walking the talk internally?
It’s a serious thing that’s why we thought it was important to share our philosophy in the letter to shareholders in effect, say it out loud. And as I said, we view it as a call to action on the part for our employees and a commitment for shareholders and our clients.
Great. Thank you. I also want to ask about the institutional advisory market generally, especially given your thoughts around active management. One of the themes in the past has been the idea of institutions pension funds and others sort of structurally under-allocated to real-estate and other real asset securities. What are the trends like in that area right now? And how do you view the climate just in terms of news headlines around people institutions pulling back from hedge funds and alternatives? Thanks.
Sure. I would say that large institutions are not under-allocated to real assets. The largest endowments in sovereign wealth funds have had a 10% to 30% allocation to real-assets for some time. However, most of those allocations have been executed to private equity strategies. Where the under-allocation is more pronounced is both in the wealth and what I would call the retirement channel, the fine contribution channel which as you know we’ve been adding to our DCIO team because there’s virtually no representation in the 401(k) market in real assets. What we’re seeing so far this year is with the rally in commodities, recovery in oil, we’re seeing preliminarily a very substantial ramp up in institutional RFP activity and certain real asset strategies like resource activities, commodities, very significant uptick there. And so, I think those two areas are viewed as statistically cheap, very attractive and relatively under-allocated in most portfolios. I wouldn’t - real-estate I think it’s very well represented in institutional portfolios.
Got it. Thank you for the color and clarification. Appreciate you taking my question.
Our next question comes from the line of John Dunn of Evercore ISI. Please proceed you’re your question.
Hi. Good morning. Just to go back to the real asset institutes. Now that we’re few years in to the process, can you kind of give us a say state of the union about, what’s gone well? What’s may be different than you thought when you started in some of the things that may be haven’t lived up to your expectations?
Sure, John. I think the institutes have been extremely very well received, the feedback from all the participants has been top notch and an important byproduct of that is, I think the time and effort that we spent there has been recognized and appreciated in home offices by fund selection units and by heads of distribution. I’d say, what has not gone as well as we had hoped was that when we started doing this about two years ago, a number of real assets were rallying and there was a strong follow through from those conferences and flows, a very tight cause and effect.
And as you know outside of REITs, commodities, resource equities and other real asset strategies have not performed well. So we continue to - I think we’ve been effectively building brand and I think we’re viewed at least in the listed real-asset space the thought and investment leader outside of REITs, there hasn’t been a ground swell of demand, at least not in the retail space. Now we’ve done real-asset institutionally and those have been very effective and I think that’s one of the reasons why starting late last year and very much accelerating this year, institutional RFP activity starting with the macro multi-strat real asset fund but also in some of that underlying individual strategies is really strong. And so, if our institutional pipeline is going to grow over the coming year, that will be the reason why.
Got you. And can you give us more of a flavor of the non-Japan sub-advisory mix and what are some of the bigger relationships there? And how do you think that channel is going to play out over the next couple of quarters?
That’s a tough question, John. We have half a dozen larger relationships in that pool. I prefer not to name them specifically, but they are each very different ones, a large annuity portfolio and other is significant European distributor, so it’s varied. We’ve been disappointed that sub-advisory ex-Japan essentially going sideways over the last few years and we’re working on ways to improve that. To some extent, that’s out of our control because we’re sub-advising so we’re not out there doing the performing the client service and marketing efforts. And so, it’s not totally in our control but we are focusing on that because it is of our four major segments, it’s the only one that isn’t solidly in positive organic growth right now.
Great. Thanks for the color. Thanks guys.
Our next question comes from Glenn Schorr of Evercore. Please proceed with your question.
Sorry. We’re asked and answered. Sorry.
Okay. And we’ll move on to the next question, our next question comes from the line of Adam Grossbard of Sidoti & Company. Please proceed with your question.
Hey, good morning. My first question is in regard to the increased interest in the institutional preferred and whether that is directly related to the new sub-advisory relationship?
I think the rising interest from the institutional market and preferred is frankly more a product of multi-year push on our part to convince institutions that preferred is really are a strategy they should consider. And because historically I think the view has been that preferred are perpetual securities, they don’t have duration and so the volatility and related risks are unacceptable. And whether it’s in Japan, where we’re seeing - primarily we’re seeing some strong institutional interest on the part of Japanese insurance companies and more domestically here, we have continued to educate the market. So we’re seeing increased increase from a variety of institutions.
Great. Thanks. My next question was in regards to may be if we can get a little update on the progress on the launch of the duration preferred fund and just the expectation with the ramp up with that offering as well as the new sub-advisory relationship? Thanks.
So this is Joe Harvey. So we launched a low duration preferred open-end mutual fund late last year and circumstances are such that it was not great timing as it relates to what the markets have done. And we don’t try to time market action like that but the reality is that what’s happened since that time credit spreads early in the quarter, first quarter blew out, then attitudes about interest rate increases changed, so there hasn’t been a lot of interest so far. But since mid-first quarter market turbulence which Bob laid out, things have calmed down so credit spreads have come in. It now looks like thoughts on interest rates might begin to change, but the big picture is zero interest rates, so it’s going to be an ongoing concern about rising interest rates. What we have been doing is signing up selling agreements and we have made some progress on that front and that will continue over the coming months and meantime, we’re working on performance building a track record and we think that on an intermediate term basis that this is a good addition to our line up because of zero interest rates and the search for yield.
I guess just one last question, the increase in the global real-estate segment, really jumped this quarter. Was that mostly related to may be one shifting allocation or was it in a more of a general shift?
It was primarily due to one new institutional relationship that Asia-Pacific real estate strategy.
Perfect. Thanks very much.
Our next question comes from the line of Ann Dai of KBW. Please proceed with your question.
Hi. Good morning. Thanks for taking my questions. I wanted to just start on the sub-advisory flows. So it looks to me, I know we have limited data points around this, but it looks like the flows are being driven both by flow in redemptions and then also better inflow. So is there any specific color that you can provide around that if that’s directly related to where rates have gone in Japan, anything you could provide would be great?
I think there are a number of factors at work there on the inflow side. I was there the week that Japan went negative on interest rates and at that time, the expectation was the Yen would remain weak and that dollar denominated yield strategies like U.S. REITs tend to be very well positioned. In addition, as we spoken about several times, Daiwa added one of the most powerful distributors in Japan late last summer as part of their group that sells their funds that’s Japan Post Bank, very, very powerful partner of Daiwa Asset Management. And Japan Post has been extremely productive in capital raising particularly for our U.S. REIT, Daiwa’s U.S. REIT portfolio. So that’s been a huge benefit.
Candidly, the non-REIT portfolios over there that were sub-advising have been out of favor and candidly outside of U.S. REITs there are very few mutual funds in Japan that are seeing those in flows. So we’re going sideways in some of those others. The redemptions - the distributions are pretty constant unfortunately very reliable so we don’t expect that to change. Related to that, it may be worth pointing out that in the quarter and the last few quarters that we’ve seen our top lines or gross inflows ramping up nicely. One of the things that we’re focused on things redemptions whether it’s in the wealth management side or even in the still some rebalancing on the institutional side. We would hope and expect to see those numbers to decline going forward and we’re hopeful that will be an additional catalyst to net inflows going forward. Obviously, it’s hard to predict, but we would hope and expect the gross outflows to begin to decline.
Great. I appreciate the color. The other question I had for you was about your non-U.S. cash. Don’t think we’ve focused on it too much but just curious whether how much of that cash you feel is liquid, whether there’s some amount you would really want to be holding in cash abroad or some amount that’s required by regulators. So essentially how much of that cash if liquid and then how do you think about the used cases for that?
Sure. That’s a great question. All of our non-U.S. cash is liquid. We do have some capital requirements and regulatory requirements in Hong Kong and the UK, but relative to U.S. standards and based on the activity levels that we do over there, they are minor. We have been whenever possible tax efficient using the non-U.S. cash to help seed some of our non-U.S. products. So we launched or we seeded global listed infrastructure in our Luxembourg - where we use non-U.S. cash in order to that. But otherwise, currently there’s no other use for it. It is virtually all liquid. So we are keeping up to this date on legislation in Washington and issues like that that potentially there is a holiday at some point it’s cost effective to bring it back and certainly we would consider that.
Terrific. And one last question on the pipeline, the 730 million you mentioned, over what time period would you expect those mandates to fund? Is it the next quarter or two?
Yes, certainly over the next two quarters a significant amount in this quarter.
Great. Thanks for taking my questions.
[Operator Instructions]. And our next question comes from the line of Mac Sykes with Gabelli. Please proceed with your question.
Good morning gentlemen. Thank you for the extra disclosures. I appreciate that. Coming back to the preferred market, could you give us some more color on the actual market may be how big it is? How much is dominated by financial firms?
It’s a large and growing market. It’s almost a trillion in size and it breaks down into the over-the-counter component and exchange listed component, the bigger part of it is the over-the-counter market issuances dominated by financial firms, banks are the largest issuer insurance companies are smaller component of financials. But they are also issued by REITs so utility companies, so it is very dominated by the financials and what’s happening is that you’ve got growth in issuance as banks need the rising regulatory capital requirements that are being implemented around the world.
And on the other side, they are calling other type of securities which get lesser capital treatment, but net-net, it’s a very large and growing and dynamic market and it’s very inefficient in our view, these securities have very wide ranging and complex structures to them. And that’s why our team of experts or specialists have had a 13 year record of outperforming the market, because that’s all they do. They are focused on the market as it’s very complex. We believe they are going to be more countries that are issuing from the banking sector, issuing preferred to meet their capital requirements. We’re hearing that Australia and Japan are going to be more active whereas a lot of the issuance recently has been from the European and U.S. banks.
Terrific. One follow up, you obviously have a terrific line of real assets, are there any other product gaps or capabilities there where you would be looking to add to over the next year?
Well we think that with the line of strategies that we have right now we’re going to be pretty fully occupied. That said, we like to find extensions to the strategies that we have. We’ve talked before about infrastructure debt as an example of that. If you go back to Bob’s earlier comments on our annual letter and our visions for the future, we believe in being specialists, we believe in being focused. And so we’re not going to add something that’s very core style box, but if we could find extensions to what we do and if we can find situations where we can get more scale in some of our newer real asset strategies, we’re interested in doing that.
Great. Thank you very much.
Okay. Mr. Johnson, there are no further questions at this time. I’ll now turn the call back to you, please continue with your presentation or closing remarks.
Great. Well thank you all for joining in and look forward to speaking with you next quarter. Thank you.
Ladies and gentlemen, that concludes the conference call today. We thank you for participation and ask that you please disconnect your lines.
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