Cohen & Steers, Inc. (NYSE:CNS)
Q2 2016 Earnings Conference Call
July 21, 2016 10:00 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
Ari Ghosh - Credit Suisse
John Dunn - Evercore ISI
Ann Dai - KBW
Mac Sykes - Gabelli
Ladies and gentlemen, thank you for standing by. Welcome to the Cohen & Steers Second Quarter 2016 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Thursday, July 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 the Cohen & Steers second quarter 2016 earnings conference call. Joining me are 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 cohenandsteers.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 non-GAAP financial measures, which we believe are meaningful in evaluating the company’s performance. For disclosures on these non-GAAP financial measures and their GAAP reconciliations, you should refer to the financial data contained in our second quarter earnings release and presentation, which are available on our website.
Finally, this presentation may contain information with respect to the investment performance of certain of our funds and strategies. I want to remind you that past performance is not a guarantee of future performance. This presentation may also contain information about funds that have filed registration statements with the SEC that have not yet become effective. This communication does not constitute an offer to sell or the solicitation of an offer to buy these securities. For more complete information about these funds, including charges, expenses and risks, please call 1800-330-7348 for a prospectus.
With that, I will turn the call over to Matt.
Thanks very much, Adam. Good morning, everyone and thanks for joining us today. As I am sure you have noticed our earnings release now contains certain non-GAAP measures, which we believe provide greater transparency into our operating results. As this is a transition quarter, I will be speaking to both the GAAP and as adjusted results. With respect to the second half of the year, my comments will focus on the as-adjusted results.
Yesterday, we reported diluted earnings per share of $0.53 compared with $0.42 in the prior year and $0.39 sequentially. The first quarter included a non-cash expense of $1.9 million or $0.03 per share associated with the accelerated vesting of certain restricted stock units. As adjusted, earnings per share were $0.46 in the first quarter – for the second quarter compared with $0.42 in the prior year and $0.41 sequentially. Adjusted earnings for these periods excluded the results from seed investments, the dividend and interest income on those seed investments and the non-cash expense on the accelerated vesting. Income taxes associated with these results have also been excluded.
Page 4 of the earnings presentation which is available on our website shows the current and trailing 4-quarter trend in revenue and breaks out investment advisory fees by vehicle. Revenue was a record $86.4 million for the quarter compared with $83.5 million in the prior year’s quarter and $79.7 million sequentially. The increase in revenue from last quarter was primarily attributable to higher average assets under management. Average assets under management for the quarter were also a record at $55.9 billion compared with $53.3 billion in the prior year’s quarter and $51.6 billion sequentially.
Operating income was $34.1 million compared with $31.2 million in the prior year and $28.3 million sequentially. Operating income as adjusted was $30.3 million in the first quarter. Our operating margin increased to 39.5% from 35.5% last quarter. Operating margin as adjusted was 38% in the first quarter. The 150 basis point increase from last quarter’s adjusted operating margin was primarily due to lower G&A costs relative to revenue.
Page 5 of the earnings presentation shows the current and trailing 4-quarter trend in expenses which increased 5.7% on a sequential basis after adjusting for the accelerated vesting in the first quarter. Increases in compensation and benefits and distribution and service fees were partially offset by decreases in G&A and depreciation and amortization. The compensation to revenue ratio was 32.75% for the quarter, consistent with the guidance provided on our last call. The increase in distribution and service fee expense was consistent with the growth in average assets in our U.S. open end mutual funds. The decrease in G&A was primarily due to lower costs associated with hosted wealth management marketing events and depreciation and amortization declined $205,000 from last quarter.
As a reminder, the first quarter included a write-off of certain fixed assets that were taken out of service. We recorded a non-operating gain, net of non-controlling interest of $4.4 million in the second quarter compared with a non-operating gain of $859,000 last quarter. Non-operating results were primarily due to unrealized gains on seed investments. As a result of our capital loss carry-forwards, income taxes are not recorded on gains associated with our seed investments. The effective tax rate of 35.5% for the quarter included the cumulative effect of an adjustment to reduce the full year expected tax rate to account for the utilization of our capital loss carry-forwards.
Page 12 of the earnings presentation shows our cash, cash equivalents and seed investments for the current and trailing four quarters and specifies that portion of our cash and cash equivalents held outside the U.S. Our firm liquidity totaled $207 million compared with $186 million last quarter and stockholders’ equity was $255 million compared with $238 million at March 31. We remain debt free. As a reminder, last quarter we revised our assets under management tables to reflect distributions as a separate line item and to classify dividend reinvestments as inflows.
Total assets under management, which can be found on Page 6 of the earnings presentation, totaled a record $58.7 billion at June 30, an increase of $3.7 billion or 7% from March 31. Assets under management in institutional accounts totaled $29.6 billion at June 30, an increase of $1.7 billion or 6% from last quarter and open-end funds had assets under management of $19.8 billion, an increase of $1.6 billion or 9% from last quarter. Assets under management and closed-end funds increased 4% to $9.4 billion. For the quarter, we recorded net inflows of $2.3 billion, an annualized organic growth rate of 17%. This marks the seventh consecutive quarter we have recorded net inflows and our highest quarter of net inflows since the second quarter of 2011.
Page 9 of the earnings presentation shows net flows by investment vehicle. Institutional accounts recorded net inflows of $1.1 billion in the second quarter, an annualized organic growth rate of 16%. During the second quarter, sub-advised portfolios in Japan recorded net inflows of $840 million compared with $864 million of net inflows last quarter. Distributions increased by $99 million to $752 million from $653 million last quarter. The continued increase in distributions has been driven by the recent strengthening of the yen as well as growth in the funds from net inflows and market performance.
Sub-advised accounts ex-Japan recorded net outflows of $30 million. Advised accounts recorded net inflows of $327 million during the quarter. Inflows of $550 million from global-listed infrastructure and multi-strategy real asset mandates that were included in last quarter’s pipeline were partially offset by outflows of $240 million from U.S. and global real estate, mostly due to client rebalancing. This marks the fourth consecutive quarter we have recorded net inflows into advised accounts. Our President, Joe Harvey, will provide some color on the level of activity and our institutional pipeline in a moment. Open end funds recorded net inflows of $1.2 billion during the quarter, an annualized organic growth rate of 25%. This marks our highest quarter of open end fund net inflows since the first quarter of 2007. Distributions totaled $375 million during the quarter, of which $268 million are reinvested.
Given the recent market reaction to Brexit, I thought it would be helpful to discuss our business and to quantify our exposure in Europe. Our European business has been focused on developing institutional advised and sub-advised relationships. European clients comprised approximately $2.9 billion of our assets under management at June 30, of which $75 million were based in UK. On the investment side, European-listed securities comprised approximately $3.6 billion of our assets under management at June 30, $1.4 billion of which were in the UK.
Let me briefly discuss a few items to consider for the second half of the year. With respect to compensation and benefits, we expect to maintain a 32.75% comp to revenue ratio. We still expect that G&A will increase approximately 1% to 2% from last year. And finally, we project that our effective tax rate as adjusted will remain at approximately 38%.
And with that, I would like to turn it over to Joe Harvey.
Thank you, Matt and good morning everyone. We experienced positive trends in the second quarter and faced some challenges, yet overall, we were pleased with our results. Markets were volatile in the quarter, but strongly favored our core asset classes compared with the S&P 500 which returned 2.5%. Measured by the indexes, MLPs and commodities led the returns across our strategies at 20% and 13%, respectively. U.S. REIT returns were also strong at 7% as were natural resource equities at 7%. Markets expressed seemingly inconsistent expectations as the quarter progressed. The 10-year treasury yield declined to 1.5%, suggesting slow growth, disinflation and a flight to safety amidst Brexit concerns. Yet, oil and commodity prices continued to rally.
These conflicting signals are hard to reconcile, especially in light of our view that inflation should accelerate towards 4% into 2017, driven by rising energy, rent and food prices. While part of the inflation bump should be temporary, rising wages, prospects for additional central bank and fiscal stimulus and a likelihood that commodities have entered a new bull market, suggest to us that the positive market performance in real assets will continue, while the fixed income bull market has less and less room to run. We are increasingly vary of the signals from the bond market considering the ever increasing influence of central banks.
Turning to investment performance, Page 11 of the earnings presentation provides a high level overview of our relative performance and Morningstar fund rankings. For the quarter, 5 out of 10 core strategies outperformed or were in line with benchmarks. Similarly, 5 of 10 strategies outperformed or were in line for the trailing 12 months. Our commodity related strategies commodities, natural resource equities and MLPs, have performed well relative to benchmarks so far this year. Our preferred strategy which underperformed in the first quarter, as global bank credit concerns spiked, had a strong second quarter while navigating Brexit and is closing in on the benchmark this year while beating peers.
Our U.S. and global real estate strategies had their second consecutive quarter of underperformance. We got a few things rolling on the property sector and country positioning and the yields squeeze hurt as we have been positioned for improving economic growth through lower yielding growth oriented companies. We are confident in our investment processes and teams and their ability to adjust and outperform going forward. While the markets provided tailwinds for our absolute returns in AUM, we were even more pleased with our industry leading organic growth. We recorded net inflows of $2.3 billion in the quarter, bringing year-to-date inflows to $3.7 billion. Our U.S. open end funds led the way with $1.2 billion of net inflows. As Matt mentioned, this was our best quarter for flows since the first quarter of 2007.
Gross mutual fund sales are on record pace this year and redemptions have been the lowest in 2 years. Open end flows were led by our five star funds and preferreds and U.S. REITs. Consistent with prior quarters, Cohen & Steers preferred securities and income fund led the way with $750 million of net inflows. What’s new is a greater flow contribution at $492 million from our U.S. REIT fund, Cohen & Steers real estate securities fund, which was recently placed in Morgan Stanley focus list. Institutional advisory had $327 million of net inflows, led by the funding of a pipeline mandate and multi-strategy real assets. This mandate by a public pension plan seeded our fourth collective investment trust, which is administered by SEI. We are excited about this CIT, as it demonstrates the growing interest in real asset allocations as well as our strategy to grow in the retirement market.
Japan sub-advisory had inflows of $840 million, primarily in U.S. REITs, which continued to be one of the most popular mutual fund categories in Japan, as negative yield catalyze the squeeze for yield. We continue to have an active level of business development for our preferreds direct strategies in Japan. This year, we have seen a notable uptick effect in RFP activity. Through the first half of 2016, we have completed almost double last year’s pace. This increased activity is dominated by U.S. REIT and global researches. In addition, we have seen more of modest increases in searches for our preferred and multi-strategy real asset strategies. While commodity RFP activity hasn’t picked up yet, we see signs of increasing interest as commodities have begun to emerge from a 5-year bear market.
We believe the increased search activity is being driven by growing allocations to alternatives and real assets. Investors face a severe asset allocation challenge of finding strategies with both attractive return and diversification potential. Most pension funds have a return bogey of about 7% and fixed income allocations are falling short of this return objective and may increasingly disappoint on diversification. And a version to draw-downs in equities remains high.
The negative yield environment has made this asset allocation even more difficult. In three quarters of developed markets, sovereign bond yields are negative or less than 1%. As a result, investors are scrambling for yield and we believe our strategies will continue to benefit. The significant uptick in researches has several drivers in our view. REITs provide a strong combination of what investors need today yield, total return potential and diversification characteristics. What’s more, over the past several years, REIT returns have fallen slightly behind private real estate returns, even though over the long-term, they have consistently outperformed core private real estate. In response, institutions who allocated both private and public real estate may be looking to shift to REITs for relative value.
Global researches have picked up recently, which if sustained, is a change in trend. Due to global macro challenges, international REITs have underperformed U.S. REITs and we have seen outflows in global real estate in most channels in spite of our much improved performance. We have also watched with interest the Brexit and disclosures of daily liquidity private property funds in the UK. This manifestation of a design flaw should bump interest in REITs in the retirement channel. We will keep you apprised as these trends evolve.
Our institutional pipeline of awarded unfunded mandates stands at $243 million, below our average for the past several years. The decline compared with last quarter was due to fundings partially offset by two awarded mandates and preferreds and multi strategy real assets. We are awaiting the decisions on $1 billion of mandates where the manager has not been selected.
Looking forward, we are highly focused on executing the strategy we articulated in our annual letter to shareholders and reviewed with you at a high level on last quarter’s call. The pace of change in our industry is accelerating with continued outflows from equities, market share gains by ETFs, investors looking for managers to deliver and distributors responding to the Daiwa fiduciary rule before it is finalized and while is being challenged in the courts. All of this makes sense to us.
Said simply, we are focused on being a specialist manager and delivering more for less. We continue across all fronts to enhance our brand and capabilities and real assets. This includes adding investment professionals to some of our teams including analyst for macro and economic research, asset allocation, commodities, natural resource equities and preferreds. We have growing confidence in what appears to be a new bull market in commodities as we have written in our whitepapers. This should lead to improving demand across our broader line up of real asset strategies beyond real estate and infrastructure with multi strategy real assets being the center piece followed by commodities, MLPs and natural resource equities.
Accordingly, we are developing additional vehicles and strategies to round out our product offerings. This includes by example an offshore commodities vehicle and a second version of our multi strategy real asset portfolio designed for lower volatility through a greater allocation to TIPS. In terms of distribution, our wealth management team is performing well and we seek to better balance sales and real assets compared with preferreds and real estate. Institutionally, we have hired a sales professional to join Marc Haynes, our recently added Head of Business Development in Europe. Also announced this morning, we’ve hired an experienced new head of consult relations Dennis Rothe from Franklin Templeton. And we continue to expand our presence in the DCIO channel. Sales campaigns and whitepapers are similarly geared toward enhancing our market share and real assets. We look forward to reporting on our progress next quarter. This concludes our formal remarks. Operator, please open the lines for questions.
Thank you. [Operator Instructions] The first question is from the line of Adam Beatty with Bank of America/Merrill Lynch. Please go ahead.
Thank you and good morning. Just wanted to ask about Brexit kind of from another angle in terms of some of the disruption in the real estate market there, what extent you know or what magnitude you would expect from that and whether or not, you know it sound like your exposure right now is manageable, so whether or not you know that might lead to some buying opportunities or whether it’s just better ringed fenced at this point? Thanks.
Sure. I will concentrate my comments on real estate and just as a high level remark I think that Brexit over the long-term will be good for the UK. It will result in some short-term pain, probably a brush with recession. But long term, I think it’s good that they can control their own destiny apart from being tied to Europe. And in terms of commercial real estate in the UK, we are expecting prices to decline anywhere from 5% to 15% or 20% depending on the property type and the biggest declines are being expected in the office market. However, we think that for some other property type such as industrial where for example the decline in the pound could be good for trade interest and to the property markets in London. I mentioned in my remarks the comment about the daily liquidity properties funds and you know this has always been a big topic for us because we provide liquidity to our investors daily and without fail. We have never been able to understand why you can provide daily liquidity from an asset class that inherently is not liquid. And so we have not tried to be involved in those types of vehicles and we do think as I mentioned that particularly for certain channels like retirement where daily liquidity is very important that it could result in increasing interest in what we do in listed real estate.
Great, thank you. Appreciate your perspective there. And then turning to Japan, just wanted to get maybe an update on kind of the diversification of accounts there and you know how you are seeing flows. Obviously the Daiwa account is larger and perhaps more susceptible to some net redemptions whereas the others are maybe faster growing but just wanted to get your comments around that? Thank you.
So, our business in Japan is till concentrated with our partner, Daiwa Asset Management and it still is very concentrated in U.S. REITs. We have expanded our business development team in Japan not just to help support Daiwa and the improved flows that we have seen in U.S. REITs but we have also been pursuing with other distributors and asset managers our other strategies. As I mentioned, the preferred strategy as you might expect with some of the highest yields in the global capital markets, it will continue to be of interest and we are – have a lot of discussions that are going on with distributors for new strategies, new versions of preferred security strategies. We are also spending more time in the institutional market that I am sure you are aware as something that takes some time. There is a process involved and so we don’t have a lot to report there today, but we are encouraged by the increased activity in the preferred area.
Great, thank you for taking my questions.
The next question is from the line of Ari Ghosh with Credit Suisse. Please go ahead.
Hey, good morning, guys.
So, could you just give us a quick update on maybe how mutual funds slows the cracking quarter-to-date compared to 2Q? And then if you have any color on what distribution should look like for the rest of the year maybe just focusing on maybe the end denominated fees if you have more clarity on that assuming of course you know normal markets and unchanged FX? Thanks.
I think the – we will be providing information in another few days or a week or so on the July flows, but everything has been continuing to track pretty consistently subsequent to June 30 on the open-end funds. On the distributions, I think you know, we had consistently said that we had about a $2 billion to $2.1 billion annual bogie on distributions and in my points I have mentioned that, that number was increased of late because of the strengthening yen and the growth of the funds that we sub-advised on the Japan side. So the numbers that we just cited were probably notwithstanding an adjustment in the currency, you know the new bogy which is a high class problem given the growth in the funds.
Got it. That’s helpful. And basically to follow-up, if you could touch on the appetite for preferreds outside the U.S. retail channel maybe you can just talk about some of the underpenetrated segments maybe new product launches or geographies that you are exploring? Thanks.
Well, as we mentioned that because of the high yields on preferreds and a zero interest rate environment there very much in demand. Heretofore it’s been primarily a retail strategy but we are – we have been seeing growing interest from financial intermediaries and institutional end clients. In our pipeline, for example, as I mentioned, we have one new mandate for an insurance company. When you look outside of the U.S., we don’t have open-end fund vehicle, but that’s something that we are talking about potentially could happen over the next year. So, we believe that because of the yield environment and with the growing issuance of preferreds by banks, and to a lesser extent, insurance companies to help meet their capital requirements that there is going to be continued growing interest in the preferred market.
Great. Thanks for taking my questions.
The next question is from the line of John Dunn with Evercore ISI. Please go ahead.
Thanks. You guys talked about somewhat to see – in the global retail area some underperformance versus U.S. and different structures etcetera. But looking forward, just with global rates where they are, do you think there is eventually going to be a pickup in demand for those over the next – over the medium-term?
John, could you restate your question, I didn’t get the gist of it?
Sure. On global REITs, just given where – looking forward, where global REITs are, do you think there could possibly be a pickup in demand for it is a product, but ends just always for your guys strategy given that you have improved performance?
Well, over the past couple of years, we have not seen a lot of global search activity, but in the RFP activity that I mentioned, REIT searches overall picked up a lot and global has been a big part of that. And just to reiterate some of my comments, while 5, 6 years ago, there was a very significant trend toward allocating to global. Over the past couple of years, it slowed down because of the global macro challenges that we all know well, whether it’s Europe or the economy in Japan, slowing growth in China, etcetera. So, when you look at the performance of the global REIT market, internationally, those companies have underperformed the U.S. REIT market. Because the search activity and global is picking up, it’s likely that some of that interest is focused on that underperformance, international versus the U.S. and thinking about improving global growth. So, again, the increase in RFP activity is pretty recent. So, I think we need to see that what’s going to happen over the next months and yet, but we are encouraged by the pickup in global REIT searches.
Got it. And then I think you had a little bit of outflows in the advisory channel for U.S. REITs. Has there been any change in the discussions, the client discussions and of the $1 billion in discussion, are there – what are the major areas comprising that pre-pipeline?
That includes U.S. REITs, global REITs and preferreds.
Got it. And then just the demand for U.S. REITs and the advisory channel, just having had a little bit of outflows this past quarter?
John, it’s Bob. The outflows in the quarter are mainly just due to rebalancing. The U.S. REITs have performed extraordinarily well. And you maybe seeing as Joe alluded to some reallocation out of U.S. and the global. Now, you are saying and I think in money started going to go back into emerging market strategies since they have underperformed for a long time and maybe represent relative values. So, it’s really, I think that’s all it is.
Got it. Just want to check. Thanks, guys.
The next question is from the line of Ann Dai with KBW. Please go ahead.
Hi, thank you and good morning. I was hoping to focus a little bit on the European business. You talked about it briefly. Can you give us an update on the work that you are doing in Europe? And maybe what are some of the things that Marc Haynes has been most focused on his first half year there?
Well, as I think most of you know, we, about 18 months ago, decided to really take a fresh look and a new start to our business strategy in Europe where while we managed about $3 billion of client capital, we think we should be doing much better than that. And so we undertook a market survey with Greenwich Associates. Mark joined us not too long ago, 6 months ago or so, put together a deep business plan, including growing the team, which Joe talked about. And we are done growing the team. Mark has, I think, been spending his first 6 months elevating the firm’s profile. He was recently outspoken and well-published on the, what I would call the, private real estate open-end fund debacle in the UK, which I think highlights the problems with investing in real estate in that mode and the benefits of investing to listed. The goal here is to elevate and develop relationships with both the consulting community, the financial institution channel for sub-advisory business and to get our existing and future products on platforms as well as to deepen along with our new Head of Consultant Relations, our institutional global consultant relations. And again, Mark has been extremely active in that endeavor and now, he will have three or four – two or three very senior people working side by side with him going forward.
Great, thanks. Also kind of on UK and Europe, you guys talked about the exposure AUM and securities wise, but could you provide a little color around what Europe internal conversations have been around Brexit focusing on the operations of the business and sales activity and just really how logistically how everything would work in that scenario?
Could you expand on that a little, are you wondering whether we might be doing more hedging of our cash and fee streams or what is it exactly you would like us to focus on here?
I am more focused on the daily operations of the business, whether you have people sitting in places where you might have to reconsider what offices people are in to do certain activities and things like that?
Sure. Our offices in London, we don’t have any other offices in Europe. And in terms of our activities, we can do them all in London just as we have. In terms of our offshore funds there use its related vehicles and we don’t expect there to be any impact on our ability to sell in the markets we are in now. So, said simply, no impact on our operations.
Okay, thanks so much.
[Operator Instructions] The next question is from the line of Mac Sykes with Cohen & Steers [sic] [Gabelli]. Please go ahead.
Good morning, gentlemen. Thanks for taking my question. Can you talk about setting up products in sub-advisory going forward, is there anyway to reduce the distribution aspects? It just seems like this mitigates to some extent your great efforts on asset gathering. And I guess for the future, should we just assume that this is sort of the nature of the business in Japan?
Yes. The distribution policies for Japan funds are set by Daiwa Asset Management. We have no input on that whatsoever and so they are set by in part the market and the market conventions and the decision by the asset managers.
And there are no other questions at this time. I will now turn the call back to you. Please continue with your presentation or closing remarks.
Well, thanks for joining us on the call. And as I mentioned, we will look forward to reporting our progress on all fronts next quarter.
Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation. And I ask that you please disconnect your line.