Waddell & Reed Financial (WDR) Henry John Herrmann on Q2 2016 Results - Earnings Call Transcript

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Waddell & Reed Financial, Inc. (NYSE:WDR)

Q2 2016 Earnings Call

July 26, 2016 9:00 am ET

Executives

Henry John Herrmann - Chairman & Chief Executive Officer

Nicole McIntosh-Russell - Vice President-Investor Relations

Philip James Sanders - Chief Investment Officer & Senior Vice President

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

Brent K. Bloss - Chief Financial Officer, Treasurer & Senior VP

Analysts

Glenn Schorr - Evercore ISI

Michael Roger Carrier - Bank of America Merrill Lynch

Daniel Thomas Fannon - Jefferies LLC

Robert Lee - Keefe, Bruyette & Woods, Inc.

Andrew Nicholas - William Blair & Co. LLC

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

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

Macrae Sykes - Gabelli & Co.

Michael J. Cyprys - Morgan Stanley & Co. LLC

Eric Berg - RBC Capital Markets LLC

Patrick Davitt - Autonomous Research US LP

Operator

Good morning, everyone, and welcome to the Waddell & Reed Second Quarter 2016 Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please also note that today's event is being recorded.

At this time, I'd like to turn the conference call over to Mr. Hank Herrmann, Chairman, Chief Executive Officer. Sir, please go ahead.

Henry John Herrmann - Chairman & Chief Executive Officer

Good morning. With me today are Phil Sanders, our Chief Investment Officer and incoming CEO; Tom Butch, our Chief Marketing Officer; Brent Bloss, our Chief Financial Officer; and Nicole Russell, our VP of Investor Relations.

Nicole, would you read the forward-looking statements, please?

Nicole McIntosh-Russell - Vice President-Investor Relations

During this call, some of our comments and responses will include forward-looking statements. While we believe these statements to be reasonable based on information that is currently available to us, actual results could materially differ from those expressed or implied due to a number of factors, including, but not limited to, those we reference in our public filings with the Securities and Exchange Commission. We assume no duty to update any forward-looking statements.

Materials that are relevant to today's call, including a copy of today's press release as well as supplements and schedules, have been posted on our website at waddell.com, under the Investor Information tab.

Henry John Herrmann - Chairman & Chief Executive Officer

Thank you, Nicole, and good morning, everyone.

Second quarter results showed some progress, although accounting charges and redemptions in our Institutional channel obfuscate results and require a deeper analysis. I would highlight we substantially completed our cost-cutting initiatives, which began to show in our financial results, and a decrease in outflows in our retail unaffiliated distribution channel as positives during the quarter. Performance remains weak, but improved during the quarter and a bit more in July. Broader preference for passive products results in weaker sales for active-only asset managers. Phil and his team will elaborate on these points later.

As this is my last earnings call, I would like to say a word of thanks to our investors for your support throughout the years. While I retain the title of Non-Executive Chairman of the board, my investment in daily operations of the business ends. The company is in good hands with this executive team, rich in talent and experience. I now would like to turn things over to Phil.

Philip James Sanders - Chief Investment Officer & Senior Vice President

Thank you, Hank, and good morning, everyone.

Underlying results showed some level of improvement, but challenges remain. We are keenly aware of the difficulties we face as an organization. We are open-minded and prepared to tackle these problems head on. We understand the role that fund performance plays within the sales cycle and the pressure it puts on flows. While we certainly have some bright spots, a top priority remains improving our investment performance.

Performance improved modestly across the complex, but remains disappointing by historical standards. We have seen an improvement in a couple of our key flagship products year-to-date, but others continued to lag. As you know, there is no silver bullet, and while we are operating with great urgency, this will take some time. I have confidence in our investment team in a process that has proven so successful over the long term.

As we discussed on our last call, this remains a very challenging environment for active managers. The current global macro-economic and geo-political backdrop has resulted in heightened investor demand for stability, safety and yield resulting in our view, in valuation anomalies across various sectors and markets.

We continue to believe that these anomalies will normalize over time, providing a much more favorable backdrop for active management. However, it is also clear that we have not been at our best in navigating the current environment and must do a better job as a whole. The recent performance challenges for active managers combined with an increased focus on fees has resulted in growing demand for passive products. We understand that the landscape has changed, but believe that there is a role for both passive and active strategies in client portfolios.

We also believe it is important to understand that there are certain types of styles where active management has more of an opportunity to capture meaningful inflows. We are making progress here by focusing on adding products where active management continues to garner healthy flows, occasionally seeking sub-advisory partners to complement our skill set. Understand, however, we believe in the value of active management and in our ability to generate high rankings within our respective competitive universes, as well as to add value over passive benchmarks over time.

As the due diligence process increases across distribution channels, we are focused on tighter integration across all aspects of our organization: investment management, sales and marketing, product development and risk management. Along those lines, we were pleased to announce yesterday the addition of Dan Scherman, an experienced industry veteran who has joined our company as Chief Risk Officer for Investments. Dan will be responsible for providing comprehensive portfolio oversight and enhanced investment risk management capabilities across the firm.

The industry is evolving just as rapidly for financial advisors. The Department of Labor's recent fiduciary standard rule has elevated the scrutiny over the appropriateness of fees and product choices. Advisors are demanding solutions for their clients and better technology to support their practice. Ultimately, the client wins, and putting the client first has always been part of our DNA.

Our investment in Project E will bring new options to our clients in a more robust technology platform for the financial advisors associated with our broker-dealer, ultimately strengthening the competitiveness of this channel. We believe we will be able to fully address the DOL requirements while preserving our ability to grow advisor productivity and sales with the ongoing inclusion of our products. We have a lot of work to do to reestablish the growth trajectory of our company and are committed to doing so prudently, but with urgency and with the full knowledge that the world has changed.

I'll now turn it over to Tom.

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

Thank you, Phil.

Flows remained challenged during the quarter, as sizable net outflows in Institutional, most, though not all of which, were known and disclosed during last quarter's earnings call, overshadowed improved net flows performance in unaffiliated distribution. Relative to Institutional, on last quarter's call, we reported that we'd been notified of two sizable Institutional redemptions that we then estimated would total $2.8 billion.

One, of about $2 billion, was in an Asset Strategy account. The other, about $800 million, was in a municipal high-income account that was being in-sourced by the firm, for which we had served as subadvisor. In June, subsequent to Phil being named as Hank's successor as CEO, another large account, again, at $2 billion, this time in large cap growth, redeemed. As with the municipal high-income account, this was not related to performance, instead, a result of the change in portfolio management personnel on that product. This imposed itself on the quarter's sales results, and in all, Institutional had net outflows of $5.5 billion, clearly, an outsized negative result.

The remaining Institutional asset base of about $9 billion is spread widely among its client base. The Institutional pipeline at present is subdued, though we continue to be included in news searches, especially in our large cap core strategy. We also believe there will be opportunities to add assets in other strategies, including small cap growth. And overall, interactions with consultants remain substantially positive.

In unaffiliated retail distribution, formerly called the wholesale channel, net outflows decreased by 28% sequentially. This decrease owed primarily to lower redemptions as gross sales remained pressured. Performance challenges in some of our largest products, lack of sizable momentum in other products and the very difficult quarter for active management contributed to the weakness in sales.

Our sales efforts at present are centered on (09:56) redemptions in those large products where performance has begun to turn, particularly high-income and mid-cap growth, while directing attention and energy to high-performing products in categories that we believe present good sales opportunities. These include international core equity, energy, small cap growth and small cap value, as well as our newer multi-asset products that include Apollo as a sub-advisor and other products. Based on month-to-date experience, it would appear that monthly net flows in the retail unaffiliated distribution channel will be roughly in line with May and June, which saw outflows of $1.1 billion and $1.2 billion respectively. And speaking of July, more favorable investment markets have helped to increase enterprise-wide assets under management to $88 billion from $86 billion at quarter-end.

Working closely together, our investment and distribution teams continued to aggressively assess new product and distribution opportunities and we are committed to ensuring a comprehensive and competitive product line and an efficient unified approach to product development, marketing and servicing. We understand that the marketplace is changing rapidly and we are committed to being responsive to those changes and the opportunities they create. That includes not only active mutual funds, but other product types and structures that draw investor attention today or are likely to do so in the future.

One such example is exchange-traded managed funds, or ETMFs, and the recent commitment by a large wire house to begin offering the next year's ETMFs in the first quarter of 2017. We will be ready for this introduction, as we already have filed for three NextShares strategies that we expect to launch later this year. We believe that only we and two other firms presently are at this level of preparedness.

In the retail broker-dealer channel, formerly called the advisors channel, proprietary outflows increased due to redemptions that offset slightly higher sales. Though they rose, redemptions still remained at just 10.5%, well less than half of industry norms. Productivity, AUM and AUA all increased sequentially. As Phil noted, Project E continues to move forward with testing of the new processing engine and brokerage and advisory platform chassis slated for September.

Project E has been broadly socialized with Waddell & Reed advisors, including at our annual national sales meeting in the second quarter. We continue to assess and integrate into our planning the impact of the DOL fiduciary role and are taking care to ensure that we understand and are responding to its myriad requirements. Project E, though initiated prior to the DOL draft and final directives, has DOL considerations front and center in its planning.

Let me now turn it over to Brent for a review of our financial results.

Brent K. Bloss - Chief Financial Officer, Treasurer & Senior VP

Thanks, Tom.

There were a number of items in the quarter that blurred the underlying operating results of the company. These included charges associated with our Project E initiative and severance and related cost associated with our employee separation programs. Our Project E investment in our broker-dealer remains on track and on budget.

So far this year, we have incurred approximately $2.6 million of our estimated $8 million in implementation costs forecasted for 2016, $1.3 million during the first quarter and another $1.3 million during the second quarter. Our share class conversion from load-waived Class A shares to Class I shares has been completed for our proprietary mutual funds. As a result, we will no longer collect Rule 12b-1 fees on approximately $15 billion of advisory assets. This revenue decline will be partially offset by a reduction in 12b-1-related payouts to our financial advisors and field management.

The share class conversion also resulted in the acceleration of the amortization of deferred acquisition costs on old advisory programs. This write-off will result in a reduction to direct underwriting and distribution costs of $5 million in 2016 and $1 million in 2017. Revenues corresponding to these advisory counts will continue to be recorded without an offsetting deferred acquisition cost amortization over the next four quarters.

With our previously announced employee separation programs completed, we realized approximately one-third of the quarterly compensation cost benefit during the second quarter and expect to hit our full run rate during the third quarter. We also incurred $17 million of severance and related costs associated with these programs with $10 million recorded in the compensation line and the other $7 million recorded in U&D indirect costs.

We remain vigilant with costs and are comfortable at this time that we are generating sufficient free cash flow to maintain the current dividend payout rate. In a normal market environment and a deceleration of net outflows, our model show an ability to continue to pay the dividend at current rates while still allowing flexibility for share buybacks offset dilution on a free cash flow basis.

We understand how important the dividend is to our shareholder base, and certainly, our bias is to maintain the dividend at its current rate. While we have a strong balance sheet that allows us some flexibility, it likely would not be our intention to support the dividend with our excess cash for an extended period of time if our earnings power were to materially differ from our current expectations.

We have made a strategic and sizable investment in our broker-dealer, including technology enhancements and the introduction of new advisory products which we believe will ensure its competitiveness into the future.

With the share class conversion now completed on a majority of our asset base, our third quarter earnings will begin to show the impact of the reduction in 12b-1 fees and related transfer agency revenues, along with reduced payouts to advisors for 12b-1 fees. A revised estimate of the impact of this transition for 2016, which includes technology implementation cost is $25 million before tax. This amount includes the $2.6 million in technology implementation costs incurred to-date and is slightly lower than our previous estimate of $29 million.

As Hank highlighted in his remarks, we have substantially completed our previously announced cost-cutting initiatives. We are on track to realize the run rate savings of $40 million in discretionary costs. These savings will help to offset the impact of Project E and operating at a lower level of assets under management.

I will now turn it back to Phil.

Philip James Sanders - Chief Investment Officer & Senior Vice President

Thanks, Brent.

Our entire organization has a heightened sense of urgency. We are well aware of the issues we face as an organization, and while we have had our share of challenges, this is still fundamentally a franchise with a long and distinguished heritage of investment excellence and a reputation for strong client service. We recognize that the industry is evolving and that in order to retain our position of excellence we must remain open-minded to innovation and change. As a result, I will be working with the team to refine our strategy, not only to address investment performance in a challenging regulatory environment, but also to leverage our considerable strengths, including a strong balance sheet, a scaled financial advisor and wholesaler network, and a premier asset management team.

Before we open the call for questions, I would like to say thank you to Hank on behalf of all of us for his many years of dedication to our organization, its employees and our clients. Hank has been a mentor to a great number of individuals over the years and his daily presence will be missed.

Operator, we would now like to open the call for questions.

Question-and-Answer Session

Operator

Ladies and gentlemen, at this time we'll begin the question-and-answer session. Our first question comes from Glenn Schorr from Evercore ISI. Please go ahead with your question.

Glenn Schorr - Evercore ISI

Hi. Thanks very much. I wanted to get that a little more detail on what you mentioned about the advisory redemption rates. It sounds like they're grounded a little higher, but still obviously well below the wholesale channel. But I was just curious on what's putting that pressure on the advisory redemption rate higher? And are we – this is the first time I've actually seen it in double-digits in a long time, so just curious if we're going to see more of a normalization of that as time goes on?

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

Glenn, this is Tom. I'm not sure what you mean by normalization. If you mean normalizing to...

Glenn Schorr - Evercore ISI

To an industry average...

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

In markets – in industry average, we certainly don't anticipate that. I think a few things that are at work are the challenges of active management. And in that light, our advisor force is one which remains loyal to our product, but is subject to some level of performance concerns and again is always late to picking up the changes that take place in the investment environment in the first quarter was very unsettled. So I don't anticipate that this is a harbinger of its accelerating into a rate consistent with that in the industry.

The other thing that is modestly at work is last year – late in the year, we lost some advisors with sizable books of proprietary assets. And until that sort of works through, they are at new broker-dealers and most of them then diversify their books of business farther upon making that move, until that sort of works through, that'll put a little pressure on the rate, too.

Glenn Schorr - Evercore ISI

Okay. I appreciate that. One other follow-up I had was on your thoughts on what specifically was cut in G&A and then when you talk about, I felt like in your prepared remarks on talk about non-comp in general that you were implying that not everything is all the way in the run rate. So I wonder if you can just address what's in the ongoing expense run rate versus the actions you've already taken.

Brent K. Bloss - Chief Financial Officer, Treasurer & Senior VP

Right, Glenn. This is Brent. Yeah, since we ended the program and folks actually left us in mid-May, we didn't get the full impact of the cost-cutting in the compensation line. So as I stated in my opening remarks, about one-third of that cost-cutting impacted the second quarter. So there'll be further benefits as we move into the third quarter.

Glenn Schorr - Evercore ISI

Okay. Then, the last one is on high income. Just, in general, high yield markets performance has improved a lot and industry flows both Institutional and retail have been very strong. Just curious, current state of high income for you guys and expectations going forward given the better market backdrop.

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

I would say that sales are somewhat subdued though we have seen an improvement over the last number of quarters. I think more materially redemptions have softened and as we kind of look at the year-to-date number, it would appear that that is in play. I do think that there has been considerable month-to-month volatility in industry flows that year-to-date they are higher. So, as I said earlier, in my prepared remarks it's important that when performance improves in these franchise products, our larger products, it's important that we be in front of it. There are many days when we have neutral to modestly positive sales and month-to-date the performance on a net basis is sort of flattish.

So, if the appetite for high income continues and we're able to sustain strong year-to-date numbers, certainly we would expect that more favorable trend to be able to continue.

Glenn Schorr - Evercore ISI

Okay. Thanks very much.

Operator

Our next question comes from Michael Carrier from Bank of America Merrill Lynch. Please, go ahead with your question.

Michael Roger Carrier - Bank of America Merrill Lynch

Hi. Thanks, guys. Maybe Tom first, just on the flow outlook, you gave an update on the retail side. Just wanted to get a sense – it seems like on the Institutional, given your comments it seems pretty diversified. So you wouldn't expect some of the lumpy flows that we've seen recently. But just wanted to get – I'm assuming you would have flagged it like you have in the past, but just wanted to get any update on the Institutional side.

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

Yeah, I think Michael, that my comment in the prepared remarks was in fact intended to convey that we have no account of the size of any of the three that recently redeemed and the remaining book of business is well diversified by client and by asset class. We're aware of no further material redemptions and so I will say that even in the subdued environment we continued to be added to searches and find opportunities. But I do think that in the present tense that the environment is relatively softer than it has been in the past. But again, the principal point is that risk in the Institutional portfolio is mitigated by the very fact of the absence of these three and the remaining asset base being well-diversified.

Michael Roger Carrier - Bank of America Merrill Lynch

Okay, thanks. And then, Brent, I guess, just in the quarter, it seemed like the underwriting distribution revenues held up really well. And I didn't know if there was anything unusual there, just given the average AUM was down, sales were down. So I didn't know if there was something that was shifting there. And then if you can give any color on the fee rate also in the quarter, it ticked up, just given mix. And so if you can just run through any nuances when we think about the different channels or products that can shift that around.

Brent K. Bloss - Chief Financial Officer, Treasurer & Senior VP

Yeah. On the revenue side, Michael, in the advisor channel, higher-fee-based revenues during the period and some higher VA revenues as well but those were offset by lower 12b-1 fees in both channels was the non-affiliated and the broker-dealer side, so it kind of evened out. But it was really due to the fee-based asset increase in fees during the period that offset the 12b-1 fees. And then on the mix shift in the rate, it had a lot to do with continued decline in the Asset Strategy. Assets, as well as the large redemptions in Institutional which carry a lower rate, as you know.

Michael Roger Carrier - Bank of America Merrill Lynch

Got it. Okay. And then the last one. Just on – you gave the processes you're in in terms of the cost savings and then also some of the impact as we get into the second half on Project E. I know there's a lot of moving parts, just given the charges, the core trends and then some of the initiatives that are in place. But just wanted to find out, if you think about that $40 million of cost saves, do you have the quarterly run rate of what was included this quarter so we can try to get to what we should expect next quarter?

And then same thing on Project E, just given that the $25 million versus the $29 million is there any nuances in terms of where should we expect that full run rate in the third quarter and then line items in terms of where that should have an impact?

Brent K. Bloss - Chief Financial Officer, Treasurer & Senior VP

Yeah. On the Project E side, I'll start with that one first. Most of the change from the $29 million to the $25 million that we gave earlier is really around timing. When you look at reducing the 12b-1 fees and shareholder service fees, right now, and these are based on our current asset base. It would be about a reduction of about $27 million in revenues related to 12b-1 fees and shareholder services.

And then on the expense side, of course, we would get some relief from not paying out the 12b-1 fees. And then there are some platform-related costs. So lower U&D expenses of about $2 million.

And then your other question related to the cost saving initiatives, just on a year-over-year basis, as we said, $41 million or $40 million was our target. We had disclosed last quarter that about two thirds of that we would expect in 2016. That's running a little higher. So when you take our G&A, indirect and compensation, we would expect about a $35 million decline of where we're running today. That's compared to the previous fiscal year.

Michael Roger Carrier - Bank of America Merrill Lynch

Okay. That's helpful. Thanks a lot.

Operator

Our next question comes from Dan Fannon from Jefferies. Please go ahead with your question.

Daniel Thomas Fannon - Jefferies LLC

Thanks. I guess just to follow-up on that and just confirm what your fixed operating expense is, as you kind of characterized earlier and 10% is what's the reductions that we're looking at comp and the G&A and then the indirect expenses.

Brent K. Bloss - Chief Financial Officer, Treasurer & Senior VP

Yes.

Daniel Thomas Fannon - Jefferies LLC

Okay. And I guess you've seen a little bit more of a pick-up in the Institutional AUM outflows than what you guys had guided to previously. How do we think about if asset levels – the market isn't as favorable, we see asset levels go down, what other kind of back stops or costs should we think about that are potentially up for review or other areas where there could be some offset from the P&L as a result of lower AUM?

Brent K. Bloss - Chief Financial Officer, Treasurer & Senior VP

Well it's an ongoing process, as you can imagine. We're consistently monitoring our AUMs. And I believe as Phil comes in as the new CEO, obviously he's going to be looking at the full operations. And so, we feel there is some room to move in some areas if we need to get there. Obviously, we don't want to cut the operations to the bone. So we believe we've taken the corrective measures currently to address our asset base and we will continue to monitor it going forward.

Daniel Thomas Fannon - Jefferies LLC

Great. Then, I guess just within the advisor channel and other kind of question on the outlook, I guess as you see the full roll-out of the new technology and the platform, I guess, do you anticipate behaviorally we should see more redemptions or on a gross sales basis going forward less of your – because of the open architecture and other things, we should see more broader usage of other products outside of the Waddell family?

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

Yeah, and I guess maybe that was what Glenn was getting at, at his first question and though in the near term we don't anticipate a material change in the redemption rate. As we introduce broader choice into our advisory programs, there may be a one-time bump relative to that and we have modeled that in. We believe that some portion of the current platform assets will migrate to that new platform and some portion of that which we've modeled at around 25-ish percent over some short to intermediate period of time would migrate. And that probably that same percentage or moderately more would be part of the new sales mix.

Certainly, our strategy would be that that would be offset my greater growth sales in the aggregate such that those percentages don't materially disrupt the overall asset level in the proprietary products. But it's only reasonable to expect that upon the introduction of the more open architecture that there'll be some disruption for some period of time along the lines that we have modeled. But again, our experience with our advisors who have moved from one environment to the broader architecture in the past, given our Classic and Choice platforms is that their books of business grow and that the overall business – that the mix changes, the overall business growth supports the proprietary asset on an ongoing basis.

Daniel Thomas Fannon - Jefferies LLC

Great. Thank you.

Operator

Our next question comes from Robert Lee from KBW. Please, go ahead with your question.

Robert Lee - Keefe, Bruyette & Woods, Inc.

Thanks, good morning. And first, Hank, best of luck on your next endeavors and I hope you get a lot of opportunity to go fishing. So with that, just maybe a follow-up question on the advisor channel. So I guess, Tom, to what extent are you seeing impact on kind of advisor recruiting or stickiness? I mean, you mentioned losing a couple of large producers at the end of last year. I mean, are you seeing any increased churn, so to speak, in the advisor channel? And when do you think you'd be able to start kind of leveraging the investments you've made through Project E and kind of step up maybe recruiting of more experienced advisors?

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

It's a great question, Rob, and you know, sometimes these things are a little bit cyclical. We had a cluster, I would say, of advisors who last year chose to go elsewhere. But I think the story is really told better in the second part of your question. Recruiting of experienced advisors this year has been very productive. We've recruited, year-to-date, about $0.75 billion of AUM. And the profile of the advisor we're recruiting is at the highest since we've had the recruitment of unaffiliated and experienced advisors. The average recruited trailing 12 revenue of advisors is north of $400,000 and the average recruited AUM per advisor is north of $45 million. These are highs. And the number of the pipeline of experienced advisors is up substantially year-over-year, and we have 10 people starting in July and August.

So I would say that that brief cluster of advisors who left us happened, but what we're seeing is, is that our story is resonating very well, and the recruitment of experienced advisors is, as I said, at a really good place. And I think it's interesting that it's taking place in the context of DOL because one could reasonably ask, how will DOL impact it? And every advisor who we're recruiting obviously is aware of its being out there. So I think the anticipation of the broader architecture and all of the technology improvements we're doing now is part of our story that we're able to tell and I think it will continue to result in good recruiting results with experienced folks.

Robert Lee - Keefe, Bruyette & Woods, Inc.

Great. And maybe a question, a follow-up for Brent, just trying to – so the restructuring charges, are there any kind of remaining charges we should be thinking about in Q3, just as from a modeling perspective? Or are we pretty much at a point where there'll obviously be the ongoing Project E costs through the end of the year, but outside of that, we're not going to have too many – anymore one-time impacts?

Brent K. Bloss - Chief Financial Officer, Treasurer & Senior VP

Rob, I don't expect anything at this time. Again, you pointed out the Project E ongoing implementation costs, as I believe we'll point out as we move forward. But outside of that, I don't expect anything at this point.

Robert Lee - Keefe, Bruyette & Woods, Inc.

Okay, great. Those are my questions. Thank you.

Operator

Our next question comes from Andrew Nicholas from William Blair. Please go ahead with your question.

Andrew Nicholas - William Blair & Co. LLC

Hey, guys good morning. I was just – the first question should be quick. I know you talked about the Institutional asset base being diversified, but I was just curious, with respect to the institutions that had the three material redemptions, in the quarter, could you give us a sense of how much assets Waddell still manages for those institutions?

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

Well, let's see. For two of them, none. And for the third one, it's broadly diversified, so I would say on a pure Institutional basis, none. But other platforms available within that larger enterprise, we're still involved.

Andrew Nicholas - William Blair & Co. LLC

Okay. Thank you. And then another separate question; you guys issued a press release yesterday after...

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

And I should...

Andrew Nicholas - William Blair & Co. LLC

Sorry. Go ahead.

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

All right. I should point out one thing. In the last of those three, the one I was just speaking of, they employ a number of managers that manage sleeves, and we weren't removed from the prospectus. We were taken to zero, but we weren't removed from the prospectus or the lineup, so sometime in the future, we might have an opportunity to manage assets there, in that part of their platform, again. I'm sorry to interrupt you.

Andrew Nicholas - William Blair & Co. LLC

No, that's fine. Understood. The second question was just on your guys' decision to appoint a Chief Risk Officer, which you issued a press release on yesterday. I was just hoping you could walk us through what prompted the hire and how you expect the investment process to change or to be augmented as a result?

Philip James Sanders - Chief Investment Officer & Senior Vice President

Sure. This is Phil. This is something we've been looking at internally for quite some time. Obviously, as the industry evolves, and I think one of the things as we've grown, we've realized we needed a more comprehensive approach to a lot of these things and somebody who could kind of take ownership of it on an individual basis and so forth. I think we're looking at – really, we're doing a lot of these things on a product level and looking to get somebody who can bring it all together and enhance the current level of risk oversight, not only within individual portfolios but across the investment complex as a whole.

I think it's going to help us tell the story. It helps portfolio managers understand the types of risk they're taking. Better tell the story in terms of sources of alpha drivers, what the real value added is of the portfolio manager. This is something that's obviously being required in the world across all distribution channels, and I think it's just something that we've kind of been doing this on a piecemeal basis and bringing it all through different aspects. And now we've got one person, more comprehensive, consistent application of our risk management story. So I think it'll be helpful to us in terms of understanding the different – various types of risk and also helping us in terms of how we go to market with different strategies.

Andrew Nicholas - William Blair & Co. LLC

Okay, great. Thanks for taking my questions.

Operator

Our next question comes from Bill Katz from Citigroup. Please go ahead with your question.

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

Okay. Thanks so much. I was wondering if you could give us an update on the Asset Strategy fund, the mix between public and private holdings, please.

Philip James Sanders - Chief Investment Officer & Senior Vice President

Sure. At the end of June, I think the percentage of illiquids private equity was just under 13% in the Asset Strategy fund.

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

Okay. And then separately on the – I think you mentioned or Hank mentioned that you're running sort of in line on the unaffiliated in terms of attrition into the new quarter. Can you give us a sense of what you're seeing within that, and then more broadly at the firm level, how the flows are in aggregate?

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

I think, Bill, this is Tom. The July experience is substantially mirroring, as we said, the June experience, which substantially mirrored the May experience, which is our franchise large products, with the exception of two of them, mid cap growth and high income, which are leveling, are not seeing substantial demand. I think we're trying to emphasize those products, which, A, have good relative performance, and B, are in categories which are being consumed, and C, are utilizing active management.

So the board has changed a bit in terms of the products which we most are emphasizing, but it's a two-part process of making sure we're telling the stories about our franchise products, which contain the bulk of the asset base, and then being opportunistic with other products. So, for example, in the quarter we're spending time telling stories such as small-cap value, small-cap growth, energy, international core equity remains front and center. The products that we've launched with Apollo managing credit sleeves are getting a lot of attention. But that's not to the exclusion of our large products.

Broadly, in retail unaffiliated distribution, I would say that sales are subdued and so the job is to re-ignite sales even as the redemption experience appears to be moderating. And I think July, as I said, looks like it would be substantially in line in retail unaffiliated. And again, the top line, the sales line is challenged right now as a result of active, as a result of all the things we've talked about, active and performance and finding the right spots to compete.

The advisors channel looks like July will be just a little bit softer than June or softer than June, I should say. There's seasonality in there. We always have our largest gathering of our top advisors who are out of the market in July. That might have a little bit to do with it, so there's seasonality in that. And Institutional is just effectively pretty quiet after what was a very difficult second quarter. So I think broadly, to answer your second question, redemption pressure appears to be moderating generally. Top line remains soft generally. The challenge is to reignite the top line.

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

Got you. Just before I ask my last question, (45:07) Hank off again, best wishes on next part of your career and life. It's been a pleasure. Just on the FAs, can you give us a sense of – I think you've done in some prior quarters, what percentage of sales are going into the proprietary products in 2Q perhaps versus the first quarter at this point?

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

We're shuffling paper, if you'll be patient for just a second. Can we get back to that one and move onto the next question? We'll get back to that one.

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

Okay. Thank you for taking all my questions.

Operator

Our next question comes from Craig Siegenthaler from Credit Suisse. Please go ahead with your question.

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

Thanks. Good morning.

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

Good morning.

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

So I just wanted to see if you guys are seeing any early signs that the DOL rule implementation could cause industry pricing competition to accelerate?

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

I don't think we're seeing evidence. We're hearing conversations about all kinds of things, relative to DOL. A couple of things that I think are relevant are – pricing was already decelerating. And I don't think anybody here thinks pricing is going to go on other than a trajectory that is other than upward. And so I think just psychologically the effect of DOL will play into that, whether it specifically becomes an issue at the distribution level is unclear. But certainly pricing, as you know, has been on a downward trend for some time, and DOL plays into that.

The other piece of DOL I think is that distributors will look intently at their investment offerings and the breadth of them. And in addition to pricing, I think risk, however defined, will be front and center in those discussions. And you've read publicly that one large broker dealer has announced a plan to dramatically prune its product offerings. Whether others follow suit remains less clear. But I think this amalgam of risk and expense will be very much a part of the DOL discussion.

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

Got it. And then just a follow-up for Brent. Brent, typically you've given us some really nice expense guidance on the call in terms of comp and G&A. And that might be helpful because you have a little bit more one-time items, I believe, in the third and fourth quarter. Can you do that again this quarter?

Brent K. Bloss - Chief Financial Officer, Treasurer & Senior VP

I'd like to stay away from giving specific guidance on those line items. Like I said, with the cost-cutting initiatives and some of the allocations between those lines, the indirect and G&A and comp lines, again, we're on track to recognize we started out with a 10% target for fixed costs in those three lines of decline. And that was a $40 million target. We expect, based on our current models, to come in around a reduction of about $35 million, based upon the current state. So that's a mix between those three lines looking at reductions over the prior year.

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

Got it. Thanks for taking my questions.

Operator

Our next question comes from Mac Sykes from Gabelli. Please go ahead with your question.

Macrae Sykes - Gabelli & Co.

Oh. My question's around the ETMF opportunity. I'm curious if you could talk about maybe the potential skill there, what your expectations are for adoption rates? And then how do you envision those products getting adopted in, in your own advisor channel?

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

Well, as you've read and as we pointed out in our opening remarks, we and others in the consortium have been confidently waiting for one of the large distributors to adopt the product. That now has been announced. The uptake of that is not clear, but certainly it should appear, in every sense, to be a product that is in keeping with the discussion we just had about a lower cost way to express asset management and one which also has tax advantages. So it's reasonable to expect that the adoption should follow suit given where we are as an industry, both from a competitive and regulatory perspective and that advisors at the firms that adopt them, that adopt the structure, ought to be very interested in it. And we've been confident proponents of the structure since it was first made known.

We have filed for three such products and expect to be ready when the broker-dealer is ready. Where it goes will depend, I think, on whether other broker-dealers follow suit. And the degree to which we and the broker-dealers are able to successfully convey the benefits of that product structure to advisors. But this is, we think, a development of considerable significance.

As to our own broker-dealer, we're very desirous of having that structure available to them. We have some technology work to do with our technology partners to accomplish that. We're in conversations with them in that regard, and that conversation is very much ongoing and very much front and center in a lot of the Project E discussions.

Macrae Sykes - Gabelli & Co.

Have you had conversations with your advisors about the product? And has there been any pull-through in terms of interest there?

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

Yes, we've had preliminary conversations with them as we would with anything. We try to be as transparent as we can with what we're doing. I think until it becomes real and we really have an opportunity to offer it to them, and that would require some operational and technology work that – getting too deep into the weeds on the product is probably not something we want to do. But certainly there's no reason to believe it would not be well met among them for the reasons I just enumerated.

Macrae Sykes - Gabelli & Co.

Great. Thank you for taking my questions. Best wishes, Hank.

Henry John Herrmann - Chairman & Chief Executive Officer

Thank you.

Operator

Our next question comes from Michael Cyprys from Morgan Stanley. Please go ahead with your question.

Michael J. Cyprys - Morgan Stanley & Co. LLC

Hi. Good morning and thanks for taking the question. I just wanted to follow-up on the DOL question around pricing pressure and so forth. It seems so far a lot of the pressure, at least today, really has been more from selling lower fee products such as ETFs and so forth. Just curious how you're thinking about potential fee waivers and so forth that could reduce fees on existing products, which I don't think has really happened much yet. But just curious what would be the scenario that could result in such an outcome?

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

Well if you look at our line-up of products, it's replete with waivers today. And we're always looking at the competitive environment and assessing also in the 15(c) work we do our fees, both from a competitive and defensible perspective. So what would make us look at fee waivers is either of those factors. We're always, obviously through 15(c), we're assessing where our funds stand versus pure funds, and as importantly, we're doing a sub-assessment of where our funds stand versus the most competitive funds in each of the asset classes where we participate. So that is already very much in play. And might it accelerate on a fund-by-fund basis at some point as a result of DOL, I don't think specifically as a result of DOL, because again, it's just carrying forward the reality that has existed for a long time which is the expenses on investment products are generally going down.

Michael J. Cyprys - Morgan Stanley & Co. LLC

And how much is being waived today? And is that just the management fee component?

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

I think as a swag (54:17), we'd say something like $10 million is being waived today.

Brent K. Bloss - Chief Financial Officer, Treasurer & Senior VP

That includes the money market waivers we have in place. But, yeah, I believe it's around $10 million.

Michael J. Cyprys - Morgan Stanley & Co. LLC

And if we just exclude the money market and just focus on the longer term assets, any color around the types of funds, how much, in order of magnitude – just in terms of the fee rate or the dollar amount there?

Brent K. Bloss - Chief Financial Officer, Treasurer & Senior VP

We'll have to get back to you on what that break-out is.

Michael J. Cyprys - Morgan Stanley & Co. LLC

Okay, thank you.

Operator

Our next question comes from Eric Berg from RBC. Please go ahead with your question.

Eric Berg - RBC Capital Markets LLC

Thanks very much. Just one question today. Tom, would you mind reviewing with us – I know you mentioned it in passing – the motivation for the large redemptions institutionally, other than in Asset Strategy? Thank you.

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

Surely. Eric, the municipal high income was a portfolio that we sub-advise and grew pretty rapidly. And the entity for which we sub-advised it decided to in-source it. And so it was not in any sense performance-related or expressive of any other kind of dissatisfaction. It was merely that they wanted to manage it themselves.

And again, the large cap growth was resulting from the fact that with Phil's moving into the CEO role and away from day-to-day portfolio management – he was the long-term manager on that strategy. And despite there having been another co-manager who had been with him since the beginning, the entity decided that it would – that that change was sufficient to provoke their removing the assets from that fund.

Eric Berg - RBC Capital Markets LLC

Tom, the reason I asked the question is because I'm trying to get a sense for the following. People probably have a right to be disappointed by Asset Strategy. I'm not speaking out of school when I say everyone knows it's had a rough patch. But what I'm trying to get a sense for is the degree, if at all, to which the world is disappointed by or has changed its thinking about Waddell & Reed because of the Asset Strategy. In other words, are people's attitudes towards your company and your ability to sell being affected by what has happened at Asset Strategy?

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

Let me answer that in two parts, and others around the table may want to also opine on it. I feel absolutely certain that Asset Strategy had nothing to do with either of those two redemptions which you've just discussed. Relative to its spill over into other conversations or other opportunities, I would answer it this way. It's something which from time to time requires conversation, but I don't think if you would talk to any of our large distributors that they would have an opinion – or our large consultants – that they would have an opinion of our company that is unduly colored by that in a negative way or that affects their judgments relative to our participation in their platforms.

Philip James Sanders - Chief Investment Officer & Senior Vice President

Yeah. This is Phil. I would just add that I think this is – we've certainly stubbed our toe and are accountable for our own performance. But I would say the backdrop has been unusual for the active management world. It's been one of the toughest first halves in history with respect to the performance of active managers. I think the environment, as I mentioned, is very unusual in the sense of this unequivocal quest for yield, stability, safety. I mean, when you have a very aggressive global central banks, excessively aggressive monetary policy around the world with approximately $12 trillion in government bonds, with negative yields. I think there are lot of valuation anomalies that I referenced with respect to different sectors of the marketplace.

And that's been an unusual. I think most active managers who apply fundamental research, which is obviously core to what we do are looking at that and kind of scratching their head and trying to figure out if that makes sense at this point. And I think that has been a contributing factor to our performance along with other active managers. I don't believe that's a permanent case and I think as the investment environment normalizes over time I fully expect that there'll be an opportunity for active managers to really add a lot of value over the benchmarks. And when that happens, I think the sentiment's going to change quite dramatically for those companies that are focused on active management. And that's really, as you know, the core of what we do. So, I don't think it'd be a permanent outlook.

Eric Berg - RBC Capital Markets LLC

Thank you.

Operator

And ladies and gentlemen, our final question for today comes from Patrick Davitt who is from Autonomous. Please go ahead with your question.

Patrick Davitt - Autonomous Research US LP

Thanks a lot. You mentioned the concentration in Institutional. Are there any large concentration issues in retail unaffiliated or is that pretty spread out as well?

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

Well, it's certainly lesser than it used to be. You know, Asset Strategy as a percent of AUM used to be as high as near 40%. 35% to 40% and now it's less than 15%. So, it still remains the largest of our strategies though, so not by the gap that once was. So I would say, relative to concentration, that risk has been mitigated pretty substantially due to what's happened with Asset Strategy. Obviously, we would have liked it to have been mitigated by growing other things rather than the shrinkage of Asset Strategy but that is one of the outcomes of its having shrunk as it has that its percentage as a total of the AUM base is much, much lesser than it used to be.

Patrick Davitt - Autonomous Research US LP

And I mean on a more onto any like – any handful (01:01:04) of broker-dealer complexes or brokerage firm.

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

I would think that that same percentage would substantially follow through on a firm-by-firm basis.

Patrick Davitt - Autonomous Research US LP

Okay. Thank you.

Thomas W. Butch - Chief Marketing Officer & Executive Vice President

There was one firm at which it was a disproportionate part – the one firm at which it was the largest disproportionate part of the base is the one we identified last quarter, which has as a result of its closing sales of Asset Strategy, that's no longer an issue as a concentration risk.

Patrick Davitt - Autonomous Research US LP

Great. Thank you.

Operator

And ladies and gentlemen, at this time, we've reached the end of today's question-and-answer session. I'd like to turn the conference call back over to management for any closing remarks.

Henry John Herrmann - Chairman & Chief Executive Officer

This is Hank. I'd just like to thank everybody for listening in. A lot of the questions have been helpful to us. Hopefully, the responses have been helpful to you as well. And then separately, on a personal basis, I've known quite a few of you for quite a while, and the relationships have always been enjoyable from my perspective. I thank you for your commitments to our firm. I look forward over time to visiting with you now and again, and thanks for listening in. Take care.

Operator

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your telephone lines.

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