Invesco's (IVZ) CEO Martin Flanagan on Q1 2016 Results - Earnings Call Transcript

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Invesco Ltd (NYSE:IVZ) Q1 2016 Earnings Conference Call April 28, 2016 9:00 AM ET

Executives

Loren Starr - CFO

Martin Flanagan - President & CEO

Analysts

Craig Siegenthaler - Credit Suisse

Glenn Schorr - Evercore ISI

Bill Katz - Citigroup

Michael Kim - Sandler O'Neill & Partners

Brennan Hawken - UBS

Ken Chow - JPMorgan

Chris Shutler - William Blair

Dan Fannon - Jefferies

Kenneth Lee - Royal Bank of Canada

Robert Lee - KBW

Michael Yule - Morgan Stanley

Brian Modoff - Deutsche Bank

Chris Harris - Wells Fargo

Operator

Welcome to the Invesco's First Quarter Results Conference Call. [Operator Instructions]. Now I would like to turn the call over to the speakers for today, Mr. Martin L. Flanagan, President and CEO of Invesco and Mr. Loren Starr, Chief Financial Officer. You may now begin.

Loren Starr

This presentation and the comments made in the associated conference call today may include forward-looking statements. Forward-looking statements include information concerning future results of our operations, expenses, earnings, liquidity, cash flow and capital expenditures, industry or market conditions, AUM, acquisitions and divestitures, debt and our ability to obtain additional financing or make payments, regulatory developments, demand for and pricing of our products and other aspects of our business or general economic conditions. In addition, words such as beliefs, expects, anticipates, intends, plans, estimates, projects, forecasts and future or conditional verbs such as will, may, could, should and would, as well as any other statement that necessarily depends on future events are intended to identify forward-looking statements.

Forward-looking statements are not guarantees and they involve risks, uncertainties and assumptions. There can be no assurance that actual results will not differ materially from our expectations. We caution investors not to rely unduly on any forward-looking statements and urge you to carefully consider the risks described in our most recent form 10-K and subsequent forms 10-Q filed with the SEC. You may obtain these reports from the SEC's website at www.sec.gov.

We expressly disclaim any obligation to update the information in any public disclosure if any forward-looking statement later turns out to be inaccurate.

Martin Flanagan

Thank you, this is Marty Flanagan and thank you for joining us today. On the call with me today is Loren Starr, Invesco's CFO and we will be speaking from the presentation that's available on the website, if you're so inclined to follow. Today I'll review the business results for the first quarter. Loren will go into greater details of the financials and we will open it up to questions. So let me begin by highlighting the Firm's operating results for the first quarter which you will find on slide 3. Long term investment performance remained strong during the quarter. 72% and 76% of active managed assets were ahead of peers on a three-and-five-year basis, respectively.

Strong investment performance and our continued focus on meeting client needs were not enough offset the impact of the volatile markets, particularly in January/February. Non-institutional and active demand where offset by volatility among retail and passive capabilities which led to long term net outflows of one $1.3 billion during the quarter. Market volatility and net outflows put pressure on the operating margin during the quarter which is 37.5%.

During the quarter we returned $238 million to shareholders through dividends and stock buybacks. In addition, reflecting continued confidence in the fundamentals of our business over the long term, we're raising our quarterly dividend to $0.28 per share, up 4% from the prior year. Assets under management were $771 billion at the end of the first quarter, down slightly from $775 billion at the end of last year. More indicative of the results during the quarter were the average assets under management which were down $36 billion during the first quarter as compared to $778 billion at year-end.

Operating income was $307 million in the quarter versus $356 million in the prior quarter. Earnings per share were $0.49 versus $0.58 in the prior quarter. And as noted earlier, we increased the dividend $0.28 per share and also purchased $125 million of stocks during the quarter. Before Loren goes into detail on the Company financials, let me take a moment to review the investment performance and flows during the quarter.

Turning to slide 6 now, you will note investment performance is strong in the quarter with 72% of assets in the top half on a three-year basis and 76% were in the top half on a five-year basis. One year results partially reflect the underperformance of energy and financial sectors earlier in the year which impacted some of our valued portfolios. We've seen both of these sectors begin to recover somewhat in March and April and consequently possibly impacted the performance here to date, in fact with some very strong performance.

On page 7 you will see positive active flows were experienced during the quarter were not as [indiscernible] to passive capabilities. Active flows were driven primarily by alternative capabilities, as we saw strong growth in real estate including both direct and REITs, a global targeted return. Those in the passive capabilities declined during the market volatility in January and February. They recovered in March, but not enough to returned to positive territory for the quarter. It's important to note that although passive flows were negative they were reduced by $1.5 billion of deleveraging from Invesco Mortgage Capital.

As a reminder, there's no revenue impact related to those flows. Again we saw strong institutional flows during the quarter, in spite of the volatility which continues a series of positive institutional flows going back nearly two years. Client demand trends remain consistent, with particular strong interest in fixed-income real estate and GTR. Retail flows were impacted by the macro environment as investors weighed their options during the volatile quarter, despite seeing outflows in many equity mutual funds in the U.S. and EMEA, we saw continued strength in retail alternative capabilities, specifically GTR and real estate securities.

As noted, our global target of assurance capability continues to attract strong flows globally, achieving $2.3 billion in net flows during the quarter across EMEA intuitional, across border, into the UK, retail, Asia-Pacific and North America. Despite some challenges in the first two months of the year, we still feel good about the momentum of our business. Flows in March were much better than January and February and we're experience solid flows in April. We continue to see strength across our global business, in particular within Asia-Pacific and EMEA. Before I hand the call over to Loren, let me say a few words about the new fiduciary rule released by the U.S. Department of Labor in early April. Ultimately, we believe this fiduciary rule is good for investors.

That said, we continue to be concerned about the potential for unintended consequences of a rule that proposes such dramatic changes within the industry. It's well known that many investors are not saving enough to maintain their standard of living during retirement. The DOL Rule, it was intended to ensure that retirement savers get better advice by expanding the types of retirement investment advice covered by the fiduciary protections. We said all along investors are best served by using advisors who can help and assist -- to help and assess their risk tolerance, savings horizons and other factors to develop a portfolio that help them achieve their investment objectives. The key outcome of the new rule could be greater confidence in the advice that investors are receiving. Investors have been through a lot in the last seven years since this national crisis. Anything that builds confidence could encourage them to save more for retirement and seek advice that helps them achieve their investment objectives, that is good for investors and would also benefit the industry as well.

The DOL Rule is long and complex. The rule and its related documents are more than 1000 pages. We're working to understand how our distributor partners are interpreting the rule which will help us support and assist them. We believe the recent acquisition of Jemstep, the market-leading provider of advisor-focused fiducial solutions, opens up further opportunities to provide meaningful support to our clients. As we engage with our clients and seek to understand how they will approach adopting the new rules, we will look, too, for opportunities for Jemstep to assist our distribution partners. We believe that Invesco's very well positioned to our clients as the DOL Rule is implemented. Because Invesco puts our clients first in everything we do and has tremendous experience in addressing regulatory topics, we view this as an opportunity to further deepen our relationship, provide new capabilities that enhance our business.

I would like to turn it over to Loren to review the financials in more detail.

Loren Starr

Thanks, Marty. Quarter-over quarter our total AUM decreased $4.1 million or 0.5% and that was driven by dispositions of $3.6 billion, negative market returns of $3 billion, outflows from the QQQs of $2.6 billion and long term net outflows of $1.3 billion. These are partially offset by inflows from the money market of $3.8 billion and positive FX translation of $2.6 billion. Our average AUM for the first quarter was $747.5 billion which was down 4.6% versus the fourth quarter. Our net revenue yield came in at 43.8 basis points and that was a decrease of 1.4 basis points versus Q4.

Currency mix reduced the yield by 0.7 basis points. One less day in the period reduced the yield by 0.4 basis points. A decrease in performance fees and other revenues together accounted for the remainder of 0.3 basis points. Now I'm going to turn to the operating results. Our net revenues declined by $68 million or 7.7% quarter-over quarter to $818.1 million which includes the negative FX rate impact of $12.6 million. Within the net revenue number, you will see that investor management fees fell by $78.5 million or 7.8% to $930.3 million. This reflects the lower average AUM, the changes in AUM product and currency mix and one less day during the quarter. FX reduced fourth quarter management fees by $16.1 million.

Service and distribution revenues declined by $9.9 million or 4.8%, reflecting lower average AUM during the quarter. FX decreased service and distribution revenues by $0.2 million. Performance fees came in at $15.5 million in Q1 and they were earned from a variety of different investment capabilities, including $9.1 million from UK equities. Foreign exchange reduced performance fees by $0.6 million. Other revenues in the first quarter were $24 million. That was a drop of $5 million due to lower transaction fees from real estates, as well as a decline in new IT rollovers. Foreign exchange decreased revenues by $0.1 million. Third-party distribution service and advisory expense which we net against gross revenues, fell by $28.7 million or 7.6% and this movement was in line with lower revenues derived from retail AUM, foreign exchange decreases expenses by $4.4 million.

Moving on down the slide, you will see that our adjusted operating expenses at $511 million decreased by $19.4 million or 3.7%, relative to the prior quarter. Foreign exchange decreased operating expenses by $6.5 million during the quarter. Employee compensation came in $340.3 million, an increase of $1.5 million or 0.4%. This was driven by a normal seasonal increase in payroll taxes which was largely offset by a reduction in variable compensation. FX reduced compensation by $4.3 million. Marketing expense decreased $9.2 million or 26.2% to $25.4 million. This drop is due to a lower level of advertising, literature, travel and client events during the quarter. These expenditures were deferred in light of the volatile market conditions that we were in.

Foreign exchange reduced marketing expense by $0.2 million in the quarter. Property, office and technology expenses came in at $81.1 million in the quarter. That was an increase of $0.7 million over the fourth quarter, driven by additional outsource administrative expenses. FX decreased these expenses by $0.9 million. General and administrative expenses at $64.2 million decreased $12.4 million or 16.2%. This decline was the result of focused expense management during the quarter, as nonessential professional services and other nonessential discretionary spending was reduced or postponed. FX decreased G&A by $1.1 million.

Continuing on down the slide, you will see that non-operating income decreased $2.9 million compared to the fourth quarter. Included in the first quarter were non-cash negative marks to March markets on inter-company loans of $7.1 million and $1.4 million on trading investments. These were slightly offset by a $3.4 million gain which was realized on our pound sterling U.S. dollar hedge. Just to remind people, as we've said in the past, we have in place a hedge through the end of Q1 2017 with a strike price of $1.4355. This is the pound hedge that we put in place. The Firm's effective tax rate on pretax adjusted net income in Q1 was 26.5%. That was down from 26 6% in the prior quarter which then brings us to our adjusted EPS of $0.49 and adjusted net operating margin of 37.5%.

Before I turn things back over to Marty, I just want to provide a quick update on the business optimization work that we began to implement in Q4 of last year. As a reminder, as we stated, we expect to incur up to $85 million in expenses during 2016 related to these activities, with an expected run rate savings, however, of $30 million to $45 million through the beginning of 2017. In the first quarter we incurred $6.8 million of the $85 million in optimization costs. That was primarily in the form of staff severance costs and as previously discussed, these expenses do impact our U.S. GAAP P&L, but they are being excluded from our non-GAAP results.

And also, just to finalize the point, we did generate approximately $2 million in permanent run rate savings in Q1 as a result of the optimization efforts to date which was in line with our plan.

And so with that I'm going to turn it back over to Marty.

Martin Flanagan

Thank you Loren. We will open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. First one is from Craig of Credit Suisse. Your line is now open.

Craig Siegenthaler

Can you provide an update on the U.S. equities business? I'm just looking here at slide 18 and looking at some of the performance across some of these capabilities and I just want to see if you maybe have any plan to sort of get some of this performance stronger here?

Martin Flanagan

Good follow-up question. So, that was my point. Actually, if you look at the value portfolios, they have had quite a bit of exposure to energy and financials in particular. And the year-to-date performance actually has been quite stunning and that's really started in the last couple of weeks here, where things like comstock is ninety-percentile, growth and income four percentile, American value three-percentile, so really, really very strong. So strong teams, really do a good job with their philosophies and it is a high conviction approach and yes, the number are coming in really strong.

Craig Siegenthaler

Got it. And then just a follow-up question for Loren. And Loren, I know there's a lot of moving pieces here and it is always tough to anticipate data, but the operating margin's always depressed in the first quarter due to a few items that we all know about. But A1 finished the quarter much stronger and you have those initiatives in place. So I'm wondering, do we have a shot of getting the margin back to the 40% range with stable market share?

Loren Starr

We certainly would hope to see margins improved through the course of the year. Obviously there is a lot of moving parts, lot of volatility, we've got the pound and the currency topics which have been bouncing around a little bit. So I'm not going to put out a number in terms of what I think margins could be. Obviously, the inherent strength of the business is there and as markets stabilize, currency stabilizes, we should continue to see the very positive trend of incremental margins working in our favor to pull up our overall rate and sort of, margin overall. But it will depend ultimately on what the markets do through the rest of the year.

We're, as you know, still at the level of assets below where we were on average for last year and so I would say we're still catching up to where we were last year in terms of overall margin potential.

Martin Flanagan

There is absolutely nothing in the way of us exceeding 40% margins where they were again. And I think that the issue, as Loren sited, it is a timing issue more than anything else with markets. But I think also very importantly, regardless, even though the market has come back some and flows are picking up again, we continue with the optimization programs. And we're going to finish those and again we'll just be net better off because of all of those activities.

Loren Starr

And just to remind people, the optimization program is operating through the course of 2016 and we do not really get to the full run rate benefit until we get to the end of the year which we talked about the $30 million to $45 million potential. We're going to see some continued benefit through the course of this year, but again, $2 million here, $3.5 million, $4.5 million, you know, it's going to kind of begin to scale through the course of the year. But it's still not at a level, I would say that's going to be the most dramatically move the margin picture.

Operator

Next question is from Glenn of Evercore. Sir, your line is now open.

Glenn Schorr

Two part on the follow-up there, with ending AUM over 3%, better than average and April positive end-year, positive comments on flows. I look at the revenue decline in the quarter, year-on-year and half of that was performance fees. So the first question is if you could talk through what we should expect from here over the progression of the year on performance fees? I know they're tough to predict, but it was half the decline in revenues in the quarter, so I think that might have a big influence on the margin in question.

Loren Starr

So you get to one of my favorite topics, Glenn, predicting performance fees which again, I still will continue to profess, I'm not very able to do that. Generally performance fees are lighter through the last half of the year, their the heaviest in the first quarter and so you sort of see the heavy performance recorded already.

So my expectation of performance fees through the remainder of the year, as I often said, is sort of place-marked, earmarked, when we're thinking about our planning, somewhere around that $5 million a quarter which is an estimate that assumes a lot of different things kicking in across the globe, but no one thing driving it. We would hope to see the other revenue line improve somewhat because the volatility in the first quarter was pretty extreme.

And so as I mentioned, in transaction fees and real estate rollovers, in the UIT business, were really slowed down by that degree of volatility. If we get to a more stable and that's a big if, but if we get to a more stable market environment that line item should be closer to, sort of, that $30 million to $35 million number through each quarter.

Glenn Schorr

And on the expense side, if you look at comp marketing and G&A oil declines, in line with non-performance fees revenue or better, I know this is a softy question, but how much of that is response to the weak revenue environment in 1Q versus more run-rateish type levels?

Loren Starr

So the optimization work is what's going to drive a permanent reduction and so that's stuff, I don't want to say real, but it certainly -- and there is work we can do and we have done in first quarter and that we're going to continue to do through the rest of the year, in terms of trying to manage our discretionary expenses to lower levels. Some of that you can defer for a reasonable period of time, some of it you cannot defer for forever. And so we do have some seasonal costs related to marketing that will be a little bit heavier in the first and the fourth quarters, as they always are.

And so it's just good to know that we want to continue to be present and then continue to be able to work with our clients and have client events as we've always had. That's important and it helps the business, it helps the growth of the business and we don't want to differ those expenses for a year, for example. So I think the other thing that we see in the second quarter versus the first quarter would be some of the impacts around salary increases and differed compensation which are typically, you get a differential of about two months' worth of impact in the second quarter versus the first quarter and between those two items, that's probably somewhere around an increase of $5 million to $6 million.

So again, there are some things that we're going to manage and we're going to continue to apply a very thoughtful and disciplined approach to our hiring and to our discretionary expense management. I don't want to give guidance explicitly quarter-to quarter, also because just given the volatility of markets and FX, it really becomes quite difficult for us to give useful information.

Operator

Next question is from Bill of Citi. Sir, your line is now open.

Bill Katz

I want to come back to Jemstep for a moment. One of your peers is out there as well with their own platform, they have actually signed up a few third-party distributors to accelerate the opportunity there. Can you talk a little bit about how you plan to leverage the platform and maybe synthesize that with your comments around the DOL?

Martin Flanagan

Bill, we're very excited about it and we look at it differently than the other, you want to call it technologies, robos out there, it was actually developed for the advisors themselves. And it is an open platform and it can use everything, all vehicles from ETFs to mutual funds and those are the limitations of some of the others. And ours is to be supportive of the advisors, not to compete with them and so there is no direct-to-consumer element to it and that was by design. And so we're able to just have a much deeper relationship with our clients, all the thought leadership that we have is an element also, delivering our solutions capabilities to various different clients through that, so another very good venue there.

And again the combination of the high conviction fundamental and factor based capabilities, whether they are mutual funds, ETFs, UITs. So we think it is also going to broaden our channel, our exposure, in the RIA market and that has been sort of an early indicator and quite frankly, the level of interest has been quite surprising. And I think frankly somewhat driven by the DOL also, because they are looking for technologies to help serve their clients and it is a market that really needs tools like this.

Bill Katz

This follow-up for Loren, on just margins overall I think you talked about -- maybe it was in the press release or maybe it was your prepared comments -- that G&A was a bit on the softer side as you delayed some items. How do you think about that on a go-forward basis? And then stepping back, pretty wide range on the optimization between, it was $30 million to $45 million, what would define the higher end of that range in terms of things to be done from here incrementally?

Loren Starr

So on G&A, that is a line item that we probably in some ways are best able to manage. It has to do with travel and entertainment and use of professional services and so those are things that are easier for us to slow down since they tend to be not as business critical as some of the other things around marketing for example. So we would hope to see continued success in terms of managing that line item. Although I would say there may be some things around some of the regulatory side that could drive certain needs and that could drive some cost in the G&A around risk management and other compliance efforts. But I still think that is an area we're putting a lot of focus on to manage and maintain somewhere around were run rate level in Q1.

In terms of the broad range of the $30 million $45 million, there are still several of these initiatives that are going through the finalization of their planning phases. And so we don't have clear line insight of the ultimate impact and so that's what is driving that spread. Again, I think we're hopeful we're going to get to the higher end of that range, but we want to be thoughtful and not commit to it until we're more certain which we'll begin to get more certain as we get through the course of this year and we will provide that feedback to you as soon as we know.

Operator

Next is from Michael of Sandler O'Neill. Sir, your line is open.

Michael Kim

First Marty, you mentioned solid flows in April. First, I just want to be clear, does that imply solid net inflows? And then I'm also assuming that refers to the Firm-wide total, so any color on magnitude or some of the underlying drivers behind that?

Martin Flanagan

You're a good skeptic, so thank you for the question. So yes, I meant inflows. Total net inflows is about $3.7 billion right now and $1.9 billion are long term flows. The institutional pipeline, again and you're going to get tired of hearing it, but it is a good news story, it is an all-time high, again, so that is another area of ongoing strength for us. I will say we're in that season where, that's today, what the flows are, this is a month where there is all that rebalancing throughout the industry. So we don't have line of sight, who knows what happens between now and the rest of the week, right?

So it could be a little noiseful, but I will tell you the quarter, if it stays on this path, will be a good quarter. But it could look a noisy, you know, month to month, just because of all the industries are rebalancing which is pretty typical and will not be unique to us. A very different environment, I'd say right now, than just where we were in January/February.

Loren Starr

In terms of what is really being quite successful right now, Michael, we're seeing continued things around real estate, fixed income alternative, global asset allocations, multi-asset products at quant, are all highly featured in our institutional pipeline. And then the other -- regionally, we continue to see really strong flow momentum, both on the retail and the institutional side in Asia-Pac in particular. And then another note, just in terms of ETFs. ETFs are positive in every single region that we're operating in terms of positive flows and so we continue to see the interest in that capability being at a high level.

Michael Kim

And then maybe one for you, Loren, sorry for kind of the narrowness of the questions here. But you called out some expenses that were sort of deferred or postponed or maybe some non-essential costs that maybe fell by the wayside. Just so I'm clear, are those items part of the business optimization plan or are the incremental to, sort of, the $30 million to $45 million of savings you've identified?

Loren Starr

Yes, that's incremental. What you are seeing in the first quarter, the expense reduction, only $2 million of that has to do with business optimization, as I mentioned. Everything else is related to us just managing expenses in a fairly disciplined and try and differ what we can differ. We're going to continue to do, as I mentioned, through the course of the year. The business optimization's going to continue to roll and help on top of that activity to improve our overall expense management.

Operator

Next is from Brennan of UBS. Sir, your line is now open.

Brennan Hawken

My first would be on regulation and Marty, you referenced unintended consequences which is certainly fair as a risk here. But do you have an estimate that you could size of how much of your AUM is in retirement accounts currently in therefore, at least at this stage, given what we know, the most clearly impacted by this DOL final rule? And then, based on what you saw happen in the UK that just went through, RDR, what lessons did you learn by going through that? And I'm guessing that had something to do with the unintended consequence comment and how does that put you in a position to be better prepared for this rule here in the U.S.?

Martin Flanagan

We're all in the advice business, being good fiduciaries is a critical thing. And putting clients first is absolutely essential and the industry of trust matters a lot. And so at that level, the notion of fiduciary ruling having better outcomes for end-clients, that is a great thing. I think we're all supportive of it. But it's really the magnitude of what has been included that went way beyond that notion. And what we learned with RDR and it's just an absolute fact, there are more unadvised individuals because of RDR right now and there probably will be individuals that need advice the most and the totality of the cost has gone up and I think that is a really bad outcome.

And I think there's a lot of -- and you can see that happening here. That said, so what are the lessons learned that we had from that is be aware of that. We also see, that is also why we went down the Jemstep route. We know we can help clients with tools like this, advice more accessible for those that could be hurt frankly from the rule. And again, that is not the intent of the rule, that's what we think as possible. And also, very importantly, how we position the firm. And I think this is what's being missed in the conversation. What money managers are going to do well and we might be challenged. If you are an index hugger, active management, I would say you are in trouble. If you have high conviction fundamentals and factor based capabilities like we do, I think you are positioned very, very well.

And if you look at the work we have done, when you look at high conviction actives, you do get better returns through market cycles, but it is not just excess return, you have better down-site capture. You also have better risk-adjusted returns and I think that's really the value proposition that collectively we need to make clear. It has been a beta run since 2009, largely with lots of government intervention and you start to look at quarters like this where all of a sudden you see active managers outperform the S&P by 300 basis points, 350 basis points that is pretty impressive.

So again, I think you have to have high conviction fundamentals and the factor base, we believe very, very strongly in the combination thereof. We think positions us very well. And much of that would, as you would say, come out of lessons learned that we learned out in the UK. Tried not to be long-winded but--

Brennan Hawken

And then follow-up, just a little bit more ticky-tacky, I think you'd said that the ETF flows were positive across regions. We're you talking about 1Q? And it looked like passive redemptions have been accelerating here over the last several quarters, so is that [indiscernible] driven? What's driving that? Can you help us unpack and square those two statements a bit?

Loren Starr

I will answer that, because it was my statement I think. So I was referring, positive in every region and that's April, so I was really referring to the April numbers. However, I would say in the first quarter, the first two months were not great month for our passive or whatever, ETF offerings, but I would say March was a record in terms of our sales. So it really came back strongly and as I sort of indicated, it's continuing strong into April. The passive category that we show, Marty mentioned it, got very much affected by the deleveraging of IVRs. So it is really is not the fill of noise in our numbers, because the deleveraging has no impact on revenues and even though we count and as an outflow, it's just really part of how their managing that [indiscernible].

So I would not read too much into the first quarter passive outflow story, really just understanding that we do believe that our ETFs business is very well-positioned and it is gaining momentum. It is the most diversified set of smart beta offerings and we're gaining share in smart data year-to-date, so we feel very confident about our ability to continue to grow that business.

Operator

Next is from Ken of JPMorgan. Sir, your line is now open.

Ken Chow

Couple for Loren. Maybe first, when we think about the management fee rates for active and passive funds, both were down a lot for the quarter, I think maybe largely expected, maybe the magnitude was off a bit. Maybe can you first talk about how the fee rate should recover given the bounce back in equity markets, foreign markets, various currencies? Should we recover a lot of the way or part of the way or all the way, any color there would be great? And then if you could maybe flesh out better for us places where the mix changed in 1Q that maybe had the most pronounced impact on the fee rate declined this quarter? Thanks.

Loren Starr

Yes, so I think we will begin to see recovery of the net revenue yield and particularly as we get into the last half of the year versus the first, there is some day-count stuff that just happens normally and you always have that benefit of the last half having more days than the first half. So I want to make people aware of that, it is no secret. In terms of the mix, obviously we're having some reduced performance fee expectations coming into Q2 versus what we realized in Q1. Some of that will be offset by hopefully higher other revenues which will help move the fee rate up.

And I think we also will see the success of our ETF business, the success of our fixed income business, a lot of that is in the pipeline. They tend to have lower fee rates, so there will be probably some degree of mix issue that's working a little bit against the higher fee. The flows that we have been getting into EMEA and U.S. retail have been more subdued and it can be a driver of fee rate mix. And I would say that is going to be a little bit of a question mark, particularly as we get through the whole Brexit thing and understanding what happened in the UK, that may have some impact, we don't know. It hasn't any impact on flows per say that we can identify yet. But it could have some impact on flows.

Based on our modeling and our thinking, we expect to see the fee rate drive up further each quarter as we move through the course of the year. I think the positive elements generally around mix still exists. And I would say that on the institutional pipeline, even despite what I said around fixed income coming in, overall the fee rate on the products that are coming far exceed the fee rate on the products that would be leading, so again a positive element on the fee rate. FX will also have a big impact, too and I think we saw a pretty big impact on FX in the quarter, 0.7 basis points and so that was with UK down 5% quarter-over quarter, the pound.

Just to understand that those dynamics are probably one of the big drivers of fee rate issues. And hopefully that does recover and we get to break and we get stabilization of the pound.

Ken Chow

And then on the other revenue obviously down a bunch for the quarter, can you maybe help us on an outlook for this? There is a number of components, real estate and UITs are one, how should this line be growing over time? And maybe how should it be growing compared to something like the management fee line? So obviously both will move up and down depending on market conditions, but should the other revenue be growing faster or slower over time?

And then maybe more near term in terms of an outlook. Based on your guys' views on real estate activity and maybe what you are seeing more idiosyncratically in the UIT markets, how should we think about that line item maybe for the rest of the year?

Loren Starr

So I think it will grow, certainly off of what we view as a pretty low base in Q1, that now that I mention it, should pick up. Generally our real estate business has been growing well and so that will as a theme help allow that line item to grow. And I say particularly as it's seeing success in Europe and Asia, that's where a lot of the funds actually do have transaction fees and that work in the U.S., some of the products that are managed by our real estate team aren't able to generate transaction fees so that will be a U.S./non-U.S. mix. But we think the outside the U.S. is an opportunity for the real estate business and still has a lot of opportunity to grow at a faster rate even than on the U.S. side.

The UIT business, we would hope to see that grow. It has been a very competitive market, particularly because it is somewhat transactional when people decide to roll their UITs, if you do get volatility they're just going to wait and see. And so we would want to see a market stabilization which would allow our ability to roll those things more rapidly and generate more of the revenues as well. But we think that the UIT business has a lot of opportunity to grow and so we would expect to see between those two elements that other line item grow. Again, on an organic growth basis, we should be able to grow in that 3% to 5% level that we talked about before.

Operator

Next is from Chris of William Blair. Sir, your line is now open.

Chris Shutler

I think early last year there was a really good story around cross-border, some of the European products are flowing very well. It seems like performance there has softened a little bit on a couple of products, others are still very good. The environment has clearly gotten tougher, so maybe just talk about how you're feeling about cross-border, that product range and the growth outlook for the remainder of the year?

Martin Flanagan

We still feel a very important part of our business, we still look at it as an engine of growth over the next few years. It's the magnitude of change and the impact to the Company has been very positive the last few years. Clearly with the market uncertainty, you then you do some of the macro-environment there, whether it be bright 50, some of the concerns on the continent, it did definitely slow down the quarter. That said, we just feel very well-positioned. We look to continue to gain market share.

With regard to performance, somewhat of a similar story -- some of the U.S. portfolios I mentioned, there's some of the exposure in some European portfolios were in financials and some energy and so there was that little bit of a drag per period, but again, they are very, very good managers, excellent and highly regarded. I would classify it more as market uncertainty than lack of confidence in the investment team. Uncertainty dwindles some, it will never go away. I think we will be back on that growing path.

Loren Starr

Our product range in Europe, still more than half of the assets are in the first quartile, so it is very strong. And when you look at the second quartile, on the five-year basis, it is more than 90% of the assets are beating peers on a five-year basis. So we think there is plenty of opportunity for us to be able to satisfy our clients' needs with the products that we have. You're right, some have soft a little bit relative to the end of the year, but it is still overall exceedingly strong.

Martin Flanagan

Not just retail, but again EMEA in particular is another area where the growth prospects for the institutional business are very, very strong. Early days of success from what we're anticipating over the next couple of years.

Chris Shutler

One other one on PowerShares. There was some talk last year I think of going through a bit of a -- I don't know what to call it, a repositioning or rebranding type of exercise, much better on factors. I know you have done some of that stuff there, rolled out some new product, but it's been I think fairly targeted to date. So I guess the question's just, do you feel like you need to be more aggressive there in making changes to that business? It looks like if you exclude the Qs, over the last year through March the flows have been fairly minimal relative to pretty favorable factor up for the industry as a whole.

Martin Flanagan

Good question, I would answer it two different ways. It is one of the areas that we have invested in quite strongly over the last number of years, because we anticipated, as Loren talked about, the factor base element of it, it's a growing part of the industry. We're a leader there with some very broad, long-dated track record and so the investments have been meaningful. With regard to the flows, I think what you have to look at is how narrow the flows were within the factor based ETFs. And probably from September through the end of February is about as narrow as you've ever seen.

And what we're now seeing, as Loren was talking about, why are the flows picking up the way that we're? We're seeing a broadening of interest in the range of capabilities that we have. So we look at it as an important subset of that whole factor base that we have as an organization and we feel we're absolutely on top of it. And I think you will start to see it again in the flows here as we move through the year.

Operator

The next question is from Dan of Jefferies. Sir, your line is now open.

Dan Fannon

First on EMEA or Asia, you continue to have great flows there, the $3.6 billion or so, the only region of influence. Can you talk about the concentration, I guess, within those flows, either through the distribution areas or products or how diversified those flows are?

Loren Starr

In EMEA, generally we have seen huge success with our GTR product, both institutionally and on the retail side. And that has been probably our primary driver of inflows in the region. So it has been probably a little bit concentrated to your point in that capability. I mean we still think there's some very, very strong capabilities, like our Quan capability for example, I think it is called structured equity, doing very well.

This current environment in the first quarter was an anomaly for everyone in terms of what behavior you would expect. And hopefully we will begin to see more take-on in the broader sales picture than just GTR. But GTR by the way, I just want to minimize that point, is doing very, very well. It is outperforming some its competitors so it has really been a success for us. And the other thing I would also say, I know your question is just on EMEA, again I can't say how happy we're that our Asia-Pac business has been really, really strong.

So the outside the U.S. which is both Asia-Pac and EMEA, has been very diverse in Asia-Pac in terms of what's being taken on through equities alternatives and fixed income.

Martin Flanagan

And I would just add that, again, it's not a concern about GTR success. We think it's a positive and again Loren made the point before, if you look at the range of capabilities in EMEA and the very, very strong performance and the reputation of the teams, it is not a concern as far as I'm concerned.

Dan Fannon

And then I guess to follow-up on the optimization, I think you said $2 million was realized this quarter. Can you give us a kind run rate or path through the year to think about how the rest of that is going to flow through or the piece of that benefit?

Loren Starr

It's just going to step up each quarter. And so the $2 million would probably get to more like a $3.5 million, then $4.5 million, $5.5 million, as you work through the course of the year. Those are sort of rough numbers and so timing could be a little bit off. But that will get us ultimately, as we get into 2017 and that run rate of $30 million to $45 million which we feel very confident and whether we get to $45 million, we'll let you know as I mentioned, as we get through the course of the year.

Operator

Next question is from Eric of Royal Bank of Canada. Sir, your line is open.

Kenneth Lee

This is Kenneth Lee on for Eric. Just had a question. There was previously mentioned that they tend to do a share repurchase at perhaps elevated rates this year. Just want to get a better handle on potential amounts that you guys could tend to think about, whether there's any kind of restrictions in terms of the cash balance that you have on hand in terms of your onshore or offshore? Just want to get a better handle on how to think about that. Thanks.

Loren Starr

In terms of where we're at the end of the quarter, we had total cash of $1.455 billion -- what's tied up in the UK subgroup, as we've talked about from a regulatory perspective, is $651 million. And so sort of the free and clear is that $804 million. Q1 is always a very heavy cash need quarter because of taxes and bonus payments, so we fell below sort of our self-imposed target of $1 billion, but we're not concerned about that. We're still going to continue to be targeting a very healthy capital return in terms of dividends and buybacks as a percentage of our operating cash flow to shareholders.

So in terms of our Q1 buyback which we talked about, that was up 63% versus what we did Q1 in 2015, so quite a step up, $125 million. But down a little bit versus the fourth quarter due to just generally the lower operating cash that we're generating now because our asset levels were affected by what happened to the market. But in terms of percentage payouts, we're sort of in line with what we were thinking about in terms of last year and the percentage of cash flow. But because our overall operating levels have been impacted by markets, the total levels may be somewhat smaller. If you look at what we paid out, it'd be probably more in line with an $80 million quarter run rate which gets us at that same payout rate that you've seen in the past. But with that said, we're going to continue to be very opportunistic.

If we see further impact on stock price which we think is unwarranted, if we get through some of the Brexit and understand the dynamics there, we may feel more able to commit more capital. Again, it's one of these things that we feel very well-positioned to return capital, but we're being a little bit cautious just given the volatility in the market right now.

Operator

Next question is from Robert of KBW. Sir, your line is now open.

Robert Lee

You didn't think you're going to get through a call without a Brexit question? So I guess I'll ask one. Aside from the currency hedge -- it may be obvious on how you think about contingency planning for it. I mean, how do you -- besides obviously huge unknowns, if it happens or what happens after happens, how can you prepare for that? I know it is maybe less about where products are registered, but operationally what are some of the things you try to put in place?

Martin Flanagan

It's a good question and needless to say, there's a team of people that have been working on it just in case that happens. And the good news, just as you were pointing to, the way we have our product ranges set up right now, we're in a very, very fine shape. And also the way that we have our operations is also set up in a way that we will not be impacted negatively. There is a small exposure. If we sort of extrapolate, I think it's a couple billion dollars of some assets that we think could sort of get caught up in the crosshairs.

But again, this is scenario planning, so exposure's high. So from that point of view, we're very well-placed. The issue is, if it is an outvote, it is going to be the stated time, they have until mid-2018, that they would still be a part of the EU. I would say most people that are very involved in this will tell you the likelihood of trade agreements and the like are going to take longer than that. It's just hard to assess what the psychological impact on investors would be.

That said, we just think relatively, we're very well-placed to deal with it as it goes through. And I think really just getting past the referendum is going to net positive regardless of what the outcome is.

Robert Lee

I guess maybe this is maybe a presentation question or what not. But could you maybe give us a sense -- in the past as AUM, what proportion of that is not fee generating or manager fee generating? Clearly last quarter there were noise and flows around de-leveraging of basically non-fee assets and clearly you break out the triple Q flows which don't generate managing fees, but neither do UITs and other things. So if we're really trying to look at kind of the pure asset base there that's generating the manager fee revenues, what would that be today? And maybe the one request that may be a helpful metric to think about providing going forward?

Loren Starr

Okay, so I think when you look at, the cues, that is about $38 billion, the IBR leverage is somewhere around $20 billion and then the UIT business which does generate revenues when they get rolled, but once they have been put in place they don't -- that is about $18 billion. So those are the big chunks that you'd have to add up to figure out what is non-revenue-generating.

Robert Lee

And then maybe just one last modeling question. I mean understanding a lot of moving pieces in comp and whatnot, if we think of it the first quarter here, was there anything in there -- I mean obviously there is always some seasonality in the U.S. -- but beyond maybe some modest seasonality there, is there anything in there that we should think of maybe that falls away next quarter outside of the expense initiatives that are in place? Or should we be thinking that all else equals is kind of a reasonable run rate?

Loren Starr

In terms of the Q2 through Q1 impact, you have obviously payroll taxes falling away, so that is a benefit of some $15 million, $20 million. But then you've got some offset, as I mentioned, in terms of dollar increases and differed compensation and sort plus $6 million. We obviously are beginning to work through some of the optimization things. And so you will get some continued run rate benefit going -- it's probably a benefit of $3.5 million to $2 million if that does translate, another $1.5 million benefit.

Now some of that make get offset if we actually have a higher level of assets and revenues, some of our intended compensation will scale up with our operating income, as it always does. So all those things together, you're probably -- hopefully, comp will actually be back up with the benefit of higher asset levels and market driving intended compensation ahead.

Operator

Next question is from Michael of Morgan Stanley. Sir, your line is now open.

Michael Yule

Just curious under what conditions you think Invesco can grow organically? Your business closely resembles another in the industry, yet they grow consistently off a higher base. And I know you're targeting 3% to 5% organically to grow and flows sound like they are pretty strong in April. But I'm just curious under what condition can we see Invesco grow consistently from here?

Martin Flanagan

I think if you look, historically we've been one of the most absolute consistent growers throughout all the different market scenarios. I think what we have learned, if you look at the last quarter again, when you are in a January/February environment it is just very difficult. When you get more to an environment that we're in now where I guess there's still plenty world uncertainties, a Firm like us, you will growth. And you'll see it both institutionally and retail and again as both Loren and I brought out, you can see looking at different parts of the world right, again, each region is actually growing. You don't need a lot, it's just where you have a massive uncertainty that it is very difficult.

Loren Starr

And I think you've said in the past, Martin, too, but when you get an equity-led market which I don't know if we're going to see that anytime soon. But if we do get an equity-led market, we will probably be able to grow much more quickly than you've seen us do in the past because a large percentage of our AUM is equity. Again that would be the converse of what we've been in, right? Just volatility.

Michael Yule

And then just a follow up on operating leverage, you cut expenses nicely about 9% or so year-on-year in the quarter, but revenues fell about 11.5% or so. So just curious how you're thinking about operating leverage here and what level of market return -- A, on growth, do we need to see in order to see positive operating leverage? And can you improve margins at flat AUM levels?

Loren Starr

We've said that when you get no market benefit, so if you just stayed flat to where we're on an average asset basis, the second quarter to first quarter, that organic growth would allow us to see revenues improve and so we would be able to get incremental margins up sort of 50%. And if we had a market that's helping us grow and FX I would say as well, incremental margins could be much higher to 65%.

So we would hope to see, as Marty had talked about, our operating leverage begin to work in our favor as opposed to work against us as assets are recovering. And we absolutely will see that happening, particularly as we manage to maintain a fairly tight control on the expense side. So that would be our hope, is to get us back to that 40% and hopefully this year just through organic growth and expense management. If we have market on top of that, we should be able to do better than that.

So there's nothing that stopped us from generating very strong operating leverage on the plus side if you have positive markets plus FX plus organic growth working in our favor.

Operator

Next question is from Brian of Deutsche Bank. Sir, your line is now open.

Brian Modoff

I'm sorry if I missed this, but the $1.9 billion in long term flows in April, what areas are those in?

Loren Starr

So the $1.9 billion in long term flows were across a variety of capabilities, investment grade fixed income, we had bank loans, we had some aging equity. We had real estates, we also had PowerShares in each of the regions across a variety of capabilities. Probably a lot of it was low volatility offering and I think we did continue to see some positive flows in GTR as I mentioned which has been a big driver. Pretty diverse capability, maybe more heavily focused on alternatives than anything else.

Brian Modoff

And just Marty, I guess a little bigger picture on the Department of Labor, it sounds like you have a very good sort of offensive game plan with the Jemstep product and the open architecture model and being able use your very wide product range, including the factor-based ETFs. But if you think about sort of the defensive nature that a lot of the asset managers will be going through that have high concentrations of active product, is there any type of plan to work with the advisors in terms of pricing class structures of the shares that you have now? And I guess if you could comment on how you think adviser behavior will turn out, post DOL Rule. And then sorry if I missed the assets in mutual funds and IRAs and 401(k)s. I'm not sure if you just --

Martin Flanagan

It's a good question and I think the reality is we've got to believe it's going to be taken by the distributors and how they are going to want to be addressing the rule. That said we're and I'm sure everybody else is wanting to be incredibly helpful to distributors as they work through the issues. That said, what I believe strongly is that there is a very, very important role for advisers.

We believe that's the best way to get outcomes for clients and also believe strongly that high conviction fundamental capabilities and factor-based capabilities are what advisors want to do because they know that's how they can give a better value proposition to their clients. And just mechanically, the industry is pretty close already, through the range of share classes that will be available, that the vast majority, they will be an advisor-based plans.

And these are stripped-down share classes that really you know what's going to be used. And so I would say money managers are -- I'm sure most everybody is well-placed in that area. But again, it is a little bit of -- time to take the lead working with the distributors on it. It is really complex actually, the role, but the high-level assumptions that we've all made are probably still in place.

Brian Modoff

And sorry, did the mutual -- I don't know if you disclosed this -- the mutual fund assets in U.S. IRAs and 401(k)s?

Martin Flanagan

We didn't. Again so much of our assets are in omnibus and quite frankly, if we just made the determination by coming up with a number, it'd probably be more misleading than helpful. We would probably have at industry levels or just slightly less than someone with regard to exposure. That is our estimate.

Brian Modoff

And do you think advisors will factor in the help that you are giving them, including with Jemstep, in terms of thinking about the least conflicted and best product for their clients? And using, say Invesco products, in conjunction with the Jemstep offering as sort of the best low-cost, better-performing option.

Martin Flanagan

Let me answer this way, again, we've talked about the range of capabilities. We think that is very important. Jemstep is open architecture which is very important. That's the only way we can be credible in helping our distribution partners and if it's important to them, it's important to us.

That said, the other element is we have Invesco Consulting which has been a really, really important part of the value proposition we provide to advisors to help them work through all these different topics. That and the thought leadership in combination are going to be, we think very, very strong forces and us being into a position to -- be strongly placed to help our distribution partners do what they need to do.

Operator

And last question in queue is from Chris of Wells Fargo. Sir, your line is now open.

Chris Harris

The record institutional pipeline, wondering if you guys could speak to the size of that if possible? And then I know we have the State of Rhode Island Mandate in there, so maybe talk qualitatively as to how it looks excluding that mandate?

Loren Starr

The good news is that the State of Rhode Island Mandate is not in this number. It does not include that. And so the record number, we're up 50% versus prior-year. We're up about 5% versus prior quarter. We've traditionally not and I think we will probably continue the tradition of not giving explicit numbers, because they can be misleading in terms the ins and the outs. And this is really what we have line of sight of in terms of the ins, but we don't have as much of a clear line of sight on the out.

But in terms of indicative levels and the pipeline and the success you have seen on the institutional side which has been, I think you've it in every single quarter. We feel very confident that we will continue to see growth in terms of the sales or success in that channel.

Chris Harris

I want to come back to one second I was asked earlier and that is regarding your long term growth targets, 3% to 5%. I'm not sure if you guys had really thought about it this way, but when you guys were thinking about that growth rate, what kind of level of growth were you thinking you would need in active equity in order to get there? In other words, can active equity sort of be flattish or negative and Invesco could still potentially hit that 3% to 5% target?

Loren Starr

I think absolutely. Across every single market that we're looking at that and I think that is the point, is that it's the consistency. We will not be the fastest grower in the industry because that going to mean you've got the one product that everyone wants in that one market. And then because we have a very diversified set of offerings, some are entirely active, others are on the more passive side and so depending on the market that we're in, we should be able to grow at a more, I'd say, modest rate but a still very good rate of that 3% to 5%. And it could be in terms of those markets scenarios where active is an outflow and we're winning on the passive side. That's not going to be every market, but it certainly has been a current market where we're seeing the interest in passive being at a higher level than some of the active offerings. But again, you've seen our active and passive both actually succeeding in this environment.

Martin Flanagan

And I just want to reiterate a point that Loren made earlier too. We feel strongly that the 3% to 5% is very, very achievable and that's really -- we have not been in, for a good number of years, a market that is kind to active and equity investing. And I do believe that is going to change. I know there's a lot of doubters, but it can persist this way and when that happens, I think you will be at the high end of the range.

Operator

Next question is from [indiscernible]. Sir, your line is now open.

Unidentified Analyst

Marty, just a quick one, two things just on the retail side of the business. When you mentioned the improvement that you have seen in March and April, just wanted to get a sense on the flows that you gave, is that more weighted towards retail versus the strength you have been seeing in institutional? And then diving into that, are you seeing an improvement in sales or some of the redemptions starting to improve? And then longer term, just any concern around some of the SEC proposals on liquidity and derivatives? Or just more manageable, but the industry will be going back and forth to try to figure out what is the right solution?

Martin Flanagan

The flow is pretty well balanced, retail and institutional.

Loren Starr

Although I would say the retail is a little more ETF flavored.

Martin Flanagan

Good point. I'm sorry, what was the second part of the question? I got the third part. I can't remember the second part.

Unidentified Analyst

Whether the improvement that you were seeing in March and April, like sales versus--

Martin Flanagan

It is gross sales picking up. So typically what happens in those downturns is the first thing that happens, people stop buying and that's where you get that -- so you're actually starting to see gross sales pick up which is a very important indicator, I would say a sort of sentiment. And then with regards to the various SEC proposals, my view is the indications I would say is that the SEC absolutely wants to get them done. They also absolutely want to get them right. And they are much more willing and capable of working with the industry to get the right answers and so again we'll have to see one by one.

So that would say they are going to come, but I'd say they'll ultimately get to places that are workable and we will get to a relatively good spot. I will say again though, back to some yet earlier conversations, this does continue to put pressure on -- all it does is drive up compliance costs and you know, in a difficult market is it's very difficult for institutions to -- and these are not optional expenses. You do compliance costs in cyber and I think that's being a larger money-management manager, you'll be in a better place to be able to deal with those. So again, that will be a continued dynamic, I would say in the industry.

Operator

And that's the last question in queue.

Martin Flanagan

Well thank you very much and on behalf of Loren and myself, thank you for your time, your questions and your interest and we will be in touch soon. Thank you.

Operator

And that concludes today's conference. Thank you for your participation. You may now disconnect.

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