AllianceBernstein (AB) at Morgan Stanley Financials Conference -Transcript

| About: AllianceBernstein Holding (AB)

AllianceBernstein Holding LP (NYSE:AB)

Morgan Stanley Financials Conference

June 10, 2014 / 2:25 P.M. E.T.


Doug Peebles – Head and CIO, Alliance Bernstein - Fixed Income

Chris Bricker – Head of Alternatives


Tom Whitehead – Morgan Stanley

Tom Whitehead – Morgan Stanley

Good afternoon, everyone. It's my pleasure to welcome AllianceBernstein to the conference today.

Before I introduce the speakers we have today, just a couple of polling questions for the audience. The first question is what would drive you to add to your position in AllianceBernstein – A, expense control driving positive operating leverage; B, traction with efforts to diversify AUM base beyond fixed income; C, positive organic growth or flow inflection; and D, a lower entry point in the stock?

We'll take just a minute to get your answers in. It looks like C, positive flow inflection, with the second best answer lower entry point. Okay.

And the second question is what do you think is most under-appreciated about AllianceBernstein – its retail distribution capabilities, particularly Asia and abroad; the build out of noncore fixed income and alternatives platforms; the distribution yield; or the stability and profitability of the private client business? I think that was B. Okay, great, so – oh, okay, so retail distribution.

So with me today from AllianceBernstein are Doug Peebles and Chris Bricker. Doug, on the left here, is Head and CIO of AllianceBernstein's fixed income unit. He's been CIO of the fixed income unit since 2008 and oversees all the fixed-income portfolio management and research teams globally. Fixed income is about 55% of AB's AUM as of April and is an area of growth and strong performance for the Company.

Chris Bricker, here on my left, has been with AllianceBernstein for over 20 years and is the head of alternatives for the Firm. AllianceBernstein manages roughly $16 billion in alternative assets and offers a range of strategies and capabilities to expand asset classes and liquidity profiles.

Welcome, gentlemen. Thanks for being here.

Doug Peebles

Thanks, Tom.

Question-and-Answer Session

Tom Whitehead – Morgan Stanley

Doug, I'll start with you. So the rotation within fixed income away from traditional Barclay's ag type benchmark products into more specialized mandates like high yield and bank loans as well as uncorrelated products and unconstrained products has been widely publicized. Can you talk for a minute about how AB's fixed-income platform is positioned to both retain and capture assets in this type of rotation and in which of the newer areas you're seeing the most success?

Doug Peebles

Right. So I think people are and have been, basically since the spring of last year, afraid of duration. And the main risk involved with traditional plus – core and core-plus strategies is duration risk. Now, I personally think this fear is somewhat overblown for a 4.5 or five-year-duration instrument, but that's what's driving people out of the traditional categories.

Now, at the same time, people still need income, and so they have a fear of duration, and instead of going in on the duration curve into a money market type product, they can't do that today because interest rates are zero. And so the folks who need income are moving into the credit space, have moved into the credit space, and that has been very beneficial for our platform. We run a very integrated, multi-sector, high-income business that capitalizes on the back of our strong track record in emerging markets and high yield and our ability to manage that sector difference.

I would say that the – so those two main risks that – one, people are moving away from the duration risk. People are moving towards the credit risk. I think that the other important element that doesn't get much discussion points is the liquidity risk in fixed income. And that is something that traditionally folks in our business haven't been used to managing. They're very astute and experienced in duration management and in credit management, not in liquidity management.

And I think that by and large, people are probably not getting paid enough for the true illiquidity risk in today's fixed-income markets. And there is an opportunity in the future, which we're enhancing our opportunity or our resources in this space, is to take advantage of giving up liquidity. And I think it's only perceived liquidity, because in the direct-lending or the private-credit space, you're getting paid to take on that illiquidity risk, as opposed to in the securities market, spreads are reasonable relative to where we are in the cycle, but I think absolute yields are probably lower than they've almost ever been in the history of these markets.

Tom Whitehead – Morgan Stanley

Great. And for you, Chris, so I just want to talk about liquid alt for a second. What's driving your liquid alt product development strategy, and can you talk about the opportunity for those products within the institutional channel as well as the retail channel?

Chris Bricker

Sure. So thanks, Tom. I'll start with maybe where we see the bigger opportunity. So at this point, we see an opportunity in both. We clearly think that retail over the next three to five years will be the bigger opportunity, for one basic reason – institutions have had access to alternative products for quite a while. They have significant allocations to the less liquid version, where retail, and let's say absent maybe 10% of retail investors, have had access to true hedge funds over time. But the vast majority of them just have not had access.

And now there is an emerging set of tools that will give them these different risk and return profiles. And certainly the long-term portfolio diversification benefit is being touted. And that's where we think all the uptake will come from, with the end goal that clients will be able to just better weather different market conditions than they were previously able to in retail.

Institutional I think, over some time, a cycle of performance if we see the liquid services that have been created performing. Clearly, liquidity is not worth nothing. They will also use the liquidity if its performing well, institutional.

Tom Whitehead – Morgan Stanley

Great. Doug, just coming back to you for a second, I want to talk about passives. So as with equities, more and more fixed-income assets are moving to passive products and creating the potential for cannibalization of those actively managed products. How do you manage this shift at AB, and what concerns do you have about capacity constraints this shift may cause?

Doug Peebles

Right. So I think that when you look at the equity business for our industry, there's been a big movement from active to passive. And part of that has been in this cycle, we've seen underperformance of active managers on average. And so there has been a similar notion of, well, maybe we should do the same thing, of move from active to passive in fixed income. I think that's a mistake.

When you look at the median active fixed-income managers, they outperform the indices. Frankly, it's no secret that fixed-income indices are actually easier to outperform because they're less efficient. They're based upon market capitalization and a market cap weighting in fixed income where whoever issues the most debt, has the highest weight in the index. It doesn't really make much sense from a common sense point of view.

And so I think that the movement towards that is probably not going to be as severe as it's been in the equity space because active managers do outperform.

One thing I do have concern about is the notion of ETFs in illiquid markets, like bank loans or like high yields. I don't think that you all of a sudden create a trading vehicle that trades on an exchange that is made up of underlying illiquid securities and you magically have liquidity in that space. So if you look at the performance of active – or of ETFs in the high yield or the bank loan space, they've underperformed quite substantially their broad benchmarks. That's not surprising.

As it relates to the capacity issue that you raised, look, I said before that liquidity in the fixed-income market is different today than it's been. And managers need to understand that liquidity, manage that liquidity risk – or illiquidity is probably a better way to put it. And therefore I think that the more assets you have, you're just going to struggle to outperform. I think it's that simple.

And that really wasn't the case prior to 2008, the financial crisis, but post-2008, I think that's a more important factor in terms of overall capacity in the industry. If you have that many more assets to manage, and we know that the capacity of the capital commitment of the market makers has dropped substantially, then it's going to be harder to move those assets back and forth in an active fashion.

Tom Whitehead – Morgan Stanley

And then just to dig in on that a little bit, which areas within fixed income are you seeing the most penetration of passives, and where do you see potential for capacity constraints to pop up first?

Doug Peebles

Well, I think the capacity – to answer the second question first, the less liquid the markets are, the more likely you're going to have capacity issues. Now, so what does that mean? It means in the credit-intensive space. Some of these private-credit markets, though, I've mentioned probably have significantly smaller capacity than the public-credit markets, and we'll have to be very cognizant, as we are, as we're developing these new products.

In terms of where our ETFs are most attractive, in the more liquid markets, right? And so a one- to five-year government ETF makes all the sense in the world, because barring some very, very unforeseen events, you should have plenty of liquidity in the one- to five-year treasury market. But as we get out into the high yield space or the bank loan space, having actively – having ETFs in a format that you're expecting liquidity when the underlying elements in those ETFs are illiquid is just illogical to me.

Tom Whitehead – Morgan Stanley

And then one for you, Chris. The definition of alternative is rather broad. Can you define alternative products as you see it at AllianceBernstein? And then, also, when you have conversations with clients and institutions and stuff, how that definition of alternatives differs?

Chris Bricker

Sure. So that is the big question. So maybe taking one step back first, the philosophy at AllianceBernstein is, as we're creating any of these alternative services, is really about the solution that it offers. So we start there. We then certainly do look inward and we define the alternative services we have under the traditional metrics – real estate, private equity, hedge-fund strategies, infrastructure. And then as we've done more liquid alternatives and done more in the retail space, we will extent that definition to meet the more Morningstar-Lipper category definition.

We then quickly step away and throw that out the door, and the second part of your question becomes much more relevant. Every conversation we get into, whether it's a big institution in the US, whether it's a private bank in Europe, whether it's one of our clients in Asia, you have to turn off how you've put this definition in a nice, neat little box to make your own material and figure out exactly how the person on the other side of the table is thinking about it, whether they're talking about it as one big bucket and trying to figure out how to just fill that bucket up, whether or not they have evolved to having long-short equity strategies come out of their equity basket. They're really speaking their own language, and you very quickly have to adopt to that language and get to what's the solution you have and figure out where the fit is.

Tom Whitehead – Morgan Stanley

Great. I just wanted to take a moment to open it up to the audience. Any questions out there? Okay.

Doug, coming back to you, not surprisingly, I want to talk about rates for a second. Can you talk about how your institutional clients are positioned for a rising-rate environment? And can you also touch on how you protect the performance of fixed-income products when you have this massive headwind of rising rates?

Doug Peebles

Right. So institution – I think the pain trades – I mean, not surprisingly, the fact that we came into the year and we've seen – literally from 12/31/2013 to now, we've rallied in the rate space, and nobody's really happy about that. Most forecasters were forecasting higher rates, not lower rates, and so the pain trade is actually a continuation towards lower rates. There's lots of trends in the industry and in the globe that are fostering this trend. The ECB just put interest rates on – their deposit rate is negative, so you're actually paying to keep your – if you're a bank, you're actually paying money to keep your money at the ECB now.

And so institutions – financial institutions, insurance companies, they want higher rates and they want wider spreads, and I think that the broad trend in the private sector to find benefit space is towards derisking and LDI. So they want higher rates and wider spreads so they can more effectively put that on their books at a smaller funding gap.

That's the main situation to protect against rising rates. Look, in a yield curve that's very steep, it's very expensive to protect against rising rates. And it's obviously the – connected to that, it's very expensive to be short interest rate risk. It's an easy call when the curves are inverted, right? So as I mentioned earlier, you move in on the curve and you pick up yields. Boy, that's an easy choice to make. And here, if you move in on the curve, you're going to drop a lot of yield.

So we're not overly worried about US interest rate risk. We do spend a lot of time looking at the forward curve, so looking at what is the market pricing and the five-year note to be in five years' time. And I don't know if the audience is aware of this. We came into 2014, and the rate on that five-year five-year forward was 4.6%. It's rallied almost 100 basis points. I think today it's around 370, 375 after touching, I think, around 360.

And I don't know, I look at where is the five-year note going to be in five years' time, and, I don't know, I'd probably put the greatest probability that it's somewhere between 360 and 460. So I don't think the market is really mis-pricing US interest rate risk.

Now, that doesn't mean that 460 wasn't cheap and 360 isn't somewhat expensive. I think it is. If we look around the world, though, the Japanese 10-year note is 60 basis points. Inflation is running north of 2% now. That doesn't seem like a very sensible long-term – that's not a very sensible 10-year investment. German bunds yield 140 now. That seems kind of expensive. So there are pockets of expensive points around the world, but on a relative basis, I think treasuries actually look, I mean, I dare say it, but of value.

Tom Whitehead – Morgan Stanley

And then coming back to you, Chris, I just want to talk about your institutional clients for a second. How are your big institutional clients putting money to work in alternatives, and what's driving this? I mean, is it barbelling, where they're using ETFs and low-cost index products at one end and then using alternatives for alpha? Or maybe you could touch on what exactly is driving that?

Chris Bricker

I don't know that I would necessarily call it barbelling. I'd probably use that more in the equity space, where we certainly see the passive strategies versus the higher active share. I would probably just say there is a greater use of alternative strategies. I think we've seen a continued use of real estate, a continued use of private equity, probably an accelerated use of hedge fund strategies over the past three to five years. This is probably the most profound thing that we've seen.

And in terms of where we've seen most traction, it has been in the long-short credit – long-short equity services we have. But on a go-forward basis – and I'll invite Doug into my side of the fireside chat here – certainly what we see developing in the private-credit space in bank disintermediation, we think that our institutional clients, from our capabilities, are going to be most attracted to the private-credit capabilities that we've added to the Firm. And maybe Doug can spend a minute talking about what they look like.

Doug Peebles

Yes, so we've added quite a bit in the private-credit space. We now have capabilities in infrastructure debt investing, in middle-market lending, in commercial real estate direct lending, in opportunistic lending across the world, with a little bit of an extra focus on emerging markets, and then residential direct lending in the mortgage space as well.

And I think there's a couple of things that are exciting about this. Number one is, as I mentioned earlier, you get paid to give up liquidity. And I think in reality, you're not giving up as much liquidity as the marketing is pricing in that you're giving up for the extra yield that you get.

And I think the other thing that's very attractive from our institutional investors is that you – the accounting for these securities is much more sort of conventional loan accounting, which is you keep the securities at – or the exposures you have at par, unless you have an impairment.

And therefore, you're less subject to the vagaries of the securities markets, which, as I mentioned earlier, I think more and more the mark-to-market changes in the securities market is going to be driven by illiquidity or more sellers than buyers or more buyers than sellers than it ever has been in the past. So you're going to have more volatile markets in that space and, therefore, less attractive accounting treatment because of that volatility. And at the same time, you have more attractive accounting features and you get paid a higher yield. So there should be demand for that, and we've seen that demand.

Tom Whitehead – Morgan Stanley

I wanted to try the audience one more time. Anybody with questions? Okay. Chris, on the – I just want to talk about the opportunity for alternatives at AB. Is there a size you have in mind for the alternatives platform at AllianceBernstein ultimately growing to one day? And do you aspire to be a leader in alternatives, or do you view them more as a complement to the fixed-income and equity offerings that AllianceBernstein's had for a little bit longer?

Chris Bricker

Sure. So from – there's no number target. What we're setting out to do is, obviously, be relevant to our clients. So I would largely expect that our alternatives within the Firm would look a whole lot like the alternative allocations from our clients. So somewhere between 10% to 20% would be a reasonable guess as we continue to develop this throughout the private clients, retail and institutional.

With regard to – the second question was?

Tom Whitehead – Morgan Stanley

Well, it was how big do you see it becoming at AB, and then also is it a focus of the Firm, or do you think it's going to be a complement to it?

Chris Bricker

Clearly, a focus. We're not going to become an all-alternative firm. We will have a mix of equity, stock and bonds. But we do think that there is clearly an opportunity to be a leader in the space. We think that within retail, the education component, which is probably often the most spoken about component, is probably often the least-served component, and we do think that that's critically important.

And given the breadth of resource that we have through the marketing group using different medias, we have a very tenured group of wholesalers that are out in the field interacting with all of our biggest partners/advisors, and we think there's really an opportunity to lead – lead with a message, lead with high-quality products, and become both a leader but still have a very balanced business.

Doug Peebles

I would just add to that if you looked at AllianceBernstein before 2008, you said – look, it has two businesses from the investment side of things. It has an equity business, has a fixed-income business. In equity, we had growth value and we blended those together, and we had a platform that's taxable and tax-exempt in fixed income.

And then you look at us today and into the future, and I think you're going to see something very, very different. Yes, we have equities and we have fixed income, but we also have alternatives and we also have an actively-managed multi-asset team that really rounds out what we're doing and mixes together actively the variety of different offerings that we have in the alts and the fixed-income and the equity space.

And so if you think about that, that's a much healthier mix. And it's not because we decided that that's the way the Firm should be. It's because our clients are demanding that we move in that direction. And I think that we've generated the business model that's necessary to serve our clients' needs, which is always going to be the right business model.

Tom Whitehead – Morgan Stanley

Makes sense. And then, Chris, just to touch a little further into that, what additional capabilities within the alternatives space do you want or do you need, in your opinion? And can you give a few examples and maybe help publicize the kind of opportunity that's out there in a couple of these different holes that you may have at this point?

Chris Bricker

So we certainly clearly haven't covered the board. We don't intend to. We're not going to be everything to everyone. I wouldn't actually point out any specific services that we're looking to desperately fill at this point. We've done a tremendous amount. Doug referred to five or six different private-credit strategies. We brought on in 2009 a real estate equity capability. In 2010 we brought in a fund-to-funds capability. We've added long-short. So we've done a tremendous amount already in both the institutional space, which Doug referred to, and in the retail space, where we think we really have an opportunity to be a very formidable force.

We have a number of products in the US retail market, some of which have three-year track records. We also have a number of products in our UCITS platform – again, some of which have three-year track records. And there what we think we're going to be able to do to clearly take advantage of the two things that we have is, one, we have franchise retail distribution inside the US and outside of the US with the ability to deploy a tremendous amount of resource for education and helping advisors help their clients get these products into their portfolios.

And at the same time, we have high-quality offerings that are desirable at this point. I think it often goes unnoticed with some of the things that we have – for instance, the fund-of-funds team I mentioned. We brought that group in in 2010. They are probably one of the longest-tenured group managing hedge fund selection with over 18 years of experience – an exceptional track record and have done a magical job.

And at the same time, we're going to be able to use them to build multi-manager products right into the liquid space and take advantage of that. That's very powerful, and it's fully integrated within the platform, so I think we have a big opportunity there.

Now, we'll opportunistically add along the way, but not out looking for anything specific at this point.

Tom Whitehead – Morgan Stanley

And then you mentioned distribution and, especially on the retail side, how education is very important. Can you give us in your mind what the profile of a retail investor that's going to use liquid alternatives would be and educate us on the education process for that one?

Chris Bricker

So the term often used there is "less sophisticated." I would probably be a little bit more soft, because only, again, about 10% of those retail investors have really had enough money to have accessed traditional hedge funds. They're probably just unfamiliar is probably the better way to think about it. And unfamiliar together with they're more complex – they are meant to deliver a solution in a portion of your portfolio. So first you have to try and have an advisor explain what the solution's all about, and then second, you have to tell them where to source that from – all very, very difficult conversations.

So we really try and go right to the beginning, and before a product is out there, we're at the home offices talking to them about what they need, where their needs are. Once we do have a product, we're clearly – let's say, for instance, the white paper that Lisa Shalett put out – we'll clearly look and figure out how a group like Morgan Stanley, in this example, is talking to their 10,000-plus advisors.

Then we'll take our messaging and make sure that our 50-plus tenured wholesalers, our marketing forces, our Web, our social media is all lined up to deliver a consistent message that reinforces it and doesn't fight the home office's message in a constructive way and then just keep doing that, repeating that and executing it. We find that that's going to be the best way to get the word out.

Tom Whitehead – Morgan Stanley

Right. I'll try the audience one more time, and if not, I've got one more question for Doug. Oh, we have one question right there.

Unidentified Speaker

Thank you. I just wanted to get your thoughts on the kind of multi-asset opportunity and how your alternatives in fixed-income offerings kind of feed into that, so what's the current (inaudible) there and the growth opportunity around that kind of solutions opportunity there?

Chris Bricker

Sure. So the multi-asset opportunity, maybe to describe it a little bit, we have two of the long-standing members of the Firm, Vadim Zlotnikov and Dan Loewy, who have really joined forces and brought into the group our flight path strategies, our dynamic asset allocation strategies and our custom index strategies, but also have the full breadth, as Doug has pointed out, of access to anything that we're doing on the fixed-income platform, anything that we're doing on the equity platform and anything that we're doing in alternatives, as well as they can use alphas or betas to construct those multi-asset portfolios.

So in the early display, because this group's only been put together now for this year or for the last couple of months, the solutions have been multi-asset income, really using different asset classes to create income. We've added different components to our target risk and are looking to do things with our target date strategies, again, to bring that asset allocation and those portfolio diversifications forward.

Doug Peebles

Yes, I think that by and large, the industry used to be, okay, what do clients want? They want a bond allocation. And so you have a platform of different bond offerings that you give to them. I think, not the whole industry, but by and large, more of the conversations are the client really doesn't care about a bond allocation, right? The client wants an outcome, and that outcome is income. And so why not use as many levers as you possibly can to offer that client what their desire is? And that might include some portion of the liquid strategies. It might include some portion of passive strategies. But we should be able to access the full resources of the Firm to get that client their outcome.

And that situation or that experience is very different than sort of, okay, you can have AllianceBernstein for stocks or bonds. The client really wants that outcome, and we have created a group that is charged with delivering that outcome.

Now, it's, I think, appropriate to do that and put the ownership of that effort on a certain group as opposed to saying – okay, let's just engineer a strategy and let that strategy run its way through to fruition, whereas the way we're doing it and we're offering it and our clients are demanding it is actively manage that solution so that we have a fine ride and that we know that there's some ownership and accountability on the top end of that.

Tom Whitehead – Morgan Stanley

Great. So I think we're out of time. Doug, Chris, thanks for being here today.

Doug Peebles

Thank you, Tom.

Chris Bricker

Thank you, Tom.

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