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Waddell & Reed Financial (NYSE:WDR)

Q2 2012 Earnings Call

July 26, 2012 11:00 am ET

Executives

Henry John Herrmann - Chairman, President, Chief Executive Officer, and Director

Nicole McIntosh - Director of Investor Relations

Daniel Paul Connealy - Chief Financial Officer and Senior Vice President

Thomas William Butch - Chief Marketing Officer, Executive Vice President, Chairman of Waddell & Reed Inc, Chief Executive Officer of Ivy Funds Distributor Inc, President of Waddell & Reed Inc and President of Ivy Funds Distributor Inc

Michael L. Avery - President and Portfolio Manager

Analysts

Cynthia Mayer - BofA Merrill Lynch, Research Division

William R. Katz - Citigroup Inc, Research Division

Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division

Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division

Bulent S. Ozcan - RBC Capital Markets, LLC, Research Division

J. Jeffrey Hopson - Stifel, Nicolaus & Co., Inc., Research Division

Roger A. Freeman - Barclays Capital, Research Division

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

Greggory Warren - Morningstar Inc., Research Division

Operator

Good morning. My name is Holly, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Waddell & Reed Financial Second Quarter 2012 Conference Call. [Operator Instructions] I would now like to turn today's conference over to Mr. Hank Herrmann, Chairman and Chief Executive Officer of Waddell & Reed. Please go ahead, sir.

Henry John Herrmann

Thank you, Holly. Good morning. With me today are Mike Avery, President; Tom Butch, our Chief Marketing Officer; Dan Connealy, our Chief Financial Officer; Mike Strohm, our Chief Operating Officer; Phil Sanders, our Chief Investment Officer; and Nicole McIntosh, our Vice President of Investor Relations.

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

Nicole McIntosh

During this call, some of our comments and responses will include forward-looking statements. While we believe these statements to be reasonable based on information that is currently available to us, actual results could materially differ from those expressed or implied due to a number of factors including, but not limited to, those we referenced in our public filings with the Securities and Exchange Commission. We assume no duty to update any forward-looking statements. Materials relevant to today's call, including a copy of our press release, as well as supplemental schedules, have been posted on our website at waddell.com under the Investor Relations tab.

Henry John Herrmann

Thank you, Nicole. Good morning, again. Early today, we reported our second quarter results. Included on our numbers was a charge for $5 million or $0.04 per diluted share for capitalized software costs related to systems that were discontinued. We encourage investors to review the current quarter's results excluding this charge, as it provides a more comparable basis to other periods presented.

Operating revenues rose slightly compared to the first quarter of the year, while operating income, adjusted for noncash charge, rose by 1.2%. The increase in our top line was due largely to our Advisors channel. As noted in our release, our financial advisors use of fee-based asset allocation product and increasing levels of assets under management in these products accounted for the majority of the increase in revenues.

Also, our expense line saw a sequential decline with the exception of underwriting and distribution costs that increased with the related revenues and general and administrative costs that rose as we resumed a more normalized level of advertising and because of the aforementioned write off.

Second quarter net income adjusted for the impairment charge was $44.9 million or $0.52 per diluted share and declined 5% compared to the first quarter. Gross sales were $5.5 billion, down 10% sequentially, while net flows remained positive despite the challenging market backdrop and investors continued to caution toward equities. Thus far, July growth sales in our retail channels are running somewhat behind the second quarter levels, with the normal pattern summer slowdown. Close-in retail channels are positive with slight outflows in our Advisors channel, more than offset by solid inflows in our Wholesale channel.

Looking at the contribution of each channel during the quarter. Advisors had net sales of $1 billion, a slight increase compared to both the first quarter of 2012 and the second quarter of 2011. Productivity of our sales force rose, reaching an average of $42,200 per advisors. Flows remained positive at $183 million representing organic growth of 2.1%. Our Wholesale channel had gross sales of $3.9 billion and inflows of $626 million. Sales of fixed income mandates remained solid, accounting for approximately 1/3 of sales in the channel.

Our flagship, Asset Strategy Fund, remains one of our top-selling products, accounting for about 1/3 of total sales volume. Redemption pressure in Asset Strategy eased somewhat as outflows during the quarter were approximately $73 million, compared to outflows of $359 million during the previous quarter.

Sales of our Institutional channel were $567 million, a sequential drop of 13%. Outflows were $433 million due to a large -- and due in large part to redemption of $300 million by a defined benefit plan that made the decision to reallocate the portfolio away from traditional asset classes. As a reminder, Institutional flows are lumpy in nature. In early July, new wins brought in approximately $315 million.

Currently, obviously, it is difficult to predict with any degree of credibility when political, fiscal and monetary pressures will be effectively addressed. That said, our results continue to validate our strategy of having a comprehensive product line derived from a proven investment process and distribute through multiple complementary channels. When no one is immunized fully from the ongoing shift in investor sentiment and behavior, we believe our strategy and its execution positions as well to surmount challenges and compete effectively allowing for continued growth.

Operator, at this time, I would like to open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Cynthia Mayer, Bank of America.

Cynthia Mayer - BofA Merrill Lynch, Research Division

A couple of questions. One is on the Institutional side. Could you give us a sense of the asset mix in terms of style at this point? And to the extent you see outflows away from traditional assets toward maybe alternatives, would that be from like large cap growth?

Henry John Herrmann

I don't know if the 2 are connected. But we continue to see some outflows in large cap growth, mostly related to Pictet. The move to alternatives, off the top of my head, I don't remember it. But I don't think it was just large cap growth. It's a back-and-forth kind of thing, I'm not sure if that completely answers your question. I can get back to you with explicit details. But at the same time, I would like to point out that it is a lumpy business and the very fact that we've had more than 300 in new rents and most of it in inflows already in July attributes to the up-and-down nature of the way the thing goes.

Cynthia Mayer - BofA Merrill Lynch, Research Division

Okay. And those new wins, any particular style or across the board?

Henry John Herrmann

No. It was core.

Cynthia Mayer - BofA Merrill Lynch, Research Division

Core, okay. And then just a quick question on the Wholesale channel expenses. You mentioned in the release that the indirect expenses rose due to higher marketing and support costs. And I'm just wondering where you seeing sort of ongoing pressure there? How would you suggest trying to model those out ahead? Does that plateau at some point?

Henry John Herrmann

Actually, I think that a small part of the increase in indirect was related to advertising. More of the advertising expenses in admin as opposed to indirect. And then, I'm not sure exactly if I understand the question, but I do think that we signaled the last time around that our advertising expense would be rising in this quarter to the rest of the year in manageable degree.

Daniel Paul Connealy

This is Dan. I'd like to just point out, there's just a lot more activity this time of the year and the amount of time being spent by other departments on that channel, it was up. And that contributed some to the cost.

Cynthia Mayer - BofA Merrill Lynch, Research Division

Okay. So looking ahead, do you expect it to sort of level off?

Daniel Paul Connealy

I would expect so.

Cynthia Mayer - BofA Merrill Lynch, Research Division

Okay. And Hank, you talked about the winds in institutional so far, just can you give any color on how the retail side is looking so far this quarter?

Henry John Herrmann

In my garbled opening remarks, I did mention that, that we're positive flows, but somewhat slower in July. And I commented that's the usual pattern. It's summer slowdown.

Operator

Your next question comes from the line of Bill Katz, Citigroup.

William R. Katz - Citigroup Inc, Research Division

Just in terms of the July volume, any change in the tenor of where the volumes are going? In other words, is it still probably in the fixed income or is there any kind of moving back into equities.

Henry John Herrmann

I'd still say that the noteworthy flow is in fixed income.

William R. Katz - Citigroup Inc, Research Division

Okay. And then just from a big picture perspective, when you look at the success you're having in the Advisor channel in terms of the asset allocation discussion, do you, as it stands currently, have enough Waddell & Reed product to satisfy that allocation or do you need to have a more robust open architecture? And what might be the implications for volumes and/or margins for that segment?

Thomas William Butch

Bill, it's Tom. I think we're more than adequately represented across asset classes in order to provide the number of models that we provide our advisors, and they in turn provide to our clients. So that's on the classic side of the business. On the choice side of business, as you know, we're recruiting people from other broker-dealers and those products tend to incorporate more nonproprietary funds. But I don't think there's any issue whatsoever relative to the breadth of the product line and its capacity to fulfill very well a comprehensive asset allocation for our clients, if that's the core of your question.

William R. Katz - Citigroup Inc, Research Division

And then just one last one for me. I might have read too quickly with all the releases this morning. But it didn't seem like there was any repurchase activity in the quarter. And I know you sort of most focused on dividends. But just sort of how are you thinking about free cash flows at this point and any shift in your thinking?

Henry John Herrmann

I didn't understand, did you say there was no activity in the...

William R. Katz - Citigroup Inc, Research Division

Again, I read very quickly through the 3 different press releases this morning. I thought I did not see anything on buyback this quarter. I might have missed it. But just more big picture, what are your latest thoughts on free cash flow usage?

Henry John Herrmann

Okay. We did repurchase about 950,000 shares in the quarter. Part of that was in market activity. Part of that was associated with the restricted grant tax implications, but it was about half and half. There's been no change in our thinking about capital allocation. We know it's still grow the dividend, repurchase shares or offset dilution. And that's the heart of the matter.

Operator

Your next question comes from the line of Michael Kim, Sandler O'Neill.

Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division

First, it does seem like relative performance is becoming more important, particularly as it relates to kind of asset allocation funds. So just curious how you're thinking about the Asset Strategy Fund within that context? And then have you dialed back, maybe some of your net equity exposure more recently or any other meaningful changes to the portfolio?

Henry John Herrmann

Mike, this is Hank. I'm going to let Mike Avery respond to that question. But I'd say we're going to have a good day today.

Michael L. Avery

Well, Mike, I think as you know, relative performance is always important. It's always the key no matter what people say. They tend to make the decisions on performance particularly, unfortunately, past performance is what drives a lot of people's decisions. If I think about the Asset Strategy Fund, specifically, we have not made any major asset allocation changes over the past year. We're still just above 80% in equities. We have about 10% of the fund in gold bullion. We have changed our cash fixed income allocation so that over the past year, we've got less cash, more fixed income. I would say in the -- and we have a relatively unhedged equity position driven primarily by the cost of hedging more than desire. I would say that looking forward, I think we're well positioned, especially if we get into a risk on equity market. That moves away from the singular focus of how the Europeans will solve their individual, respective problems. Equities of an asset class if you look across the spectrum or inexpensive relative to fixed income, earnings yield relative to bond yields is the widest spread that it's been, certainly, in the last 30 years. We're getting to the point now where individuals would have made fixed income allocation decisions. They're going to have to think harder about where the return that they've enjoyed over the last year are going to come from. In other words, a lot of people have benefited well from the flattening of the yield curve. If you bought, say, the 30 year U.S. Treasury a year ago, you’re up probably about 39% year-over-year. And then in the 10 year you're up about 17%. The only reason I'm pointing that out is that with the 10-year yield at 1.44%, whatever it is this morning, pretty close to that, it's going to be harder to replicate those types of gains unless you expect that yield to the U.S. will collapse even further. So what I'm saying is, as people look at that return expectations relative to how they're currently allocated; the desire to go further out on the risk curve in an environment where the U.S., relative to other developed markets, is getting better; where the known, unknown of what's happening in Europe is fairly well discounted. And as a leadership change in the fall in China, we think will be the harbinger for reforms that will help the Chinese economy stabilize, sustain a real GDP growth rate of 7% to 8%. So in terms of how we're positioned, I think we're positioned fairly well going into the second half or for the asset strategy.

Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division

Okay. That's very helpful. And then it looks like flows into the Mid-Cap Growth Fund really ramped up in June, so any color there? Was that a function of maybe an outsized institutional mandate? Or maybe the fund being added to model portfolio? Or anything noteworthy as it relates to that particular fund?

Thomas William Butch

Both were in play during the quarter. The fund has been well received at some of the large broker-dealers. And there was a large win in the fund as well, institutionally.

Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division

Okay. And just maybe one for Dan, just any sort of outlook in terms of compensation expense? I would imagine it's still a bit too early to adjust some of your bonus accruals. So expectations of sort of flattish from here?

Daniel Paul Connealy

Yes. I think it might be probably in the range between $42 million and $43 million. I would expect the probably further reductions in payroll taxes slight, but other than that not big changes.

Henry John Herrmann

Talking about the third quarter.

Daniel Paul Connealy

Third quarter, excuse me, yes.

Henry John Herrmann

And whatever our bonus accruals have been, for now they remain because we're pretty much where we've kind of been all year. Some are real good, some are not so good and kind of in between. The only thing I would say is, and I hope everybody appreciates because I know you're living it, the volatility changes things pretty quickly in rankings. And so we could find ourselves in the last 2 weeks of December with something really significant up or down that would change what we do. But for the moment, it looks like we're going steady as she goes.

Operator

Your next question comes from the line of Robert Lee, KBW.

Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division

Just a quick question, I'm just curious as to your thoughts on, I guess, recently Tom also took over the Institutional business or at least from a marketing perspective. And maybe talk a little bit about your plans in that business, and is that a place you'd see some additional incremental opportunity for maybe investing some new resources or what not?

Thomas William Butch

Well, I think it will be premature to sort of give you a grand plan, Rob, because we're still talking it through with the very capable people in that area. A couple of things to make sure that every strategy that is institutionalize-able, if you will, is made so. There might be some opportunity there. I think some additional sales, resources also are likely in the offing. And with the opportunity that we see broadly in sub-advisory, with a subset of that being insurance, targeting resources against that certainly will be important as well. Folks there have done a lot of great work with the -- pardon me, with the consultant community and are well ensconced there. And I think it's a matter of executing on those few things I just talked about by way of the product and human resources that would be the next leg of the growth strategy.

Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. And maybe just to -- Hank, if we could, I think it's been a while, maybe just any kind of update on the Pictet relationship. Just kind of what you're seeing from that? Where that stands? And I guess maybe a follow-up from Tom's comments, any evolving opportunity you see for similar arrangements?

Henry John Herrmann

I'd say in several different ways. But if you measure it in terms of the assets that reside with Pictet relationship is contracting. If you measure it in terms of the relationship between the 2 parties, I'd say that's still pretty good. But the reality is, the client base of Pictet is like the client base in a lot of other places, headed off in a different direction and that has resulted in the large cap growth strategy losing assets. At the moment, there's nothing under the hood that I'm ready to talk about in terms of something else we might be doing with them.

Operator

Your next question comes from the line of Bulent Ozcan, RBC Capital Markets.

Bulent S. Ozcan - RBC Capital Markets, LLC, Research Division

I have a few questions regarding the Advisory channel. And specifically, I would like to know could we separate the increase in the productivity with being shift in product mix versus a reduction in headcount?

Thomas William Butch

Do you want to quantify that right now?

Bulent S. Ozcan - RBC Capital Markets, LLC, Research Division

If possible, just an indication. How much of that is due to an increase in productivity by getting rid of some of the underperformers and how much of that is due to shift in the product mix?

Thomas William Butch

Well, headcount is not materially lower at this point. So I think at this point it's driven more substantially by the revenue increases. But we have come down over time from a much higher level of advisors. I don't have that analysis right at hand, but I would say that it has been a combination of the 2. Headcount is down from last year, but not at a hugely material rate. So we can look to separate those 2 out.

Bulent S. Ozcan - RBC Capital Markets, LLC, Research Division

Great. And then on the underwriting margins in the Advisory channel. I've also seen a decline in the margins and some of the explanation was due to higher field office expenses. Should we expect this expenses to continue and what would have been the margins x the high expenses?

Henry John Herrmann

I don't really believe that field office expenses went up. But they did have BRSU going on throughout this quarter. If you compare it to last year, we were not doing this repapering until the start of July. So that would be a big difference year-over-year. But quarter-over-quarter, that wouldn't have been much change.

Bulent S. Ozcan - RBC Capital Markets, LLC, Research Division

Okay. And then final question on the utilization rates in the Advisory channel. Could you give us an update on that as well?

Henry John Herrmann

Sorry, I don't understand utilization rate. Could you...

Bulent S. Ozcan - RBC Capital Markets, LLC, Research Division

So basically, the take rate on Waddell & Reed products. Are your advisors selling more of the Waddell & Reed products? I think you had previously mentioned that you would like to have a reutilization rate of 30% in that channel that used to be around 20%. I'd like to see what the progress has been in the quarter.

Thomas William Butch

Okay. I think that question relates specifically to some comments that we have made in the past about our choice of our Advisors channel, which is the relatively newer part of the channel, where substantially the effort is aimed at bringing experienced advisors into the channel. And so among the recruited advisors, about a little over 20% of their mutual fund assets are in our proprietary products, if that's specifically what you're referring to. The overall rate of course in the channel, in the Advisors channel, as a whole, is hovering in the mid-90% range.

Operator

Your next question comes from the line of Jeff Hopson, Stifle, Nicolaus.

J. Jeffrey Hopson - Stifel, Nicolaus & Co., Inc., Research Division

So some of your competitors have seen better flows in July. And the comment seems to be investors, while they're still nervous, low returns in money market, concerned about long-duration fixed income is moving some money off the sideline, so to speak. So is that wishful thinking at this point? Any comments?

Thomas William Butch

I'll take a crack and others probably have an opinion as well. If it's anymore than wishful thinking, it's just a tick more than wishful thinking in our experience. If you look at the categories that continue to dominate the flow experience, they are risk-off categories. The exception, of course, being allocation, wherein to the extent people are taking on risk, they're doing it in the context of an allocated product. And you're seeing more and more entrants into that category. We've had some good successes, it was pointed out by a previous questioner with our Mid-Cap Growth strategy. And I should correct that, that was not -- there was not institutional. And that was in the first quarter, I still have that in my mind. So all the flow you saw on Mid-Cap Growth was on the retail side of the business. But that has been our outlier from a retail perspective. And I think if you look at the categories that are gathering assets, they are still substantially risk-off. So I do think, Jeff, for your point, to the extent that people are stepping out a little bit, it maybe into allocated products and that's where they're choosing to consume their risk.

J. Jeffrey Hopson - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And for Mike, it was reported, I'm not sure if it’s true, of some cut back, I guess, maybe in asset strategy, in gaming stocks, et cetera. If true, does that represent any meaningful change away from the broader themes that you've played in emerging markets, I guess?

Michael L. Avery

Well, I'm not sure I totally understand your question. But without speaking specifically to where we made changes, we did make some allocation changes that affected equities a little bit in order to take a position in a fixed income instrument that we thought was more attractive than some of the other asset choices, which included a reduction in some of the individual equity names that we owned. But where we made reductions is not a reflection of any change in how we're thinking about the sectors that those securities resided in. I don't really want to get in on an open call like this, what stocks you're buying and what stocks you're selling. That would be very helpful but...

J. Jeffrey Hopson - Stifel, Nicolaus & Co., Inc., Research Division

Sure. I understand. I just was curious if you'd cut back on kind of the big broader theme of emerging market or middle classes, et cetera.

Michael L. Avery

No. No, that's a secular theme that if you take a close look at the portfolio, what you'll see in our equity concentrations is a worldview that reflects the emerging middle class. Where you have a rise in prosperity is where you're going to make money. So those companies that offer a product or service to those individuals that have got rising discretionary income in their pocket, we believe those humans are going to make purchases in the same sectors, industries that others before them have done. Which means, an increase on, as you pointed out, entertainment. It means an increase in health care for their families. It means an increase in financial services, technology. Transportation becomes more sophisticated. And so that theme in the portfolio remains. So there's no change in the thought in terms of how we want to position the portfolio long term.

Operator

Your next question comes from the line of Roger Freeman, Barclays.

Roger A. Freeman - Barclays Capital, Research Division

I guess, first to Hank. Just on the institutional pipeline, you've kind of talked a bit about this, but last quarter, I think, 1 or 2 mandates that you'd had coming in the quarter funded. It sounds like maybe the other one just came in July. And I guess just more broadly, from the perspective of what you considered to be large mandates you're working on, I mean, how does that pipeline look right now?

Henry John Herrmann

I don't have a detailed list off the top of my head, but the pipeline looks pretty good. And it's mostly core, although there's other things going on as well. But core is a big opportunity. I think I started talking about it pretty close to 2 years ago, making the point that I thought that this product had a good chance of outperforming its benchmark, which is the S&P. And as you know, when the performance is strong relatively and somewhat of a consistent basis, people can explain effectively what they do, you all of a sudden get in competitions to win mandates. And that's the process that's unfolding. So I continue to be optimistic. In this particular category the assets come in on pretty big chunks.

Roger A. Freeman - Barclays Capital, Research Division

Right. I guess, for a final question, too. Is any mandates won but not yet funded that are of size?

Henry John Herrmann

I did mention a total number. And 90% of that number in July was funded, but 10%, 15% of it is not. Tom might want to add a point here.

Thomas William Butch

Only the pipeline, per Hank's point, there's better diversification, I think, than in the past with large cap and core. But also international core and to the extent that we have capacity, small cap as well. Second quarter search activity was very high. So it appears the pipeline is fertile.

Roger A. Freeman - Barclays Capital, Research Division

Great. Then on the choice platform, just looking for an update there, maybe how many added advisors? And then also if anymore -- I think one of the things that came out last quarter is now that you've had time to test it with folks that have come on from outside is starting to see some turnovers. I'm just wondering if there's any acceleration to that? And then also, if you're kind of reevaluating some of the functionality with some of the anecdotal evidence or feedback you're getting from advisors?

Thomas William Butch

Well, that was a lot of questions. I'll do my best. There are 169 advisors on the channel, in the choice channel, and 116 of those are recruited and the remaining 53 are converted. AUMs at 6/30 were about $3.4 billion. And as what's described previously, the degree to which the proprietary funds are being utilized as a percentage of overall fund utilization by those we have recruited is just a little north of 20%. So there was, as you pointed out, a net loss of 7 advisors during the quarter with -- pardon me, a net gain of 10 advisors during the quarter. We added 17 and lost 7. We're ahead of last year's pace relative to recruiting those advisors. And I'm not sure I get your question on functionality, whether it is do we have the right products and do we have the right things in place to make people successful once they come here. Is that...

Roger A. Freeman - Barclays Capital, Research Division

Yes. That's sort of it. I think I recall that there was some -- some of the turnover was that people found they didn't have everything they thought they had to bring their whole book of business over and not -- I think there was some one-off examples. But just wondering...

Thomas William Butch

I think in fairness, certain people had that perception early on. I don't think that's an issue at this point. We have a very active product development process and a product committee and all the things you would expect us to have. I don't think that, that is an issue anymore. Most of them come here, I think, to engage financial planning, to engage in a platform of multiple wrap-type options, about half the business on that side is wrapped. And to have a -- be part of a field structure where there's a lot of support, both from the home office and at the field level. So I think those past issues of platform have been substantially, if not wholly resolved.

Roger A. Freeman - Barclays Capital, Research Division

Okay. All right. And then just lastly, the books and records of repapering project, I guess, a, is the write-down this quarter related to assessment retirement in there, and is that done now? And how many people will be coming out as a result of that consultant or temporary?

Daniel Paul Connealy

First, the write-down was not related to this at all. It was in other areas of the business. And the temporary employees that have been used will begin to ramp down. They won't be completely gone in the third quarter, but they will begin to ramp down.

Roger A. Freeman - Barclays Capital, Research Division

Okay. I mean, roughly is it a handful or is it more?

Henry John Herrmann

Let me say it a little differently. The expense for books and records has been material and it will be ramping down. There's a number of different ways to think about the cost there. I think after the end of the third quarter, we'll have 6 people still involved, down from 20 something from my recollection.

Operator

Your next question comes from the line of Marc Irizarry, Goldman Sachs.

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

Just in terms of the sales and sort of the flows and the fees here, if you will. It looks like there's a bit of a shift going on toward fixed income. Can you just talk maybe about what the implications are for, I guess, your margins or at least marginal profitability? If you're shifting a bit more towards sort of lower fee and some of profit margin on fixed income for your business you want to sell off relative to equities and what's sort of the long-term margin target for this is?

Henry John Herrmann

As it relates equity versus fixed, obviously, the fee is somewhat low on fixed. I know you've noticed that the slippage in the fee on a year-over-year and a quarterly basis. I just encourage you to keep in mind that the important part of that is related to outflows and Global Natural Resources as well.

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

Okay. And then the margin target here long term, if there's a sort of where you think that can settle out?

Henry John Herrmann

I think if 90% of our assets are in fixed income in 2 years, margin pressure will be a little different than if it's 100% equities. But for the moment, you're asking me to try to figure out what the outlook is going out. The reality is, in the short run, modest mix shift pressure on fees.

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

Okay. And then, Hank, just in terms of the equity performance what are the key themes near term that you think will turn -- will start to turn the equity performance around for you guys on a relative basis?

Henry John Herrmann

Well, let me see. I'm going to answer 2 questions you didn't ask that are related to that, and then I'll answer the final one. But you know the performance is so volatile because the volatility of the market. If you look back 8 or 9 weeks, you would come to a conclusion about our relative standing in a more positive light than you might at the end of June after the market just had a pretty big pullback. And the volatility, look at today, is another example of that. And so I would just say that broadly speaking, the difference between being in the top quartile and the bottom quartile in most of the mandates where we have benchmarks is not that material. And so a shift in gear up or down, could change things pretty quickly. And that's part of the reason why when we were talking about what's our bonus allocation going to be, I elaborated somewhat about -- we could go all the way to the fourth quarter before we decided we had to do something materially different. Said another way, our growth fund doesn't have 90% of the equities paying 4% yield or higher. And that probably is true for a lot of the other funds. And as you know, for the last 6 months, the answer was chasing after equity returns in the form of income. We have a star system and every portfolio manager has a different slant on how to play the environment we're in. Not that we got people who are totally left or totally right of everybody else, but there are magnitudes. There are differences. And some of us are more focused on the staples versus discretionary or energy versus food and beverages or whatever. But the performance, broadly speaking, I think in an environment we're in, is pretty darn good. And we'll just have to remember that portfolio manager's life begins on the 1st of January and ends on the 31st of December. And so we see where those numbers come out. I'm going to say we're doing okay.

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

And then just -- I guess, this might be for Tom and then maybe hand over to Dan. When you think tactically about the more challenged equity performance and going at the Wholesale channel, is there sort of a urgency tactically, maybe spend a little bit more to sort of educate the channel and ensure that the wholesalers are sort of armed with everything that they need, so to speak, to hold on to the assets?

Thomas William Butch

Well, I think, yes.

Henry John Herrmann

Hold on a second, Mr. Irizarry, I'm not going to let you get away with this idea about equity being challenged. We've got a handful of really solid performance on year-to-date basis, 3 years, 5 years. There's still lots and lots of products out there in the equity arena that are attractive and our organization can sell. It's a little different, however, when you know, as I said to you many times in the past, we can't control what the dogs want to eat. And if they don't want to eat the chow, they don't want to eat the chow. I'm sorry for the interruption, but I just would have been remiss if I didn't comment.

Daniel Paul Connealy

I would only add that, Mark, it's axiomatic to say that you want to have your wholesalers fully armed, and we spend a lot of time with them to make sure they are. And I think with the support of our investment team, they have great access to the best thinking. And their -- the currency of the ideas and the knowledge they take to market is really quite high. It's not something you solve with money, I don't think. It's something you solve with that kind of approach in time and making sure that you have the educated group of wholesalers. You take the messaging to market in a really thoughtful way. There's a tangent to your question, too. That is you just have to make sure that you have ample breadth of product you're taking to market across a span of circumstances and that people are educated in all of those products. And we spend -- that's the greatest time -- that's the greatest investment of time that we make with our wholesalers. And you also have to have the right product set. And I think we've had been very fortunate to have for our wholesalers products that have been sellable and in favor across whatever circumstances the market has given us. And I would just mention we were working hard now to educate them on 2 new products that we just have created. One new, one altered product that we think will be good fits for the teams that we have taken to market for a long time, and fits for the brand that we take to market and fits for investor sentiment as well. So it's a long and somewhat rambling answer, but really the answer to your question is absolutely, that's what we spend a lot of time on. I don't think it's so much a money issue.

Operator

Your next question is a follow-up question from the line of Cynthia Mayer, Bank of America.

Cynthia Mayer - BofA Merrill Lynch, Research Division

I guess, just one more specific question on product, which is you do have a bunch of 4 and 5 star funds, Mid-cap, Small-cap, core, Science and Tech. And I know in the past you've occasionally said you incent wholesalers to sell certain ones over others. And I'm just wondering if you're using that system at the moment and what, on the equity side, you're particularly focusing them on? And then just secondarily on the Science and Tech fund. It's a 4-star fund, really seasoned and at a time when that's outperforming and it is outperforming NASDAQ. How do you guys sell that fund and the fact that hasn't really collected more flows? Is that a function of active equity not competing well with passive or is it something specific to the fund or how it's marketed?

Daniel Paul Connealy

Okay. Starting where you ended, I'd say it's more a function of the category being relatively narrow. It has, over its recent past, collected assets at the upper end of funds in that category. It happens to be in a specialty category. And you're quite right, it's having an exceptional year. And we're well prepared to, and do, market it. But it is in a category that's relatively narrow. And what's really, unless I'm mistaken, really has never recovered fully over the last decade. But the one of the things we do market is its breadth and the degree to which it's not hostage, just the technology or just to science. The manager interprets the mandate reasonably broadly and looks at applications of technology as well. And so we try to tell the story having a little more breadths than a the narrow category. And you're right, we should be collecting more assets in the fund, and I would be surprised if as the year unfolds, we do not. Your first question, I think, related to are we incenting the wholesalers toward any particular fund. Not outside the rails from what we started from the comp program that we introduced early in the year. So that is not something that's in play right now. It's something we can bring to bear whenever we see fit.

Operator

Your next question comes from the line of Greggory Warren, Morningstar.

Greggory Warren - Morningstar Inc., Research Division

I just have a longer-term sort of modeling question. I know in the past you've guys have talked about targeting, say, 30% of operating margins. And you were making some decent strides towards that in '10, '11. But my thought is as long as we end up in the sort of risk-on, risk-off environment and the ongoing mix shift that continuous to go on towards fixed income, whether or not this is something that -- I mean I'm not trying to say that you guys have a date here, but something that's quite a bit longer out than it might have been in the past.

Henry John Herrmann

Well, I guess I've never let myself get put in a place where I would put a timetable on it. I always said it would be difficult to achieve, but I thought we could do it. I haven't changed my view on any of that. Clearly, in the short run, there are headwinds, one, mix, if we're going to continue to see fixed income be a bigger percentage of gross sales and our assets. That is going to hold it back a little bit. But at the same time, if we had an improvement in the equity market and our flows improved in equity products, I don't think it would be that tough of mountain to climb. So the question is, do we still not think we have a shot at doing 30 overtime? The answer is, yes. In the short run, however, attaining that at present doesn't seem likely.

Greggory Warren - Morningstar Inc., Research Division

That was sort of the gist of the question, whether you were still standing by that. But again, I wasn't trying to peg you down with a date. And my assumption was that it was going to take significant improvement in the equity markets and the flows, particularly on the active side of the business to really see that pan out.

Henry John Herrmann

When I first said it, I didn't think it would take a significant improvement, but the equities haven't cooperated with my forecast. So you're directionally more correct than I was at the time I opened my mouth.

Operator

[Operator Instructions] And currently we have no further questions.

Henry John Herrmann

Well, we thank everybody for listening in. We appreciate it. We understand that it was a complicated morning for releases from investment managers, and I know you're hard pressed. But thanks for your questions, and we look forward to talking to you soon. Please take care.

Operator

Thank you for your participation on today's conference call. You may now disconnect.

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