Eaton Vance Corporation (NYSE:EV) Q3 2018 Earnings Conference Call August 29, 2018 11:00 AM ET
Eric Senay - Director of IR
Thomas E. Faust Jr. - Chairman, CEO and President
Laurie G. Hylton - VP and CFO
Patrick Davitt - Autonomous
Ken Worthington - JPMorgan Chase
Michael Carrier - Bank of America Merrill Lynch
Dan Fannon - Jefferies & Company, Inc.
Ari Ghosh - Credit Suisse
William R. Katz - CitiGroup Investment Research
Good morning. My name is Stephanie and I will be your conference operator today. At this time, I would like to welcome everyone to the Eaton Vance Webcast Conference Call. All lines have been placed on mute to avoid any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Eric Senay, you may begin your conference.
Thank you very much. Good morning and welcome to our Fiscal 2018 Third Quarter Earnings Call and Webcast. With me this morning are Tom Faust, Chairman and CEO of Eaton Vance, and Laurie Hylton, our CFO. In today's call, we will first comment on the quarter and then take your questions. The full earnings release and charts we will refer to during the call are available on our Web-site, eatonvance.com, under the heading, Press Releases.
Just a reminder, that today's presentation contains forward-looking statements about our business and financial results. The actual results may differ materially from those projected due to risks and uncertainty in our business, including, but not limited to, those discussed in our SEC filings. These filings, including our 2017 Annual Report on Form 10-K, are available on our Web-site or upon request at no charge.
I will now turn the call over to Tom.
Thomas E. Faust Jr.
Good morning, everyone. Thank you, Eric. Earlier today Eaton Vance reported adjusted earnings per diluted share of $0.82 for the third quarter of fiscal 2018. That's up 32% from $0.62 of adjusted earnings per diluted share in the third quarter of last year and up 6% from $0.77 per diluted share in the second quarter of fiscal 2018. The 32% year-over-year increase in fiscal third quarter adjusted earnings per diluted share reflects 9% higher revenue and an increase in adjusted operating margins from 31.6% to 33.0% and a decline in our adjusted effective income tax rate from 36.9% to 27.1%.
We ended the fiscal third quarter with $453.2 billion of consolidated assets under management. That's an increase of 12% from a year earlier. The year-over-year increase reflects net inflows of $23.2 billion and market price appreciation of $24.4 billion.
In the third quarter, the Company set new highs in terms of quarterly revenue and earnings and ending consolidated assets under management. During the third quarter, Eaton Vance had consolidated net inflows of $3.7 billion, which equates to annualized internal growth in managed assets of 3%. Excluding exposure management, which has lower fees and more volatile flows than the rest of our business, we saw net inflows of $7.4 billion and 4% annualized internal growth in managed assets in the third quarter.
Looking at our organic growth from a revenue perspective, in the third quarter we generated annualized internal growth in consolidated management fee revenue of 5%. Our calculation of organic revenue growth measures the change in consolidated management fee revenue resulting from net inflows and outflows, taking into account the fee rate applicable to each dollar in and out and excluding the impact of market action, adjustments in the fee rates of continuing managed assets, and any acquisitions of managed assets. By this measure, we believe Eaton Vance continues to rank among the fastest growers in the asset management industry.
The key contributor to our continuing strong internal growth is favorable investment performance. As shown on Slide 14 of the Webcast slides, of our mutual fund assets at the end of July, 47% were in funds ranking in the top quartile of their Morningstar category on a three-year basis, 59% in the top quartile on a five-year basis, and 44% top quartile over 10 years. We ended the third quarter with 24 U.S. mutual funds rated five stars by Morningstar for at least one class of shares. During a period in which net demand for active strategies has narrowed, we are fortunate to have high performing funds across a broad range of asset classes.
As we highlighted last quarter, a second key contributor to our strong quarter results is the range of top-performing strategies we offer in investment areas having particular appeal during periods of rising interest rates, such as we are now experiencing.
Consistent with the prior quarter, in the third quarter we had positive net flows across all our investment mandate categories except exposure management. Leading the way was portfolio implementation with net inflows of $3.1 billion. Growth in this category continues to be driven by Parametric Custom Core equity separate accounts which compete against index funds and ETFs on the basis of enhanced tax efficiency and the ability to customize account holdings to reflect client-determined responsible investment criteria and other specified portfolio tilts and exclusions.
Parametric continues to be the market leader in what is commonly referred to as custom indexing. Within Custom Core, in the third quarter Parametric grew in both tax-managed and non-tax-managed applications and across retail, high-net-worth, and institutional markets.
In fixed income, we had $2.7 billion of net inflows in the third quarter. Within this category, the largest contributor was laddered bond separate accounts with $1.7 billion of net inflows. Other leading contributors included high-yield bonds with net inflows of $360 million and mortgage-backed securities with net inflows of $340 million.
Among our line-up of fixed income mutual funds, those positioned to short-duration, short-term, ultra-short, or floating-rate municipal, contributed nearly $550 million of net inflows, led by the five-star rated Eaton Vance Short Duration Government Income Fund. Launched in 2002, Short Duration Government Income recently surpassed $1 billion in net assets and now ranks as one of our top-selling funds.
In the third quarter, net inflows in the Eaton Vance floating-rate bank loan mandates totaled $950 million. Continuing strong net inflows into our industry-leading line-up of floating-rate U.S. mutual funds were partially offset by net withdrawals by institutional investors, primarily from clients located outside the U.S. While some commentators have recently expressed concerns about a potential decline in bank loan market credit conditions, our team remains sanguine believing that there are attractive return prospects available in loans today.
Within equities, third quarter net inflows of just under $500 million were led by EVM growth, Parametric defensive equity and Calvert emerging markets mandates, with Parametric Emerging Markets Strategies accounting for the bulk of net outflows. With our top-performing Eaton Vance Atlanta Capital SMID-Cap Fund now closed to new investors and net demand across most active equity categories remaining quite muted, we are finding that our best opportunities to grow in equities are in specialty products.
In the alternative asset category, third quarter net inflows of approximately $250 million were driven by EVM's global macro absolute return mandates, which dominate this category's managed assets and flows. Our global macro absolute return strategies hold long and short positions in currencies, short-duration sovereign debt, and related instruments of emerging and frontier market countries. Because they invest in both long and short and have limited duration, these strategies have been less exposed to recent declines in emerging and frontier debt markets than the local EM debt indexes. For the year-to-date, the I-share classes of our two U.S. mutual funds following global macro absolute return strategies are down in the range of 1.9% to 4.6% based on total return. With the recent selloff in EM debt markets, these funds have recently moved into modest net outflows.
Our exposure management business had third quarter net outflows of $3.7 billion, in line with the $3.6 billion of net outflows in the prior quarter. As a reminder, this Parametric offering uses financial futures and other derivative instruments to help large institutional investors efficiently manage their equity duration, currency, and other market exposures within their portfolios, with Parametric serving on either a discretionary or non-discretionary basis.
The exposure management outflows we experienced in the third quarter reflect net reductions in active exposures held by continuing clients rather than the loss of clients. Indeed, the number of active exposure management clients we have increased in the third quarter. As we have discussed in prior quarters, fluctuations in exposure management positions held by continuing EM clients are driven by these institutional investors' shifts in investment policy or market outlook, changes in underlying securities holdings, and other portfolio consideration.
While lower-fee and more volatile than our other asset management businesses, we value our exposure management franchise for the close client relationships it affords with many of the foremost institutional investors and the potential for business growth that arises from both new client acquisition and expanded offerings to existing clients.
On an overall basis, we view our broad line-up of high-performing funds and accounts and our leadership in investment strategies that are well-positioned for an environment of rising interest rates as presenting significant opportunities for Eaton Vance to grow in active management, even as the overall market for active management continues to decline. In the third quarter, net inflows into our actively managed funds and accounts totaled $2.7 billion, with positive contributions across equity, fixed and floating-rate income, and alternative categories. This equates to 5% annualized internal growth in active-strategy-managed assets for the quarter.
Our position in responsible investing continues to expand under the Calvert brand and across our affiliates. Since Calvert became a part of Eaton Vance at the end of December 2016, we have made significant progress growing managed assets in Calvert-branded investment strategies and positioning Calvert as the center for excellence in environmental, social and governance research and engagement activities.
Including the Atlanta Capital sub-advised Calvert Equity Fund, assets under management in Calvert strategies have grown from $11.9 billion at the time of the transaction to $14.7 billion at the end of the third quarter of fiscal 2018. The 24% growth in Calvert's managed assets over the 19 months of Eaton Vance's ownership reflects net inflows of $800 million and market appreciation of $2 billion. In the third quarter, Calvert-branded strategies had net inflows of $350 million. This equates to 10% annualized internal growth in managed assets.
Separate from Calvert, Parametric manages over $21 billion of AUM based on client-directed responsible investment criteria, with these assets held in more than 2,000 Custom Core and other Parametric-managed separate accounts.
Combined, we believe Eaton Vance is today one of the largest players in responsible investing, a position we are committed to growing in conjunction with the surging demand for investment strategies that incorporate ESG-integrated investment resorts and/or that are managed with the dual objective to achieve favorable investment returns and positive societal impact.
Turning to our NextShares initiative, the number of NextShares funds in the market expanded to 18 during the third quarter, with offerings from Eaton Vance, Calvert, and six other fund families now available. Expected benefits to fund performance from use of the NextShares structure are being demonstrated and NextShares' novel NAV-based trading mechanism continues to function smoothly.
Commercially, our progress growing NextShares' assets under management continues to be slow, with sale success still hampered by very limited distribution access. Despite UBS' commitment to supporting NextShares at our initial launch in last November, sales of NextShares through UBS financial advisors have to date been quite modest. Our biggest challenge is that NextShares are available for purchase at UBS only through brokerage accounts and through their Strategic Advisor non-discretionary advisory platform. Without access to UBS' substantially larger and more broadly appealing discretionary advisory program, known as the Portfolio Management Program or PMP, it has been difficult for us to gain the necessary attention of UBS financial advisors to achieve meaningful sales.
Given the slow progress at UBS, over recent weeks we have redoubled efforts to pursue other paths to commercialization. Where this leads is hard to say. We are open to a variety of arrangements but we'll be guided by our obligation to act in the best interest of Eaton Vance shareholders.
In closing, I want to congratulate my 1,700 colleagues on the strong business, financial, and investment results achieved in the third quarter, and express my optimism for the Company's continuing success. The momentum our business continues to enjoy reflects the range of high-performing investment strategies we offer that are well-positioned for the current market environment, the broad and growing appeal of specialty strategies and solutions we provide, and the strong distribution and client service delivered by our sales and marketing teams. Longer-term, I remain confident that Eaton Vance has the people, culture, resources, and capital structure to support continuing success as the asset management industry evolves.
That concludes my prepared remarks and I'll now turn the call over to Laurie.
Laurie G. Hylton
Thank you, Tom, and good morning. As Tom mentioned, we reported adjusted earnings per diluted share of $0.82 for the third quarter of fiscal 2018, an increase of 32% from $0.62 of adjusted earnings per diluted share in the third quarter of fiscal 2017 and an increase of 6% from $0.77 of adjusted earnings per diluted share reported in the second quarter of fiscal 2018.
As you can see in Attachment 2 to our press release, GAAP earnings exceeded adjusted earnings by $0.01 per diluted share in the third quarter of fiscal 2018 to reflect the reversal of $1.3 million of net excess tax benefits recognized from the exercise of employee stock options and vesting of restricted stock awards during the period.
In the third quarter of fiscal 2017, adjusted earnings exceeded GAAP earnings by $0.04 per diluted share, reflecting $5.4 million of costs associated with retiring the remaining $250 million aggregate principal amount of our 6.5% senior notes that were due in October 2017 and $3.5 million of closed-end fund structuring fees paid during the quarter. In the second quarter of fiscal 2018, GAAP earnings exceeded adjusted earnings by $0.01 per diluted share to reflect the reversal of $1.9 million of net excess tax benefits recognized from the exercise of employee stock options and vesting of restricted stock awards during the period.
Adjusted operating income, which excludes the closed-end fund structuring fees paid in the third quarter of fiscal 2017, increased by 14% year-over-year and 7% sequentially. Our adjusted operating margin was 33% in the third quarter of fiscal 2018 versus 31.6% in the third quarter of fiscal 2017 and 32% in the second quarter of fiscal 2018. Our adjusted operating margin for the first nine months of the fiscal year improved from 31% in 2017 to 32.4% in 2018.
Tom noted, this was a record quarter for Eaton Vance in terms of managed assets, revenue, and net income, both on a U.S. GAAP and adjusted basis. Ending consolidated managed assets of $453.2 billion at July 31, 2018 were up 12% year-over-year and 3% sequentially, driven by strong net flows and positive market returns. Average managed assets in the third quarter of fiscal 2018 increased 13% from the third quarter of fiscal 2017, driving a 10% increase in management fee revenue.
Growth in management fee revenue trailed growth in average managed assets year-over-year due to a 2% decline in our average management fee rate from 34.2 basis points annually in the third quarter of fiscal 2017 to an annual rate of 33.5 basis points in the third quarter of fiscal 2018. This decline in our average management fee rate is primarily attributable to the shift in our business mix over that period as lower fee portfolio implementation and bond ladder businesses grew as a percentage of our assets under management.
Average managed assets in the third quarter of fiscal 2018 increased 1% versus the second quarter of fiscal 2018. When combined with the 1% increase in our average annualized management fee rate and the impact of three more fee days in the third quarter, this drove a 4% increase in revenue. Sequentially, our average annualized management fee rate increased to 33.5 basis points in the third quarter of fiscal 2018 from 33.3 basis points in the second quarter of fiscal 2018.
Performance fees, which are excluded from the calculation of our average management fee rate, reduced income by $0.4 million in the third quarter of fiscal 2018, contributed $0.5 million in the third quarter of fiscal 2017, and were a negative $0.5 million in the third quarter of fiscal 2018.
As Tom noted, in the third quarter of fiscal 2018, our annualized internal growth and management fee revenue of 5% outpaced our annualized internal growth and managed assets of 3%, primarily reflecting the impact of net inflows into higher fee strategies during the quarter. This compares to 6% annualized internal growth in management fee revenue on 9% annualized internal growth in managed assets in the third quarter of fiscal 2017 and 7% annualized internal growth in management fee revenue on 4% annualized growth in managed assets in the second quarter of fiscal 2018.
Turning to expenses, compensation increased by 7% from the third quarter of fiscal 2017, primarily driven by hiring, a modest increase in benefit cost, and an increase in operating income and performance based bonus accruals and stock-based compensation, partially offset by a decrease in sales-based incentive compensation. Sequentially, compensation expense increased by 3% from the second quarter of fiscal 2018, primarily reflecting higher salaries associated with increases in headcount and the impact of three more payroll days in the third quarter, higher stock-based compensation associated with employee retirements and other terminations, and an increase in operating income based bonus accruals, partially offset by lower sales-based incentive compensation and a seasonal decrease in payroll taxes and benefits.
Non-compensation distribution related costs, including distribution and service fee expenses and the amortization of deferred sales commission, decreased 2% from the same quarter a year ago and increased 3% sequentially. The year-over-year decrease primarily reflects lower marketing and promotion cost and $3.5 million of closed-end fund structuring fees paid in the third quarter of fiscal 2017, partially offset by higher commission amortization for private funds and an increase in intermediary marketing support payment, mainly driven by higher average managed assets. The sequential quarterly increase primarily reflects higher distribution and service fees, driven primarily by an increase in average managed assets in share classes that are subject to these fees and the impact of three more days in the quarter.
Fund related expenses increased 13% from the third quarter of fiscal 2017 and were up 3% over the second quarter of fiscal 2018. The year-over-year increase primarily reflects higher fund subsidy accruals and sub-advisory fees, driven by asset growth in affected strategies and an increase in fund expenses borne by the Company on funds for which we earn an all-in fee, partially offset by the $1.9 million in fund reimbursements made in the third quarter of fiscal 2017 that were one-time in nature. The sequential quarterly increase primarily reflects an increase in fund subsidy accruals.
Other operating expenses increased 10% versus the third quarter of fiscal 2017 and decreased 2% from the second quarter of fiscal 2018. The year-over-year increase primarily reflects higher information technology spending and facilities expense, partially offset by lower travel and other corporate expenses. The sequential quarterly decrease primarily reflects lower facilities, professional services and travel expenses, partially offset by an increase in information technology spending. We continue to focus on overall expense management and identifying ways to gain operational leverage.
Net gains and other investment income on seed capital investments contributed $0.01 to earnings per diluted share in each of the comparative quarterly periods presented. When quantifying the impact of our seed capital investments on earnings each quarter, we take into consideration our pro rata shares of gains, losses and other investment income earned on investments in sponsored strategies, whether accounted for as consolidated funds, separate accounts, or equity method investments, as well as the gains and losses recognized on derivatives used to hedge these investments. We then report the per share impact net of income taxes and net income attributable to non-controlling interests. We continue to hedge the market exposures of our seed capital portfolio to the extent practicable to minimize the associated earnings volatility.
Net gains and other investment income in the third quarter of fiscal 2017 included a $5.4 million loss on extinguishment of debt incurred in connection with retirement of $250 million in aggregate principal amount of the Company's 6.5% senior notes which were due in October 2017. We excluded this one-time charge from our calculation of adjusted net income and adjusted earnings per diluted share for the third quarter of fiscal 2017.
Non-operating income/expense in the third quarter of fiscal 2018 included $1.2 million of net expense allocation from consolidated CLO entities versus $0.8 million of net income contribution from consolidated CLO entities in the second quarter of fiscal 2018. The Company did not consolidate any CLO entities in the third quarter of fiscal 2017.
Our effective tax rate for the third quarter of fiscal 2018 was 26.2% versus 36.9% in the third quarter of fiscal 2017 and 26.7% in the second quarter of fiscal 2018. The Company's effective tax rate for the third and second quarters of fiscal 2018 reflect net excess tax benefits of $1.3 million and $1.9 million respectively related to the exercise of stock options and vesting of restricted stock awards during those periods. New accounting guidance adopted in the first quarter requires these net excess tax benefits to be recognized in earnings.
Shown on Attachment 2 to our press release, our calculations of adjusted net income and adjusted earnings per diluted share remove the effect of the net excess tax benefits recognized in the third and second quarters of fiscal 2018 in connection with the new accounting guidance. On this basis, our adjusted effective tax rate was 27.1% and 28.2% in the third and second quarters of fiscal 2018 respectively. On the same adjusted basis, we estimate that our effective tax rate for the fourth quarter of fiscal 2018 and for the full fiscal year as a whole will range between 27.25% and 27.75%, and our fiscal 2019 effective tax rate will range between 25.3% and 25.8%.
During the third quarter of fiscal 2018, we used $35.3 million of corporate cash to pay quarterly dividends of $0.31 per share and repurchased 1.4 million shares of non-voting common stock for approximately $76.6 million. Our weighted average diluted shares outstanding were $122.7 million, up 5% year-over-year and down 1% sequentially.
We finished our third fiscal quarter holding $820.7 million of cash, cash equivalents and short term debt securities and approximately $390.8 million in seed capital investments. This compares to outstanding debt obligations of $625 million. We continue to place high priority on using the Company's cash flow to benefit shareholders. Even as we support strong business growth, we've maintained significant financial flexibility.
This concludes our prepared comments, and at this point we'd like to take any questions you may have.
[Operator Instructions] Your first question comes from Patrick Davitt with Autonomous Research.
Last quarter you gave us some helpful kind of specific guidance on how the flow outlook was for the current quarter, how pipelines were looking. Any chance you could update that same disclosure and kind of talk about the trend through the quarter?
Thomas E. Faust Jr.
So, just a little bit we can say about flow outlook and in significant parts of our business we don't have a lot of visibility. Most of the retail business, you don't have a real good lens. We know current trends. In places where we do have visibility, it's primarily on the institutional side. I guess one thing I would highlight is we have a one not-funded pending high-yield mandate which we expect to fund in the high hundreds of millions of dollar range that's pending. That's probably the most significant thing I would point to in terms of significant inflows other than the Parametric Custom Core and exposure management business where we have quite a strong backlog for new business that's coming in, again in a similar magnitude. Laurie, anything you want to add on that?
Laurie G. Hylton
No, I think those would be the most significant inflows that we have identified in the pipeline.
Great, thanks. And then to that last point, any update on the non-U.S. opportunity for both exposure management and portfolio implementation? I think few quarters ago you had mentioned your first non-U.S. mandate in one of those, so I was just hoping for an update there.
Thomas E. Faust Jr.
Yes, that was probably an exposure management. I would say it's been relatively slow. We continue to grow in both. Those are both Parametric businesses. The biggest market for them in exposure management and portfolio implementation is in Australia where we have what we call Centralized Portfolio Management offering there. Business there is stable. It's an elephant-hunting business. Not a lot of visibility to new business growth but also a steady stream of ongoing business there.
Your next question comes from Ken Worthington with JPMorgan.
I apologize if I missed this. Exposure management had outflows for the second quarter in a row. Just maybe what's happening here both on the sales side and the redemption side?
Thomas E. Faust Jr.
I had a couple of comments about that, but I'll just review those. So we had a net gain in client. I think we were net up two clients I think or up a net four clients on a base of something like 200 I think. So, the business is growing modestly from the perspective of the number of clients with whom we have relationships. So, essentially all of the decline in assets in this quarter were due to reductions in outstanding balances with existing clients. And that can be driven by several things.
So, remember what this is. This is an overlay service where if a client wants say 63% equity exposure and their underlying managers have 61% equity exposure, they can add 2% synthetically through Parametric using derivatives. Most commonly, exposure arrangement is used to equitize cash positions but it can also be used on a transition basis to add or subtract exposure to different parts of the market. Increasingly we're finding that as investors are moving to immunize their fixed income portfolios, there is an increasing role for exposure management in managing the duration of their portfolios to match their liabilities.
Overall we think this continues to be a growth business for us. There is a fair bit of volatility. We've had two straight quarters now of negative $3.6 billion and negative $3.7 billion of outflows. Our history over time has been balances with existing clients over time grow but that's with fits and starts and we've certainly seen that over the last couple of quarters.
So, nothing fundamental that we can really point to and say the business has changed or there's any reason to think that the negative trends in terms of flows over the last couple of quarters is going to continue. In fact, I believe for the quarter to date we're in the positive territory. So we're hopeful this will return to being a growth business in the sense of flows. We know it's a growth business in terms of the number of clients we're serving.
On ETMFs, you had been talking about the potential for the UBS relationship for a number of quarters. Is what you kind of mentioned on the call, the more limited access to the financial advisors, like why is that a surprise, has something maybe changed more recently in this relationship or was it always designed to have sort of that limited access to the UBS advisor?
Thomas E. Faust Jr.
So just a little bit of review, so we in I think July of 2016 we announced an agreement to gain distribution access at UBS. In November of 2017, we launched our first product at UBS, first NextShares products at UBS, and have been slowly rolling things out ever since. There is a process that UBS has imposed where every fund had to go through internal due diligence. I think essentially that process is mostly done for – it is done for all the Eaton Vance products, and I think for the non-Eaton Vance products it's mostly done.
There is a requirement also that each financial advisor to sell NextShares had to take an exam or a quiz. I think it's about a half-hour test you have to take to do that, to ensure that they have working knowledge of the product structure. So, we've had some progress there. It's been frustrating that we haven't had more advisors doing this, but in the absence of distribution access through the right platforms, it hasn't been particularly compelling for advisors to sign up for this exam and to take the exam.
But the biggest issue, the one that I highlighted in my prepared remarks, is that today we're only approved in brokerage and we're only improved in Strategic Advisor, and Strategic Advisor is a discretionary advisor program, meaning that – sorry, non-discretionary program, which means that when a financial advisor wants to make a trade or make some change in the portfolio on behalf of the client, the advisor needs to go to the client and get consent to make that trade, so there's not a discretion to the financial advisor, and it's called Strategic Advisor at UBS.
The larger program at UBS, called PMP, is their discretionary advisory program where financial advisor has full discretion to buy or sell within the limits of the account guidelines on behalf of the client without having to get the consent to every trade.
Relatively recently we have learned that there are rules there in the program that UBS has imposed that will make it more difficult for us to gain access there. In particular, there's a requirement that no more than X percent, don't know what that number is exactly, but there is some percentage threshold that they are not willing to own of any fund, NextShares or otherwise, in that program. So it makes it very hard for us to use PMP as a way to jumpstart this business, which about two years ago we would have hoped that this program would have been available to us, but it turns out that for reasons largely relating to internal legal regulatory judgments that they have said that for NextShares, for any ETF, or any mutual fund, that they can't own more than a certain percent of a fund.
And so that wasn't designed to address NextShares but it had the effect, because we don't have broad distribution elsewhere, of limiting our ability to grow in NextShares at PMP, and PMP will largely drive the success of NextShares in total of UBS. So, it was not good to learn of this policy change at UBS over the last really couple of months we've been hearing this.
Got it, okay. I think I understand better. Thank you very much.
Your next question comes from Michael Carrier with Bank of America Merrill Lynch. Please go ahead.
Maybe one just on operating leverage and the margins, so given that you guys have been able to put up the positive flows, the organic revenue growth has also been favorable and you've got the markets as a tailwind, and I know you guys have been making ongoing investments, but when you look at maybe the year-over-year like operating leverage that we've been seeing in that 140 basis point range, when we think about going forward, is there anything that we should be thinking about that should either limit that or accelerate that as we look over the next call it 12 to 18 months?
Laurie G. Hylton
I wouldn't think so at this point. I don't think that there's anything that's going to push that around a lot. I think, to your point, net flows are wonderful. They are a high-quality problem. They do put pressure on margin because there are immediate point-of-sale costs associated with it. To the extent that we continue to see strong inflows and have to pay for that, it will put pressure, but the rest of fundamentals of the business really have not changed. And I think as we file our Q and you are able to see a lot of the detail on the expenses, you're going to see that the relationships have been hanging together and there really haven't been any significant changes.
Okay, got it. And then Tom, maybe just one, this is kind of bigger picture, but just when I think about like the growth avenues going forward, you guys have made some investments for international distribution and that would be like a longer-term kind of avenue of growth, obviously NextShares is one of those, but it sounds like depending on how this UBS relationship pans out and then if you can have other wins, you guys will make a decision on different paths to go on. But I just wanted to try to get – because if I look at the net flows that you are putting up, relative to the industry you are already doing well, but when I think about maybe other kind of like avenues that you guys have been making investments, where can some of the future growth come from that maybe we're not already expecting?
Thomas E. Faust Jr.
I think there are a number of future growth paths. I mean I'll tart with bank loans which has been a big source of growth for us in the last couple of years. In the U.S. mutual fund market, we are I believe the largest, if not one of the two or three largest, I think we're number one in terms of total assets in mutual fund bank loan funds. I think this is a business that can continue to grow for us for quite some time. We're in an environment where short-term rates are moving up. We're in an environment where credit conditions continue to be pretty benign. We've been blessed with very strong performance across our bank loan products. I think we have two five-star rated funds. So we're I believe the market leader, if not a market leader, in the U.S. retail space, and I think the positive flow dynamic that we've seen there will continue.
Other things I would point to in terms of growth avenues for us are really the whole Parametric business, starting with Custom Core, their tax-managed separate account index-based strategy business. We're at a revenue level of I think it's about $140 million or so for that business. I think there's, if we can do this the right way, I think there's a chance for that to become a business that's multiple the current size. The value add versus pure passive index funds and index ETFs is quite clear in terms of tax, the benefits in terms of customization, to provide better alignment with personal values or to better fit with other investments that a person has, and to be able to deliver that at a price point that's quite competitive versus index type offerings. I think there is tremendous upside potential for that business.
I think more broadly across the Parametric platform of implementation and exposure management businesses, we see lots of room for growth across that franchise using their ability to efficiently implement portfolios of all kinds of different flavors, index-based, non-index-based, single index, multiple index, tax-managed, non, responsibly invested, otherwise, we see lots of opportunities for growth.
The third thing I would mention is just the general area of responsible investing, both in the customized separate account world as done by Parametric and through Calvert. This is an industry where there's huge demand and no obvious market leader and we think we can be that or we can become that with a range of offerings, led by our Calvert brand but also including customized strategies offered through Parametric. I think this can be a much bigger part of the asset management business and I think Eaton Vance is in a position potentially to lead that.
Your next question comes from Dan Fannon with Jefferies. Please go ahead.
Tom, you had mentioned in your prepared remarks that within equities the best opportunity you see for growth is in specialty products, and that's not surprising given some of the industry trends. I guess as we think about your current mix and what that would mean just in terms of profitability or fee rate as we think about going forward with Calvert and Parametric and some of the various kind of products that would fit that category, how should we think about the trend in fee rate as a result of that?
Thomas E. Faust Jr.
I don't think there should be a big change in the fee rate. Some of the specialty products that we have in mind are relatively high-fee, some of the products are relatively low-fee. One of the drivers of that business has been the Parametric defensive equity strategy, which is a derivative-based strategy, which is relatively low-fee. I think it's in average in the 30 range, 35 range. As that grows, maybe that pulls down fee rates a bit. We also offer some specialty tax-managed equity strategies that tend to be at higher than average fee rate. So I think the blend of the two is probably positive.
We do have I should say add in the realm of equities, we have a good relative performance here across our line-up of equity strategies; growth, value, core. Across asset classes, generally we're ahead of benchmark, generally we're ahead of peer group.
We have a team of global equity analysts and portfolio managers based primarily in London that joined Eaton Vance just about three years ago and they have some strategies there that are hitting their three-year performance mark, particularly on the small-cap side, small-cap global and small-cap international. We're hopeful or optimistic that over the next 6 to 12 months we can see significant flows there for strategies that are at the higher end of our average fee rate for equities.
Got it. And then I guess, Laurie, as a follow-up on just expenses and kind of outlook for margin, I guess anything in the quarter one-time that we should be thinking about that what have you just kind of normalizing for next quarter and going forward that you would highlight? And then given the beta that we've seen thus far just to start kind of your last fiscal quarter, anything that would kind of derail kind of continued margin expansion?
Laurie G. Hylton
No, this was an incredibly clean quarter from an expense perspective. So, I wouldn't identify anything as a one-time item that would be worthy of note. I don't think that there is any impediment to margin expansion outside of the fact that there are obviously a number of different components that are going to factor in. And as I mentioned, we're obviously experiencing significant growth in our flow story and it's a quality problem but there are costs associated with it because everything on the retail side obviously is point-of-sale, so in terms of our incentive compensation. But I don't see anything that would necessarily represent an impediment to growth over time. It's just going to be the mix of things that happen in the course of the quarter.
Got it. Thank you.
Your next question comes from Ari Ghosh with Credit Suisse. Please go ahead.
Could you remind us of the size of your international AUM, is this primarily still the fixed income business out of Germany and Asia at this point? And then perhaps related, as you think of potential M&A opportunities, is the main consideration adding product scale or is that more towards increasing your footprint in any key non-U.S. markets?
Thomas E. Faust Jr.
So, in terms of AUM in our international business is about 6% of the total. Maybe somebody here is looking to pull up the number, but…
Laurie G. Hylton
So, $25 billion roughly.
Laurie G. Hylton
Yes. That's 6%.
Thomas E. Faust Jr.
Biggest single market is Japan, representing maybe slightly less than half of that. Australia would be probably the second biggest market. We have been adding – growing distribution presence in markets outside the United States. We have about 50 people in London. Roughly half of those are on the sales and distribution side. Roughly half of those are asset management. I think you might be referring to earlier this year we did a transaction or we took on a team, I should say, based in Frankfurt that added about I think $600 million to $700 million in managed assets in fixed income.
The mix of our assets outside the United States is, as your question suggests, I think is primarily on the income side. We have a well-established business in bank loans, particularly in Japan. As we think about growing further outside United States, I would say, big picture, to me it doesn't feel like the right ratio to have only about 6% of our business represented by the 95% or so of the world's population that lives outside the United States. So, probably not the right balance.
We need to grow primarily I would say on the distribution side. We feel like we've made good progress in developing a range of really global investment capabilities, highlighted I would say by our global income capabilities and our range of emerging market strategies offered through Parametric and now also through Calvert. We are interested in and open to ways to jumpstart our business outside the United States, including potentially on a transaction basis. We certainly look at properties that become available outside of the United States with the goal to jumpstart that. But the main thing we're looking for more than anything else is a bigger distribution platform outside of the United States. We think we've got largely the product that we need to be successful around the world.
Got it, very helpful. And then just back to NextShares and comments around new efforts that you are doing right now, is this in the form of new distribution platforms that you are in talks with, or is there a way you could license or sell the NextShares IP, and are there any internal targets that you have before you consider maybe like shortening the initiative or removing the earnings drag which I believe is around $8 million a year? I'm just trying to get a sense of the different options that's under consideration here.
Thomas E. Faust Jr.
So, I think our current spending in the most recent quarter was about $2 million. So, your $8 million a year estimate is accurate. We have been able to pull that down a bit. So the run rate I think is more in the range of $5 million to $6 million we'll say. But we need to figure out what we're going to do here. As you pointed out, one of the options would be to shut it down. If no one wants to buy NextShares, we don't want to spend $5 million or $8 million a year.
We think we have something of value here. We've spent a lot of time and effort developing this. This remains the only approved, less than fully transparent active exchange traded product structure approved by the SEC. It's performing in the marketplace. It's trading well. We have I think six or seven different partner firms that are up with product in the market. But we haven't been able to sell anything and the reason we haven't been able to sell anything is because we don't have distribution access. If we could maybe wave a magic wand and make that problem go away, we would, but that's the world we live in.
How we break through that is the challenge at hand. Is there something we can do in partnership with some other financial organization, either another asset manager or potentially a distributor that would break that logjam and distribution access, that's what we're focusing on. But at the end of the day, we're going to decide what to do based on what's best for our shareholders, and if that means continuing to invest in a significant way or it means moving down to a lower-level spending or it means declaring that this thing isn't going to work, we're going to make that determination based on ultimately what good it does for the Eaton Vance shareholder.
Got it. Thank you very much.
Your next question comes from Bill Katz with Citigroup. Please go ahead.
William R. Katz
So just coming back to the spending outlook, Laurie, as you think about the next 12 to 24 months, are there any big picture projects coming down the pike that could otherwise absorb some of the incremental margin opportunity that you highlighted?
Laurie G. Hylton
Nothing that's outside of things that we're already doing today. I think that we have referenced on previous calls that we are engaged in some larger scale technology projects. We haven't called those out separately and I wouldn't intend on doing that now, but we have been standardizing some platforms on the investment management side and I would anticipate we're going to continue to have like projects, whether it's in Boston at Eaton Vance or whether it would be in Seattle at Parametric. So I wouldn't anticipate that you're going to see a sudden spike as I think the spend has been continuous.
I think that we have noted in the past, we continue to invest in the business. Not that we are immune to being mindful of margin, but we do recognize that in order to be a growth company and have a scalable platform, we have to continue to make those investments, and we don't view those as being outside the ordinary course of business. So, no, I don't say that I would call anything out specifically, but I also would not anticipate that we would see a diminishing in our spend in technology and platform scalability projects anytime soon.
Thomas E. Faust Jr.
I might add that one other area that I would say that's an area of focus that certainly involve some spending is the technology underlying Calvert and more connecting the Calvert research process to the Eaton Vance fundamental analysts is an ongoing project that we'll be spending more money on over the next year or so.
William R. Katz
Okay. And then just, Tom, for you, or maybe Laurie, you've mentioned that you're still sort of prioritizing your capital to the benefit of shareholders. Could you sort of walk through how you sort of think about that today, where the stock as trading particularly at today's reaction? Seems like you're drawn pretty close to the end of your existing buyback authorization. Maybe sort of tick off your sort of top two or three priorities as we look at over the next several quarters.
Thomas E. Faust Jr.
I will say they remain the same. There's only so much, so many different categories, the things we can do with our cash. We can pay dividends and look to expand our dividend rate, which we have evaluated annually typically in conjunction with our October meeting. So we'll be making a decision there at our next Board meeting. Share repurchases, we've been active, we have not historically been constrained by current authorizations because we've been able to get those reauthorized so that doesn't interfere.
We can invest in our business through seed capital, and we have a pretty large seed capital portfolio, we don't see any particular call on that near-term. And we can do acquisitions. You may recall, at the end of 2016 we bought Calvert which was we think a very good purchase for us both financially and even more so strategically, really putting Eaton Vance in a position to emerge as the leader in responsible investing.
So, we feel like over time our record of growth through acquisitions has been quite good. The Eaton Vance as it exists today would be a very different company if we had not acquired Parametric in 2003, Atlanta Capital in 2001, Calvert in 2016, and assorted other acquisitions along the way.
We will probably not be the high bidder if there's an auction for property. That doesn't tend to be our style. But if we can find something that strategically makes sense, helps us meet our goals, and is attractive at a price, that can certainly be a call on corporate capital. We have a lot of liquidity on balance, we think that's a good thing, and we're certainly committed to using that to the benefit of our shareholders.
William R. Katz
Thank you for taking the questions today.
We have time for one more question.
Your next question comes from Brian Bedell with Deutsche Bank. Please go ahead.
This is actually [indiscernible] for Brian Bedell. So just really going back to the flows for a second, there seems some strong flows in fixed income over the past few quarters. I was wondering if you could just give a little more detail on the drivers behind that including by product and distribution channel.
Thomas E. Faust Jr.
Sorry, it's a little hard to hear you. So, the key drivers of our growth in fixed income over recent quarters by product and distribution channel, I think you said?
Thomas E. Faust Jr.
Okay. And just to be clear, are you including bank loans in that or not?
No, but both would be helpful.
Thomas E. Faust Jr.
Okay, all right. So, the biggest single driver of our flows into fixed income over the last several quarters have been laddered bond separate accounts, which are both municipals and corporate. In the quarter we had positive flows in high-yield, we had positive flows in mortgage-backed securities, we had the laddered business was positive. Calvert, which became part of Eaton Vance at the end of 2016, has a nice portfolio of fixed income business which is on balanced, have been growers. So, most of all of our munis outside of the ladders have been modest growers. Core fixed income outside of the short-duration strategies haven't really done a whole lot.
So, I would say it's been primarily, in recent quarters it's been primarily high-yield, it's been mortgage-backed securities, and it's been ladders, the laddered bond separate accounts sold to the retail market that have been the primary drivers.
And if you want to look at it by channel, I mentioned that we have a large high-yield mandate, part of which is already funded, part of which is coming in the next quarter. That was noticeable in the current quarter on the institutional side. The balance was primarily in retail strategies, either funds or separate accounts.
Okay, I think that concludes our call for today. Thank you very much and we look forward to speaking with you soon. Thank you.
Thank you. This concludes today's conference call. You may now disconnect.