Janus Capital Group, Inc. (NYSE:JNS)
Q3 2007 Earning Call
October 25, 200710:00 am ET
Gary Black - CEO
Robert Garvy – Chairman/CEO, INTECH
Greg Frost - CFO
Ken Worthington – JP Morgan
Thomas Gallagher -Credit Suisse
Marc Irizarry - Goldman Sachs
William Katz - Buckingham Research Group
Cynthia Mayer - Merrill Lynch
Donald Neiman - William Blair
At this time I would like to welcome everyone to the JanusCapital Group third quarter 2007 earnings conference call. (OperatorInstructions) Before the company begins,I would like to reference their standard legal disclaimer, which alsoaccompanies the full slide presentation located in the Investor Relations areaof Janus.com.
Statements made in the presentation today may containforward-looking information about management’s plans, projections, expectations,strategic objectives, business prospects, anticipated financial results,anticipated results of litigation and regulatory proceedings, and other similarmatters. A variety of factors, many of which are beyond the company’s control,affect the operations, performance, business strategy and results of Janus andcould results and experiences to differ materially from the expectations andobjectives expressed in their statements.
These factors include, but are not limited to, the factorsdescribed in Janus’ reports filed with the SEC, which are available on theirwebsite, www.Janus.com, and on the SEC’s website, www.SEC.gov. Investors arecautioned not to place undue reliance on forward-looking statements, whichspeak only as of the date on which they are made. Janus does not undertake toupdate such statements to reflect the impact of circumstances or events thatarise after the date these statements were made.
Investors should, however, consult any further disclosuresJanus may make in its reports filed with the SEC. Thank you.
Now it is my pleasure to introduce Gary Black, ChiefExecutive Officer of Janus Capital Group. Mr. Black, you may begin your conference.
Good morning, and thank you for joining us for our thirdquarter earnings call. With me today are Bob Garvy, our Chairman and CEO ofINTECH; and Greg Frost, Chief Financial Officer.
As you can see from the results we reported this morning, wehad a fairly strong quarter in most respects. Third quarter earnings per sharefrom continuing operations were $0.29. We did announce our plans to sell ourprinting business and as a result we took an impairment charge on these assets andhave excluded these results for all periods. Other than that, I think it was afairly clean quarter.
Long-term flows were a positive $0.7 billion which was belowsecond quarter. On the Janus managed side, flows continued to strengthen. Wegenerated $2.9 billion of positive flows in the quarter. Recall last quarter,which was $1.5 billion of positive flows, was the first time we had beenpositive in about six years.
INTECH flows were disappointing at -$2.2 billion, reflectingsome challenging short-term performance; Bob will talk more about that in aminute. We also had $8.1 billion of net new flows in the money market area,which pushed our assets under management up about 9% for the quarter to $208billion, which is up about 26% from where we were a year ago.
Performance from our investment teams remains exceptional.Across our retail products, all of our JIF products, 89%, 73% and 67% of ourfunds were ahead of peers over one, three and five years, respectively. On theJanus managed equity side, 100% of our funds are now ahead of peers over thepast year; 87% and 73% are ahead of peers over three and five years,respectively.
Our investment margins were 33.7% in the quarter and werepurchased $184 million worth of stock, reducing the shares outstanding by anadditional 3.4%, which brings us to a 12% net reduction year-to-date.
Turning to slide 3. Overall flows, again, were a positive $0.7billion during the quarter. The Janus flows you can see at the bottom, werestrong at $2.9 billion. I think itreflects the outstanding performance which, again, we’ve had now for severalyears and it also reflects a shift in the marketplace back to growth-orientedmanagers, following Growth’s performance in the marketplace, which Growth hasbeen beating Value now for about a year.
It also reflects the buildup of our distribution efforts,particularly our intermediary business; we’ll talk more about that.
Many of you get the strategic insight retail market sharedata. For the quarter, Janus improved to ninth in the industry in the Equitiesside; for the month of September we’re actually seventh.
Putting it in perspective, a year ago we were 597 -- thatwas for third quarter 2006 -- and we were actually 19 in the second quarter, so we’ve madesome good progress on the retail share front.
INTECH closed, again, with -$2.2 billion, you’ll see that atthe bottom right, and I’ll let Bob address that.
On slide 4 by channel, retail net flows were positive forthe third consecutive quarter fueled by gains in our supermarket subchannel. Inthe supermarket subchannel AUM is actually up about 50% versus where we were ayear ago. We now have 18 funds on the so-called select list at Schwab andFidelity, who dominate the channel.
Looking at the domestic intermediary business, the top right,the flows continue to accelerate. The Growth flows are actually double wherethey were just a year ago. This is the second consecutive quarter of positivenet flows, driven by the broker-dealer subchannel. We now have 47 wholesalerson the ground. This is almost all of the Janus-managed products.
On the institutional side, bottom left, we posted netoutflows of $1.1 billion; it reflects the outflows from the INTECH products andagain, as Bob will talk about it, it’s more a rebalancing by large quantitiesthan terminations. I think most of our institutional clients understand ourprocess, and understand that our performance, while challenged in the shortterm, has been very strong long term. Our fourth quarter [inaudible] fundedpipeline remained very strong, and we are getting some traction on theJanus-managed side. We actually had $300 million of inflows in the quarter onthe Janus-managed side.
On the international front, which again is the bottom right,net outflows for the quarter, sizablenet outflows in our offshore mutual fund for INTECH products. But like theinstitutional business, we have a pretty robust pipeline going into the fourthquarter.
Turning to slide 5, we’ve had a very robust market year-to-dateand over the last 12 months, particularly outside the U.S.,you look at the MSCI EAFE Growth and Value benchmarks, and that has provided anice tailwind for the entire industry.
If you look at the top right, retail flows in Septemberrebounded nicely after a pretty tough August. Looking at the bottom left,Growth is now outperforming Value for all periods we show here. So thirdquarter, year to date, and last 12 months. And over the last 12 months you’llsee Growth outperforming Value by about 500 basis points, which is causingindustry flows to shift away from value managers and toward growth managers,which is obviously benefiting Janus.
Given our strong performance and given our distributionbuildup, we think we’re very well-positioned to take advantage of this. Again,you saw that Janus flows in the quarter of positive $2.9 billion, which isabout 10% organic growth.
Turning to slide 6, the Janus investment team continues todeliver just superb investment performance across all time periods. Again, onthe Janus managed equity side all of our products have beaten peers over thepast year, 87% and 73% are beating theirpeers on a three and five year basis. 50% of our JIF funds are rated four andfive star by Morningstar.
85% of our Janus managed equity products are actually topquartile over the past year and 80% are top quartile over the past three years.It is a testament to the depth of our investment team. On a since-inceptionbasis, 88% of our Janus-managed products have been in the top quartile sinceinception.
INTECH performance has been challenging short term, butlong-term performance is still very strong. All seven of our strategies for atleast a five-year record are ahead of their benchmarks since inception. We’vetalked about batting averages in the past. If you look at the percentage ofperiods where Strategy has actually out performed its relative benchmarkindependent of when you start the clock, greater than 75% of Strategy’s have abatting average for three-year rolling periods which means 75% of the timethey’re beating the benchmarks. If you look at five-year rolling periods, 85%batting average, which again are very, very strong numbers.
You can see this graphically on page 7. It’s prettystraightforward, the numbers continue to be extremely strong across the board.
On page 8 you see the detail which in the past we’vehighlighted specific performance, but it is exceptional across all the Janusmanaged products, across all time periods. I will again call out some standouts:
- Janus 20 top 1% one, three, and five; it’s managed by Scott Schoelzel.
- Janus Research, top 3% over one, three, and five, which is managed by the research team.
- Janus Orion, top 2 percentile on a one, three, and five basis, managed by Ron Sachs.
- Our Venture product which is closed, managed by Will Bales, top 7%, one, three, and five.
- The Contrarian product, top 1%, one, three, and five managed by David Becker. David is actually the number one across 662 funds over the past three years, number two out of 493 funds over the past five years.
- Overseas, managed by Brent Lynn, top 1% in the international arena. He’s actually number one out of 1,049 funds over one year, 812 funds over three years, 671 funds over five years.
- Some of our newer products, Janus Triton, top 5% since we launched it about two years ago, managed by Chad Meade, Brian Schaub.
- And our Global Research product, which we also launched about two years, is top 5%.
The reason it’s important to just think about this isbecause we do have a very broad bench, a very deep team of investment talent. Ido want to talk at this point a little bit about some of the recent departuresat Janus. Some of the investment talent is in the process of either retiring orleaving the firm, which has gotten some press. We don’t like losing any of ourinvestment talent. It is the lifeblood of our firm. This team is the best inthe industry, and we want to make sure that we keep them.
As the industry continues to mature and move away from atraditional, self-directed model to advice-driven platforms, towardinstitutional channels, we have responded by shifting our strategy to betterposition our clients in the firm. That means that we have moved to more of ahybrid model, both individually managed products and team managed products.
So in some cases the traditional model of having a singlemanager, we keep that where it’s appropriate. In some products, like on theJanus Fund where we announced recently that Jonathan Coleman and Dan Riff would take it over, we’ll haveco-managed products and we do have some team-managed products, particularly inthe institutional space.
We’ve also asked our portfolio managers to play a biggerrole in client relationships as a result of the shifts in the industry. We’veevolved our compensation philosophy to more closely align the interests of ourPMs and our clients. Specifically, there’s more focus on consistent, long-termperformance defined by three- and five-year performance, and we’ve linkedoverall compensation to the firm’s success.
So in some cases, that can lead to decreased compensationfor an individual, but so far in 2007 our aggregate portfolio manager comp isup sharply given that we’ve had strong performance, given that we’ve hadfavorable markets and given that we’ve had strong flows.
What hasn’t changed about Janus is the focus on in-depthfundamental research. It is the core of our culture. For 37 years it’s been thedriving force behind our strong results. So what I’ll conclude -- and I’m surewe’ll get some questions about this -- is that losing investment talent isnever easy. That said, we have a very deep bench and we have the utmostconfidence in our succession planning. We feel very confident in our investmentteam’s ability to continue to deliver for our clients and our shareholders.
With that, I’d like to turn it over to Bob Garvy, Chairmanand CEO of INTECH.
Thank you, Gary.Hello, everyone. It’s a pleasure to be with you again. I will begin my portionof this presentation on slide 10, inwhich you’ll note that INTECH celebrated its 20th year of risk-managedmathematical strategies in July 2007. So we now, I think, are a firmly wellestablished provider of risk-managed strategies using a mathematical process, primarilyin the domestic market, but as we’ll discuss, now extending out into theinternational realm as well.
We were founded back in 1987. We have offices in Palm Beach Gardens, Florida; Princeton, New Jersey, in which our research facilityresides; and as of June of ‘06 we have established a presence in Londonwith the head of our international business and a high level investmentspecialist to service our growing business that’s non-U.S. based.
With this 20-year record we now have established -- if notthe longest -- one of the longest continuous records of mathematical investmentmethodologies in the industry.
We of course have had a disappointing performance over thepast 21 months. But this underperformance is not unexpected, nor is it outsideof what we would have seen in the past year in our actual performance or in oursimulated performance. It is significant; it’s unsettling. None of us are happywith it, but as any manager knows that takes positions different from thebenchmark itself there will be periods of underperformance. We don’t like itand we are doing everything we can, of course, to deal with it.
But I think it’s important to point out the differencesbetween the kind of performance we’ve been experiencing and that which manyquant managers have experienced, particularly in August of this year. There’s avery significant difference between the processes employed by the typical quantmanager with which we are usually accompanied, versus the mathematical processthat INTECH uses.
First among those is that INTECH is a completely transparentprocess. There’s not a black box involved in the methodologies that we employ.We first published stochastic portfolio theory and stock market equilibrium inthe Journal of Finance in 1982, and so our process was well described in thatand has been well described in many other publications that we have releasedover the ensuing two decades.
We also tend to try to produce a high risk-to-reward ratioversus simply maximizing portfolio returns or minimizing portfolio volatility.We’re very much interested in the information ratio or the relationship betweenthe excess performance that we’re attempting to generate and the risks that weundertake in generating that excess return.
We do employ a mathematical process. There are nofundamental predictions or forecasts about expectation regarding individualsecurities, industries or sectors within which they reside or the marketitself. We remain fully invested at all times.
Our process does not depend on mispricing of individualsecurities and is consistent with the efficient market hypothesis in thatsense. Our investment process is based on mathematical principles, notmultifactor modeling.
Turning to page 11, there are two essential things thatINTECH needs to do in order to generate an excess return at the risk levels thatwe are attempting to control. The first of those is to identify and tooverweight stocks with higher relative volatility. The second thing is tocontrol the tracking error of the portfolio by using lower correlation amongsecurities to control that tracking error.
As we look back over this period of underperformance, wecontinue to do those two essential things: that is, our portfolios arecontinuing to overweight stocks with higher relative volatility whilecontrolling tracking error. So this underperformance that we are experiencing;we believe it is primarily the result of the random nature of the stock priceprocess, and we would expect, given our long history of employing this processsuccessfully, to have that continue in the future.
On page 11, we’ll just give you a very quick review of howwe go about building our portfolios. In the first step, of course, we establishan eligible universe. In the case of the S&P 500, for example, for ourenhanced strategies or the Russell 1000, that would be the universe with whichwe begin our process.
We then essentially eliminate stocks that are so small or soirrelevant or too illiquid to trade. To that we apply our mathematical process.This process attempts to identify stocks with higher relative volatility, butthen combine them in such a way as to incorporate the advantages of lowercorrelation to provide a risk-managed portfolio. Risk management is one of the key elements ofINTECH’s process.
Now while we emphasize risk management, of course no processis risk-free but we believe that this mathematical process results in a moreefficient portfolio than the capitalization-weighted indices to which it’sbenchmarked. We apply this mathematical process consistently across all of theproducts that INTECH offers. In fact, as I mentioned before, we are continuingto identify both stocks with higher relative volatility and with lowercorrelation to allow us to control tracking error.
Specifically, on our Enhanced Plus portfolio for example instep 1, we would start with the S&P 500 index. So we start with 500 stocksthere. In step 2, as of September 30 of this year, that liquidity screenessentially eliminated ten stocks from that universe, leaving us with about 490stocks to which we apply our mathematical process.
The risk controls and the mathematical processes that areemployed there result in what we believe is a more efficient portfolio than thecapitalization weighted index, and as of September 30 of this year, there were295 stocks in that portfolio. That process is essentially duplicated for allthe various benchmarks and strategies that we employ.
Moving to page 12, you can see that we have had substantialgrowth of assets over the past number of years, and that asset growth hasallowed us to reach nearly $70 billion in assets under management as ofSeptember 30 of this year.
One of the key considerations when one experiences that sortof growth is the impact of that growth on the implementation process and wehave, throughout our history, paid a lot of attention to implementation costs. Therewere a couple of developments in the industry since 2001 that havesubstantially assisted us in controlling trading costs. The first of those was anoptimization alteration that we made in 2001 which significantly reduced ouraverage order size. Essentially we went from a single very large quarterlyoptimization to 13 weekly partial optimizations throughout the quarter. Thatsignificantly reduced the order size, and as a result of that as well, reducedour trading costs.
Secondly, the decimalization of the market was ofsubstantial benefit to a manager like INTECH, where we hold a large number ofsecurities and essentially trade at the margin on those holdings. So thatdecimalization also assisted us in terms of the way that we have measuredcosts. We call those the implementation shortfall costs, which are essentiallythe difference between the decision price of the stock and the execution priceof the security, plus commission costs.
We have spent a lot of time concentrating on developing anefficient and integrated trading system, which is an integral part of theimplementation process at INTECH. We continue to study and analyze our tradingcosts, and to consider alterations to the processes that we employ that willallow us to counter any increases that we will encounter due to informationleakage, due to the asset growth that we experience, or other considerationsthat may enter into the marketplace.
This is not an area in which we’re steadfastly assured thatwe have all the answers. We continue to look at this, and if it’s necessary tomake changes, we will make changes. But as you can see from this graph, atleast in terms of the implementation shortfall trading costs, the costs appearto be under control at this time.
On page 13 and 14 we refer to the performance that we havesuffered in the short term. The red diamonds on the left of 13 and 14 areINTECH’s performance relative to both the benchmark and a group ofinstitutional managers that fall into our various categories as developed andpublished by Callan Associates. As you can see, the short-term performance hasbeen disappointing.
But over the long term, extending out longer term, ourperformance continues to be substantially above both the benchmarks to whichthey are competing against, as well as the managers that are in thesecategories.
Very significantly to us on the far right, the informationratio in both these key strategies, the Enhanced Plus and Large Cap Growthremain near the top of the industry from inception. The information ratio ofcourse is key to us because it measures the amount of risk we take for theexcess return that we are generating.
So while the short-term performance has been disappointing,we remain very confident that over the long term our mathematical process willcontinue to provide investors with the returns that they’ve come to expect fromINTECH.
We can see on page 15 that over the long term we have beenable to achieve high levels of outperformance and that over the short term,underperformance is not unexpected or unprecedented.
On page 15 here you see a graph of all of the strategiesthat we have that have at least a three-year time horizon and the percentage oftime over those various horizons that those strategies have outperformed theirbenchmarks. You can see clearly that from inception, while some of thestrategies over three-year periods are behind the benchmarks, as we move outthrough five, seven and beyond, all of the strategies achieve 100% outperformancerecords compared to their benchmarks.
On page 16 we focus on the disappointing flows in the thirdquarter of ‘07. While those flows are definitely disappointing to us, webelieve that INTECH is very well positioned for positive, long-term growth.
I’ll point out in the upper left-hand corner of page 16 thatin the period of ‘04 through ‘06 there were some very, very extraordinary, ifyou will, positive net flows which were part of the growth replacement cycleand the fact that INTECH’s performance was significantly above target duringthose periods. When you have that kind of performance combined with a majorreplacement cycle in a category, it’s not unusual for managers to experienceunusual positive flows; that occurred.
Now over the past 18 months, our performance has beenchallenging and that is definitely going to affect flows, but as I indicated,we believe that long-term performance remains strong and that the flows will returnto a positive level as that performance improves.
We might also point out that a substantial amount of the netnegative flows that we have experienced are actually the result of therestructuring portfolios that institutions are going through and are notnecessarily tied to underperformance.
As you know, many institutions are moving away fromlong-only strategies. They’re moving into hedge funds, to internationalportfolios, to private equity and other areas than the long-only portfolioswhich have dominated the institutional marketplace for decades.
We think that approximately 60% of the outflows that we haveexperienced in the third quarter are actually associated with re-assetallocations as opposed to terminations or redemptions due to performance. Nowthat’s not to say that if performance continues negatively that we won’tcontinue to experience outflows, but we would expect performance to return toits normal status; and as that returns, for the flows to stabilize and turnpositive.
Finally, I’d like to point out that we are very wellpositioned for continued growth in the future. INTECH has launched a number ofadditional products over the past couple of years including a global coreportfolio, which will achieve a three-year track record in December of thisyear; a track record that has averaged over 250 basis points annually above itsinternational benchmark. This product should be very attractive to the non-U.S.based institutions.
We also have launched an international equity portfolio ofnon-U.S. stocks, a long-short 120-20 portfolio as well as a market-neutralportfolio. These along with our international focus, we believe, will have uswell positioned for growth going into the future.
That summarizes my comments. We’ll be taking questions atthe end. At this point, we’ll turn it over to Greg.
Thanks, Bob and good morning, everyone. As Garymentioned, the quarter from a financial perspective was fairly clean. It wasclearly marked by our decision to pursue a disposition of our printingbusiness. For a little color there, it’s no secret that company has struggledfinancially since it’s been under the Janus umbrella. I think we believe that both sides willbenefit from the transaction. RSG will now have the ability to join up with apartner with the expertise and resources to fully capitalize on its strengths,and Janus can return its focus on its core investment management business. As aresult of the decision discontinuing operations, as Garymentioned, the RSG operations are now classified as discontinued operations.Included in the quarter is the 110 operating loss, as well as a $0.21impairment charge, which really reflects just the poor year-to-date financialresults. To close the transaction in the first part of 2008, and we’ll havemore information once the transaction presents itself. The third quarter EPSnumbers, as Gary mentioned, of$0.29, up from $0.28 in the previous quarter, and 16 a year ago, showing fairly healthygrowth in the business.
Turning to the investment management segments, which willnow be our continued operations, as Garymentioned, it really was a clean quarter. Average assets and revenue bothshowed fairly healthy growth, really shows the growth on the Janus side fromthe positive flows, and continued momentum on the performance fee revenue side,which -- there’s a chart in the Appendix -- which shows that growth quarter toquarter.
From a margin perspective, we returned margins of 33.7% inthe quarter, slightly lower than Q2, but remember in Q2 we took an almost $4million net benefit as a result of some legal reserves that we were able toreverse. If you factor that into Q2, margins will be comparable to where theywere in Q3. Employee comp and benefits were up, but as Garymentioned, when you tie the incentive comp to revenue and to the business modelyou would expect to see it up on higher revenue and the tremendous investmentperformance. I’ll also call out that based on higher Janus product sales,you’re going to have higher sales commissions during those times.
A quick note on marketing and advertising: we talked aboutthis over the last couple quarters. We did underspend in Q3, and now our Q4guidance is between nine and 12 million. We are still very committed tosupporting our brand and our products, but again, I think it’s fair to call outhere that this is a timing issue. We still will be spending money on the brand,on our products, but many of the dollars that we expected to spend in ‘07 willbe shifting into ‘08.
And as Garymentioned from a buyback perspective, finally, we did complete 184 million ofbuybacks at an average price of just over $28 a share, and we continue toreturn cash to shareholders in a very prudent and smart fashion.
And with that I’ll turn it back over to Gary.
Thanks ,Greg. So to sum up, we continue to make considerableprogress in achieving our strategic and financial objectives. We continue todeliver strong investment performance, which obviously is the most importantthing. We have, we believe, limited the effect of turnover because we do have adeep bench and we think a pretty effective succession planning; continue tohave positive flows across the company and the Janus ex-INTECH flows continueto look very strong. Despite our disappointing close in the quarter, we dobelieve that INTECH remains very well positioned for long-term growth. Wecontinue to focus on our intermediary and institutional distribution. Themarketplace clearly has recognized a lot of our success. We continue toleverage the business model, and you see that with our operating margin improvementsand our growing earnings per share. We do continue to return excess cash toshareholders via buybacks, and we are obviously now focusing on our corebusiness of investment management with the decision to dispose of the printingbusiness.
So with that, I’d like to open up for questions and answers.Operator?
Your first question comes from Ken Worthington – JP Morgan.
Ken Worthington – JPMorgan
Hi; good morning.
Ken Worthington – JPMorgan
I guess two questions on the management turnover. I guess,Gary, first, what steps are you taking or do you need to take to preserve theexisting team, and if you’re not taking any steps, should we expect turnover toremain elevated?
We don’t like losing any of our key talent, whether it befrom the investment team or the senior -- the executive team. But we workreally hard to create a culture where our top talent can thrive and can becompensated at the top of the industry if they perform well. We always try topromote from within. That’s the type of culture we have. 16 of our 19 portfoliomanagers started as analysts here. I think people want to work for a winningfirm. And if we can continue to put up performance that’s top in the industry, andwe continue to have success in the marketplace, and we continue to pay peopleat the top of the industry if they perform well, we think we can keep those.That said, we’ll continue to cultivate our deep bench investing in talent andmake sure that we have strong succession planning in place. We had a longhistory, as you know, of developing talented managers, and we do think we’rewell prepared to address any potential changes. Will we lose any additionalfolks? It’s hard to tell. Hopefully, people subscribe to the changes in thebusiness model that we put in place, the evolution of our compensation process.This is -- turnover is a reality of this business, and we could have additionalturnover. Hopefully we don’t.
Ken Worthington – JPMorgan
Thanks. And then the follow-up is, with the managementturnover, how does that impact your ability to market the funds in thesedistribution channels: supermarket, broker dealer, 401(NYSE:K)/insurance, and theninstitutional?
I think the retail world has become very institutional overthe last couple of years. If you’re pitching to any of the buyer houses, theyall have consultant-like gatekeepers, and they look for repeatability ofprocess. They look for the deep bench. And I think it’s becoming increasinglyhard to distinguish between, particularly in the advisory space, retail andinstitutional. So stability of firm is critical, and we do take it veryseriously. I think what I’ve told clients is -- I’ve probably met with probablya dozen clients in the last week, or talked with a dozen clients -- I thinkpeople understand the changes we’re making to our business model. Peopleembrace, in the industry, this hybrid model -- so having some solo managers,some co-managers, some team-driven portfolios. And I think people know Janus.We’ve always had a deep bench, but we have experience departures before, andwhat I think people realize is we have a history of developing analysts intogreat portfolio managers. David Corkins is a great example. He took over as a PMat the age of 30. He’s built an exceptional track record as one of thepreeminent growth managers in the industry, and I think people understand thatwe have a repeatable process of analyst development, a repeatable investmentprocess, and we think we will have repeatable success in delivering strongresults, and I think that message -- most of our clients get that.
Ken Worthington – JPMorgan
Your next question comes from Thomas Gallagher -CreditSuisse.
Thomas Gallagher-Credit Suisse
Hi. I guess just a couple for Bob Garvy. First is, have youaltered the INTECH investment process at all? You know, I was listening to yourpresentation, and it struck me, or it sounded like there were some tweaks tothe models that have gone on, so that was question number one. And number two,it looks like the big swing in net flows for the quarter was more on the salesside, and I assume those are going to remain subdued for a while, but can youcomment on how you think asset retention holds up?
Sure. Well, we have not altered our process, no. Our processhas remained essentially intact since its inception in 1987. So the fundamentalidea of identifying these more volatile stocks and overweighting them in theportfolio to create alpha and then using correlation analysis to control thevolatility and risk of the portfolio itself -- that fundamental idea remainsunchanged.
What we do make alterations to from time to time is theengineering involved in the implementation, and so my reference to going from alarge trade once a quarter to weekly partial optimizations throughout thequarter really is an engineering idea, or an implementation idea. And those wewill make some alterations to through time if we see an advantage to either theimplementation, the cost structure or the performance. Those alterationsthroughout time have been very small. The contribution that they make to thebasic process is generally on the order of one to three or four basis points,so they’re quite small, but over time they can contribute to some substantialimprovement over a decade or more. And so we continue to work on those and makesmall adjustments where we can.
The big swing on the sales side versus redemptions: salesare down somewhat but our pipeline remains very robust. We are in a largenumber of continuing assignments and finals presentations. Our close ratio isdown but it’s still above 50%. If we get into a final, we’re closing over 50%of the opportunities that are presented to us. And I think that’s largely --will be determined by performance. If performance improves, our participationin finals will improve, and I think our close ratio will improve. Ifperformance remains challenging we can expect that our opportunity set willremain muted, and the same thing for redemptions. Redemptions are likely todecline under an environment of returnto a positive performance, which we expect, but can remain challenging ifperformance continues to underperform.
I’ll point out that September was a positive month forperformance. October is a positive month pretty much across the board for mostof our portfolios. This isn’t enough time to claim a trend, but it’s certainlybetter than underperformance.
Thomas Gallagher-Credit Suisse
And so based on what we’re seeing right now, it sounds likewe may have seen the trough in terms of net flows. Is that fair to say?
Well, over the short term we have, clearly, with Septemberbeing positive and October being positive thus far. But whether or not that isthe bottom of the underperformance is yet to be seen. We outperformed in thefirst quarter of ‘07 in all of our strategies, except for Growth. So weactually thought that possibly the underperformance in ‘06 had basically beenterminated with that, but it turned out the second quarter and third quarterscontinued underperformance. So we can’t know until we get past it, butcertainly over the short term the signs are positive rather than negative.
Thomas Gallagher-Credit Suisse
Okay. I was referring more to net flows as opposed toperformance when I was asking about their trough.
Oh, I see. Well, I don’t know; that’s hard to say. You know,the institutional business is quite lumpy. You can have big inflows or bigoutflows that will come as a result either underperformance or, in our case, asubstantial amount actually has come from reallocations among accounts. We hadone very, very large fund that had done quite well, in fact, and had to limiton the amount of assets that any manager can hold, and we were several hundredmillion dollars above that maximum amount, and so their outside allocationcaused them to scale back. You know, the equity markets have been up verysubstantially. Many institutions have policy guidelines that limit their equityexposure, and they’ll scale those back when the equity markets are performingwell relative to other markets. So I can’t tell you exactly what the flows willbe. We can’t forecast those into the future.
Thomas Gallagher-Credit Suisse
Okay, thanks. And then just one numbers question on the compratio for Greg. The 32% ratio we saw this quarter, is that likely to go down aswe look at ‘08 ballpark? Can you give us any guidance there? I guess I amreferring especially in light of some of the recent departures.
No, with the business model structure the way it is, I don’tthink I would expect significant declines in that ratio. It’s tied to revenue,and the departures won’t have a significant impact on that.
Thomas Gallagher-Credit Suisse
<A>: Next question.
Your next question comes from Marc Irizarry - Goldman Sachs.
Marc Irizarry -Goldman Sachs
Oh great; thanks. Just a question on the build-out ofJanus-managed accounts in the institutional channel. Maybe, Gary, for you: Whatdo you expect the response to be in terms of either when you market theperformance of Janus to the institutional community to maybe some of the PMdepartures? Is that potentially a stumbling block, and can you provide anycomfort that maybe that will be overcome over the near term? Thanks.
I think it’s a balancing act. I think most institutions thatwe talk to -- and again, we haven’t had that much traction on the Janus-managedside. We’ve been getting traction, and again, we got about $300 million of newflows into that business this quarter. But I think that channel wantsteam-managed products and we’ve tried hard to deliver team-managed productswith repeatable transparent process, where risk management is a part of the investmentprocess. And again, I’ve met with or talked with about a dozen clients in thelast week and you hear that consistently: that in order for Janus, theJanus-managed side, to be successful in the institutional business, they needto see that.
On the other hand, to your point, folks don’t likeinstability. And so we talk about both things: that we are becoming moreinstitutional, team managed, but we have had some departures, which always setsyou back when you have departures. I think the good news is still in theperformance; we’ve had strong performance pretty much across the board. Andwhen we have had turnover you can look back over the last three years, forinstance, where we have had a turnover of one of our products. We’ve had aboutnine of our funds actually have a PM turnover. In eight of those funds, eightof those nine funds over the past three years, the performance since the PMinception has been in the top quartile. And I think that evidence that it’sabout the research, it’s about the investment process. I think people recognizethat we are able to repeat that process even if we do have an unfortunateturnover.
Marc Irizarry -Goldman Sachs
Your next question is from William Katz - BuckinghamResearch Group.
William Katz -Buckingham Research Group
Okay; thank you. Good morning, everybody. First questioncomes back to INTECH -- sorry to keep going this line. But I’m still looking atthe slides where you show the performance of some INTECH’s funds against thebenchmark with the diamonds and triangles, and what sort of strikes me there isthat the delta, the difference between a diamond and a square there, whatever,diamond, triangle, continues to decline over time. And I’m just sort ofcurious: are you reaching, from a theoretical respective, any kind of scaleissues and even though the underlying – the process works, you just starthitting critical mass on AUM?
Well, we don’t believe so. Our simulations and our actualperformance except for the short term continues to be strong, and in the firstquarter of this year we had very strong performance relative to the benchmarksacross all the strategies with the exception of the Growth strategy. If we dobelieve, if we were to believe, that the size of the assets under managementwere impacting our performance, we would simply stop taking assets in thosestrategies. We have so many other strategies that have such significantpotential, such as the Global strategy, the International strategy, the long, shortand the 120/20, that there’s no need to focus -- also Value, for example. Wehave excellent Value performance and not much in the way of assets, and we mayvery well be entering a period of a significant shift in value managers as themarket shifts more towards growth. So we do not expect – we do not believe thatwe are at capacity at the current time in our core Enhanced Plus and Growthstrategies. Should we reach that conclusion, we will simply stop taking newassets in those categories, however.
William Katz -Buckingham Research Group
Okay; thank you. And then a question for Greg or Gary. I’mjust curious: your buyback and dollars -- gets slow a little bit as with theshare number. Just a little curious if you could talk a little bit about your outlookfor free cash flow usage. Thank you.
You know, Bill, I don’t think we’re going to vary from whatwe’ve done in the past. I think we’re going to continue to be prudent and smartin our buyback strategy. I think we still feel like it’s a good use of cash anda good way of returning it to shareholders. Beyond that, I probably not goingto speculate.
William Katz -Buckingham Research Group
Okay; thank you.
Your next question is from Cynthia Mayer - Merrill Lynch.
Cynthia Mayer -Merrill Lynch
Hi; good morning. I apologize, I want to ask just one moreINTECH question, which is -- and maybe you covered this but I think in the pastyou said that you thought volatility was good for performance, and I wonder ifyou still think that’s true or if it’s a particular kind of volatility thathelps.
Yes, okay. Well, it is the relative volatility of stocks tothe benchmark
that allows us to create an alpha above that benchmark. Andso overweighting the more volatile stocks is significant to us. Now we havelooked at whether or not the lower volatility that has existed in themarketplace over the past couple of years has been a key component of ourunderperformance, and that does not appear to be the case. And that’s because we’renot attempting to maximize our excess performance. If we were attempting tomaximize the excess performance, then we believe there would likely be a directcorrelation between the amount of relative volatility in the marketplace andour outperformance. But that’s not what we’re attempting to do. We target aspecific amount of excess performance. It ranges from 125 basis points inenhanced strategies to up to 350 basis points of excess performance in our moreaggressive strategies. But having targeted those levels of excess performance,if you will, the question then is, is there sufficient relative volatility toprovide for that excess performance. And our studies to this point indicatethat there is sufficient volatility, even in the low-volatility environmentthat we’ve experienced generally over the past few years, to provide thatexcess performance.
Cynthia Mayer -Merrill Lynch
Okay. And then, Gary, on a different topic, I’m justwondering if you could talk a little about the overseas sales, and I’mwondering whether a declining dollar hurts or helps your sales overseas, if youhedge that out in any way, and if the dollar were to bottom, whether that wouldhelp you.
Yes, outside the U.S.,I don’t think the declining dollar is really that big of a factor. We areinvesting in that business considerably. Today it’s 7 or 8% of assets. We’dlike to take that number higher. It’s probably 15% of our flows. We have putadditional folks on the ground on the distribution side, and we’re going to continueto launch new products for that marketplace. So we’ve launched a lot of globalproducts this year, which is what folks outside the U.S.will buy. We’ve really, on the INTECH side, tried to focus on institutionsoutside the U.S.We opened an office in Australia,Singapore. Sowe’ll continue to invest in that business, and we recognize that half of theworld’s assets are outside the U.S.,and so you’ll continue to see us reinvest in that side of the business.
I think we could probably take one more question, operator.
Your next question is from Donald Neiman - William Blair.
Donald Neiman -William Blair
Oh, hi. Great. Most of them have already been answered. Ijust wanted a real quick touch on plans for institutional, [inaudible] institutionalspace. Gary, are you going tocontinue to be focusing on that or if you have any additional hire information?And to what extent do you think or did that maybe impact flows that impactedthe quarter?
Could you repeat the question one more time? I’m sorry; Ididn’t quite understand the question.
Donald Neiman -William Blair
Yes, I mean my question was just in terms of plans foradding management capacity to the institutional channel. I know you stepped inas John Zimmerman left and I wonderedwhat products was on that front and then as well if you could comment on if youthink disruption at the management level added to -- potentially added tooutflows in the quarter.
I don’t think there’s really much of a change in our strategy.John Zimmerman, who was running the channel, departed, and I’ve been running itas we look for a new head of Institutional. Our commitment to that business isextremely strong. In the U.S. it represents about half the assets on theinstitutional, so we won’t change our strategy, which is basically going at thelargest, probably 1,000 planned sponsors and trying to establish relationshipswith them, such that, when they’re going to do a search we have goodrelationship, we have a product that they can use, and that strategy is notchanging. Did I answer the question?
Donald Neiman -William Blair
Yes, I guess so. I mean do you think it would -- do youthink there was any impact in the quarter -- do some of the impacts reflect anysort of changes at the management level?
I don’t think the departure of John caused the outflows tochange. I think it’s more, as Bob Garvy said, some rebalancing, [inaudible]some public funds more than anything, and very little of it actually reflectedon the performance.
Donald Neiman -William Blair
Okay; great. Thanks
Thank you very much for joining us, we’ll see you nextquarter.
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