Waddell & Reed Financial Management Discusses Q3 2012 Results - Earnings Call Transcript

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 |  About: Waddell & Reed Financial Inc (WDR)
by: SA Transcripts

Operator

Good morning. My name is Tiffany, and I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter 2012 Earnings Conference Call. [Operator Instructions]

I would now like to turn the conference over to Hank Herrmann, Chairman and Chief Executive Officer of Wadell & Reed. Please go ahead, sir.

Henry John Herrmann

Thank you, Tiffany. 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 Operations Officer; Phil Sanders, our Chief Investment Officer; and Nicole McIntosh, our VP 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 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 today's 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. Hello, everyone. This morning, we reported third quarter results and announced the sale of The Legend Group. As a result of the sale, we have moved Legend's numbers in our financial statements to a separate line for discontinued operations.

Discontinued operations included noncash charge of $42.4 million, reflecting of loss on the sale.

The purchase of Legend in 2000 marked our first foray into selling our products beyond Wadell & Reed's proprietary distribution. Legend has proved to be a steady source of flows for a broker-dealer of its size, and today has assets of approximately $560 million in our products. At the same time, managing a separate broker-dealer whose principal business, the 403(b) Market is changing rapidly has provide -- proven to be, excuse me, a challenge. Therefore, this transition allows us to continue and blast our efforts to sell our product through Legend, in its new partner, First Allied, with that responsibility in diversion of managing this broker-dealer business, which for us is no longer a core asset.

Moving on, earnings per diluted share for continuing operations saw a significant growth compared to both the previous quarter, as well as last year's third quarter.

Income from diluted share of $0.61 rose 27% sequentially, and 33% year-over-year. Our operating margin finished the quarter at 27.2%, a multi-year high.

Sales of $5.2 billion during the quarter declined to $287 million, compared with the previous quarter and $1.3 billion, compared with the same period in 2011.

The third quarter of 2011, including the funding of new mandates, totaled in $800 million. Net flows remained positive at $826 million during the quarter, marking the 15th consecutive quarter of positive flows.

October saw a very modest outflows in all 3 channels.

Looking at the contribution of each channel during the quarter, Advisors had sales of $906 million, $140 million less than the second quarter, but a $39 million increase compared with the same period last year.

The quarter's redemption rate was 9.7%, far below the industry's approximate 25% rate. The percentage of sales and assets in fee-based products continue to increase, adding growing predictability to revenues.

Our Wholesale channel had gross sales of $3.6 billion during the quarter and inflows of $670 million.

Fixed income sales continue to expand to account for nearly 50% of total sales during the quarter.

On a gross sales basis, asset strategy remained one of our top-selling products in the Wholesale channel, with new sales of nearly $1 billion during the quarter. However, redemptions have kept this product in outflows over the past 4 quarters, despite good relative performance.

Sales of our Institutional channel of $721 million, and net inflows of $231 million, opportunities for new mandates remained favorable, especially for large cap core equity.

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Cynthia Mayer of Bank of America Merrill Lynch.

Cynthia Mayer - BofA Merrill Lynch, Research Division

It looks like from the restatements of the operating margin, like the sale of Legend, added about 1% to operating margins, is that right?

Henry John Herrmann

Yes, we did add somewhat to the margin. And that will be the case going forward, as that's a broker-dealer business that operates at a lower margin than our main Investment business, so there should be some modest pickup in operating margin.

Cynthia Mayer - BofA Merrill Lynch, Research Division

So I guess, the question is, since you have a longer-term goal of 30, does this get you closer to it? And it sounds like you expect some further increase in the margin due to Legend going away? Or is that from just a higher asset level?

Henry John Herrmann

I don't think there'll be further increase in the margin. It just might just move it -- the needle just slightly toward that eventual goal.

Cynthia Mayer - BofA Merrill Lynch, Research Division

Okay. And I guess on a specific line item, it looked like G&A went down a lot. Is that sustainable?

Henry John Herrmann

Well, included in the G&A line is a net of about $2.5 million, that were items that will not go forward. One was a reduction in an accrual for distribution of our products from the 2006 or fees from our 2006 settlement with the SEC. And another was a reduction in legal accruals for positive actions in our class-action suit in California. There's offset by some higher consulting costs, so about $2.5 million.

Cynthia Mayer - BofA Merrill Lynch, Research Division

Okay, great. And then I guess, just Hank, if you could update us on the pipeline, that would be great. It looked -- it sounds as if Core is selling well. I don't know how much -- how big an appetite for that strategy is there, generally in the industry. How's the pipeline looking?

Henry John Herrmann

The pipeline looks as good as it ever has for that product, and pretty much true for the Institutional business. Core could be pretty big, relative to where it stands right now. Obviously, we're talking about very large capitalization opportunity. And as -- unlike a lot of other, I guess, issues about what's transpiring, actively managed Core, that's outperforming, it's been attractive alternative in a number of different places. And we'll just see how that unfolds. At present time, there's interest in sovereign wealth funds and also on our Institutional area where there's somewhat of a backlash against some of the other alternatives, including index.

Cynthia Mayer - BofA Merrill Lynch, Research Division

Okay, maybe just one last question. Given how strong the performance is of asset strategy this year, and some of the other strategies, is there any upward pressure on comp?

Henry John Herrmann

I'd say, at the moment, our accruals are in line as what it looks like as likely. If that is your question regarding year-end bonus and so forth. Other than that, just basic comp, I think at present time, we are anticipating no big changes from the trend line that existed in the last couple of years.

Operator

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

William R. Katz - Citigroup Inc, Research Division

In terms of the sale of Legend, a number of your peers have also been more focused on non-U.S So I'm curious if you could update us on the key strategic growth drivers for the company over the next couple of years?

Henry John Herrmann

Bill, repeat that for me. I'm not quite sure I got it.

William R. Katz - Citigroup Inc, Research Division

Just with your sort of carving off Legend, a number of your peers have been increasing focus on distribution regions outside the United States. Just wondering if you could update us on your thoughts or strategically how to grow the business over the next couple of years? Where you might see the best growth of assets?

Thomas William Butch

Bill, I'll take that first whack at it. It's Tom. I think there's 2 discrete questions there I'm hearing. And the first, dealing specifically with offshore opportunities, and the second, more broadly strategic relative to distribution channels. Relative to the former, as you know, we made a small equity investment about a year ago in a start-up distributor. And that distributes exclusively offshore. We have our asset strategy and high income products now in that offshore structure. That is still a nascent business, but that has -- we believe is a good way to get started. We have had good response with our domestic distribution partners on their offshore platform just relative to those 2 products. I think, Hank also mentioned that institutionally, we're seeing potentially good opportunities through certain of our consultants outside the United States. Second, relative to your broader question, and I'll defer back to Hank on it, I would say that we see very good but obviously, differing opportunities in each of our businesses. There's a lot of growth trajectory on the Wholesale side, obviously and Institutionally as well. And you are aware of our efforts to grow the Advisors business, which is important and foundational to the organization. But from a distribution perspective, there's -- we believe enormous opportunity to continue to grow the Wholesale business, and the Institutional business in parallel with that.

Henry John Herrmann

So what I'd say is, that the strategy has continued to execute on tactics. We discussed the strategy part of it in different ways over time. The last really significant strategy move was to get into the Wholesale channel that continues to be very effective for us. And we're going to continue to try to bring products in the marketplace with a solid performance, a proven track record, stable -- the usual kind of response you're going to get. But we don't have any magic bullet at the moment that's going to completely change the profile of anything we're doing.

William R. Katz - Citigroup Inc, Research Division

Okay and just one last one. I think you mentioned, again my reception is difficult, I apologize if you have answered it. I thought I heard you say you had outflows in each of the different businesses in October, I was wondering if you could just expand on that between equity fixed income or any other type of dynamic that might be driving that attrition?

Thomas William Butch

It's Tom again. I think the same things that we have seen now for some time were evident in October, and that is, that our fixed income products, which have been generating a substantial flow continue to do so. We have certain of our equity products that are also managing to capture flow in a very difficult environment for that. So that's the Wholesale business. On the Advisor side, nothing remarkable. The word modest, I think, really fits that. And then on the Institutional business, as Hank pointed out, searches are at a very robust level and we would see how the quarter unfolds.

Henry John Herrmann

Bill, just to add on. I think that there's a bunch of things that are going on right now, that kind of confusing flows altogether. Most probably, the most important one is the election and what's the outcome of that, and what will people's presumptions be as a result in terms of what they should do about capital gains and dividends and that sort of stuff. A lot of people are going to be wondering if their tax rates are going to be materially higher next year, and should they do some things. That's one way of looking at it. The other way to look at it, is just see if the Republicans are in a stronger position. Perhaps people will take a different point of view and then, we could see a shift toward more enthusiasm for equities. I'd say, at the moment, everything -- my sense is, everything is in limbo until we get to the other side of the election and into the new year. The trend that has been in place is a strong cash flow is into fixed income. Some people are starting to wake up to the fact that equities, on a relative basis, are a lot more attractive than fixed. We certainly have been trying to communicate that to our Advisors and also to our Wholesale distribution. And we're doing that because we think that's really the relative opportunity. And it's a little easier to tell that story when equities are outperforming fixed, but it's still not easy. I'll let you know when all of a sudden, a lot of people are jumping on board that idea. But you'll probably notice it in the marketplace, anyway.

Operator

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

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

First, so the Asset Strategy Fund continues to outperform particularly, looking at year-to-date returns and yet as you kind of mentioned earlier, still dealing with some modest outflows. So just curious to get your read into some of the potential drivers behind the redemptions? Is it a function of investors still kind of favoring fixed income? Is it maybe, a function of the 3-year numbers being a bit weaker, or maybe some concerns around the volatility of the funds' returns? I suspect it's some combination of all those factors, but what's the feedback you're getting from your wholesalers, who are out there pushing the funds?

Thomas William Butch

Michael, I think you answered the question, quite affectively, honestly. It is some combination of the 3 of those. And it is frustrating that given the funds' very good performance this year and on a 5-year basis that we continue to experience redemptions. Each of the factors that you identified are biased towards fixed income when the weight of this fund has been in equities and that thesis has been proven out. But I think, the overwhelming bias towards fixed income and towards the perception of lack of volatility is sort of the headwind, relative to the product. We're out telling the story aggressively. I think, as Hank pointed out in his opening remarks, the good news is that on a gross sales basis, it's still on a daily basis taking in a very material flow. And so you may have some transition in the shareholder base that's taking place. And as long as we are continuing to generate good gross flow, this should correct itself over time.

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

Okay. And then, maybe with fixed income continuing to drive more of your overall flows, any concerns around sort of concentration risks? Just with the High Income Fund continuing to generate the lion's share of net flows? The fixed income flows? And then related to that, are you thinking about maybe adjusting some of the payouts to your wholesalers, to incentivize them selling another strategy similar to what you've done in the equity side?

Thomas William Butch

So, I guess, we've had this conversation over the years on a number of products, relative to concentration. First with Global Natural Resources, then with Asset Strategy and now with fixed income. And of course, our bias is to have lack of concentration in sales. And the good news is, we're getting good sales in a span of products. But ideally, you don't want to be in a place where you're unduly relying on any one product, certainly. Relative to the wholesalers, we're always looking at aligning their compensation program with the organization's goals and diversification, certainly is an ongoing goal. And their compensation schedule reflects that.

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

Okay. Then just one last question on the capital management front. Any change in thinking more broadly, and/or more specifically, as it relates to maybe, some proceeds from the sale of Legend?

Henry John Herrmann

Well, first, we need to get the proceeds in hand. But I think that the overall perspective is that we'll continue to buy back shares and make sure that we offset dilution at a minimum. I think we've purchased about 1.2 million shares, or committed to 1.2 million shares, so far this year. I'll place about 1.5 million will turn out to be what the shared grants are equivalent to. So we'll at least do that much. And the other part of the equation is to pay out significant dividends, relative to earnings, and the area of historically, in a way 40%-or-so. The other point I'd make is that, the balance sheet shows that we're sitting on a significant amount of cash and if opportunities develop that make sense, so we may accelerate one thing or another. But that's the best I can do for the moment.

Operator

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

Michael Durwood Strohm

I'm really remiss. I think I should have said at the very beginning, I hope everybody's families are okay, and I feel for everybody. Being a native New Yorker who was raised on the South Shore, I've been very focused on how things are going there. Hope all is well.

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

I have this follow-up real quickly on the capital management front. I guess, maybe just more directly. You've given perspective potential changes in tax rates with the sale of Legend, you've kind of been building up cash balances. Would something like the special dividend be something that would be with, do you think, within the mix as you look over the next month or 2, depending on how things shake out?

Henry John Herrmann

Well, I'd be in a lot of trouble if I spoke for the Board. And the board hasn't decided on what dividend action will be taken. That should be coming up in the next couple of weeks. I would say the election is going to impact everybody, thinking about pretty much everything. So we'll keep you informed.

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

Okay, fair enough. And maybe, just a quick question on the Institutional channel. You talked about a bunch about the pretty good, I guess, I'll call it pipeline at least or fee activity. But within the DCIO business -- the sub-Advised business team, can you maybe update us a bit on that? I don't know if that's included in part of your pipeline, and how that's going? And maybe more specifically, any kind of color that we may have if we're looking at kind of the sales, and that kind of what proportion of your sales are coming quarter-to-quarter, coming out of that sub-Advised platform?

Henry John Herrmann

It was very difficult to catch everything that you were saying. I'm going to let Tom take a crack at it first, and see how much of your question we answer and then go from there.

Thomas William Butch

I'm sorry Rob, but I heard 2 things. I head DCIO and then I head sub-advisors as a percentage of total. DCIO really cuts across 2 businesses, the Institutional and the Wholesale businesses. And we're working to coordinate those more tightly because some of the searches are driven, obviously, through consultants and then there's a very robust broker-dealer, DCIO opportunity, as well. And so, we have created specialists on the Wholesale side that cover that. And obviously, our consultant relations folks and sales folks on the Institutional side cover that. And the span of opportunity is really quite interesting, going all the way from our Advisors business, actually, and I should have include that as well, to our small broker-dealer -- driven plan and all the way up through large bundled consultant-driven opportunities. And one of the things we worked very hard to do is make sure that we have all the right share classes, because that's evolving very, very rapidly. And I think we're probably well situated there, and well situated to attack that whole span across the spectrum of the DCIO world. I don't have the exact percentage, I apologize, of sub-advised is in front of me. Somebody might have that number and we can append it to the conversation. But the relativity of advise to what we would call the traditional DGBC [ph] business has continued to grow over time. And now has more than half of that opportunity, and maybe more than that number.

Henry John Herrmann

Hey, Rob, I would just point out that -- and I'm sure you appreciate the fact that we've been in the Institutional marketing arena since the late '70s gives us a very good understanding of what consultants need. And we've been able to transfer that over into the rest of Retail business, and I think, we're in pretty good stead there.

Nicole McIntosh

Rob, to your question on sub-Advisory, of the most recent quarter sale, $449 million of the $721 million was sub-Advised so about 62% of assets under management, about 65% of the $12 billion that we have in our Institutional channel is sub-Advised.

Operator

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

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

Hank, can you just talk about sort of the outlook for retail? I think some -- maybe some of the competition out there is talking about maybe ramping up some of the advertising and marketing spend to sort of get the investors to maybe, start thinking about re-risking? When you look ahead, do you think that that's for you guys? Are you pushing on the string a little bit in terms of if you do ramp up advertising? Or how should we think about the way you're thinking about arming the wholesalers and getting sort of the message out there, that maybe it's time to shift back a little more aggressively toward equities?

Henry John Herrmann

I'm going to let Tom start, and then I might have Mr. Avery jump in, and then I'll have some comments to Mr. Avery who's out on the road trying to get the message out as you speak.

Thomas William Butch

I guess, what I would say is that there's no singular way to get the message out. And it's a combination, obviously. And I think in this order of very effective wholesaling, very effective and persuasive sales and value added pieces that support that, and advertising is sort of the bulwark underneath that. I don't think I would look to us to dramatically ramp up advertising as a means of getting out that message. We believe our wholesalers are very well armed with compelling sales materials, compelling product pieces, compelling product and market knowledge to take to market. And that is the first line of getting that or any message out. Obviously, support of context and a consistent brand that is a function of advertising, web presence and all the sales support materials is critical to that as well. The research that we see, and we saw it as recently as yesterday, really suggest that our brand message of being a global, highly-capable and well-diversified manager has continued to grow. And it's continued to resonate in the Advisor community. So that combination of everything that we have been doing has been validated and quantified in the research that we have seen. And so, I think, I would look for us to continue that sort of mix going forward.

Michael L. Avery

Mark, I would just say that the reception that we have received to asset strategy in recent months really, since the beginning of the year, has been fairly positive. People that have been investors in the Asset Strategy Fund, whether it's been 5, 10, 15 years have continued to be very supportive. Going back to a prior question, where there have be outflows seems to be isolated in that group that came into the fund, either at or close to the beginning of the global financial crisis. And got themselves, I think, philosophically, caught in the risk return paradox, imparted upon them by their clients. Meaning, since the beginning of that time, investors generally, have taken a view of the world where they want a reduction in their tolerance for risk, either based on articulating a concern about volatility, or global macroeconomic events, or the steep decline in 2008 as an experience that a certain subsegment of our investor base just doesn't want to repeat. Particularly, if they are new to the product. And what you find though, is that even though people's tolerance for risk may have been adjusted downwards, their requirements for return have not changed from precrisis levels. Meaning, even though I want to take less risk in this environment that is macro driven, I still expect the same return that I had prior to the crisis, which helps explain perhaps, the move of flows into some fixed-income products, out of equities. And as Hank and Tom had both mentioned, as the performance of asset classes, relative to fixed income show improvement, and now we're anniversary-ing performance on let's say, a 10-year basis where some individuals are looking at what they gave up in terms of either performance in domestic equities or equities outside of the U.S. We're going to come pretty close to anniversary-ing 5-year numbers here, where I think it's going to cause a question in the part of the clients, as well as the Financial Advisors' minds about the extent to which they may have moved assets into what they thought was a defensive posture, relative to the return potential that they gave up. So we are certainly seeing again, people who have -- have had a long-term interest in asset strategy, continued to have a long-term interest. And with those folks, there's a lot of discussion about how individuals, people groups, globally are climbing the global S-curve. And those conversations have gone on. And with newer or more recent shareholders, it's been this reexamination of what has caused the tight correlation in markets, what are the macro events that have driven that, and the risk trade-offs that they made by moving perhaps, dramatically from one asset classes to another. So based on the response, Mark, that we see from people, I think, you're beginning to see people in some way move out the risk curve in some ways. It's still very incrementally from looking at solely fixed income products to dividend payers, to dividend growers, and then there will be a focus on large cap growth, perhaps. And then finally, refocus on emerging markets. Sadly, for many people though, they will have missed a significant period of outperformance in the last couple of years.

Henry John Herrmann

And Mark, this is Hank. Just to kind of finish up on this. When you talk about advertising on an effort to get the message out, advertising is one tool, but we use a lot of other things, obviously. And over the last 1.5 months or maybe 2 months, we have had, in our home office, large groups, 4, 5, 6x, I've lost count, Tom could tell better, but in 6x these thing's correct. And then in each one of those cases, we put in front of these individuals, which is a couple of hundred at a time, our portfolio managers, to try to tell the story and get the message out. And there's been clear emphasis on the kind of commentary across the board from the PMs, that Mike just ran through when he's talking about what's going on. Mike is not sitting at the table right now because I think he's in Minnesota. I mean, he's out there at the time we're talking, getting the message out. He's talking to wholesalers and retail clients. And I'm highly confident of that. And I know his itinerary and there's a lot more of that coming over the next couple of weeks. So that's another way of thinking about how we try to get the message out. Thank you for your question.

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

Just one quick follow-up. Just on -- in the Wholesale channel, it looks like redemption rates really stepped down sequentially, actually versus the last few quarters. Anything happening there in the Wholesale redemptions that suggests that we're sort of at a different level of -- is it may be certain relationships where you're not seeing as much money coming off the platforms? Or -- and then also gross sales, it looked like they stepped down. Any comments just on the gross ins and outs in Wholesale?

Henry John Herrmann

Not along the lines you were suggesting. But it's more, to me anyway, just the matter of fact that you had heightened fear in the third quarter a year ago which created pretty interesting opportunity. And you know that, that at the time drove a lot of redemptions. And you're just looking at the high watermark from there, and it's obviously been in a downtrend since that time in the Wholesale channel. I think the redemption rate this quarter was the lowest we've seen in the last 5 or 6 quarters, I'm not positive with that, but some place in that area. I think Nicole has got some tables to review, if you care to, but that's my shot on that.

Operator

Your next question comes from the line of Jeff Hopson of Stifel.

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

In high yield, any issues there regarding capacity? And I guess, spreads have come down, there's been a little bit of debate out there as to how much additional opportunity there is. Any thoughts on that whole issue? And then in the underwriting and distribution expenses in non-prop, are those good numbers now that we saw in the third quarter as far as maybe a run rate?

Henry John Herrmann

Well, in this quarter, we did have some adjustments of accruals, which normally take place in this quarter, it affected both our comp and our U&D. So we've taken a look at our health care accrual, we're basically self-insured. And our results have been favorable, so we brought that down a bit. And that would be an item that would be nonrecurring, potentially, but it's not a big number. And as regarding to the high-yield capacity, obviously, at some point in time, there is an issue. I don't think we're there at this point in time, but we're getting up to $6.5 billion at this juncture I think, it's growing very rapidly. It's pretty hard to put additional management capacity in place because of the scarcity of talent. We're working on doing it that way. And there's also liquidity issues that, regardless of talent, will come into play. But at the moment, I think we're still all right. The other thing I'd say is that, again, I hate to do it this way. But the reality is, whether or not there's going to be continuing focus on defensive or a move towards equities, which what I'd say is more assertive, in my opinion is a function of what happens November 6. Keep in mind that -- and I've made this point I think to you, but I'll repeat it, and most people I believe realize it, our clients are not risk adverse. They're just adverse to equities at the moment, wrongfully, we think. And if you go back a couple of years, we were talking about, well, fixed income made sense and we're focusing on a high-yield product. But now, we're trying to get out a different message in. If there's a turn in the market, I'd think it's likely we won't be particularly concerned of our capacity in high income fund.

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

Okay. And Hank, I know over the last couple of years, you've been at times a little cautious on the market. But it sounds like you are a little bit more optimistic, or is it just that equities on a relative value look that much more interesting?

Henry John Herrmann

Well, unfortunately, we're micro and macro-driven around here. And so on a micro basis, the latter part of your point, we think equities on a valuation basis just make a lot more sense. On a macro basis, I'm still not highly confident of anything. But I would say that I believe very strongly that in the end, politicians do not commit suicide. And then I've got my hat hung on that a little bit. I don't think it's going to be an easy workout, but I don't think we’re going to fall off the cliff, and I think the markets are going to demand reasonably appropriate solutions in time. Meanwhile, I'm looking at this incredible differential in valuation between equities and fixed income, I'm just thinking, given that where interest rates at the present time -- are and they could be a lot higher and I could still make the same point. Given where interest rates are now, price earnings ratios look very reasonable. So we'll just see how that plays out. And then the final point I would make, I don't want to think this way, but I have to make the point that if we have to continue to have our foot flat on the gas pedal in the world, not just in the U.S, in terms of monetary policy, then that effect is that more and more people are going to realize the potential for meaningful change in the inflation outlook, and that will translate into equities being a lot more attractive place to be than fixed. And so, we're hedging our bets a little bit. I wouldn't want you to take me as really, well, that optimistic. There's uncertainty here. And I can be optimistic and like equities, and I can also be a bit of a pessimist and still like equities because inflation hedge aspect. So I'm kind of yin and yang in it here. But that's the best explanation I have.

Operator

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

Roger A. Freeman - Barclays Capital, Research Division

Maybe just to pick up on that last point, Hank. In asset strategy, has the positioning vis-a-vis equities changed there at all? Or maybe Mike, if you're on the line still. I think last quarter you said you'd increased allocation to get to fixed income?

Henry John Herrmann

I'm not going to preempt Mr. Avery, I'm going to let him answer your question.

Michael L. Avery

Roger, our equities allocation is fairly close to what it was 3 months ago at the time of our last call. We're right above 80% in equity allocation. We have 10% of the fund allocated to gold bullion. We do, as you pointed out, have about 4% of the fund in a fixed income product, which is very unique, private placement opportunity, an opportunity that we invested in earlier this year. And the remainder of the fund is in cash. We have not used derivatives to hedge the equities in a significant way for some time, probably going back 18 months or so. Based on the cost associated with using derivatives as a hedging tool, so we have 80% of the fund in equities and not hedged.

Roger A. Freeman - Barclays Capital, Research Division

Okay, that's helpful. And then just on the Advisor account, it looks like it's declined in the last 3 quarters. Is that more of a function, just a quarterly weeding out, or a larger sort of expense management? And in a couple of, I guess, 2 of the past 3, the productivity had gone up in terms of gross sales, this quarter was down, maybe it's tied back to the lower gross sales, lower redemption discussion. Just any commentary around the Advisor account productivity?

Thomas William Butch

Yes, I think -- yes, you're right. It's a sort of normalized attrition, there's nothing remarkable in those numbers. If you go back to the first, second or third quarter, the declines are really quite small, and I just think it’s normal activity. And I think your analysis of the productivity is correct. I would just reassert that productivity still remains at historically very high levels, and we don't expect that to change.

Roger A. Freeman - Barclays Capital, Research Division

Okay. And then just on the -- one more on the Advisors. In terms of the CHOICE platform, can you run through any growth in net adds declines on that?

Thomas William Butch

Yes, we -- at the end of the third quarter, we had 172 on the platform, that was a net positive 5 from the prior quarter. And we haven't had a sequential decline nor should we in the number of Advisors in that channel. Assets in the channel are about $3.7 billion at the end of the quarter. And that's pretty healthy growth from about just over $3 billion at beginning of the year.

Roger A. Freeman - Barclays Capital, Research Division

And were the adds external or folks internally moving up?

Thomas William Butch

Principally, external. If I understand your question, is that -- is your question, were you [indiscernible] people recruited outside, yes.

Roger A. Freeman - Barclays Capital, Research Division

Correct. Okay. And then just lastly, quickly on books and records, is that wound down? Now, I think Hank you said last quarter, you'd thought it'd be down by 6 or so by the end of 3Q. And where do we see any of that in the P&L? Do they run through comp or elsewhere?

Henry John Herrmann

Well, the P&L would run through both U&D and comp. And there has been a reduction, not completely down to 0 as certain cleanup measures continue. But the margin pressure associated with it is running down materially from the high watermark. And I think some of that will certainly show up in the fourth quarter.

Operator

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

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

A quick question on the Wholesale flows. As Mark has mentioned, redemptions rates are down, but also the sales are down. How should we think about the flows going forward? What are your best, I guess, what should be the best assumptions regarding that?

Henry John Herrmann

Could you repeat the question? I'm not quite sure I understood. Sorry.

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

Sure. So I'm looking at your net flow numbers, the net sales in the Wholesale channel. And I'm just looking at the pattern of that. If I compare to the first half of 2011 versus where we are today, we see that there's a decline in sales and also a decline in redemptions. And my question is how should we think about that going forward? Because I think initially, there were some comments about that it's going to become more [indiscernible] or resemble more that of larger competitors? And my question is, what are your thoughts on that going forward?

Thomas William Butch

Well, it's kind of -- we're in a place where predicting sales, per Hank's prior comments, about the marketplace in general are very difficult. The flattish experience of October is hard to extrapolate one way or the other. Obviously, we think we have a lot of good product to take to market and I'm just loathe to forecast looking ahead other than to say that the importance of the channel is very high. That we're doing all the things that we have been doing. And that I think one of the differences, perhaps, is that the need to gather sales from an expanded span of products remains very central to what we're doing.

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

And on your operating profit margins, with the sale of Legend, what needs to happen to get to the 30% operating profit margin?

Henry John Herrmann

Well, that's a question that's been asked of me many times. Hopefully, I'm pretty consistent with my response. The perfect answer or the perfect environment for us is a strong market action and no sales. That will definitely get us to have a big improvement in operating margin. However, I'm not sure that everybody would love that outcome. The worst thing that could happen to us is great sales and no market performance, and that would cause us never to get to our target. So there are a couple of moving parts, obviously, in trying to figure that out. We continue to work pretty hard going in the direction of the goal that we have. And sometimes, if the market interferes and assets depreciate, we just can't make a lot of progress. That's been pretty much the problem for a couple of years now. And we have a strong quarter, and then market action is bad and then it's good and so forth. But I believe we are making progress toward that goal. If we get more normal situation, I think it will show up.

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

Just going back to the possibility. If I compare the Advisors channel to the Wholesale channel, for Advisors, you break even when you do the sale with the Wholesale, you basically generate negative margins of about 30%, I think that those are the past comments. The assets stay much longer with you if the sales is though the Advisors channel versus the Wholesale channel, which is probably has a duration of 3 to 4 years. How should we think about the profitability of the Wholesale channel? Does it make sense to push hard for sales to that channel?

Henry John Herrmann

Yes, I really think it does. Because I'm a proponent of Ibbotson and Sinquefield, and I think annualized rate of return over the long period has been 7.6%. And think we regress to the mean. If we regress to the mean, the fees associated with the appreciation of the assets is well worth the effort to collect them today, even though there's a negative margin upfront.

Daniel Paul Connealy

This is Dan. I think the holding period in Wholesale is closer to 5, from 4 to 5 currently, rather than 3.

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

Okay. And then, maybe a comment on kind of on the share buybacks. Is that preference of buybacks versus special dividends in your view? What are your thoughts on that?

Henry John Herrmann

Versus special dividends? Right now, based on what's going on in the world, I would say, if you put a gun to my head and say, choose, I'd probably focus on special dividends, I -- on an extraordinary basis. My point has been for a long, long period of time, that we want to buy shares to basically protect the dilutionary aspect of a restrictive share grants. But I've never been comfortable with the idea that you should buy a lot of stock back and drive earnings that way, because I've always been concerned of the price-earnings ratio could have an impact on how viable that strategy is. And I still worry about that. On the other hand, in today's environment with the possibility of tax changes as a comparison with share repurchases, I'd say special dividends would win out.

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

And are you still intending on -- of keeping your dividends to net earnings ratio of about 50%? Should we assume that this is going to be the same going forward or...

Henry John Herrmann

I think that the ordinary dividend payment procedure would probably keep us in the area of 40% to 50% of earnings.

Operator

Your next question comes from the line of Mac Sykes of Gabelli & Company.

Macrae Sykes - Gabelli & Company, Inc.

My question is around just how dynamic the retail investor is today. So assuming we did get a certain political outcome and we got a quick -- could we get a quick transition in appetite to equities? Or would it still take some time for that to work out? In other words, could the political...

Henry John Herrmann

I understand it both ways. My answer is, we'll get some of each. There are people who are very quick on their feet and the flash to bank time can be very short. I've seen it before and it will happen again. And then there are, what I would call, the normal average investor who's been through a decade of tough sliding in equities and is going to be a little slower to shift gears. So I think it's a kind of a jump up with early adopters, and then a smooth line upward over time, would be my best guess.

Macrae Sykes - Gabelli & Company, Inc.

And your comments, would that be anecdotal of sort of your asset base then in terms of the people that you were just talking about?

Henry John Herrmann

Try me again. I couldn't quite hear it, sorry.

Macrae Sykes - Gabelli & Company, Inc.

You talked about it sort of the industry fashion from your comments, is that sort of consistent with the holders of your assets today? Is that anecdotal of what might happen with your asset base?

Henry John Herrmann

Well, it is, and it has been that direction for quite a while now, about a year when we've been taking slow steps toward a more constructive equity outlook.

Operator

Your next question comes from the line of Daniel Fannon of Jefferies.

Daniel Thomas Fannon - Jefferies & Company, Inc., Research Division

I guess, just from a modeling perspective. I think because you moved the stuff out this quarter, I just want to make sure, going forward, the Legend's contribution versus what you guys published this morning should have really no impact? Or we shouldn't see any change going in the next quarter?

Henry John Herrmann

Well I think, we should expect continued -- that we will have some modest increase in our margins, based upon this. Because the Legend was a low margin business, so it's not going to be that significant, though.

Daniel Thomas Fannon - Jefferies & Company, Inc., Research Division

Okay. And then just in terms of potential distribution. I guess, is First Allied a partner today in terms of using your products? Does that potentially represent an opportunity going forward post the sale?

Thomas William Butch

Yes, this is Tom. It is and it does. Yes, I think it's really important to note that: a, they are a partner; and b, we anticipate maintenance of all the relationships that we have with Legend Advisors, and we'll continue to Wholesale all of those folks as well. So yes, I believe that it will be an incremental opportunity.

Daniel Thomas Fannon - Jefferies & Company, Inc., Research Division

Great. And then I guess, just a clarification, Hank, on the question earlier around comp. I think into the fourth quarter, you said it should follow the normal pattern in the last few years. So just you should see some step up in the 4Q based on how things sit today?

Henry John Herrmann

Misinterpreted what I said, and I might not have said it very clearly. So that probably added to any misinterpretation. When I talk about trend line, I was talking about our normal wages and salaries line anticipating the question being directed at what's expected in 2013. And so, I'll stick with that. If you think about wages and salaries in 2013, I would expect no real significant difference from the trend line we've seen over the last -- past few years. And that would translate into a 4% or 5% increase. As it relates to bonus payments, I think I said that our accruals through this year so far, look about right. And so I'm not anticipating any material change in the fourth quarter. The proviso is this: In a lot of situations, our fund performance is sort of in the middle and it's -- the difference between being at the high or the end or the low-end of the competitive universe that portfolio managers is measured against, is not really all that different. And so, the gap is not very wide. And if we have the right kind of circumstance, you could see people's performance jump up materially, relatively, and that would impact to some degree. On the other hand, if things don't go quite right, you could see them fall further in their universe. So that's the proviso. Usually what happens is these things kind of balance out once you get to the fourth quarter. And so I'm pretty comfortable saying that I'm not expecting any change relative to what we've been accruing. Dan might have a comment.

Daniel Paul Connealy

I just like to point out that included in comp is some variable comp to our portfolio managers for the performance of their deferred bonuses. And so that can swing it a few hundred thousand, one way or another. We're projecting, probably for the fourth quarter, without any major change to bonus accruals, something like, a little north of $43 million.

Operator

Your final question as a follow-up from the line of Bill Katz of Citigroup.

William R. Katz - Citigroup Inc, Research Division

When you look at your balance sheet, you have a significantly high level of net cash. So I'm wondering if you could update us on regulatory and other working capital? And how much excess cash you might view the balance sheet have at this point?

Henry John Herrmann

I'm sorry, Bill, ask me again. I apologize. You're not coming through as clearly as my...

William R. Katz - Citigroup Inc, Research Division

If you look at your net balance sheet -- your balance sheet, excuse me, you're seeing there's some significant net cash. And I'm just sort of curious, when you look at regulatory needs towards working capital needs, how much of that excess net cash might be eligible for special release, is what I'm trying to get at, at the end of the day?

Daniel Paul Connealy

Well, all of our cash balance, Bill, about $100 million included in that, is what we would call required. Well, among the required, we keep a little cushion. So you would say in the amount above $100 million would be free cash that we have at this time.

Henry John Herrmann

And so, the remainder of it is subject to -- I'm not sure what the right word is, but this excess cash, that phrase you used, is correct. But as you know, I'm a bit of a conservative by nature, and so I always like to have a cushion that's fairly meaningful. And we do have some debt that, God forbid, somebody might refuse to refinance. So I would say that you shouldn't think that all of that cash would be the sort of thing that should be -- that could be subject to any kind of a special dividend.

Daniel Paul Connealy

I'm also reminded, I should mention that included in that so-called free cash is seed capital. So in the case of a new fund, where we've just put the seed capital in, we would not really expect to get that back very soon. It would wait until that fund and that share class would grow and not need that seed capital. So that's a hard one to predict.

Operator

There are no further questions at this time. Presenters, do you have any closing remarks?

Henry John Herrmann

We thank everyone for listening in. Again, I repeat, I hope everyone in the East Coast is faring reasonably well on the circumstances. Thanks for your time.

Operator

This concludes today's conference call. You may now disconnect.

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