Artisan Partners Asset Management Inc (NYSE:APAM) Q4 2016 Earnings Conference Call February 7, 2017 12:00 PM ET
Makela Taphorn - IR
Eric Colson - Chairman and CEO
C.J. Daley - CFO
Robert Lee - KBW
Chris Shutler - William Blair
Bill Katz - Citi
Surinder Thind - Jefferies
Mike Carrier - Bank of America Merrill Lynch
Alex Blostein - Goldman Sachs
Hello and thank you for standing by. My name is Amy, and I will be your conference operator today. At this time, all participants are in a listen-only mode. After the prepared remarks, management will conduct a question-and-answer session. The conference participants will be given instructions at that time. As a reminder, this conference call is being recorded.
At this time, I will turn the call over to Makela Taphorn, Director of Management Reporting at Artisan Partners.
Thank you. Welcome to the Artisan Partners Asset Management business update and earnings call. I'm joined today by Eric Colson, Chairman and CEO and C.J. Daley, CFO. Before Eric begins, I would like to remind you that our earnings release and the related presentation materials are available on the Investor Relations section of our Web site.
Also, the comments made on today's call and some of our responses to your questions, may deal with forward-looking statements which are subject to risks and uncertainties. Factors that may cause our actual results to differ from expectations are presented in the earnings release and are detailed in our filings with the SEC. We undertake no obligation to revise these statements following the date of this conference call.
In addition, some of our remarks made today will include references to non-GAAP financial measures. You can find reconciliations of those measures to the most comparable GAAP measures in earnings release.
I will now turn the call over to Eric Colson.
Thank you, Makela. And thank you all for listening for the call. In 2016, it was particularly important for us to maintain our business discipline and fortitude. This year was filled with surprise and disruption. The Brexit vote and U.S. presidential elections were the biggest headlines.
Disruption was also a major theme in our industry. Asset flows into passive products continued to accelerate. The availability of these products and the perceptions that they are low for cost and in many cases lower risk is impacting all aspects of the investment management industry. Likewise, the many regulatory initiatives aimed at increasing transparency and reducing conflicts of interest also continued to disrupt industry practices and business models.
Lastly, technology continued to cause disruption as well, enabling investors and innovation, but also exposing everyone to constantly evolving security threats. In analyzing these and other changes and what they mean for us, we will start with who we are as a firm. Artisan Partners is a high value-added investment management firm designed for investment talent to thrive in a thoughtful growth environment. By remaining grounded in who we are, we are better able to capitalize on long-term opportunities created by disruptive change and avoid chasing fads. With that in mind, in this presentation, I want to communicate three main points.
First, Artisan Partners Investment Team had added significant investment value for our clients. If our teams continue to add value, we are highly confident that net sales and AUM growth will follow over the long-term. There is plenty of demand for active managers to deliver differentiated results with integrity.
Second as a high value-added investment manager, we welcome disruption in the industry that causes investors to scrutinize their managers and advisers to determine whether value is been added, fees are transparent and rational, and the clients’ experience comes first. We believe we are well positioned to benefit from the ongoing shake-up of the traditional active industry, as well as the increasing frustration of hedge fund investors.
Third, our competitive advantage will continue to be the unique combination, our investment talent, business model and culture. For over 20 years that combination has delivered positive long-term outcomes for clients and investors, partners and shareholders, and our talented professionals. We believe that our people, model and culture, will continue to be do very well.
Slide two illustrates the value our Investment Teams have added over the long-term. The chart shows the growth of a hypothetical Artisan portfolio, consisting of $1 million invested at the inception of each of our 15 existing and historically marketed strategies. The hypothetical Artisan portfolio would have grown from $15 million initial investment to approximately $65 million at the end of 2016. The $65 million is after subtracting approximately $6.1 million in management fees. So, after fees, the Artisan portfolio would have returned almost $23 million, or 55%, more than a portfolio consisting of each strategy’s corresponding passive index.
If you flip to slide three, you will see the strategy specific returns that are the primary drivers of the aggregate outcome on slide two. Slide three shows the growth of $1 million invested at inception in each of our nine largest strategies with at least a five-year track record compared to the returns of their benchmark industries. The percentage in the gray box for each strategy is the percentage of five-year rolling periods in which the strategy has outperformed the index.
Taking the Non-U.S. Growth strategy, as an example, we launched the strategy with Mark Yockey in January 1996; $1 million invested at inception would have grown to about $6 million net of fees; $1 million invested in the EAFE index on the same day would have grown to a little more than $2 million.
Within the 21 year period, there were 193 rolling five-year periods. Net of fees, Artisan’s Non-U.S. Growth strategy outperformed the EAFE index in 155 or 80% of those rolling five-year periods. The information on the slide shows that, at Artisan, multiple investment teams with different decision makers have applied their investment philosophies and processes to generate long-term value for clients and investors across multiple inception dates and time periods. Not only have those investment teams beat their benchmarks they have delivered these results with integrity. These results are not the product of a centralized research process or a firm-wide CIO or investment committee. These results are the outcome of our Autonomous Investment Team working within our distinct business model, something I’ll come back to later.
Turning to slide four, long-term investment results do not translate into positive net flows each quarter or year. During 2016, we experienced firm-wide net outflows of $4.8 billion. We don’t believe that our 2016 experience is particularly helpful in understanding the long-term health and prospects of our business. Instead of reacting to the single period changes, we focused on longer term trends that help us to separate information from noise, avoid overreaction and align our business with long-term durable changes.
On this slide, we’ve summarized our net flows over the last four years, basically since our 2013 IPO, when many of you began to follow Artisan. Over that time period, firm-wide, we have had $2.7 billion in net outflows. Unpacking that $2.7 billion, we see three big picture themes. First investment performance remains a primary driver of net flows for the Artisan investment strategies. Over the four year period, we experienced net outflows of $17 billion from strategies managed by our U.S. Value and Emerging Market Team. Both which experienced for a long period of underperformance in difficult market environments for the respective investment philosophy.
During the same period, across our five other investment teams, we saw net inflows of over $14 billion. Investment performance remains the primary driver of net flows. That’s good, because we believe that the combination of our talent, model and culture will continue to deliver the kind of long-term results I discussed on the last two slides. This also shows how the diversity of our Investment Teams stabilizes our business that some teams have struggled for periods of times others have thrived. That balance allows each of our team to maintain their discipline and focus on delivering long-term outcomes for clients and investors.
The second theme on the slide relates to our defined contribution business. In the DC market, we are clearly facing structural headwinds. Even outstanding long-term investment performance cannot insulate us from continued outflows in the DC space. Over the course of our Firm’s history open architecture, DC plans have been a perfect fit for our strategies. As a percentage of total AUM, DC assets peaked in 2009 at about 25% of our AUM.
In recent years, DC plans and beneficiaries have accelerated the shift in assets towards proprietary target dates and passive products, which have reversed our historical DC experience. It hasn’t helped that our DC assets were and remain heavily weighted towards our U.S. Mid-Cap Value and Mid-Cap Growth strategies, either of which have strong three and five year relative performance.
At year end our DC assets were $15.2 billion, representing 16% of our total AUM. But we expect to continue to see net outflows in our DC business. We think the DC business will eventually turn back in our favor. At some point, we believe that plan sponsors will look to best-in-breed active managers to deliver alpha and consistency within customized DC solutions. That will take time. In the current environment, the combination of strong recent returns and index funds and legal risk will continue to drive DC plans away from active managers, even those who have generated outstanding long-term performance for planned participants.
Slides two and three give an idea of the potential opportunity cost of the passive approach. We understand the incentives for DC plan sponsors to take the passive approach. But it's worth asking participants whether that approach will maximize outcomes for planned participants over the long-term.
The third theme on this slide is a continued growth of our intermediary channel and our non-U.S. business. In 2009, when our defined contribution AUM peaked as a percentage of total AUM, the intermediary channel and non-U.S. AUM were $11.3 billion and $900 million respectively, representing 24% and 2% of our total AUM. At the end of 2016, the intermediary channel and non-U.S. AUM were $27.9 billion and $17.8 billion, representing 29% and 18% of our total AUM.
Like the stability provided by multiple economist investment teams, our distribution model, channels and geographic diversity, helped stabilize and balance our business. While we expect our intermediary channel to continue to grow as demographic changes push more assets into the wealth management space. In 2016, we saw net outflow in the intermediary channel, and our institutional channel with this longer duration clients with a primary source of stability.
The last point that I want to make on this slide is that we’ve had periods of prolonged organic contraction before. From 2005 to 2008, we experienced net outflows in four straight years. During that period, we evolved our investment strategy line-up in light of our Investment Team capabilities and our views about long-term demand from sophisticated investors around the world. We launched the core of our second generation strategies, value equity, global opportunities, global value and emerging markets. Since inception, those strategies have combined net inflows of $19.6 billion, and it’s today accounts for 30% of our AUM.
Over the last several years, we have launched the first of our third generation strategies, high income and developing world, both of which have gathered assets at record rates within our firm. We were in the process of launching our Thematic Team’s first strategy, and plan to launch additional third generation strategies during 2017. We are designing and launching these strategies in light of disruptions and changing client preferences, which takes me to the next slide.
The diagram on this slide, which should look familiar, reflects the ongoing disruption in the investment management industry that we expect will continue to play out for some time. Investors are trading-out of traditional active products in favor of passive products on the left side, and alternative strategies on the right side. The asset allocation curve is flattening for a number of reasons; first and foremost, an oversupply of traditional active strategies resulted in too many products, hugging indexes and not delivering value.
As less expensive passive products came online, offering the same exposure at a substantially lower price, a large migration of assets was inevitable. That somewhat obvious and sensible trade though does not explain what we have seen with the proliferation and popularity of narrow and/or more complicated passive products, such as ETF providing narrow sector exposures, or significant leverage. How those products will ultimately work-out for investors remains to be seen.
Looking at the right side of diagram, the migration of assets from traditional active to alternatives is primarily about risk reduction. Investors have moved assets into alternative products in search of returns that are less correlated to broad markets, strategies actively hedge risked, and the optical risk reductions, resulting from price smoothing in the most illiquid asset classes. After the Bernie Madoff scandal and other hedge fund scandals, many investors realized that their efforts to reduce investment risks may have exposed them to increased operational and legal risks. That led, we believe, to investors flooding into the most well-established alternative investment firms. The flood of assets, has in-turn, resulted investment returns that have failed to meet client expectation, and in recent net withdrawals in the space.
So, we see two types of disruption working in our favor over the long-term. First, we expect investors to continue to shift away from traditional active managers who have hug benchmarks for too long. All of those investors will go passive. Our experience, over the last several years, supports our belief that many of those investors will select managers who offer differentiated strategies with high degrees of investment freedom and strong investment track records. We have seen this, in particular, with our global strategies, as well as our high income and developing world strategies. As the $28 trillion number at the bottom of the page indicates the opportunity that is massive. The reallocations of even a small portion of that wealth in favor of strategies, like ours, will work well for us.
Second, we believe that there is a good opportunity to attract assets away from hedge fund measures who have sales to manage capacity, rationalize fees or provide the transparency and controls that investors increasingly demand. Of the estimated $8 trillion invested in alternative products, about $3 trillion is invested in hedge funds. Some of the strategies we have in development will be classified as hedge funds, while others will be offered through more traditional vehicles. Whatever the classifications, we see these products putting into the gray shaded area on the chart, attracted to investors looking for strategies there are differentiated and outcome oriented with greater degrees of freedom and more tools for risk management.
We believe that offering these strategies within our Firm’s culture and environment will be very compelling for sophisticated clients and investors. While some of the terminology and classifications maybe different, these efforts are just an extension of what we have always done, launch and manage strategies to help clients and investors achieve their goals over the long-term.
Turning to slide six, our confidence at our Investment Team will continue to deliver value over the long-term is based on the historical performance I discussed earlier, and our commitments to who we are as a firm. Artisan Partners is different than other investment management firms. At Artisan, investment talent fits within a business model and culture that are cautiously designed and managed for investment talent to deliver positive long-term outcomes for our clients and investors. Much of what makes Artisan unique stems from our Autonomous Investment Team model. Autonomy and powers are portfolio managers to create their own to spoke investment teams, and invest on the basis of their own research and philosophy.
With empowerment comes accountability. In our model, there is no hiding behind somebody else’s investment philosophy, research or decisions. Combination of empowerment and accountability attracts entrepreneurial investors to Artisan. Individuals who believe in themselves, their philosophies and their ability so much that they are willing to leave behind comfortable and lucrative positions to build something new and different with Artisan. It’s a different kind of investor than you will find at most management firms.
Artisan’s distinct business management team enhances investment team autonomy. Our job, as a management team, is to create the best environment for the Investment Teams, and help them develop from a group of individuals into an investment franchise with multiple decision makers and strategies.
The fact that we are not ourselves investment professional minimizes the risk that a centralized or uniform world-view tanks or waters down the philosophies of each of our teams. Our approach to economic alignment is also unique. Each of our investment teams participate in a straight-forward revenue share, that’s the same across teams and across time. This approach increases predictability and enhances stability, which are both important characteristics of our environment. We also align our Investment Team’s interest with those of partners and shareholders through equity grants.
As C.J. will discuss in greater detail, last month, we made our annual equity grant. Consistent with our standard practice, 90% of the grant was made to Investment Team members and about 50% of the equity granted is in the form of career shares, which remains subject to corporate share until the end of recipient’s career. Artisan’s culture is also very important to outcomes. We embrace our statuses fiduciaries to remarkable thing to be instructed with the wealth of others. If we lose trust, we lose everything. We also appreciate that, in our industry, with great responsibility comes many of obligations, both from regulators and clients. Complying with those obligations is not only the right thing to do it’s a smart thing to do.
Lastly, we strive to transparent, as part of going public in 2013, we naturally became much more transparent as a business and a firm, and that is the good thing for us. It’s consistent with the expectation of clients, shareholders and regulators. As technology continues to enable people to access and digest more and more information, the demand for greater transparency will continue to grow. Firms like ours that rely on trust that will get comfortable with this, and we are.
We reject the argument that transparency forces short-term thinking and decision making. Since our IPO, we have not changed our long-term mindset. The continued success of our business will primarily turn on our Investment Teams continuing to deliver long-term outcomes for clients and investors. For the reasons I’ve been discussing, we expect they will continue to do so. In turn, we expect that our business will also do well over long-term, and we’ll continue to deliver positive long-term outcomes for our shareholders, our partners, and our talented professionals. I appreciate your time. And now I’ll turn it over to C.J. to discuss our fourth quarter and 2016 financial results.
Thanks, Eric. I’ll begin on slide seven. Our earnings release and this presentation disclose both GAAP and adjusted financial results. But I will focus my comments on adjusted results, which we as management use to evaluate our profitability and the efficiency of our business operations.
Revenue in the fourth quarter was $181.5 million, down 1.4% from the previous quarter, and the adjusted operating margin was 35.8%, down from 37.3% in the previous quarter. For the year, revenues were $720.9 million, down 11% from the previous year, and our adjusted operating margin was 36.4% compared to 40.3% the previous year. Our results in 2016 reflect the overall net client outflows and slightly lower ending AUM, amidst the secular trends that Eric discussed, including ongoing demand for low cost market exposure and structural changes in the DC markets. A combination of these trends and performance challenges in some of our mature strategies resulted in firm-wide net outflows during the year.
Taking a look at our AUM on slide eight, we ended the year with 96.8 billion of assets under management, which was down $3 billion or 3% compared to both last quarter and last year. The decrease in the quarter was due to approximately 2.8 billion of market depreciation and $231 million of net client cash outflows. The decrease in the year reflected 4.8 billion of net client cash outflows, partially offset by 1.8 billion of market apprecition.
Taking a closer look at cash flows by team, the Growth Team had net client cash inflows of $800 million in the quarter, primarily due to a large non-U.S. institutional win and the global opportunity strategy, which was partially offset by net client cash outflows in the Mid-Cap Growth strategy.
For the year, the Growth Team had net client cash inflows of $450 million, reflecting net inflows of $2.7 billion in the global opportunity strategy, offset in-part by outflows in the Mid-Cap Growth strategy of $1.9 billion. While the global opportunity strategy continues to see strong demand from clients outside the U.S., the Mid-Cap Growth strategy continues to face headwinds, particularly in the DC space.
The Global Value Team had net client cash inflows of $600 million in the quarter, primarily from non-U.S. clients. For the year, the Global Value Team had net client cash inflows of 1.5 billion or 5% organic growth in both of their top performing global value and Non-U.S. Value strategies. Our two newest teams, the Credit Team and Developing World Team continued to see net client cash inflows with $212 million in the quarter and $1.2 billion in the year. These two teams continue to build strong performance track records, which should bode well for future cash flows.
In the quarter and for the year, the Global Equity Team had net client cash outflows of $1.7 billion and $4 billion respectively, primarily in the Non-U.S. Growth strategy due to reduced EAFE allocations and strategy under-performance. These net client cash outflows follow a three-year period with $7.5 billion of net cash inflows or an average of 12% annualized organic growth when intermediaries were increasing their EAFE allocations, and the strategy had strong one and three year outperformance.
We expect the Non-U.S. Growth strategy will continue to experience net redemptions until performance improves. The U.S. Value Team had a $158 million of net client cash outflows in the quarter and $3.6 billion of net client cash outflows for the year, primarily in the Mid-Cap Value strategy due to previous under-performance. During 2016, U.S. Value Team had a very strong performance. The Mid-Cap Value strategy posted an annual gross return of almost 24%, and outperformed a broad market index by over 1000 basis points.
Moving onto financial results for the quarter on slide nine, for the quarter, both average AUM and revenues declined 1% compared to the previous quarter, and 4% and 5% respectively compared to the same quarter last year. For the year, average AUM decreased 10% and revenues were down 11% compared to the prior year. In 2016, we experienced the modest 1 basis point decline in our average fee rate as a result of greater redemptions in pooled vehicles compared to longer duration institutional minded clients. We believe that the longer duration of institutional clients offset the lower fee rates, yielding a better return over the long-term.
Slide 10 shows expenses on an adjusted basis. Operating expenses, net of pre-offerings related compensation expense, were up 1% sequentially and year-over-year due to higher compensation expense, which I will comment on shortly. Operating expenses, net of pre-offering expense for the year were down 5% compared to the prior year due primarily to lower compensation and third-party distribution expenses. The majority of which vary directly with revenue, offset year increased investments in technology. As previously guided, we continue to invest in technology, to among other things, support our new and existing investment teams with increased data and capabilities.
On slide 11, we’ve broken out compensation and benefits expenses, which comprise close to 80% of our total operating expenses. Compared to the prior quarter, compensation and benefits expenses, excluding pre-offering related compensation expense increased $1.1 million or 1%. Incentive compensation in the quarter increased due to incentive compensation expense associated with the on-boarding of Thematic Team and our Chief Operating Officer of investments.
Equity-based compensation declined in the quarter, following an elevated September quarter due to accelerated awards. Year-over-year, comp and benefits expenses, excluding pre-offering related compensation expense, decreased $15.4 million or 4%. Incentive compensation was down 11% in line with revenues. Equity-based compensation increased as we layered-in the expense for equity grants granted in January of 2016. Our compensation ratio for the quarter and the year was 50% and 49% respectively. The increase from prior periods was primarily a result of lower revenues and increased equity-based compensation expenses, which accounted for about 600 basis points of the 2016 compensation ratio, up from 450 basis points in 2015.
Moving on to slide 12, in the quarter, adjusted operating margin decreased to 35.8% compared to 37.3% last quarter and 39.7% for the prior year quarter, primarily due to the on-boarding expenses discussed earlier and lower revenue levels. For the year, the adjusted operating margin declined to 36.4% from 40.3%, primarily due to lower levels of revenues and the increased investments in our business, which I have already discussed, including equity-based comp, our newest team and technology. Adjusted net income in the quarter was $39.3 million or $0.53 per adjusted share and in the year was $158.7 million or $2.13 per adjusted shares.
On to slide 13, in late-January, we announced that our Board of Directors declared a quarterly dividend of $0.60 per share and a special dividend of $0.36 per share, both payable on February 28, 2017 to shareholders of record on February 14th. Quarterly and special dividends declared in the last four quarters totaled $2.76 per share, a yield of approximately 9.5% based on where our stock price has been trading over the past several days. The $2.76 represented more than the cash we generated from earnings in 2016. The amount declared also includes cash retained from prior year earnings, as well as tax savings after payments under our tax receivable agreements.
With respect to our ability to maintain the $0.60 quarterly dividend, we continue to generate cash in excess of the $0.60 quarterly dividend. Our calculation of quarterly cash generation principally includes the $0.53 per share of adjusted earnings plus the non-cash post-IPO equity-based comp expense.
And, similar to last year and considering the amount of this year’s special annual dividend, we elected to retain approximately $0.25 per share of previously generated cash and TRA related cash savings to cushion against downturns we may experience in levels of AUM and earnings over the next several quarters.
Slide 14 shows our balance sheet highlights. Our balance sheet remains strong with healthy cash balance and modest leverage at 0.6 times. Looking forward to 2017, in the near-term, we expect to continue to see net outflows due to short-term under-performance and some of the structural headwinds we’ve discussed. While these headwinds are real, our long-term record of outperformance in the active strategies we manage, along with our new teams and strategies and global product offerings, position us well to return to growth organically over the long-term.
Specifically, related to comp expectations just a reminder that our comp ratio runs higher in the March quarter of each year due to increased equity-based comp expense from January equity grants and seasonal compensation costs. In January 2017, we granted $1.3 million restricted shares to our employees, which will add approximately $1.2 million in expense to the first quarter of ’17 and $1.7 million in future quarters. Offsetting the incremental equity comp expenses will be the roll-off of approximately $1.5 million of one-time expenses in the fourth quarter related to the on-boarding costs I discussed earlier.
Before I finish up, a couple of points in employee partner liquidity. As you are aware, our employee partners are restricted from selling more than 15% of their pre-IPO equity in any one year period. The one year period resets in the first quarter of each year. After the reset this year, employee partners will have the right to sell in aggregate an additional 2.2 million shares. Combined with the shares that previously became eligible but had not yet been sold, employee partners will hold 3.6 million shares eligible to be sold. They are not required to sell any shares, and we don’t know how many shares they will choose to sell.
That concludes my prepared remarks. We look forward to your questions. And I will now turn the call back to the operator.
[Operator Instructions] The first question comes from Robert Lee at KBW.
I guess my first question maybe C. J. if you could just -- I want to make sure I had it right. The $1.5 million of one-time expenses in Q4 was that -- I believe that was related to Thematic. Is that -- C. J. were you referring to the incremental comp expense?
Yes. Well, on-boarding, you obviously have to bridge the gap of people coming to the firm. So the $1.5 million of additional cost for Thematic was in the fourth quarter, and then our run rate, as the team has built-up, will be about $1.25 million to $1.5 million ongoing per quarter. So, quarter-to-quarter, it's about flat for the Thematic.
Okay, I just want to make sure I had that right. And then thinking about capital management, I believe you do have a tranche of debt that comes due this summer. So, just as you think about cash on the balance sheet and stuff, is it kind of that your current attention to kind of use some of the excess cash to pay down debt, or leave it -- or refinance it. I mean how you’re thinking about that as part of capital management?
I mean we certainly have a lot of flexibility and optionality given our strong balance sheet and the amount of cash that we retained. But given the current markets in favorable environment, most likely, we will refinance the entire $60 million that’s coming due.
And then maybe just one last one, and just kind of more of a big picture. I mean, given a lot of the challenges that, as you pointed out in headwinds, that traditional active managers have faced, particularly in kind of the intermediary and some of the retail channels. I mean, have you -- is there any -- have you thought at all about, that changing fee structures, maybe there has been some talk about to maybe more funds should have full from fees as a way that try to attract more attention. What are your -- any thoughts around that? Or what you’re thinking about, maybe altering some of the pricing constructs, not so that -- if you perform overtime, you are in the same or more fees but in the short-term maybe they give something up?
We think about fees quite a bit obviously, given the environment. We’ve first and foremost just look at the performance and the results we’ve delivered over the long-term. And as we step back and look at the structural trends, as you said a big picture, we look at what’s changing in vehicles one. I mean, just the massive movement of assets to ETF signals, assigned towards the mutual fund structure. And then you saw, last year, a shift of within Artisan of adding the third share class. So, we have three new mutual funds share classes now, and that changed -- shifted assets of close to $10 billion in a 12 month period on the mindset of trying to reduce third-party fees. So, there is scrutiny going on and there need to be more transparency around the total fees structure. But we feel good about the returns that we’re delivering and the management fees that we’re charging.
Next question is from Chris Shutler at William Blair.
Maybe first, could you just talk about the -- I think, Eric, you mentioned third generation strategies you plan to launch in 2017. I know there is the Thematic Team. I’m guessing maybe more from the high income team. So, just anymore details on what the additional strategies could be, or at least what teams?
We certainly see that that shift in preference by clients and in advisors and consultants, looking for more differentiated strategy. And we highlighted that on the call. Clearly, the Thematic Team is front in center there. So, we have a mutual fund in registration for the Thematic Team that we expect to launch by the end of March that will be highly a concentrated, long oriented fund managed by Chris Smith and our new Thematic Team that we’ve built-out.
After we launch that, we are looking into a variety of private funds, or LPs, that were under construct now to bring out in 2017. We don’t have any specific details on launch dates for those, but 2017 looks like a good year to push forward with the couple of teams.
Couple of beyond the Thematic Team…
Thematic Team and one other team for sure, I think, could be a third. We’ll see how we can take those out. But all of our teams are in the mindset of higher degrees of freedom that we mentioned on the last call. And each of the teams are looking to use their talent and their philosophy and their process to add to a differentiated approach to meet client demands.
And then, secondly on the Global Value Team. How much more AUM do you feel like they can take on before you consider closing that again?
The strategies of International and Global Value, and I guess Global Value, in the pooled vehicles we’ve been managing that flow. We’ve been fairly judicious on the inflows. We’re going to continue to manage that. So, I would not expect much asset growth out of those two strategies, or managing capacity there. And so, we’re keeping mindful eye on flows. So, I wouldn’t put much into any big movement in flows there.
And then lastly C.J. just on the expense trajectory in 2017, how should be thinking about some of the more fixed expense line items, so occupancy, tax, G&A, et cetera?
I would say stable to slightly up. The big movements we’ve had over the last couple of years have really been in our technology spend and that -- while it might increase slightly should level off. And then the other expenses should be relatively stable. We are doing a bit of some office build-out, but not major expenses. And we’re largely built out, from an infrastructure standpoint, to feel a good portion of the capacity we have.
The next question is from Bill Katz with Citi.
Thanks very much for taking my questions this morning. I appreciate all the extra color, Eric, particularly just when I think about the cross currents to the industry is very helpful to get that perspective. Just sticking with that theme for a movement, as I still listen to your commentary, it seems like your franchise, it does seem to be a lot of different cost currents, whether it’d be product geography, or distribution line. So, as you look ahead, and is it more of an institutional non-U.S. opportunity that might drive it? Or on the retail side, I guess the corollary is it seems like distributors continue to narrow down the number of players. And if you do the math, I think you said about $30 billion or so of assets with the more traditional retail side. Is that a platform that even with good performance this could be maybe too small to really capture any type of incremental growth? I’m just trying to understand the long-term growth drivers here a little bit.
Certainly, there is quite a bit of cross-currents as we stated. And to hit on your first point, it has been an institutional oriented story. Certainly, last year, with the Global Opportunities and the Global Value strategies, we made good strides outside the United States with long-term oriented institutional clients. We think that really gives us a much longer duration. And at this competitive fee that we’re getting, we think that gives us a really high present value on that client compared to some of the shorter term channels that you look at, even though you’re getting a slightly better fee.
And as we think forward, we’re thinking more and more about the wealth management channel as a whole, globally. And we look at that next generation strategy that differentiates quite a bit from the index, brings in a little bit more risk management. And it more than likely has a strong fit in wealth management, which would be high-end retail family office into the intermediary, and also into the more sophisticated institutional client that fits their asset allocation. And even though the cost capacity might be slightly lower, you pick that up on the fee. So, that’s our mindset over the next few years or longer term, as you said.
Underneath that, I think, high yield comes into a three year track record, if not this quarter, very soon. What some of the pipeline behind that do you think? And then, conversely, are there anything that’s closed right now that might be available to open up more broadly to potentially offset some of the management on the Global Value Team?
The high yield is coming upon it’s to your track record, which gives, usually a tipping point for many advisors. They like to see that three year track record. Fortunately, we’ve had a little bit of a head-start given the history that Brian Krug brought with him at his track record. We believe there is a good institutional pipeline building with advisors and consultants. It's little bit kind of a tail of two stories; so, one side the strong performance of the high yield marketplace of, I think it was 17%, 18% on the index, somewhere around there, is going to attract to quite a bit of people just from the strong absolute performance. Others may look at that and say we’d like to see that reverse a little bit before we more back into the high yields. So, we’ve had mixed interest on those type of clients given the strong last year.
And on closed strategies, the only think we’ve done is we’ve opened up the Mid-Cap Value strategy as we see the performance starting to stabilize and move back in. I think we’re in the early phases of that. We never look at the reopening of a strategy as a way to just attract immediate assets. We think it’s a longer term story. So, that’s the only strategy that has reopened. The rest will manage in a diligent manner.
The next question is from Surinder Thind at Jefferies.
Just to touch based on the DC space. How are you guys thinking about the DCIO opportunity given the challenges in that space, the near-term versus the longer term? I mean, when I look across more broader industry comments, some of your competitors are touting this as a significant opportunity, while it seems you guys are fairly cautious over what I would probably characterize what seems the next couple of years.
I certainly think it’s an opportunity for us. We’ve done very well in the defined contribution market. We expect that the defined contribution market will remain a more sophisticated market with institutional advisors helping to structure those plans. But in the short-run, we continue to see that push towards target date funds that remain closed, or proprietary. And even on top of that have pushed towards passive. I don’t think every plan will move to those, some clearly want the diversification. And on top of that, I think some of the third-party fees are under pressure into that channel.
And the combination of those third-party fees, coupled with the current run on passive results, I just think the opportunity gets pushed out outside of 2017 for a real opening up of defined contribution solutions. We think inevitably it will occur, it happens the first go-around in the 401(k) proprietary model moving to open architecture into the DCIO. And we think it will happen again, it's just timing. And 2017 looks like there is still continued pressure on those plan advisors.
And then just a question about strategy here. When I look at some of the different products that are offered by each of the teams, it appears that there's maybe some meaningful correlation in investment performance between products that are maybe managed by the same team. Specifically, thinking of the U.S. Value Team, the Global Equity Team in this situation. Any color around this? And is it potentially an issue from a sales perspective, or how do you guys think about that?
Our expectation is that it should be highly correlated within teams. For the most part, when you look at across our equity teams, they are all investing in public equities. And they’re all using the exact same philosophy and process. And so, within teams, it’s going to generate a high correlation, and that’s what we expect. And in fact, we’d expect some decent security overlap in some of these teams as well. So, the mindset we have, it’s going to be highly differentiated among the Autonomous Teams to give the firm diversification, but within team, it should remain correlated.
So does that generally present a sales challenge then? So for example, if one of the funds starts to underperform, it seems like the rest of the remaining funds might be underperforming as well. I guess that was the heart of the question here.
It sometimes brings up a sales challenge. But when you really dive into the different indexes, clients and consultants can quickly understand that. So, if you look at the Growth Team, specifically, with the strong outperformance in Global Opportunities and then the under performance in the Mid-Cap Growth and Small-Cap Growth in the short run, it does bring up a question. Then you look at the absolute return of all three strategies over the last five years. And if you look at those strategies, the Mid-Cap Growth strategies at 13%, the U.S. Small-Cap Growth strategies at 13%, and the Global Opportunities is at 14.5%.
So, the factors and the type of companies that they look for are prevalent across all three of the strategies. The real differential is the make-up of the index, and I guess the passive investing, and that’s a whole other topic that I don’t think I want to open-up right now. But we do get back to talking about consistency of these strategies across any team quite frequently.
And then C.J., maybe just a quick question for you. I was a little bit surprised that you guys did top-off the quarterly dividend this year. But I also understand, it sounds like you guys have generally held back about $0.25 to top things off in case there is a shortfall in the quarterly dividend. How are you guys thinking about that reserve level? Meaning that it seems like it's about 10% of the annual dividend. Is that the way you guys were thinking about it? Or are you guys just trying to think about it to make sure that you guys have enough for a couple of quarters, and then there might be an adjustment at that point if there is a meaningful downturn in the markets? Or how should we think about that?
Yes, I mean it's more of the latter. We’ve been covering our quarterly dividend, but not by huge amount. So, the thought process is exactly what you’re suggesting. Let's kick-out enough cash, but reserve a bit that we can go a couple of quarters, not covering the dividend before we would take any action. And so that’s been the general philosophy. And the $0.25, as you can imagine, very subjective and there is no specific science to it.
The next question is from Mike Carrier, Bank of America Merrill Lynch.
Just given the strength in the separate account of inflows this quarter, just wanted to get a sense on the traction that you’re seeing in that area, the business. And it seems like you mentioned some of the international where we've seen strength, but just any traction for the distribution channels?
The primary traction that we have seen is in institutional separate accounts, primarily outside the U.S. with a global orientation. The Global Value, the Global Opportunities, the Global Equity, and more recently even a higher degree of interest in Developing World in Emerging Markets as that asset class pick-ups in performance; all those strategies are very well suited for non-U.S. oriented clients. And we’re getting strong traction there.
And as you can see on our presentation, you saw the differential in flows of U.S. to non-U.S. since the IPO. And so, we continue to see that pick-up. During that period, I think we’ve had an exchange of checks in the intermediary space with the first couple of years been positive and then some rebalancing. There, we just see continued back and forth in the intermediary space. And then as we mentioned long-term DC, we hope that that turns around. But we think that’s unlikely in ’17 and probably pushed out more to ’18, ’19.
And then just within Global Equity, just given some of the flow pressures that we're seeing. Just wanted to get some sense, if you have it, particularly on the non-U.S. growth strategy of the make-up like the clients, because the long-term track record is still -- it remains strong. Obviously, the one and three year is under some pressure. But just maybe how, I don't know, volatile the assets are versus maybe the longer term clients?
That’s been a client base that’s been around for numerous years. Obviously, with the team and strategy being kicked off in ’95 and the fund being launched in ‘96, you can imagine that some of these clients have been around with us for many years. So, we have really good diversification on inception date. And the further you go back and you look at anything past four or five years, I mean the five-year return on the non-U.S. strategy is up 7.5% above the EAFE Index by a full 100 basis points. It really is those shorter term clients under that five year. And when you get into the retail and some of the lower end of the intermediary space, you have a little bit more turnover with shorter duration clients. But the bulk of that asset base is a longer duration book.
The next question is from Alex Blostein at Goldman Sachs.
A question for you guys around some of the new strategies. So, I guess as consider launching different types of products, particularly focused around some of the alternatives. Can you talk a little bit about any incremental infrastructure that you guys would need to build out? So, thinking similar to what you had to do in fixed income a couple years ago. And then it sounds like the launch of these strategies will be later on in ‘17. So, just thinking through the expenses and the build on the expense base to accommodate the new setup into 2018 and beyond? Thanks.
Alex, we’ve been building that out in anticipation of bringing on a Thematic Team and launching hedge funds. And so, we did a lot of that work last year. So, I wouldn’t expect anything material based on what we have on-board today, going forward.
This concludes our question-and-answer session. Would you like to make any closing remarks?
Amy, I think, we’re good. Thank you everybody for joining in the call.
The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.
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