Douglas Peebles - Head and Chief Investment Officer, Fixed Income
AllianceBernstein (AB) Presentation at Morgan Stanley Financials Conference June 13, 2012 12:00 PM ET
It’s my pleasure to introduce Doug Peebles, head of AllianceBernstein’s fixed income unit. Doug became chief investment officer of AllianceBernstein’s fixed income in 2008, and oversees all of the fixed income portfolio management and research teams globally. Fixed income has been an area of strong growth and solid performance for AllianceBernstein, representing over half its assets under management as of the latest quarter, with $224 billion.
With that, I’ll turn it over to Doug.
Thank you. Good afternoon everybody. So as Kevin said, I run the fixed income group at AllianceBernstein. I’ve been with the firm now for literally 25 years and 12 days. So I’m in my 26th year at the firm. I have always been involved in fixed income. Most of the time, over my formative years if you will, were in the global fixed income area. So I’m unabashedly pro-global as it relates to investing, in all types of investing, fixed income in particular.
So if you will, when the industry thinks about fixed income, largely because this is what we put forth as our key tenets, or our key elements, is first and foremost a global firm. We actually think and act globally in all that we do.
The second one is an integrated research approach, which is not particularly strange for a large asset manager. And AllianceBernstein in particular, the combination of quantitative and fundamental, but in the world of fixed income, that’s a little bit strange. Most of the big fixed income asset managers are predominantly fundamentally based.
And the last element is a dynamic investment approach. So I have a firm belief that market premiums are not static. They vary over time, and therefore managing assets, the risk premium in portfolio, should vary over time to take advantage of that.
In terms of what do our clients think about fixed income, more and more importantly, people are thinking about fixed income in three different ways: what types of objectives do they need to meet with their fixed income portfolios.
This is actually quite different than the equity world. The equity world is total return against an index, for any type of client that we have, globally. That’s basically what it is. For fixed income, some people use fixed income differently.
We can summarize it into three core buckets: stability, which is just that. You need to make your college tuition payments, you need to make whatever payment it is. You need that money in its stable format. That’s generally money market, something like that.
The second bucket is core. Core fixed income is the offset to risky market volatility. So this is the area that needs to go up in price when your stocks or your risky assets are going down in price. And then the third area is just what is stated there, high income. So people not getting enough return on their assets that they have in a bank account, and they need to go out and buy high income.
By and large, people run into trouble in fixed income when they confuse these buckets. When they say, well, I’m not getting enough yield on my core bond portfolio, so let me replace that with high income. The problem with that is that high income is actually more highly correlated to the equity market. So all you’re doing is adding more risk to your overall asset allocation. That’s generally not beneficial, because you’re not getting the diversification elements that you want in your core fixed income portfolio.
So that’s an important backdrop to think about, okay, what sort of products do we have, and what are the solutions that our clients are asking us for? So if you look at our product and our clients, on the right hand side, you can see the distribution of the assets that we have under management, which are $227 billion. About two-thirds institutional. We split the other third between our high net worth business, which we label private client, and the retail mutual fund business, both onshore and [unintelligible] bonds here, and offshore as well.
On the left hand side, you can see the assets by the way we manage those assets, what sort of index are we looking to be. What sort of assets are we invested in. The three biggest categories here, global, number one, credit, number two, and munis, number three. If you go into the consultant community, they would basically say, look, Alliance is known for, and really good at, global investing and credit investing. I would completely agree with that. I would add one other element, where we’re somewhat underrepresented right now, is munis.
So if you look, and you can see that the 14% in munis ties in very closely to the 15% in private clients. So that’s our U.S. high net worth clients, who obviously are using munis for their fixed income allocation. Where we’re light in the muni space is in retail. The mutual fund area. We’ve been in that space for a long time. We’ve just launched a new product or two, and I think that over the course of the next couple of years, you’re going to see us make a significant push into the municipal market for retail.
Our resources, or our people, are located in these various different locations. So we basically have trading, we have research, we have portfolio management as our investment professionals, and they’re located in these various locations throughout the world. We cover the Americas in New York. We cover EMEA region through London, and you can see that we have six different offices in the Asia-Pacific region. Throughout the rest of this presentation, you’re going to see that is a particular area of strength for us, the Asia-Pacific region.
And because it’s somewhat of a fractured market, it’s actually very good to have boots on the ground in each of these markets. I think as that market develops, it will actually develop in a way that’s a little bit more homogenous, and we’ll see over the years, if we need to continue to have so many outposts there as opposed to what has evolved in the Americas and in Europe. But for the time being, this is very good for us, and for our clients in that region.
So that’s where our talent is located. I can’t overstate how important talent is in the investment industry. That’s basically what we have. We have some computers, and we have people. And that’s basically what decides whether or not our clients are going to be happy or not.
So in terms of the investment talent, we have about 117 different investment professionals. And I just want to give you a flavor for my view on how you bring talent together to make a successful investment approach. First and foremost, I think that you need experience and longevity in your talent. So the professionals in our group average 18 years of investment experience. So it’s a long tenured group on average. And 20 of those people - so just under 20% - have been with AB for 15 years or longer. I think that’s important because it drives the culture and it creates a very strong understanding of what the culture is within AB fixed income.
Second, elevating talent. It’s really important - and I’m somewhat biased here, I’ve worked for AllianceBernstein my whole career - so I’m biased that I think that it’s important and strong for the effort to build talent from within. So over the last few years, we’ve elevated 10 people to very senior roles in the organization, and we’ll look to continue to do that as part of the talent generation.
The other part is to add people from outside, so that we don’t get caught up in an insular view of things. We want to know how other people think. So in the last few years, the new talent that we’ve added has averaged 16 years of investment experience. So it’s a combination of long-tenured people and people from outside. I think that’s very important.
For those of us who know AllianceBernstein, our quarterly reports, our earnings announcements, we’ve hammered home four key elements to our success, and fixed income embodies that firm-wide strategy as well. The first one is the most important metric in the world of investing. That’s performance. Nothing else really works in investing if performance isn’t strong. That’s the first one.
The second one is to diversify our business across different geographies and channels. The third one, particularly now - I was listening to the gentleman from Zions. We’re sitting here with zero percent interest rates. That’s obviously somewhat new for America, even though it’s happened for several years. I’ve been studying Japan for a long, long time. It’s nothing new there.
And as you sit with zero percent interest rates, the needs of fixed income investors evolve. And we need to evolve with those needs by creating products that serve those needs of our clients. And that’s our third initiative. And final is our unit holders. We need to have high margins and profitability, so our unit holders are happy.
For the rest of the discussion here, I will go through each one of those four elements, and I’ll start with performance. Again, performance is the most important thing that we do. What I’ve listed here is for three key metrics for us. So in the institutional world, some of our biggest composites for our Luxembourg retail family of funds, our largest funds, and some of our most important funds in the U.S. [fortiac] space.
And I’ve listed one, three, and five year returns, both in an absolute sense and importantly in peer rankings. The color code is green, this first quartile. Gray is second quartile, blue is third, and that awful orange color is fourth. So first things first, there’s a lot of green and gray.
If you do the arithmetic, it’s 90% of our products listed here are in the top two quartiles. We have obviously 10%, then, in the third quartile, and nothing in the fourth quartile. That’s over one, three, and five years.
Now, we’re pretty proud of that. I would say that over the rest of my career, if I can get 90% of our clients’ performance in the top two quartiles, we’re going to be doing pretty darn well. And importantly, also, nobody in the fourth quartile. So that’s something that we’re proud of, and we will continue to do that.
The only area up there - I’ll just mention quickly - that doesn’t have three and five year numbers is the municipal high income product, which is, as I mentioned earlier, one of the new products that we’ve developed in the muni set to really solidify our space in the U.S. retail arena for munis.
With this strong performance has come some awards, and the awards are nice. What they really do is help build your brand, particularly in these different regions. So we’ve won awards in the United States, in the Gulf region, a lot of awards in Europe, and many awards in the Asia-Pacific region, including Japan.
And you know, I’m not going to get into detail about these awards. I think that what I’m most proud of is that they’re diversified. So it’s not like we have one theme that’s doing well. We have diversification on performance across product profiles in those three buckets that people use fixed income. That’s important for us.
And then the last thing that I’m proud of is these awards that we’ve won in 2012, which indicates the best large bond group - so for all the people who manage a lot of assets in fixed income, who is the best group as a whole. So if you look at the platform, stability, core, and high income, who does the best over that? And we’ve won that award for the last three years in all of these areas.
So strong performance, and recognition is important, and so when we move to look at, again, those four key strategies, we can check the first box on performance. The second one is diversifying our business across channels and geographies. So if we go back to the quarter before the S&P bottomed - the S&P bottomed in the first quarter of ’09. If you look at the fourth quarter of ’08, AllianceBernstein fixed income had $164 billion in AUM, which represented just under 40% of the firm-wide total.
If we fast forward to the end of the first quarter, our assets are up 37%, and that now represents 53% of the total, and you can see where the big growth has been. It has been in the area of global strategies. So that’s global government strategies, global aggregate strategies, emerging market strategies, and global high yield strategies. Again, I am a firm believer that that’s the best way to manage money, and I think that we do that very well. That has shown up in the growth area for us.
Of particular importance, as I mentioned earlier, is Asia. So if you look at the right hand side of the slide, you can see 2008 we had just over $5 billion in AUM for Asia ex-Japan retail client base. That has grown over three times to just under $24 billion at the end of the first quarter.
The key countries, South Korea, Taiwan, Hong Kong, Singapore. I don’t know if you can see those numbers there, but Taiwan we manage $14 billion for Taiwanese clients. The 19 represents - that’s 19% of the mutual fund industry in Taiwan. That’s not 19% of the fixed income assets. It’s 19% of the industry assets in Taiwan. Huge, huge market share.
And by the way, if we think about which area of the world is saving and going to likely invest further and further, in these types of products, we think it’s Asia. So 19% market share in Taiwan, 9% market share in Hong Kong. These are dominant market share positions. Very excited about that.
And again, why do we have success there? I think we have success for a couple of reasons. We have good performance. These are the awards that we’ve won in that space. We have an unbelievably strong sales force in that region, who are touching the clients, knowing what the clients need, and we’re supporting them with new products.
If you look in that middle box, 2011 best of the best awards, we won the Hong Kong award for most innovative products in 2011, with a Chinese currency income product. That’s going to be exciting. I don’t know if it’s going to be exciting in 2012 or 2013. I think it is, but certainly over the next five years. To offer people a chance to save in Chinese currency is going to be important.
And then also, in Korea, which is an area where we have tackled a little bit, but not as strong as we’d like to, very exchange that we won, also, the most innovative product award for Korea. That’s a huge potential growth rate for us.
So performance? Check. Diversification of products and geographies? Check. The third one is new products and what we’re trying to do in the new product front is really to capitalize on a very strong offering that we have in the high income space. So I’m going to start with high income.
If you think about high income, most people use single sector products in high income. Either high yield, or bank loans, or emerging market debt. Our view is that the best way to manage high income products, particularly for retail audiences, is through a multisector approach.
So why think in single sector terms? Think about who needs high income. It’s people like my mother, right? My mother doesn’t have a clue what the Credit Suisse 2% High Yield Constrained Index is. She doesn’t know what the JP Morgan Emerging Market Bond Index Plus is. She just needs income. So we want to get her income in a way that’s diversified across those sectors, where we can use asset allocation, sector rotation, in order to add value. It has worked very, very well. Frankly, I’m not sure why more people don’t do it that way.
So in that space, we launched in this area, in 1997. Our product in that space has won several of those awards on the previous page. In 2007, actually five years ago, in the U.S. we had each of those individual buckets. We combined them together in one fund, and that has won the best high income award over those past five years.
Now, obviously I’m biased. So partly it’s because I think we have better investors than everybody else. But truth be known, it’s actually because the product is smarter than most other people’s products. So if you can combine strong people and strong products, you generally produce good returns.
And then finally, leveraging that idea into a high income product for tax-free investors, which we’ve launched in 2010, where we added some new resources to help us do that in a better format, and so far, in just a little bit over a year, it’s raised almost a billion dollars.
So the need for high income is prevalent. I personally believe interest rates are going to be low for a long time, and so there’s going to be a demand for income for all investors around the world. As we’ve leveraged our high income returns, we’ve tried to think in terms of, okay, if this is the spectrum, and our global high income product is the farthest right out on that spectrum, that might not be for everybody, right?
So how can we produce an income product that’s a little bit lower on the risk scale? We actually think it’s going to have a higher information ratio, a higher return relative to risk, called short duration high income. Now, what is short duration high income? It’s income with an eye on volatility. So what does that mean? It’s going to have a slightly shorter interest rate risk. It’s going to have a slightly higher credit quality.
For those of us who have studied Solvency II, which is coming to Europe, financial institutions are getting severely punished in their capital requirements for two things. What are they? Long duration - so we’re shortening up - and very low credit quality. So we’re increasing the credit quality. This product should fit in very well, I think, in both the retail and in the institutional front.
Another thing that we’ve done over the years is our income portfolio strategy, where we tell our clients, look, here’s a way within fixed income that you can add value through rebalancing between core and high income. We tell them don’t confuse it. This is what we’re going to do. We’re going to take a balanced approach, 50% of the portfolio in investment grade securities, 50% in lower quality securities. They tend to be negatively correlated.
We want to be able to rebalance. We want to be able to asset allocate. And we want to be able to add convexity to the portfolio by balancing these two things. It’s been a time-tested process and strategy. At the same time we launched that global high yield fund in 1997, we launched the American Income Fund in 1997. And these are the quartile rankings over the long term.
So again, first quartile, three, five, and ten years. The number two out of 65 funds over ten years. What did we do? As the euro came to play in 1999, we launched a European income portfolio. Same strategy, barbelled approach, rebalancing. First quartile, three, five, and ten years. First fund out of 29 over ten years.
As Asia is developing, what are we doing? Launching an Asia-Pacific income fund, as well as the RMB Income Plus. I particularly like the RMB Income Plus, because this is the first product that for a Chinese saver actually fits into the core bucket. But if you’re saving in euros or dollars or Latin American currencies, it fits into the higher risk bucket. So we have one product that actually fits both buckets. That’s something that we really haven’t found before. So that’s exciting for us.
Innovation. Since 2009, we’ve launched 35 new products. For AllianceBernstein that’s a lot. It might not average too many per year, but for us that’s a lot. Those new offerings have generated just under $10 billion in new accounts. These aren’t new services, these are new offerings. And so you can see the variety of different strategies where we’ve gained these new offerings.
So it’s launching new products. Why are we doing that? Because our clients have needs, and we’re meeting those needs with our offerings that are new. So first three buckets are check, check, check, and then the fourth one is achieving greater results for our shareholders, or our unit holders.
So I mentioned earlier 2008 we started with $164 billion in AUM. The little green dot is market performance, investment performance. So as you can imagine, our high income funds in 2008 got rocked pretty hard. So the mark-to-market losses were $15.7 billion. Quite significant. The blue dots represent new gross sales of our products during that year.
So even in the tough year of ’08 and ’09, we saw $20 billion plus in new sales. In 2009, we more than made up for the mark-to-market losses in the portfolios. So we managed the risk actually quite well during that timeframe. Have seen further gross sales gains in 2010 and 2011 of $30 billion plus. Decent market performance. So we’ve had the wind at our backs in fixed income. I’m well aware of that.
And I think that as we look in the first quarter of 2012, these are not annualized numbers. So the market is up about $4 billion for us in the first quarter, and $12 billion in new sales. Now, obviously we can’t annualize that, but if we did, we’d be going from $20 billion into the $30 billion into the higher $40-50 billion. So I think that’s very good for our shareholders as well.
Now, in our industry, fund flows tend to be lumpy. But if you look at the upper left, you can see that we’ve had strong net inflows in nine out of the last 13 quarters. And upper right, you can see that that fixed income has seen the greatest AUM growth among our targeted product areas. So at AllianceBernstein, we sort of have four key target areas: fixed income, equities ex large cap, asset allocation, and alternatives. And you can see those flows have been reasonably strong, with fixed income leading the charge.
The bottom right, you can also see that the pipeline is the largest in fixed income. And then the lower left, this is where I think we have the biggest wildcard of good news for us. So of our growth, we’ve seen 60% AUM growth of our non-U.S. offerings, and only 23% in the U.S.
And I think that’s because fixed income investors, particularly in America, are very home country biased. As I said earlier, I think that’s the wrong way to invest. It doesn’t matter where you live. It matters where you can find returns. And you can find a lot of returns clearly inside the U.S., but you can find a lot more outside the U.S.
So going global is important. The rest of the world has gone global in fixed income, or is going global. Europe came kicking and screaming, but they’re there now. And in the U.S. we really haven’t done that, even though U.S. equity investors have gone global. So that’s an area for potential growth for us looking forward.
So just to summarize, and then we can maybe answer a question or two. Remember, it’s a solutions driven platform. Stability, core, and high income. And then those four key areas of focus for us, first and foremost is performance. The second is expanding our presence in different regions, geographies and products. Leveraging our skill sets to offer new initiatives that serve our clients’ needs, and finally doing it with a methodical eye toward investing for the future.
So with that, I’ll answer any questions.
Unidentified Audience Member
The weighted average coupon in maturity, maybe people were kind of overreacting to Whitney’s comments. Maybe she’s two or three years early. Who knows? But, I mean, risk is something that’s unforgiving in the muni world. I mean, it’s not paying their bills and not amortizing their debt. High income, what kind of coupon and maturity are you talking about?
You know, I’ll have to check on this, but I think we’re roughly around a 4.5-5% yield on that portfolio. Maybe a little bit stronger. Again, most of the competitors offer high yield muni, right? And what that means is if you have a [fortiac] fund, and you have the name in your title, that means you have to have at least 65% of the assets in that class. We call ours high income, so that we can go about gathering income in what we think is a smarter way. Some of that is through duration. Some of that is through lower credit quality securities. Those two things in that barbell approach that I mentioned earlier, they tend to offset each other.
So you like to have interest rate risk to protect the credit risk. That gives you convexity in the portfolio. Look, there’s no doubt that there are going to be credit issues in the broad range of the municipal marketplace. I think the comments that you mentioned, the 60 minute comments, were completely blown out of proportion.
And the other thing that I think it really focuses on, particularly for the financial advisor community, is that the muni market is an evolving market. If we go back five years ago, it was almost 100% AAA rated because of the monoline insurance wrappers on top of it. They’re all gone, right? And so now, the AAA component of that market is small. A lot of those issues that came with insurance you can throw the insurance in the garbage, and now you have the underlying credit to analyze. Most financial advisors, don’t have the time to do that work.
Unidentified Audience Member
Or the bench. They don’t have the people either. Could you use somebody outside? You’re adding some…
We added three people in the research department. So we already have a formidable municipal bond research department, credit research department. We added three new people in that space to focus on the lower credit quality securities, and we added a new portfolio manager.
Unidentified Audience Member
And one other quick question. From a cash flow standpoint, say roughly 4-4.5%, also with spreads coming in, a lot of the return has come about because of basically the spreads…
We have Ms. Whitney to thank for that.
Unidentified Audience Member
With all the interest in income product globally, are there capacity issues to both the high yield space and the [unintelligible]?
The question was, are there capacity issues in high yield and emerging market debt? I think in emerging market debt, not so much. Because emerging market debt continues to evolve. When we first started doing it, it was a dollar denominated credit market, and all the issuers were not investment grade. Now, the stronger issuers are all issuing in their local currencies. So there’s still some dollar debt outstanding. There’s now local currency debt outstanding, and there is an evolving corporate debt, of corporations in emerging market countries.
You actually get paid an extra risk premium for that. Rightfully so. But if you have the research and you can do it, that’s a really good opportunity. So there’s plenty of, I think, capacity in that space.
High yield is a little bit different. Look, think about the European high yield space, which didn’t exist 15 years ago. You think that the credit markets are going to continue to be intermediated and taken away from the banks in Europe? I think they are. The same thing to a certain degree in Asia.
So there might be some specific capacity issues, but the fact that the banks are getting out of the lending business is actually good for folks like us. So I think that we have to keep an eye on that. I’m a little bit more worried about not so much capacity in the issuers, and diversification. I’m worried about the Volcker rule, and what that means for the market making element of the high yield market.
Anything else? Thank you very much.