Franklin Resources (BEN) Gregory Eugene Johnson on Q3 2016 Results - Earnings Call Transcript

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Franklin Resources, Inc. (NYSE:BEN)

Q3 2016 Earnings Call

July 28, 2016 11:00 am ET

Executives

Gregory Eugene Johnson - Chairman & Chief Executive Officer

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

Analysts

Glenn Schorr - Evercore ISI

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

William V. Cuddy - JPMorgan Securities LLC

Michael Roger Carrier - Bank of America Merrill Lynch

Daniel Thomas Fannon - Jefferies LLC

Brennan McHugh Hawken - UBS Securities LLC

Chris M. Harris - Wells Fargo Securities LLC

Brian Bedell - Deutsche Bank Securities, Inc.

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

Alexander Blostein - Goldman Sachs & Co.

Robert Lee - Keefe, Bruyette & Woods, Inc.

Eric Berg - RBC Capital Markets LLC

Patrick Davitt - Autonomous Research US LP

Michael J. Cyprys - Morgan Stanley & Co. LLC

Operator

Good morning, and welcome to Franklin Resources Earnings Conference Call for the quarter-ended June 30, 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 Matt, and I'll be your call operator today. At this time, all participants are in a listen-only mode. As a reminder, this call is being recorded.

I'd 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, hello and good morning, everyone. We appreciate you joining Ken Lewis, our CFO and me for this call today. The good news is that our results were pretty straightforward for this quarter. So hopefully, the commentary we made available earlier this morning provided much of what you're looking for.

To quickly recap, although we experienced another quarter of net outflows, we did see encouraging signs with redemptions continuing to slow and improving investment performance, particularly Franklin Income Fund that as of July ranks in the top quartile against peers for the trailing one-year period. Financial results and capital management were solid as operating income increased 11% and the trailing 12 months payout was $2 billion. Now, we'll be happy to take your questions.

Question-and-Answer Session

Operator

Our first question comes from Glenn Schorr from Evercore ISI. Please go ahead.

Glenn Schorr - Evercore ISI

Hi. Thanks very much. I guess a question on both sales and redemptions. On the sales side, it's good to see an increase in international sales for the first time in two years. Just curious what the biggest drivers of that are. And then on the redemption side, I guess it's a similar question. It's a really big drop in redemptions; I'm curious if you think that was a point in time or are we at a different level of redemption because that can make a really big difference.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah, Glenn, let me – I'm just trying to be clear on the question. You said global sales, is that referring to global bond and global equity or sales outside of the U.S.?

Glenn Schorr - Evercore ISI

Sorry. Sales outside of the U.S.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah. I think the – a couple of things. I mean the global bond which is a bigger driver of flows outside of the U.S., we did see an improvement, significant improvement in redemptions and that led to the major improvement in net flows. I think the last quarter; we did have some lumpier redemptions in that number versus this quarter. And I would – I still think, that's the one area that continues to be under pressure where we are seeing improvements in a lot of other areas in terms of flows. But the global bond, that's the one that continues to be under pressure. And I think if you look at the other area that I would call out just in terms of flows because I think it's a little bit confusing as the global equity net flows that increased and redemptions increased there and I want to point to – there were three lumpy one-time institutional redemptions within that, that totaled $3.5 billion out of global equity. So otherwise, on the retail side, it's an improving trend there as well.

Glenn Schorr - Evercore ISI

Okay. And then you mention the launch of LibertyQ and LibertyShares and you talked about three multi-factors funds I think, but can you just expand a little bit more on what channels you're going to be selling that through and what kind of uptake we should expect say over the next year?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

I mean I wouldn't, I think we have moderate expectations within the next year as far as flows going into that. I think we have made a major commitment to that segment as far as resources and exposure and marketing dollars to get the message and brand out there. But it will take a little bit of time. And right now they've been up and running, doing well, performing well, and it's a matter of just getting on platforms. Now, we can do that probably faster than a lot of firms because of the relationships. So hopefully, that we – we have built and with our broker dealers and advisors out there and hopefully get some demand putting them on. But, again, it's a start for us in a new segment and it'll take a bit of time as these records get out there. And I hope it won't take three years, but we are getting a lot of calls and a lot of interest on them and I think in the meantime we'll also look at expanding the lineup beyond just smart beta.

Glenn Schorr - Evercore ISI

Excellent. Okay. I appreciate it. Thanks.

Operator

Our next question comes from Wilma Katz (sic) [William Katz] (5:57) from Citigroup. Please go ahead.

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

Okay. I think that's William Katz. Thanks for taking the questions. Good morning, everyone. Just on the – on your P&L, you didn't call too much out on your prerecorded comments, and it looks like you had some softness relative to I think prior expectations particularly on the IS&T line (06:15). Can you give us a sense, maybe this quarter how much was still in severance in the comp line? How do you sort of think about that going forward? And then something near the line items, just given some seasonal and/or core-to-core dynamics?

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

Sure, Bill. There's about $8 million of severance in this quarter. And then, looking forward, and it's dependent upon a onetime item that may or may not hit next quarter, but inclusive of that, we do expect to see increases next quarter in most of the line items. I think comp would be more or less flat, but the G&A will be up. So, we're expecting possibly a charge related to the wind up of the UK benefit plan, and that should be in the neighborhood of $25 million. It may hit next quarter; it may hit the quarter after that.

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

Okay. And then, Greg, you had mentioned – gave us some nice detail on the – sort of how you're positioned on the other side of Brexit. Can you talk a little bit about what you might be seeing in July, or maybe before and after Brexit in terms of sales volumes, just to get a sense of what's going on the platform?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

I don't think there's been any effect on our flows. I think the July performance has been very strong and worth mentioning as the market is kind of settled back and even global bond had a very strong July. So hopefully that'll help sales, but we didn't – I don't think there was much of a disruption anywhere and munis continue to be very strong for us.

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

Okay. All right. Thank you.

Operator

Our next question comes from Ken Worthington from JP Morgan. Please go ahead.

William V. Cuddy - JPMorgan Securities LLC

Good morning. This is Will Cuddy filling in for Ken. Cash outside the U.S. continues to grow. What are your latest thoughts on utilizing cash outside the U.S.? How realistic are investments or M&A to utilize the cash? And how much hope are you placing in a new administration reforming the tax code?

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

The last point is a key point in the discussion. There's been – it's a current topic in Washington. It's been a current topic. It continues to kind of move a step forward, then stop. Move a step forward, then stop. So, we're keeping an eye on that. And we think – well, the consensus that we hear is probably sometime in 2017, there might be something that involves corporate tax reform.

And I would point out, it's a long time ago, but in 2005 when they had that, you can look to see what we did there. So, depending on – it all depends on what we think is the best long-term interest of the shareholders what we do, but in 2005 we did repatriate some money. And so, that's not an unreasonable thing to expect, but it depends on what the law is.

The cash continues to grow, and we're just planning to continue our capital management strategy that we've been doing over the last few years and essentially our payout ratio is more than cash generated or net income. And that means we're using U.S. cash, but U.S. cash still a healthy number. So we don't expect any material change in our strategy.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

And I would just add, I think my sense is in meetings in Washington that you are getting momentum on both sides for tax reform. It's clearly – Paul Ryan and something that he feels very strongly about. So obviously, we're in an election cycle right now. When we get past that, we'll have a lot more clarity on seeing how the House and Senate and the Presidency looks, but we are still hopeful that that's something that's coming, but I think in the meantime as we've said before, the M&A probability, and certainly with some of the currency shifts in Europe and the sterling, make M&A activity that much more attractive to something that we have had on our wish-list. So, I would say again, as I said in prior calls that that's the most probable area for us.

William V. Cuddy - JPMorgan Securities LLC

Great. Thank you. On expenses, expense growth seems to be coming in better than your guidance. Are expenses in this past quarter a good rate to use in 4Q, and as we move into next calendar year?

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

I think as I alluded to in the prior question, I think next quarter, we should see a little uptick in probably all the lines. The most notable one would be G&A for that charge that I talked about. Comp, I think could be flat; it could be even be down a little bit next quarter. So, that's what we're looking for, for next quarter.

William V. Cuddy - JPMorgan Securities LLC

Thank you for taking our questions.

Operator

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

Michael Roger Carrier - Bank of America Merrill Lynch

All right. Thanks, guys. Hey, Greg, just given that you've had more time to go through the DOL rule and have discussions with the distributors and with the industry, just wanted to get your take on how you feel like Franklin's positioned and for some of the potential changes, whether it's 12b-1 fees or commissions, just how Franklin will try to position for the retail channel going forward?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

I think that, obviously, it has been the area of greatest focus with our distributors. Certainly, since the announcement, I would say trying to make sense of the 1,100 pages. It's a little bit like a Rubik's cube where we're making progress and then turn it over and realize we got two other problems. So, I think we are getting some clarity around where it's heading.

We've talked about a standard class of shares, that's something that within the best interest contract can work. I think we're seeing some broker dealers committed to doing the brokerage side and others saying it's not something they're going to do. I think the initial reaction that you're going to have a ton of money moving into the advisory side. I think once we really look at what that means, there's other implications of the rule that may mean monies that are held – that paid a frontend sales charge should stay where they are and not move to advisory because that would actually increase cost.

But I think we are making a lot more sense of the rule. I think the net results are also that there'll be less funds on platforms. We're seeing that, again more of that consultant gatekeeper approach and narrowing the funds that any broker dealer follows, so I think that puts pressure on smaller funds out there to get distribution and ultimately less advisors. I think you'll see more retirements as this transition will be too much. And then, just issues, simple things that sound, again, I mean having a robo-advisor for a small account, but can you have your own ETFs within that robo-advice under the rule. I mean these are the kind of problems that I think are coming up, and obviously, the ERISA lawyers are trying to clarify that and we're working with many in the meantime.

But I think the net effect for us is to have some kind of standardized pricing. We, obviously, we don't want to have 100 different pricing structures out there and are trying to come to some new standard that works for most of our, most broker dealers and advisors and that's really where we are.

Michael Roger Carrier - Bank of America Merrill Lynch

Okay. That's helpful. And then, just as a follow-up. So the quarter, there were a lot of – I don't know, volatile events and markets were all over the place. But we got some improvement and you mentioned July. When you look at those redemption trends in terms of the improvement, was it pretty consistent throughout and maybe even into July. Are you starting to see more improvement particularly given some of the performance trends that you mentioned?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah. I mean I think we're always careful about to talk about flows beyond the quarter. I think the big one for us that as I stated before, that it tends to snap back the fastest is the Franklin Income Fund, which you look at that category just two quarters ago, we had a hybrid $5.6 billion in net redemptions, in the last quarter $2.2 billion. So, I think that that trend we hope will continue as people – even in the last quarter, the three-year number or the five-year number actually improved back to the second quartile, and hopefully in another – the end of this month hopefully will be back in the second quartile for the one year. And as we stated earlier, we're at the 8th percentile for year-to-date. So, that's a pretty big recovery there.

And I think that that's where you'll see the improvement in flows. I think we have some good stories as well on the equity side with one of our largest funds, the Franklin Rising Dividends Fund is $17 billion, $18 billion-fund doing extremely well right now and getting a lot of attention for its performance, which is first quartile for the one year, second quartile for three and five.

Franklin Growth also very strong. So, I think those are areas where we could see a turnaround in flows. And I think as long as the market's stable, the other trends should continue as well.

Michael Roger Carrier - Bank of America Merrill Lynch

Okay. Thanks a lot.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Thanks.

Operator

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

Daniel Thomas Fannon - Jefferies LLC

Thanks. Good morning. On the prerecorded call, you talked about a platform loss, and I think you've mentioned that at other points in time over the last 12 months. And I think insurance was an area of weakness a few quarters ago. I was just curious if there's like a channel or if there's any consistency to some of these platforms in which you're seeing market share losses are being taken off or is it just kind of performance and fund-specific?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah, I think the main driver when I talked about a platform change was one of our large broker dealers that we work with building an in-house sub-advise platform and was moving some assets, and it was $1.1 billion out of our Mutual Discovery Fund. So, that's a one-off event that's not performance related that drove that. We did have – I think the other one on the – just in general. I've talked about the variable annuity business and how that's undergoing change, and certainly with the DOL, we'll have more changes. But we have seen some groups get out of that business. So, they're really in a wind down.

So it kind of changes what they're looking for on their platform. And we, with our solutions group, we're doing our best to transition those assets. But they're the ones that still you have a pipeline of redemptions over the next, say, two years as those groups are transitioning out of that business. So, I would guesstimate that you probably have $5 billion plus in assets over the next two years that will transition. And hopefully, we can capture some of that but it will go out of the traditional funds into a lower fee type solution to meet whatever liability they have.

So, those would be the big changes that have driven the lumpier redemptions. And I think we'll continue to create some headwinds in the next two years on the VA side.

Daniel Thomas Fannon - Jefferies LLC

Great. Thank you.

Operator

Our next question comes from Brennan Hawken from UBS. Please go ahead.

Brennan McHugh Hawken - UBS Securities LLC

Yeah. Hi. Good morning. Thanks for taking the question. Just wanted to follow up on DOL. Could you speak to the penetration of your products in advisory accounts within the broker sold channel as a percentage of your total assets in that distribution channel?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah. I don't have the exact number. I know we have about $100 billion in retirement assets in the traditional brokerage side. I don't know what the number is. Maybe – somebody's putting some numbers in front of me now, so I hope they're right. But, about $40 billion in advisor class, to be more of the wrap side, so about 2:1 in the traditional A share to advisor class

Brennan McHugh Hawken - UBS Securities LLC

And that was actually up.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

We're at $140 billion total.

Brennan McHugh Hawken - UBS Securities LLC

$140 billion total and all of that is within the retirement accounts rather than in.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Right.

Brennan McHugh Hawken - UBS Securities LLC

Okay. Okay. Rather than (20:31) – got it. Are those general proportions though different for taxable versus non-taxable? I would assume proportionally probably similar.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

I would think so. Yeah. I don't – I think they would be similar.

Brennan McHugh Hawken - UBS Securities LLC

Okay. Okay. Great. And then, the expense front. Is the – just a clarification, is the potential for the UK charged next quarter or – and the somewhat uncertain timing which you highlighted, the reason why you just don't want to update that previous 3% expense reduction with commentary that you've given in the past?

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

No. I mean, it's not relevant. I mean, we've known this was coming. We're unsure of the timing. So we've incorporated it into any guidance that we've given in the past. So, I think including – inclusive of that, we should be within the range that we've told you before on the change of expenses year-over-year.

Brennan McHugh Hawken - UBS Securities LLC

Okay. Okay. Great. And then, last from me. We saw an uptake in buybacks here this quarter. Was that opportunistic just given some of the volatility or a potential indication that your capital allocation policies may be shifting ex, of course, any momentum on reform and in the tax code as you laid out before?

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

Yeah. Surely opportunistic. Trying to take advantage of price dislocations as they occur, and it doesn't represent any change in strategy.

Brennan McHugh Hawken - UBS Securities LLC

Okay. Thanks for taking my questions.

Operator

Our next question comes from Chris Harris from Wells Fargo. Please go ahead.

Chris M. Harris - Wells Fargo Securities LLC

Thanks. Hey, guys. So, in your prepared commentary you did talk a little about Franklin's history, being able to adapt to changes in the industry and that's certainly well documented. But when we think about the situation we're in now, this period certainly feels a lot different just because it appears like you have a lot of investors out there that just don't want to own active funds or at least in certain areas anyway.

So, and I guess what we're wondering here is what's your kind of long-term strategy to manage around that or manage that type of an environment? And, we know you guys have K2 and the ETF initiative going on, but that just doesn't quite seem like enough, so any commentary you can give in that regard would be helpful?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Well, I think, again, as we've stated in our prior calls, continuing to look at alternatives, continuing to look at solutions where we can add value outside of just market traditional beta as we again, stated before, to come into the market and offer passive today doesn't make a whole lot of sense for us as we've seen the race to the bottom and fees that continue and to drive down close to 2 basis points.

So, that doesn't seem like an attractive alternative. I think we also believe that active, that there are forces at work over the last 5, 10 years that have contributed to the passive strategies and once active outperforms. And that tends to be in more of a rising rate environment historically. I think that conventional wisdom could shift pretty quickly. And that's something we firmly believe. But in the meantime, we have built out our solutions. We're looking at our multi-asset capabilities; we're getting a lot of interest in that. And that's just another area how we can add value to investors by combining different asset classes over time.

So that's going to be an important growth area, and whether it's real estate alternatives, long, short, hedge funds, those are all private equity things that we plan on continuing to expand outside of your traditional U.S. large cap stocks.

Chris M. Harris - Wells Fargo Securities LLC

Okay. Great. Thank you.

Operator

Our next question comes from Brian Bedell from Deutsche Bank. Please go ahead.

Brian Bedell - Deutsche Bank Securities, Inc.

Great. Thanks for taking my question. I think, Greg, you've mentioned – if I heard this right, $3.5 billion of lumpy institutional redemptions in the global international equity category. Is that correct?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Right, right.

Brian Bedell - Deutsche Bank Securities, Inc.

Okay. And so then maybe adding on to your commentary on the VA side of the $5 billion sort of potential redemption pipeline over a couple years is there anything else that you foresee on the institutional side, both positive and negative I guess over the next quarter or so.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Well, we have – we do, if we know something is being redeemed, we try to call it out and I've done that on past calls. We do have a large institutional low fee account that was redeemed; I think this month about $1.2 billion, $1.3 billion in the global equity area.

I don't have anything to call out, I think the institutional pipeline again, we feel like it looks good, as far as the opportunities that have identified and RFPs that we're responding to. And I know one area that would be a new growth area for us but one that we've had excellent numbers, it would be on the Franklin Global Growth side, and we are – hopefully we'll see some nice wins there over the next year.

Brian Bedell - Deutsche Bank Securities, Inc.

Okay. That's helpful. And then, Kenneth, I think you mentioned on the recorded call some adjustments to CDSC amortization, and the impact on the sales and distribution expense. What was the level of that I guess in the quarter?

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

I think it was about $6 million.

Brian Bedell - Deutsche Bank Securities, Inc.

$6 million, okay. And you view that as one time or is it something that's potentially ongoing?

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

No, I think that's one time. There's a little bit left of it that we might get next quarter but essentially one time.

Brian Bedell - Deutsche Bank Securities, Inc.

Okay. Great. And then just lastly, Greg, just maybe your view, I mean you talked a little bit of M&A and that looking a little better given the build-up with non-U.S. cash. Maybe if you can talk sort of more broadly about – you've been in the industry a long time. Your view of to what extent we'll potentially see more consolidation in the industry if active continues to underperform and product needs to get rationalized. And then from your angle, do you see yourself as more of a participant in acquiring firms or potentially even combining with another large firm?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah. I think the – as I stated before, I mean, I think any industry that is maturing and gets larger, you hit a point where consolidation makes sense. I mean, I'm not sure we're there yet, but certainly you have some outside forces at work that we haven't seen before. So I think that will contribute. I think the other point that I've stated when asked about this is that it's not the easiest industry to do large mergers and consolidations with funds are – you have separate contracts and boards, and it's very time consuming and difficult to do a merger.

So I think for us, we again are open to anything that we think enhances the line-up and creates shareholder value over time. And we try to build as many relationships across our industry to be able to act on things that make sense, and that's where we are today. And I wouldn't state one way or another. I think we're always out looking on behalf of shareholders and trying to create value and if that's a merger, if that's an acquisition, we're open to any and all.

Brian Bedell - Deutsche Bank Securities, Inc.

Great. That's great perspective. Thank you.

Operator

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

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

Thanks. Good morning. I just had a question on capital. Can you quantify how much excess cash you have in the U.S. operating sub today above any working capital or regulatory needs?

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

Sure. I think that – roughly, and that would even include some of our voluntary restrictions on it. We have about $2.5 billion U.S. cash, roughly about $800,000 of that I would call restricted of some sort. Sorry. Sorry, $2.5 billion and $800 million restricted.

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

Got it. And, then, if we look at your net income this quarter, $446 million after tax, do you have the mix that was generated in the U.S. And I also think your Canadian, UK entities kind of sit under the U.S. sub and then what was the level that was generated outside the U.S.?

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

In terms of the earnings mix?

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

Yeah.

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

I'm not sure I have that handy. Yeah, I don't have that handy. But, it's a tough thing to estimate. And so what we – we see development quarter-over-quarter that earnings are shifting one way or the other. We just kind of project that out. And so, we just sort of shift this quarter.

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

Then on a trailing 12-month basis or a run rate basis, is there a rough range that we should think about? Is it like 50/50, 60/40?

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

Yeah. I think we're talking about two different things. Overall, GAAP income, again, we could say 50/50 is not bad but on a taxable basis; it's a completely different ballgame there. Taxable income and book income are completely different.

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

Okay. All right. Great. Thanks for taking my questions.

Operator

Our next question comes from Alex Blostein from Goldman Sachs. Please go ahead.

Alexander Blostein - Goldman Sachs & Co.

Thanks, hi, good morning, guys. Just to follow-up around expenses. This year, there's a lot of moving pieces, a bunch of one-timers, severance obviously was a big part of that and it sounds like there's obviously another charge with the $25 million. So, all in all, can you guys help us understand kind of – as we look for 2016 as a whole, how much of some of these one-time items been when you run (31:57) expenses and I guess more importantly as we look out into next year I guess presumably these will not repeat. How should we start to think about next year's expense run rate?

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

Yeah. Maybe that's a better approach instead of kind of listing all the one-offs and trying to estimate what one-offs will be next year. I think we could just like take a higher view of it. So, as we've been talking on this call about all the changes in the industry and because of all that, we're continually examining all of our strategies.

So if we look forward to next year, we're looking at – and I mentioned this in a previous call as well, we're looking at every facet of our business model to determine if we have the business models and service capabilities that we need for the future and that may include structural expense increases or decreases over the next few years. So, that's kind of a long way to answer your question that we are currently looking at our cost structure, but it's a little too early to kind of give definitive guidance because some of these initiatives are multi year. But I can tell you that based on what I know now if I look towards 2017, it looks like expenses will be flat to slightly down compared with the current year or the estimate of the current year expenses.

Alexander Blostein - Goldman Sachs & Co.

Got you. Assuming the $25 million shows up in the fourth quarter, the $25 million UK...

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

Assuming the $25 million shows up in the fourth quarter, I think, correct.

Alexander Blostein - Goldman Sachs & Co.

Got it. That's helpful. And then, I wanted to go back to the DOL discussion for a second. As you guys discuss the change among the distributors and more decision-making process taking place more in a kind of gatekeeper way and more consolidated top of decision-making and, I guess, more centralized, what do you guys think will be the criteria for active fund placement in that environment? And I guess, more importantly, how do you think you are positioned in that backdrop?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Well, I think we're positioned well because the first driver is going to be assets. You have that – around their books with their clients, so you're not going to eliminate those. And the other performance and risk-adjusted returns and relationship, the size of the company, I think those are all factors. I think each firm will have their own. Clearly, we will not have every one of our funds on those lists. And it may mean more consolidation of funds within our lineup as we rationalize. And that's been – an emphasis of our firm is to streamline the lineup and a number of products that we're servicing. And I think in this environment, that's going to probably accelerate their process of closing some smaller funds that wouldn't get the shelf space.

Alexander Blostein - Goldman Sachs & Co.

Got you. And then maybe if just squeeze one more. Around the fee rate dynamic, it seems like at least more recently there's been a little bit more or widened divergence between domestic product versus international product and especially given your comments about slowing redemptions in the hybrid side of the business. Is there a meaningful enough of a difference between the hybrid product, domestic equity product versus the global bond and international equity product that could – given these slow trends result an actual shift in the mix that's big enough that we can kind of see it in the fee rate or not very meaningful?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

No. I think that if you look at the fees across those different categories, they're actually fairly aligned; probably the hybrid one's a little bit lower, obviously, than international equity. But I don't think it would have a meaningful shift in your effective fee rate at all.

Alexander Blostein - Goldman Sachs & Co.

Got you. Great. Thanks very much.

Operator

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

Robert Lee - Keefe, Bruyette & Woods, Inc.

Thanks. Good morning and thanks for your patience in taking all the questions. Curious about in the alternatives business, and obviously, you have K2 and you've launched some liquid strategies which had some early success. Could you maybe – I guess, first update us on the progress with some of your liquid alternatives? And then maybe also your thoughts about building out a broader alternatives capability where you would be particularly interested, and maybe update us on what your current capabilities are, maybe outside of K2?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

I think the K2 is working well as planned in bringing liquid alts to the retail channel. In the last year, we expanded the lineup and added a Long Short Credit Fund and a Global Macro Fund, and we think those could be nice complements again to diversifying a portfolio.

Outside of that, we have a lot of areas whether its real estate and private equity and it's really trying to build more scale within those. So I think we are looking at considering acquisitions on that side, and continuing to build out our capabilities and just think it's a natural extension of what we do.

But I think we are open, I think as I've stated in the past, it is difficult just to go out and buy a hedge fund or buy companies that have done well in the alternatives space because they are so driven by the specific person. But, we are looking actively in that area and whether, again, its real estate, private equity or traditional hedge funds. Those are all on the table.

Robert Lee - Keefe, Bruyette & Woods, Inc.

And maybe just a follow-up on the global bond, global fixed income. You talked in the past about seeing these two strong channels of big opportunity for those strategies broadly and can maybe update us on that? Given maybe some of the performance challenges of the past year that's slowed down but where do you think that opportunity exists currently for the – on the global bond side institutionally.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah. I think it's – the institutional market, especially, I think they are less sensitive and because this fund – to just – to benchmark it against global bonds, I think is not – really is more of a Global Macro type fund. And it doesn't fit really well into any one given category. I think the standpoint of diversifying from local currency and local sovereign debt. There is still a big appetite for that.

I don't think that's changed. And I think also when people – sophisticated investors look at the portfolio and look how it's positioned, it is very different and does offer something very different and that it will be one of the few games in town if rates actually do go up at some point.

And I think the risk, certainly, from the perspective of an individual country's currency depreciating in some cases is still very much there. So we are getting institutional interest, and that really hasn't changed. So, hopefully we'll get some significant wins in there.

Robert Lee - Keefe, Bruyette & Woods, Inc.

And one last question if I can on the distribution, retail distribution, I mean, you've talked in length as have peers about changes there, maybe approved lists shrinking and a number of products you may have in any platform moving around. At the same time, you've had a lot of new product initiatives, LibertyShares, K2, your whole broad line of traditional products. So within that kind of mix, I mean, are you thinking or have you thought that there's some kind of change you need to make in terms of your own distribution capabilities? Is it, I don't know, shrinking it or is it changing the type of personnel given the changing product mix? I'm just kind of curious how you feel about strategic changes in your capabilities.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Well, I think that's already been happening, and it's been really an effort probably the last three or five years for us transitioning your traditional retail sales force into a more institutional quality level especially at that gatekeeper level the people calling on the home office. Those are really more of your traditional consultants with that kind of background there to talk about metrics that are very different from how we viewed funds, I think, in the traditional way.

So, that's already happening. I think as far as even our sales force, and we've made changes there over the last year focusing specifically more on having a targeted group for the advisory side that's a little bit different again than your traditional. So, we've been evolving as the market has been changing and we will continue to do that. And hopefully, at some level, you'll get some efficiencies out of that as we get better at providing useful information on a real-time basis through digital side, which has been a big emphasis in trying to reach more advisors in a more efficient way. And I think that again as the model changes, the use of technology and information getting to advisors can create a lot of efficiencies from the traditional way that we've done it. So, I think that's happening as well.

Robert Lee - Keefe, Bruyette & Woods, Inc.

Great. That's all I had. Thanks for taking my questions.

Operator

Our next question comes from Eric Berg from RBC Capital Markets. Please go ahead.

Eric Berg - RBC Capital Markets LLC

Thanks much, and good morning. The improvement in the redemptions took place it seems pretty much everywhere across the complex except of course for global equity. And I understand that there has been improvements and very significant improvement in your flagship hybrid product. But it was also an extraordinary quarter in so many respects. What with the Brexit vote and terrorism and interest rates declining and extreme volatility in currency. I mean, it's a long list of factors that made it a remarkable three-month period.

To what do you attribute this company-wide decline, not just in certain categories, but company-wide decline in redemptions? That's my first question.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Well, I think the effect for us, and again, we've stated in the – we had more exposure to energy rolled up through probably four different entities. And we don't do any top-down risk management, each individual firm, we look at separately. And so, you had an overexposure to energy, had an overexposure to Europe. Those were trending nicely until Brexit, and even if you look at the trend in equities to quality away from more of your traditional momentum to strong balance sheet's rising dividends, quality earnings. Those were all trends that fit nicely into our – generally, into our philosophy with many of our equity funds. You did see an improvement in rotation happening, a rotation into value as well.

And if you look at the quarter, I mean Brexit kind of hit right at the end of the quarter, so it was at the beginning, and maybe it would be a little bit of a different story. But what we had captured a lot of good relative performance during the quarter, which unfortunately in the last couple weeks when you had more a risk off environment, you lost some of that, which has been gained back in July.

So I think it's really just looking at the flagship products for us. And also, munis, that's a strength area for us, and munis are very attractive in this environment, and should continue to be. So, I think that that's counter to what is happening on – and a result of a lot of the, I think, uncertainty in equity markets, money moving into munis right now. So, that's another factor as well.

Eric Berg - RBC Capital Markets LLC

The second and final question I had relates to fixed income in general. And you've just touched on it a little bit, but maybe you could expand in responding to the following question. I have been struck by not only the fact that your company is having very stable, not growing, but very stable fixed income gross sales, and so are many of your competitors. It's surprising to me, given that there is no yield, and that – and the duration risk is very substantial should interest rates rise over the next couple years.

My question, given all that, the absence of yields, the duration, the loss of principal risk, why do you think fixed income across the industry is doing as well as it is in terms of gross inflows?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

I mean, that's a great question, but I do think fixed income always has a place in a diversified portfolio and does reduce risk. I think you are correct that where we sit in this cycle, I think many would argue that there's greater risk from rates going up. That's certainly the position within our Global Bond Fund. But at the end of the day, it's very hard to take a portfolio and just ignore fixed income. It – you'd put a lot more risk into that given portfolio if you go 100% equities. But at the end of the day, you look at something like munis. It still has an attractive yield relative to the Treasury market, certainly on an after-tax basis. And the general consensus right now, right or wrong, is that rates are not going up. So, I think there's a sense of security that even with these small yields, they're going to be fine for X number of years.

Eric Berg - RBC Capital Markets LLC

Thank you.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Thanks.

Operator

Our next question comes from Patrick Davitt from Autonomous. Please go ahead.

Patrick Davitt - Autonomous Research US LP

Hey, thanks. Good morning. Cohen and Steers recently announced that they had hired Dennis Rothe who, I guess, was your Head of Consultant Relations. Was that separation your decision? And I guess what are the plans, I guess, for replacing him and has it caused any kind of dislocation in that part of your group?

Gregory Eugene Johnson - Chairman & Chief Executive Officer

No, it hasn't, and we really don't – we will not comment on about the surrounding circumstances with...

Patrick Davitt - Autonomous Research US LP

Okay.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

...a departure, but it has not been disruptive and it's been replaced.

Patrick Davitt - Autonomous Research US LP

Okay. And then more broadly, I know you're probably tired of talking about capital, but if we're in a situation where there is no tax holiday either because of the continued kind of impasse in DC and you can't find an M&A target, is it just the status quo then you'll continue to just kind of build the cash or are there other options that you would consider if we get into that kind of situation next year?

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

There's always other options and I guess I would respond to that as a pretty big hypothetical there with three or four possibilities. So, it's hard to predict what will happen. We just – maybe we have like an 18 month time view when we look at these things, and I think it's going to be status quo, we're not going to – we don't plan on changing anytime soon.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

I mean I think it's the – we don't want to feel like we have a timetable to do a big deal that you have to do something by X and I am a firm believer that once we get past this cycle that some form of a repatriation will come through, but that doesn't mean in the meantime that we're not looking at opportunities especially with some of the currency devaluations in Europe right now.

Patrick Davitt - Autonomous Research US LP

I guess on that point, you touched on this a few questions ago, but, your tone on M&A has kind of ebbed and flow over the last few years. What is kind of the primary reason that you haven't found something, has it just been a lack of businesses that really fit or is it more price? What do you think the overarching kind of reason for that is?

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

I think it's probably those two items and more. I mean we're pretty active every year and looking at properties and some of us come to us, some of us we're proactive on – and for the ones that we haven't done, it tends to be, they don't really meet our criteria. So quality, repeatable investment process, culture, price – yeah, price could be an issue and it has been in some cases. As Greg mentioned earlier, it's not the easiest industry to integrate. We think about that. And also, a lot of – we come across situations where there's ownership structural challenges as well. So, it kind of runs the gamut of why a deal doesn't go through. But those are some of the things that we found.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Yeah, I think like anything in life the best ones are not for sale right now. And we're going to continue to build relationships and I think if both firms see the benefits, then you can have a successful merger-acquisition, and that's what we're hopeful for. But at the end of the day, it's not – we don't feel like that's necessary to be successful either. And I think that's an important point too.

Patrick Davitt - Autonomous Research US LP

Okay. Makes sense. Thank you.

Operator

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

Michael J. Cyprys - Morgan Stanley & Co. LLC

Hi. Good morning. Thanks for your patience and taking the question. I just wanted to follow-up on the M&A point. I know you're not necessarily the easiest industry for M&A, at the same time I realize you sound like you're open to anything right about now. So, just curious how you think about the value and benefit that could potentially be derived from large scale M&A and/or potential consolidation.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Well, we've done it in the past and it's added a lot of value to this firm. I think we have experience, we recognize some of the pros and cons, and large scale deals just from a branding standpoint and product and disruption are difficult, and are making a big bet. But they're also the ones that are going to move the needle the most. So I think for us it's really looking at what areas we could strengthen our line-up, and there are certain firms that do that out there, but we also don't want to get to the point where we have so much brand and product that it becomes confusing to the marketplace too. So I think those are all issues that it's challenging to get two big firms to view what's right for the future, I think, in a consistent way.

But, we're going to keep trying to do that.

Michael J. Cyprys - Morgan Stanley & Co. LLC

Okay. Just as a follow-up. If we could just dive in a little bit on the digital front, just curious how you're thinking about your digital strategy. I know some of your competitors have acquired certain capabilities in that area, if you just maybe elaborate on how you're thinking about it. Now I think you mentioned a little earlier just in terms of how platforms looking for more of that.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Well, I think that we are looking and even with the DOL having some capability and whether that's built internally or we go out and rent the capability or buy the capability. Those are all things that we are exploring. And I think the traditional model of saying we'll go out and buy a robo-advisor for us. Again, unless you have a large scale ETF business, we're not sure that makes a whole lot of sense.

But we do need some form of allocation for existing clients within. That would be helpful for smaller accounts within the fiduciary rule as well.

So, it is something that we're looking at and seeing how those capabilities and looking out on the long horizon makes sense one way or another for us as well. And there's a lot of different ways we can do it. And, that's really the stage we're in right now, is meeting with as many of them and deciding whether to buy or build

Michael J. Cyprys - Morgan Stanley & Co. LLC

Great. Thank you.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Thanks.

Operator

I would now like to turn the floor back over to Mr. Johnson for any closing remarks.

Gregory Eugene Johnson - Chairman & Chief Executive Officer

Well, thank you, everyone for participating on the call, and we look forward to speaking with you next quarter. Thank you.

Operator

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

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