Franklin Resources (BEN) Gregory Eugene Johnson on Q2 2016 Results - Earnings Call Transcript

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Franklin Resources, Inc. (NYSE:BEN)

Q2 2016 Earnings Call

April 27, 2016 11:00 am ET

Executives

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Kenneth A. Lewis - Chief Financial Officer & Executive Vice President

Analysts

Daniel Thomas Fannon - Jefferies LLC

Robert Lee - Keefe, Bruyette & Woods, Inc.

Craig Siegenthaler - Credit Suisse Securities (NYSE:USA) LLC (Broker)

William Raymond Katz - Citigroup Global Markets, Inc. (Broker)

Patrick Davitt - Autonomous Research US LP

Michael S. Kim - Sandler O'Neill & Partners LP

Kenneth B. Worthington - JPMorgan Securities LLC

Kenneth Hill - Barclays Capital, Inc.

Michael Roger Carrier - Bank of America Merrill Lynch

Chris M. Harris - Wells Fargo Securities LLC

Brian Bedell - Deutsche Bank Securities, Inc.

Alexander Blostein - Goldman Sachs & Co.

Michael J. Cyprys - Morgan Stanley & Co. LLC

Eric Berg - RBC Capital Markets LLC

Operator

Good morning and welcome to Franklin Resources Earnings Conference Call for the Quarter Ended March 31, 2016. Statements made in this commentary regarding Franklin Resources, Inc., which are not historical facts, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a number of known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from any future results expressed or implied by such forward-looking statements.

These and other risks, uncertainties and other important factors are described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including in the Risk Factors and MD&A sections of Franklin's most recent Form 10-K and 10-Q filings.

Operator

Good morning. My name is Melissa and I will be your call operator today. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded.

At this time, I would like to turn the call over to Franklin Resources' Chairman and CEO, Mr. Greg Johnson. Mr. Johnson, you may begin.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Well, good morning and thank you for joining Ken Lewis and me to discuss the company's second quarter. Although we continue to experience net outflows in the March quarter, the nature of the mid-quarter market rebound marked an encouraging transition for us. As many of the weakest performing sectors of 2015, we're among the strongest performers in the quarter. As the quarter progressed, investment performance of many of our key strategies improved as did redemption trends.

Overall, our financial results were solid as we continued to exercise expense discipline, notwithstanding some notable onetime items that are discussed in more detail on our 10-Q which was also filed this morning. Now, Ken and I are happy to take your questions.

Question-and-Answer Session

Operator

Thank you. Our first question comes from the line of Dan Fannon with Jefferies. Please proceed with your question.

Daniel Thomas Fannon - Jefferies LLC

Thanks. Good morning. I guess, Ken, if you could clarify some of the one-time items in the quarter, I know you called out some of the $40 million or so in severance but I believe there were some other things in the G&A line and others.

Kenneth A. Lewis - Chief Financial Officer & Executive Vice President

Sure. We did have an impairment charge in G&A that was about $30 million. That was offset a little bit by contingent liability. So those were the two major large lumpiness in the G&A account.

Daniel Thomas Fannon - Jefferies LLC

I guess in the context of last quarter, we had 3% to 4% expense decline for the year and now you're seeing 3%. What are the variables in terms of that change?

Kenneth A. Lewis - Chief Financial Officer & Executive Vice President

Well, one of them was that impairment charge. We weren't counting on that in the 3% to 4% guidance. And also looking out for the remaining quarters for the year, we might have another non-recurring charge in the fourth quarter, although that could roll into the first quarter as well. So those are two things that weren't known last quarter that we're factoring in as well as there's a lot of moving parts to this. We're rationalizing business lines and departments and all that. So we're just refining our estimate.

Daniel Thomas Fannon - Jefferies LLC

Great. I guess and then, Greg, as my follow-up, if you could talk about the DOL and now that the final rules are out, and how you guys are thinking about that?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Well, I think a lot obviously has been discussed already. I mean, it affects a huge part of the industry. I think, for us, it's difficult to get an exact number on the amount of assets that it potentially could affect, but we did our best, and with omnibus accounts, that's a little bit tricky. But we estimate that it affects about $130 billion of our assets. I think we're probably a little bit lower than most because of our heavy concentration in retail assets offshore, as well as municipal bond funds, and the fact that the key area around 401(k) tends to be in U.S. growth, and that's an area where we don't have huge penetration.

So I think, overall, a little bit lower, but like everybody in the industry, very concerned about and still trying to understand what a 1,000-page document means to our business. And that's really where we're focused today is working with our advisors, working with outside legal assistance and really making sense of the proposal. I think the good news is that some of the most unworkable items have been adjusted, but that obviously a very difficult rule that will eliminate advice to many people that need it most and that's the smaller end of the market.

Daniel Thomas Fannon - Jefferies LLC

Great. Thank you.

Operator

Thank you. Our next question comes from the line of Robert Lee with Keefe, Bruyette & Woods. Please proceed with your question.

Robert Lee - Keefe, Bruyette & Woods, Inc.

Thanks and good morning. I guess my first question, I'm just curious if it's – I mean if we can – you have a couple of new initiatives underway. You mentioned the NextStep strategies in the prepared remarks, and I know you've obviously taken some steps in the ETF market. Can you really kind of update us on maybe where you are with both of those? And then and particularly NextStep maybe kind of fleshing that out, what the opportunity is there and is that part of the relationship you have globally with the Citi?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yes. I mean that is and it's addressing that area of the market using technology and trying to penetrate those that may not be large enough to be able to get individual help or advice. So it does address a new market for us. I think our partnership, a lot of that was based on our global reach and the fact that we can help them get the marketing message out in markets like Asia and Latin America where Citi has such a strong reach. I think that will take a while to develop, but it is off and running now.

The other area is just around the alternatives and multi-alternatives, and we continue to extend our capabilities there with the Long Short Credit and Global Macro Fund that was recently introduced. And then our Liberty shares ETF, which will be available in June, and we expect to continue to build out that line as well. Those are just a few of the newer initiatives.

Robert Lee - Keefe, Bruyette & Woods, Inc.

Okay. And maybe going my follow-up, just curious if you could give us an update on the institutional demand you're seeing for the global bond and related strategies. I know that's been a place in the prior quarters. You've talked about seeing increased interest and activities. Can maybe update us on that?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah. We are seeing that, and I think that's clear when our team's out visiting various countries and meeting that there is a strong interest in diversifying their currency exposure. So we continue to see a strong pipeline there. And I couldn't give you an estimate or number of when, but that would be highest, I think, on our list of opportunities in the institutional space.

Robert Lee - Keefe, Bruyette & Woods, Inc.

Okay. thanks for taking my questions.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Thanks.

Operator

Thank you. Our next question comes from the line of Craig Siegenthaler with Credit Suisse. Please proceed with your question.

Craig Siegenthaler - Credit Suisse Securities (USA) LLC (Broker)

Good morning. So just coming back to the $130 billion, did that include all retirement accounts, variable annuity, commission-based IRA, 401(k), and is there anything else in there?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

No, it doesn't. I think that one did not include annuities, which you probably would – you'd want to include in that number, and that's probably another $50 billion in sub-advised annuities which obviously could be affected as well. That's a good point.

Craig Siegenthaler - Credit Suisse Securities (USA) LLC (Broker)

Got it. And then just a question on M&A. Is my understanding both the UK and Canada fall under the U.S. in terms of how you're domiciled from a tax standpoint? If you guys wanted to acquire a business in the UK, could you restructure the business so you could use your international capital to do that acquisition?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Craig, could you just repeat the question a little bit? You're a little faint.

Craig Siegenthaler - Credit Suisse Securities (USA) LLC (Broker)

Sure. So, I believe the UK and Canada are under your U.S. domicile from a tax standpoint. So, I'm just wondering – and you've recently done Rensburg. But I'm wondering, if you did a future acquisition in the UK, could you use your foreign capital to do that acquisition?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

The answer is yes, we could.

Craig Siegenthaler - Credit Suisse Securities (USA) LLC (Broker)

Okay.

Kenneth A. Lewis - Chief Financial Officer & Executive Vice President

It would not require a restructure.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

It wouldn't even require a restructuring. We could do without that.

Craig Siegenthaler - Credit Suisse Securities (USA) LLC (Broker)

Did you use foreign capital for Rensburg?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah. I don't recall. We probably did. Yeah. We probably did.

Craig Siegenthaler - Credit Suisse Securities (USA) LLC (Broker)

Got it. Okay. That's it for me.

Operator

Thank you. Our next question comes from the line of William Katz with Citigroup. Please proceed with your question.

William Raymond Katz - Citigroup Global Markets, Inc. (Broker)

Okay. Thanks so much. Just want to come back to the impairment you took on K2. I guess that's been an area of growth for you, so I'm a little surprised to still see the impairment. So could you talk about what drove the impairment? And then, if you just sort of step back and you talk about maybe your incremental appetite for alternatives which seems to be a pretty big area of growth still for the industry.

Kenneth A. Lewis - Chief Financial Officer & Executive Vice President

Sure. So the impairment wasn't related to K2. In total, it was related to a specific component of the K2 business, which would have been the old business contracts that we put a value on. And so we were just adjusting that value based on there've been a couple of redemptions and there've been sales having met the original projection. So, that's why we impaired it. So, it's just that one stream of business, if you will, not the entire enterprise.

William Raymond Katz - Citigroup Global Markets, Inc. (Broker)

And just your bigger picture view on appetite for alternative capabilities?

Kenneth A. Lewis - Chief Financial Officer & Executive Vice President

I hand that to Greg.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah. I mean, I think we still view it, as you said, in a strong area of growth and we're going to continue to look at expanding the product line in less traditional types of investments. So, we're – whether it's M&A or building it organically, that's certainly part of our plan.

William Raymond Katz - Citigroup Global Markets, Inc. (Broker)

Okay. And this is follow-up. You had mentioned in your pre-recorded call, maybe just happenstance, but you had listed deals first within your use of cash – cash flow. Sort of wondering if you step back, how you're thinking about capital management priorities given when the stock recovery versus growing out the business. And within M&A, what kind of things are you looking at?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah. I think that it might have been happenstance. Probably that ordering – I don't think it was intentional. And I say that because nothing has changed in our strategy, our capital management strategy. I mean, we don't say the stock is up or down so now we'll place more or less emphasis on M&A. They're all kind of independent positions. And we're continuing to focus on M&A – evaluate M&A opportunities. That hasn't changed.

William Raymond Katz - Citigroup Global Markets, Inc. (Broker)

All right. Thank you.

Operator

Thank you. Our next question comes from the line of Patrick Davitt with Autonomous. Please proceed with your question.

Patrick Davitt - Autonomous Research US LP

Thanks for the time. Going back to the expense guidance quickly, I just wanted to clarify that the 3% decline does include kind of all these onetimers we're talking about.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

It does.

Patrick Davitt - Autonomous Research US LP

Yes. Okay. Perfect. And then on the DOL, can you speak to Schwab decision to stop selling loaded funds today from the standpoint of your own exposure to them, if at all? And then more broadly, what that could mean for your sales, in particular, if that becomes a trend for the broader distribution world?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah. I mean, I have to say I wouldn't make much of that decision. I doubt they do anything in what we – particularly you called loaded sales and everybody looks at the A share sales and assumes somebody's paying commission. For us, it's now less than 9% of our sales have a commission on them and we are traditionally what you'd call, I guess, load-based firm. So for Schwab, that's an – I would say it's a non-event that they're not doing that because it's probably less than 1% of their sales.

Patrick Davitt - Autonomous Research US LP

Right.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

And the world, as we know, continues to move towards fee-based and with the fiduciary changes probably more with R6 or shares that don't have 12b-1 fees associated with them, you'll see more and more of that.

Patrick Davitt - Autonomous Research US LP

And you say 9%, that means kind of all kinds of commissions frontload, 12b-1, et cetera.

Kenneth A. Lewis - Chief Financial Officer & Executive Vice President

That's 9% of U.S. commissionable sales.

Patrick Davitt - Autonomous Research US LP

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Michael Kim with Sandler O'Neill & Partners. Please proceed with your question.

Michael S. Kim - Sandler O'Neill & Partners LP

Hey, guys. Good morning. First, Greg, I know you called out the two global equity institutional redemptions at total $1.8 billion, but it sounds like there were some other lumpy institutional redemptions related to allocation changes and/or sovereign wealth fund redemptions. So just wondering if you could sort of provide any more color on maybe the size of those losses and/or the strategies impacted, and any sense of sort of the residual AUM that might be at risk for further attrition.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah. I think the – there's probably another – there were two accounts that were – at total $1.8 billion global equities, one Middle Eastern sovereign wealth and another in Australia doing a rebalancing of a global equity. And then really only – there was only two other large global equity that were about $300 million apiece in Canada.

It's interesting. I think looking at quarter-to-quarter, our global equity was actually – while the net number was very high out, it was mostly due to this institutional redemption fee. Retail trend is actually better, and I think the retail trend is important, too, to call out just in general that it was a lot better than the prior quarter with redemptions declining as well during kind of a choppy quarter. It's really the institutional quarter-over-quarter change in flows that mask, I think, some of the improved trends within the retail side, especially the hybrid side.

Michael S. Kim - Sandler O'Neill & Partners LP

Got it. That's helpful.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah. Nothing else to really, I think, call out on the large institutional ones.

Michael S. Kim - Sandler O'Neill & Partners LP

Okay. And then just to come back to M&A, any color on what you're seeing across the landscape in terms of pricing and/or competition, particularly in light of the recent rebound in the markets? I guess been hearing anecdotally that maybe the pipeline is starting to pick up, if you will.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Well, I mean I would just – Ken can jump in. I think that's right. I think when you're kind of in market lulls and volatile periods, you don't really see a lot. And I think that's been kind of true that there hasn't been a ton of M&A activity. And as markets rebound, I think that people start thinking about it, so I think that's fair. I don't know if we could say specifically that we've seen that, but that certainly has been the case historically and pass it to Ken.

Kenneth A. Lewis - Chief Financial Officer & Executive Vice President

Yeah, I agree. We haven't seen any specifics – changes in the trends. I mean, there are a number of targets out there that are always being rumored to sell and whatnot. And perhaps some of those are changing from non-actionable to actionable, but we haven't really seen a pickup in opportunities.

Michael S. Kim - Sandler O'Neill & Partners LP

Okay. Thanks. Thanks for taking my questions.

Operator

Thank you. Our next question comes from the line of Ken Worthington with JPMorgan. Please proceed with your question.

Kenneth B. Worthington - JPMorgan Securities LLC

Hi. Good morning. Gross sales across the board look weak over a multi-quarter period and it's driven by those cyclical and secular issues. Are ETFs in these multi-asset products, do they have big enough potential over, say, the next three to five years to offset the redemptions that Franklin is facing? And if those products don't have the potential, what's your next step into kind of driving the business back to positive organic growth?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Well, I think it's hard to ever know. I think the multi-asset's a huge category that continues, I think, to garner more attention in the distribution channels and I think for a lot, it makes a lot of sense. I would look at the organic growth rate trends are more the flagship areas like the Income Fund, which somewhat has been a multi-asset before people started calling it that.

You've seen a pretty strong rebound in two quarters of performance, and that can translate pretty quickly into organic growth. If these trends continue, that have really been moving that last couple of months. And we have seen that fund move from, just the fund alone, $3.5 billion in net outflows in the prior quarter to $1.9 billion this quarter and that continues to improve. So, that's always been a big driver of net flows.

I think the Global Bond one is a little bit harder, a different category and not – while it's doing better with some of the emerging currencies, I think the duration in rates continuing to decline. Need to back up in rates. If the rates back up, that will see significant organic growth and I think pretty darn quickly because it'll be one of the few funds that will do well in that environment.

So, I think you continue to bring new products out there and hope you catch on in a way that it can grow. But certainly the multi-asset category is a huge one and you've seen what's happened in Europe with it. So, there's no reason why that can't happen here in the U.S. as well.

Kenneth B. Worthington - JPMorgan Securities LLC

Great. Thank you very much.

Operator

Thank you. Our next question comes from the line of Ken Hill with Barclays. Please proceed with your question.

Kenneth Hill - Barclays Capital, Inc.

Hi. Good morning. Just had one on repurchases, so you guys have come – had a few really strong quarters of repurchase, but I'm assuming some of that was opportunistic in nature. I'm just wondering how to think about that moving forward and kind of what level at your stock price might cause you to purchase more or purchase less from a U.S. cash perspective. Thanks.

Kenneth A. Lewis - Chief Financial Officer & Executive Vice President

Sure. So, I think – I was anticipating I might get this question looking back at our history over the last eight or nine quarters and I think the message that I want to give is that our strategy for repurchases is consistent. I don't see anything today that would cause us to change what we've done historically. And sure, it's definitely in terms of activity ramped up when the prices declined in the opposite, but we continue to believe in the stock and we'll continue to be opportunistic.

Kenneth Hill - Barclays Capital, Inc.

Okay. And then just as a follow-up, I know you guys mentioned in the pre-recorded call expanding into some of the local markets. I think Poland was the one you mentioned. Just wondering the strategic rationale for that type of investment in a smaller market versus maybe some of your key geographic centers on the distribution front.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Well, I think it's a question of resources being taken away from some of the bigger markets because of our initiatives in the smaller one. I think we have always felt that part of the competitive edge we have is our presence in all these different markets. And for us, Poland is also one of our operations and servicing centers for Europe, and we have a lot of employees that have strong presence there and it is a growing middle class in that market.

And you take markets like a Taiwan that, for us, years ago, somebody would've said why are you bothering with that. But they can become very meaningful if you have an early dominant position. So it's not taking away any resources for us; it's just continuing to build out that retail capability where it makes sense, and you add it all up and it can be very meaningful.

Kenneth Hill - Barclays Capital, Inc.

Okay. Appreciate the color there. Thanks.

Kenneth A. Lewis - Chief Financial Officer & Executive Vice President

Thanks.

Operator

Thank you. Our next question comes from the line of Michael Carrier with Bank of America. Please proceed with your question.

Michael Roger Carrier - Bank of America Merrill Lynch

All right. Thanks a lot. Greg, on your – the pre-recorded call, you just mentioned as the market rebounded, both performance and redemptions were showing signs of improvement. I just wanted to get some color on what you saw.

And then, I think sometimes when we look at the one-year to three-year performance, you've mentioned when some of the larger funds are maybe just under the 50 percentile. So just wanted to get any color on the larger funds, if they're kind of approaching that threshold to see the performance start to pick up.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah. I mean, I think it is significant because I would look at the first two months of this last quarter as in a risk-off environment where it was – the underperformance was getting worse every day and just the last six, seven weeks, it's been probably the best overall performance and we talked about some of the concentrated exposures that we have overall as a firm.

But I think that to me, it's almost also a leading indicator to the market where we were saying, hey, it's been 10 years of this growth value cycle and, all of a sudden, value is starting to outperform and you look at even emerging markets had a better quarter. Value was up 7.5% and growth was up 3.3%.

So you have – I think the turnaround and what people have been looking for whether it's currency is doing better abroad, oil obviously rebounding, and that affects probably four major groups' performance right now with the energy exposure and also the high yield exposure in the Income Fund. I think all of that can turn pretty quickly. I don't know exactly which ones are right. I haven't looked at that to say the three-year number who is within two percentage points or that. But I think the more important number is the market kind of gets the drivers for our bigger funds and I think for the first time in a while, we're getting some wind behind us as far as the relative performance goes.

Michael Roger Carrier - Bank of America Merrill Lynch

Okay. Thanks. And can you just – a quick follow-up. Just on the impairment, I think you mentioned there was maybe an offset. Just wanted to try to understand maybe what the net impact was on maybe the G&A line just to understand from – what the build-off (25:03). And then I think you also mentioned about $20 million in performance fees. So I know those are hard to predict but maybe just in terms of locks or when you typically realize the outlook there.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Sure. Maybe it's better to just give you what we're thinking about in terms of G&A going forward. We do think that that line is going to come down a little bit so we're not expecting a lot of upward pressure there, keeping in mind that there's a lot of market-driven items that go through that line.

So assuming a flat market, we just generally expect for the remainder of the year for that expense to come down from where it's been in the last two quarters. So, I mean, I'm not avoiding your question. It's just that you don't want to, like, waste all the time with the in-and-out accounting details. But generally speaking, we're thinking for G&A and other to kind of come down a little bit from where it's been the last two quarters for the rest of the year.

Michael Roger Carrier - Bank of America Merrill Lynch

Okay. That's helpful. And then just on the performance fees.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Sorry. Yeah. The performance fees, yeah, they are hard to predict and they impact over $20 million. If I think about it in terms of seasonality, typically we might have a little bump-up next quarter. So I mean, it wouldn't be unusual for us to see some performance fees next quarter and then, the fourth quarter, typically we don't have too much.

Michael Roger Carrier - Bank of America Merrill Lynch

Okay. All right. Thanks a lot.

Operator

Thank you. Our next question comes from the line of Chris Harris with Wells Fargo. Please proceed with your question.

Chris M. Harris - Wells Fargo Securities LLC

Thank you. A larger question, big picture question I guess on the flows. If you look at this quarter relative to last, things got a little worse, but we've talked about some of the drivers, the institutional impact and so on. But also I guess there's another impact and that's the market selling off as much as it did in the first part of the quarter. And so I'm wondering, I know this is probably really hard to gauge or frame up, but how much impact do you guys think that had on the flows? And I guess what I'm getting at is if we sort of didn't have this mini blow-up in the market, might the flow picture looked even better than actually what occurred?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Well, I think it would. I mean, I don't think there's any question it was – when the market sell off to a 10% down through the first couple of months, that – and generally what is a very strong month this January. So, it's always very hard to say what would it mean, what would the number look like, but certainly, it definitely had an impact. And especially as I said for us, I mean, the positions that we had and with the dollar, oil and energy value growth, everything kind of moving the wrong way for the first couple months, that didn't help in the key areas where we had the largest assets.

And we've seen the impact, and redemptions were actually a little bit lower for the quarter, which is kind of counterintuitive a little bit, but gross sales dropped quite a bit. That's what generally happens in that --when you get in that really volatile period.

Chris M. Harris - Wells Fargo Securities LLC

Got it, okay. And follow-up question on the taxable U.S. fixed income business. There's still outflow in there. Can you speak to that? Is that primarily a performance issue? And if so, what's the driver?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

The U.S. taxable?

Chris M. Harris - Wells Fargo Securities LLC

Correct.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Oh, I think a part of it was just the high yield exposure and for us having a fair amount of assets in the high yield area and the overexposure to energy there, I mean that led to some of the outflows.

Chris M. Harris - Wells Fargo Securities LLC

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Brian Bedell with Deutsche Bank. Please proceed with your question.

Brian Bedell - Deutsche Bank Securities, Inc.

Hi. Good morning. Thanks for taking my questions. Maybe, Greg, just go back to the $130 billion of assets that you thought were at risk from the Department of Labor perspective. If you could just stratify the 401(k) part of that, I think we were spending – less than $20 billion of that would be 401(k). And then, if the rest of that is IRA-related, are you just looking at the accounts that are with brokers in that regard? So would IRA assets be higher than that, overall?

And then, is there – to any extent you think pricing dynamics might change in a post-DOL world, would that influence some decisions, longer term decisions on changing pricing structures in your funds including 12b-1s?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah. I mean, as I've said, I wish we had an exact number because it's a little bit hard to collect and we did our best to collect from various sources. And I think the 401(k) specific number, which mostly is investment-only business, is about $31 billion, $30 billion, somewhere in that range. And IRAs are probably in the $70 million to $100 million range, I guess, is our best guesstimate there.

And I think when you say it – I wouldn't say it's at risk. I mean, I think there's clearly – it means there's going to be some changes in how they're serviced and how we service and how we deliver through the advisor community, and still a lot of work to be done there. We have the share classes already in place that are being used today and some of that could move to those types of classes.

We think the net result will be there will be more motion of money and we want to make sure, first and foremost, that we're doing everything with our advisors to make sure that the burden – we can help them manage this huge change.

Brian Bedell - Deutsche Bank Securities, Inc.

No, that's helpful color. And then I think, Greg, on the last quarter comfortably, you mentioned there were some large variable annuity accounts, so we're doing allocation changes. And I thought you said there was one that looked like it was susceptible coming in that. I don't think that came in the – correct me if I'm wrong, did that come in this quarter or is that something that still remains a potential redemption?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah. That got moved back for a while; I think probably six to nine months from hitting this quarter. So we'll keep you posted when we get better color, but it's still, I think, still hanging out there.

Brian Bedell - Deutsche Bank Securities, Inc.

Okay. Great. Thank you.

Operator

Thank you. Our next question comes from the line of Alex Blostein with Goldman Sachs. Please proceed with your question.

Alexander Blostein - Goldman Sachs & Co.

Thanks, guys. So one more to DOL, if I may. So, speaking through – obviously the rule is still fresh and I'm assuming we're all kind of collecting information from various distribution channels on how things will continue. But when you take a step back, the $100-plus billion as I'm assuming it's grandfather and obviously because the sales already occurred. But taking a step back, do you guys think performance will be a much bigger kind of point of influence on the way financial advisors decide how to allocate assets from here? And I guess the reason I'm asking is if a fund underperforms for a brief period of time, is there greater risk redemptions other than new contract (33:08) versus what we've experienced in the past?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

I mean, I do think it's early to speculate on those types of thoughts. And obviously, it'd be nice to have clear rules and, here, we don't in a lot of cases on the suitability and standard and how it's enforced and risks, and how advice is delivered. And I think a lot of that has to be vetted and figured out and a lot of legal fees to get there. And then, you're still going to have some exposure in doing it. So even the question of figuring out performance and what time period is the right one and at that at end of the day, anybody can question an underperforming fund versus an index during any given period. And I think those are the questions that we have to somehow address.

I think at the end of the day, a lot of it is always performance-driven and more than ever. Today, you have more consultants involved in the selection of the platforms. So I think that has been in place for a while. And regardless of a fiduciary rule, I think that was just the trend where a lot of the 401(k) plans having a strong kind of – consultants helping pick the options, I think, that performance will always be critical.

Alexander Blostein - Goldman Sachs & Co.

Right. Thanks. And then kind of just one follow-up on expenses. You guys have done a good job maintaining margins at the current levels and keeping expenses well managed despite of severance and a few other onetimers kind of running through the numbers. Just curious if you were to kind of strip all that out and say, okay, the base line is maybe a little bit over $2 billion for the year, how much more room do you guys have to drive the non-distribution expenses lower into the next 12 months or so assuming markets are flat?

Kenneth A. Lewis - Chief Financial Officer & Executive Vice President

I think we're at the point – I think there's room. I think there's room to drive the expenses down more in a number of different areas. And kind of – what's left, though, is a little bit more complicated to sift through and come up with definitive plan. So, it's going to take a little bit longer to execute those cost savings than the ones we've done so far. But that doesn't mean that there's not more room to trim expenses, it's just going to be harder to see that impact in the P&L in the short term. It could take longer.

Alexander Blostein - Goldman Sachs & Co.

I see. Great. Thank you.

Operator

Thank you. Our next question comes from the line of Michael Cyprys from Morgan Stanley. Please proceed with your question.

Michael J. Cyprys - Morgan Stanley & Co. LLC

Hi. Good morning. Thanks for taking the question. Just wondering if you could elaborate a little bit more just on your last point on some of those additional expense savings that could come through that could take a little bit longer, what some of them might be. I think in the past, I mean you referred to potentially greater outsourcing. Just any update on that and just generally how you're thinking about additional actions that you could take on the expense side.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah. I think it's more just looking at the way we do things and challenging our business processes that may have been set up when the business environment was different, and just seeing if there is ways we could leverage technology to do things smarter and better and more efficiently and gain more scale. That's the point I'm trying to make.

When you start to take that approach, it gets a bit more challenging and time-consuming to go through and that. But those are the type of things. So specific lines of business, perhaps specific functions. Just are we – is our processes best-in-class right now or can they be improved? That's what we're looking at.

Michael J. Cyprys - Morgan Stanley & Co. LLC

Got it. Okay. And then just as a follow-up, just trying the M&A. Just curious how active the dialogue has been on the M&A side and to what extent we gotten close on a deal and if that's the case, sort of what's been the hang-up? And if you could just talk more broadly to your M&A strategy, what sort of AUM or deal value magnitude you think makes the most sense, characteristics that you're looking for right now?

Kenneth A. Lewis - Chief Financial Officer & Executive Vice President

Well, there's different ways of looking at M&A. I mean, we never start with, okay, we need an AUM target so let's look at the targets that have that assets under management and consolidate. It's more of a strategic-driven approach and the debt you have to marry with what the supply is and what the targets bring to the table. So everyone – every single deal that we look for the strategic rationale tends to be bespoke and adjusted for that target, so very difficult to generalize like in terms of AUM targets or specifics.

Michael J. Cyprys - Morgan Stanley & Co. LLC

Okay. Just on the activity of the dialogue, have you gotten close to anything and what's sort of been the hang-up, if you have?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

I mean, again we have dedicated people that are out there looking at the industry and like I wouldn't say anything been closed and we probably wouldn't mention that anyway, but we're going to continue to look. And as we said on the last call, it continues to be a priority with the offshore cash to utilize that in a way that enhances shareholder value and that's really what we're trying to do.

Michael J. Cyprys - Morgan Stanley & Co. LLC

Okay. Thanks.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

I think looking back, if there's one common theme for why deals weren't done, it tended to be cultural fit

Michael J. Cyprys - Morgan Stanley & Co. LLC

Okay. Thanks.

Operator

Thank you. Our next question comes from the line of Eric Berg with RBC. Please proceed with your question.

Eric Berg - RBC Capital Markets LLC

Thanks very much and good morning. On the area of expenses or in the area of expenses, would you say that if the equity market were this volatile as it has been and if equity prices were higher, not off the way they are compared with a year ago, would you still say that given the state of the business, what's going on in your industry, that there would still be a need to lower expenses?

Kenneth A. Lewis - Chief Financial Officer & Executive Vice President

I think there would be perhaps more of a desire or want than a need, but we would still focus on that. And I think that that's a lesson that we've learned during the last two downturns that it's human nature when times are good to relax the purse strings and do things and do the nice to haves. But I think as a firm, we've grown up and realized that we need to be disciplined so that we don't get into those situations where we have to have massive layoffs or something at downturn and disrupt the business. So...

Gregory Eugene Johnson - Chairman & Chief Executive Officer

But I would also add – I mean, your question just beyond what are the obvious issues the active manager faces in today's marketplace with – and changes in the distribution model and regulatory environment. Even in a robust environment, you'd probably, yes, be looking for more efficiencies, but I'd also say you don't cut your way to prosperity. And we have always felt like there are times when we have to continue to invest, to be strategic, to do M&A, to bring out new products. I mean, I think it's a changing world, and just trying to cut your way to maintaining margins, you'll be out of business at some point.

Eric Berg - RBC Capital Markets LLC

And if I could just have a little discussion with you following up on the matter of share classes and the DOL. I find it almost a full-time job keeping track of share classes A, B, C, R, L, I, Advisor class, Investor class, Admiral class, it goes on and on. The lexicon differs by company.

I'm wondering whether one of you could maybe make it a little bit easier for us by offering any general comments you think hold true as to what is going to happen here. In other words, can we say just as a general statement that irrespective of what the share class is called, A, B, C, R, L, I, whatever, that lower expense ratio share classes will be doing better as a result of DOL? That's what I'm sort of looking for, some general guidance on how to think about this.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

I mean, I think that's right. I think there's more pressure, especially for newer business, to utilize what we call an R6 class. But again, I think it – there's still a lot of work to be done before you can draw any conclusions on how fast that'll move. And certainly, you can conclude that the lower end of the market will be more passive, robo, and less people-intensive or advice-driven.

Those conclusions you can kind of draw how quickly the pace moves to specific classes. I think, as you said, there's a lot of work to be done in the meantime before you can just say X percent's going to be there by this date.

Eric Berg - RBC Capital Markets LLC

Thank you.

Operator

Thank you. Our next question comes from the line of John Dunn with Evercore ISI. Please proceed with your question.

Unknown Speaker

Hi. It's Finn (43:24) in for Glenn Schorr. Can you guys give us a little more color on that composition of the sales and distribution fee line, maybe what's the recurring fees versus the 12b-1, et cetera?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah, I can. So think it was – let me just get your reference there. I think that we included a slide. Maybe it was it was 27%-ish or something. It's in the back that kind of breaks down. So there is a component of those two lines, distribution, revenue and expense that is sales-based and we've talked a lot about what percentage of the assets are sales-based. It's very small. And then the percentage that's asset-based.

And so part of the reason that the net line has been going down is because of the assets under management be going down. So if you look forward a couple of quarters, I would expect that the net number would be a little bit less than it has been. I think it's been, I'm going to guess, like 115, something like that and probably it might – we're thinking now flat markets. It might go down to like 105 net per quarter.

Unknown Speaker

Got you. Thank you.

Operator

Thank you. Our next question comes from the line of Patrick Davitt with Autonomous. Please proceed with your question.

Patrick Davitt - Autonomous Research US LP

Hi. Thanks for the follow-up. With the understanding that DOL's really focused on the relationship between the broker and the client, do you guys think there's any risk of increased expense load at the manufacturer level and thus at your level as a result?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Well, I think there's an increase in just your – I don't know if I'd call it specifically on your share class, but certainly the potential for an increase in how we did business versus how we're going to do business and terms of compliance costs and how we assist the adviser. Think all of that it's still there. We have a close partnership with many of them in delivering this and a lot of that has to be done, but there's no question that there's a major cost burden of compliance to – between all of the disclosures and sign-offs that has to be done that will increase costs.

Patrick Davitt - Autonomous Research US LP

Is any of that in your expectations right now?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

No. I think it's too early to try to budget that or figure out how that's going to be worked, but I think we would anticipate that based on everything we've seen.

Patrick Davitt - Autonomous Research US LP

Yeah. Okay. And just one last one, it looks like for some of the larger funds that have been underperforming, that short-term performance is starting to bleed into the three- and five-year numbers. Are there any large platforms or consultants that may be more focused on those longer term numbers that you could be worried about right now?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

I think you always worry about that. But as I said earlier, I think what people – if you could understand that performance in relation to the market, simply whether it's value growth or different exposures in portfolios and then look at more near term and just – I don't think I've seen a better six-week period of relative performance for our flagship holdings, and so that's going to bleed in pretty quickly, too.

Patrick Davitt - Autonomous Research US LP

Right.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

When you have 500 basis points, 800 basis points of outperformance in a six-week period, that's going to help pretty quickly. And I think that's the momentum certainly with Templeton energy dollar, more recently some financials. All of that moves to numbers pretty quickly. So I would be more encouraged about the six-week trend than I would worrying about bleeding into the three and five because that's going to be more important. And as I said, that will bleed in, too, pretty quickly.

Patrick Davitt - Autonomous Research US LP

Great. Thanks a lot.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Thanks.

Operator

Thank you. Our next question comes from the line of Brian Bedell with Deutsche Bank. Please proceed with your question.

Brian Bedell - Deutsche Bank Securities, Inc.

Hi. Thanks for taking a couple of follow-ups. I think you mentioned, either Ken or Greg, on the pre-recorded call about the – that the fee rate being different on a simple monthly average versus an average – daily average. I think you said a basis point differential. Just wanted to sort to get color on the go-forward fee rate given the mix, is that then therefore fairly stable with the fourth quarter or do you see that lower?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Right. So I just pointed that out because – and it was my feeling that we're not seeing a big change in the effective fee rate for the mix. In general, over the last longer term, it's been coming down a bit but it comes down very gradually. It's been coming down very gradually and it's effectively very stable percentage. So that's why I tried more to point out the anomaly this quarter.

Brian Bedell - Deutsche Bank Securities, Inc.

Yeah. It looks exacerbated by the average in calculation is what you're saying.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah.

Brian Bedell - Deutsche Bank Securities, Inc.

Yeah. Okay. And then I missed your response to the question on the performance fee outlook in the next quarter or two, if you want to repeat that.

Kenneth A. Lewis - Chief Financial Officer & Executive Vice President

I think the caller before said it correctly, it's very difficult to say it because obviously it depends on the markets. If the global equity has a good quarter, I would expect to see some performance fees in June, maybe July that were similar to perhaps last year, but it's very difficult to say.

Brian Bedell - Deutsche Bank Securities, Inc.

Okay. That's fair. Thank you.

Operator

Thank you. Our next question comes from the line of William Katz with Citigroup. Please proceed with your question.

William Raymond Katz - Citigroup Global Markets, Inc. (Broker)

Okay. Thanks so much. I joined a couple of minutes late, so I apologize if you did cover this. How did you stratify your platform that you came up with $130 billion of assets that might be at risk? And then when you thought about that, what kind of risk do you anticipate?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah. I mean, it's a great question and I couldn't tell you how much – in terms of quantifying risk, I think we did our best in a, for us, in a world where we have omnibus and assets. We don't seem to come up with a fair guesstimate around how much is in 401(k) and how much is in IRAs, and we didn't include – if we include VA, that number is probably $180 billion of exposed assets, breaking out between about $50 billion in VAs and $20 billion, $28 billion in 401(k) investment only, and the rest in IRAs.

So I don't think there's a big – certainly there's more risk than an average account because of the changes that are being imposed on the industry. But I don't know how I could possibly quantify that right now, Bill.

William Raymond Katz - Citigroup Global Markets, Inc. (Broker)

Just a matter of segment, what you chose. Just what is an IRA – I just want to understand, just an IRA or 401(k), then that's basically the selection criteria you used against the $130 billion.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Right. Right. Right. Yeah, and then VA on top of that.

William Raymond Katz - Citigroup Global Markets, Inc. (Broker)

I understand. Okay. And then just one last follow-up. Ken, you mentioned that there may be another impairment coming down either in the fiscal fourth quarter or early next year, fiscal next year. You probably won't be specific on the call, but can you generally talk about where that might be and is it an AUM level? Is it an exit-of-business strategy? I'm just trying to understand what that might be.

Kenneth A. Lewis - Chief Financial Officer & Executive Vice President

Yeah. So, I was referring to we're winding down a defined benefit plan in the UK and I'm not really sure on the timing of that but that's what I was referring to. It could be fourth quarter. It could be first quarter next year.

William Raymond Katz - Citigroup Global Markets, Inc. (Broker)

All right. Thanks so much.

Operator

Thank you. Our next question comes from the line of Michael Cyprys from Morgan Stanley. Please proceed with your question.

Michael J. Cyprys - Morgan Stanley & Co. LLC

Hi. Thanks for the follow-up. Just curious if you could provide any sort of color on April flows and performance trends so far given some of the positive commentary that you've provided around the end of March.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah. I mean, as you know, we're careful about any looking-forward pass the prior quarter. I would just say that the trends that were in place continue even today with oil continuing to move and energy moving in the right way, the dollar weakening, helping our assets and relative performance for some of our areas. So, all of that helps and certainly helps with the pressure on retail redemptions that you have a nice sort of rebound there, so I'll kind of leave it at that.

Michael J. Cyprys - Morgan Stanley & Co. LLC

Okay. And then, anything that we should be keeping our minds on in terms of potential lumpy institutional inflows or outflows?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Oh, I think there's still pressure on the VA business as some of it closed out, so there'll be some lumpy timing items over the next year but nothing to really call out the next quarter.

Michael J. Cyprys - Morgan Stanley & Co. LLC

Got it. Thanks.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Thanks.

Operator

Thank you. There are no further questions at this time. Mr. Johnson, I'll turn the floor back to your for any final remarks.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Well, thank you again, everyone, for participating on the quarterly call, and we look forward to speaking next quarter. Thanks.

Operator

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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