Manning & Napier, Inc. (NYSE:MN) Q4 2020 Results Conference Call February 9, 2021 5:00 PM ET
Nicole Kingsley Brunner - Chief Marketing Officer
Marc Mayer - Chief Executive Officer
Paul Battaglia - Chief Financial Officer
Good evening. My name is Erica, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Manning & Napier Fourth Quarter 2020 Earnings Teleconference. Our hosts for today's call are Nicole Kingsley Brunner, Chief Marketing Officer; Marc Mayer, Chief Executive Officer; and Paul Battaglia, Chief Financial Officer.
Today's call is being recorded and will be available for replay beginning at 8:00 p.m. Eastern Time tonight. The dial-in number is 404-537-3406 and the PIN number is 8297218. At this time all participants have been placed in a listen-only mode. [Operator Instructions]
It is now my pleasure to turn the floor over to Ms. Nicole Kingsley Brunner.
Nicole Kingsley Brunner
Thank you, Erica, and thank you, everyone, for joining us today to discuss Manning & Napier's fourth quarter and full year 2020 results.
Before we begin, I would like to remind everyone that certain statements made during this call not based on historical facts, including any statements relating to financial guidance, may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Because these forward-looking statements involve known and unknown risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements.
Manning & Napier assumes no obligation or responsibility to update any forward-looking statements. During this call, some comments may include reference to non-GAAP financial measures. Full GAAP reconciliations can be found in our earnings release and related SEC filings.
With that, I will turn the call over to our Chief Executive Officer, Mr. Marc Mayer. Marc?
Thank you, Nicole. There are three main points we would like to make. One, we have made good progress on our strategic initiatives; two, that progress has translated into excellent results for clients, and an improvement in our financials; and three, our improved financial position will allow us to return capital to our shareholders.
Paul and I will elaborate on each of these. But we will begin first, as we always do, and as we always should, as fiduciaries, with a review of our results for clients in both the fourth quarter and full year.
Let's begin with our traditional multi-asset class solutions as they represent approximately 70% of total AUM, have track records dating back to the early 1970s and are core to who we are as an active, fully integrated wealth and investment manager.
Our fourth quarter multi-asset class results were competitive with modest underperformance and more aggressive objectives and slight outperformance in the more conservative strategies. Broadly speaking, our small overweight to equities and a very strong quarter for global stocks compared to our blended benchmarks, helped overcome some underperformance within our equity portfolios in the quarter.
We are pleased to have helped clients strongly participate in the end of the year equity market rally. Our disciplined approach to dynamic asset allocation and risk has since led us to reduce the substantial overweight to equities that we had in place in the late spring and summer of 2020.
For the full year, our traditional multi-asset class strategies delivered significant outperformance versus benchmarks across all risk-based objectives. Our strong performance was a result of a combination of timely asset allocation adjustments during the first half of the year as well as excellent sector positioning and security selection decisions.
Most importantly, our time-tested disciplines in both security selection and asset allocation helped us deliver meaningful downside protection during the equity and credit market sell-off at the beginning of 2020.
Then subsequently, we adopted portfolios to the rapidly changing environment, allowing us to substantially participate in the sharp equity market rally since the end of March. Our long-term growth strategy is a globally diversified portfolio of stocks, bonds and REITs that is also available as our Pro-Blend extended mutual fund.
It represents our single largest pool of assets and was up 18.7% for the year, net of fees, slightly ahead of the S&P 500. Notably, it delivered those results with half the risk of the S&P 500.
Our traditional multi-asset class strategies are the heart of our investment solutions for our wealth management clients. The strong absolute returns, moderate risk level, the nature of the performance pattern and the advice we provided helped our clients stay on track during such an unusual year.
2020 was an important year in demonstrating our wealth management value proposition. As you may recall from prior quarters, 2020 coincided with the 50-year anniversary of our firm, making it a propitious time to look back upon what we have achieved over our first half century.
From an investment standpoint, one of our most differentiated characteristics is that we have a very low fully audited performance track record for our flagship strategies, dating back to 1973. This is exceptionally rare in the wealth management business with the vast majority of financial advisers and RIAs who employ open architecture cannot quote the results they have delivered for clients.
Over 47 years, long-term growth returned 10.4% net of fees, virtually identical to the S&P 500's 10.6% written over that time frame. Although, as just noted, our dynamically allocated portfolio is globally diversified and balanced among asset classes, consequently, it delivered equity market like returns with 30% less risk dating to inception almost half a century ago.
It's important to note that we do not target specific absolute or relative risk levels. In fact, we think the most important measure of risk is the permanent loss of capital. Most of our clients make systematic withdrawals from their portfolios, whether it is individuals, paying taxes or spending in retirement, pension funds paying retirement benefits or endowments and foundations supporting good causes.
The need to withdraw funds, often regardless of capital market results can crystallize losses during severe downturns. This is a form of permanent impairment because it precludes subsequent compounding on those assets as markets recover. All else equal, lower volatility portfolios reduced the risk of this occurring.
Putting risk return statistics into something more meaningful for our clients, $100,000 invested in our long-term growth strategy in 1973 would have grown to approximately $8.3 million today. A client in 1973, who had invested $100,000 in our second largest strategy by AUM growth with reduced volatility, which dynamically allocates around a 40-60 stock bond mix would have $5.8 million today.
Turning back to our 2020 results, the excellent full year performance of our multi-asset class strategies was also reflected in the strong performance of our risk-based mutual fund suite and in our Retirement Target Date CITs. By way of example, most of our Pro-Blend suite of mutual funds finished the year in the top decile, and almost all of our various vintages of Target Date CITs finished in the top third percentile or higher versus Morningstar peers.
In our fundamental all equity strategies, our U.S. Core Equity, Core non-U.S. Equity, Core Equity unrestricted and Global Equity portfolios all underperformed for the quarter by between 1 and 3 percentage points. However, each still finished the year with substantial outperformance, delivering 251, 1,432, 388 and 644 basis points of relative gains versus their respective benchmarks. Our three- and five-year numbers for these strategies are all strong as well.
These performance figures are available on Page 6 of the earnings supplement. Our Rainier International Small Cap strategy underperformed by 130 basis points in the fourth quarter, we finished the year having delivered remarkably strong returns. The mutual fund version of the strategy outperformed its benchmark by nearly 2,700 basis points for the full year, reflective of excellent security selection and portfolio management in a very attractive asset class for active management.
Our Disciplined Value suite underperformed in the fourth quarter and full year as its tilt towards quality within the value space weighed on absolute and relative returns. While the strategy had a disappointing year on both relative and absolute basis, its long-term track record remains compelling.
On a three- and five-year basis, the fund is ahead of its benchmark by 96 and 198 basis points, respectively, and ranks in the 29th and 12th percentile versus Morningstar peers. We had a very good quarter and year for our fixed income strategies, which are an essential part of our wealth management solutions and represent good opportunities for our intermediary business.
Our aggregate fixed income strategy rose 9.4% for the year, outperforming by 187 basis points. Our unconstrained bond fund rose 7.5% for the year and is in the top quartile of its Morningstar category over the past decade. Our high-yield fund was in the top third of its category last year and is in the top decile for 3, 5 and 10 years.
Our real estate strategy underperformed for the quarter has generated another strong year of relative performance, outperforming by 243 basis points. Our REIT strategy has outperformed consistently over the past decade. Our ETF based multi-asset class solutions managed by our quantitative strategies group also outperformed during the year. Almost without exception, our performance was broadly excellent for the year and positions us well for the years ahead.
Let me speak for a moment about our capital markets outlook. And in particular, the manner in which our core investment processes derived that outlook. While we leverage both bottom-up and top-down perspectives when making asset allocation decisions, our analysis of investment opportunity at the individual security level is our primary driver of asset allocation.
We believe in being patient and flexible. While it is undeniable that both equity and debt valuations are elevated, we believe there are parts of the Global Equity markets that remain attractive. For example, and as seen during the February to April time frame last year, in the event of equity and credit market dislocations, there were many stocks and bonds that are a fundamental interest to us and sharp declines may allow them to meet our valuation disciplines.
After having been substantially underweight equities early last year and then substantially overweight after equities plunged in February and March, we are now around our neutral points in equity allocations in our multi-asset strategies. It is important to note that in equities, we are neither dogmatic growth nor value investors. Rather, our disciplines give us very specific tools to evaluate both what return profile stocks, which would look at home in the portfolios of growth managers as well as what we term hurdle rate and bankable deal stocks, which have classic value characteristics.
Today, our equity portfolios tilt towards value after five-plus years of skewing towards growth. Humility and investing is a virtue. In that vein, we should note that the magnitude of our outperformance in many of our strategies should be viewed as an unusual occurrence. As should the very high proportion of our strategies that outperformed, while we will always strive to deliver excellent results for our clients we expect to be hard-pressed to consistently repeat our results from 2020.
Finally, and regarding absolute returns, while we don't make calls on broad equity or debt markets per se, we believe investors should be measured in their expectations given high current valuations.
Let me now turn to a review of our progress against our strategic initiatives. We have just reviewed the most important initiative to deliver excellent investment results and well engineered solutions for our clients. We have articulated three other strategic initiatives, improving sales productivity while delivering exceptional client service, increasing operational efficiency and ensuring a talent rich, diverse organization with a great culture. We made important progress on each of these measures in the fourth quarter and throughout 2020.
Speaking first of sales productivity and excellence in client service, we increased our investment in our client-facing teams throughout 2020. We hired five new financial consultants in wealth management, including one in the fourth quarter, bringing our total to 19. We plan on adding a comparable number in 2021.
Our new hires did not bring books of business, and we anticipate that they will ramp-up in productivity over the next few years. We created team structures in multiple geographies, which has enhanced client service and increased our capacity to generate new business. We also added a dedicated consultant relations director in the fourth quarter, supporting our institutional business. We also anticipate a ramp-up here as institutional consultants move slowly.
Our rate of outflows improved substantially in 2020 reflecting superior investment results and excellent client service during the pandemic. The ultimate measure of improvements in our client basing areas will be positive net flows. While we continue to sustain net outflows in 2020, it was at a much lower rate than prior years.
Megan Henry, President of the Exeter Trust Company, our Captive Trust Company, which provides custody, discretionary trust services and CIT administration, announced our plans to retire at the end of the first quarter of 2021. In addition to Exeter Trust company Megan is responsible for our client services area.
Megan has been an important executive at our firm for 15 years, and we will miss her. Megan's responsibilities will be taken up by Scott Morabito, who adds operations and fund services. We are truly fortunate that Megan has agreed to remain as the Chair of the Exeter Board, and she will provide valuable experience and continuity to all of us in management and to Scott as he takes on his expanded responsibilities.
We recently implemented a revised pricing plan for new wealth management clients. For our entire history, we only charge for our investment solutions. Plus custody if clients custody their assets with us. Our aggregate fees for advice, which we simply never charge for plus investments we're substantially below the combined fees charged by competing firms, but we received no competitive benefit from this pricing structure.
Going forward, new wealth management clients will be charged a bundled fee that incorporates wealth planning and advice, investment solutions and custody. This fee is higher than our current investment only pricing and will be additive to revenues over time. In setting the new fees, we carefully studied the competitive environment, and we believe our new bundled fees are highly competitive. Current clients' fees will be grandfathered and will not change. Also, institutions who use us for an asset class sleeve of a larger portfolio and not for comprehensive advice will also be exempt.
With respect to improving operational efficiency, our technological overhaul is in the thick of the execution phase as we push forward across several key initiatives simultaneously, replacing the entirety of our technology infrastructure. In the fourth quarter, we launched the first deliverable from our implementation of InvestCloud to support all our distribution initiatives. That first deliverable was a new client portal that has been very well received by clients across channels.
In 2021, we will be implementing additional major capabilities within InvestCloud. We also completed the implementation of Workday's general ledger functionality in 2020, and we'll be rolling out its budgeting and financial analysis module in 2021. In addition, in 2021, we will be implementing Workday for human resources and talent management.
We made important progress in implementing Charles River for trade order management, trading and portfolio compliance and portfolio implementation in 2020, and important steps remain and completion is targeted in 2021.
By the end of 2021, the fully integrated suite of software as a service platforms that we are implementing will enable substantial operating efficiencies, allowing us to offer better client experiences increased targeting and discipline in sales and service, improved productivity and trade processing and portfolio implementation and providing us greater and more actionable business insights.
Our fourth strategic initiative is to ensure that we have a talent rich, diverse and inclusive team with a powerful, distinctive culture. Talent density is the lifeblood of our business. It helps us analyze, manage and optimize our investment strategies. It helps us relate, reach and connect to more people, amplifying our strategy, solutions and our story. And it helps us innovate and remain nimble in our evolving, highly competitive industry. We want to be a destination of choice for the most capable and promising talent.
Ours is largely a homegrown team with the majority of staff entering as recent graduates. So, we are focused on finding the best, developing the best and retaining the best. It is a false dichotomy to believe that the pursuit of meritocracy and diversity cannot be accomplished at the same time. It is our belief that in principle, the demographics of our firm should broadly reflect the demographics of our nation and the communities in which we do business.
We are committed to getting there but acknowledge that it will take time, but we must commit to making consistent progress. While we are close to gender equality in our workforce overall, that is not yet entirely true in our management ranks. Today, 30% of our Executive Committee is female, and 40% of our more extensive group of management, our leadership council is female.
Our ratio in ethnic diversity has a longer way to go. The proportion of our organization that our people of color is not representative of our nation, while 20% of our Executive Committee are people of color for our broader leadership team, the percentage is less than 10%.
As has been repeatedly demonstrated, we have no doubt that greater diversity of background, experience and perspectives lends itself to stronger decision-making, a more solid culture and superior outcomes for all stakeholders. Our corporate culture will embrace and celebrate all our differences, and they will make us a stronger, more successful and more lasting business.
With that said, we still have much work to do, and I look forward to providing further tangible updates on this essential initiative in the quarters ahead. In sum, we believe our full year 2020 was broadly positive as we continue to execute on our long-term strategic plans, focusing on building the foundation of our firm in a way that positions us for sustained success.
I'd now like to briefly address our newly announced share repurchase program. We are committed to both increasing employee ownership of the firm and ensuring attractive returns to our shareholders. Two years ago, we announced our intention to meaningfully increase employee ownership over time. We have made progress with a $5 million long-term incentive plan last year comprised of stock grants vesting over five years and that identically structured $6 million one recently granted in 2021.
Increased employee ownership is critical to stimulating the employee base and ensuring a culture that has committed effective and engaged, helping drive value for our clients and our shareholders. Importantly, it is not our intention to dilute public shareholders as we increase employee ownership. We are guided by these dual principles. As a result, today, we announced the share repurchase program meant to accomplish that goal, and Paul will provide more details.
So in conclusion, we continue to believe that we are progressing well with our strategic initiatives, that the progress has begun to translate into improving financial results and that we are committed to sharing that financial improvement with our shareholders to return of capital. We are optimistic that we will see more tangible proof of this progress in the coming year.
And with that, I'll turn the call over to Paul for more detail on our financials. Paul?
Thanks, Marc. Good evening, everyone, and thanks for joining us today. I hope everyone on the call is doing well. My remarks will be focused on our fourth quarter and full year 2020 results, starting with assets under management.
We finished December with AUM of $20.1 billion, up from $19.2 billion as of September 30. The 5% increase was the result of approximately $1.7 billion of market appreciation, partially offset by $800 million of net client outflows. Gross inflows were just over $600 million for the quarter, with $290 million of inflows from our wealth management channel and $315 million through our intermediary and institutional team.
Gross client outflows for the quarter were $1.4 billion, with the increase from prior quarters due to the few institutional and platform redemptions that we mentioned during our last call, which accounted for approximately $500 million of the total outflows. By sales team, the wealth management team had net client outflows of $142 million during the quarter, and the institutional intermediary team had $674 million in net outflows.
For the full year of 2020, we reported $2.3 billion of net client outflows, an improvement from the $4.5 billion of net outflows in 2019. This result was consistent with our outlook on flows going into 2020, which was that net client flows for the year would be improved from prior years, though still negative as we work towards stabilizing AUM.
While gross client inflows decreased slightly from $2.7 billion to $2.4 billion, we saw significant improvement in gross outflows, down from $7.2 billion in 2019 to $4.7 billion in 2020. Our separate account retention rate improved to 96% for the 12 months ended December 31.
Turning to our fourth quarter P&L, we reported revenue of $33.5 million for the quarter with overall revenue margins of 68 basis points compared to revenue of $32.1 million reported last quarter with revenue margins of 66 basis points. The increase in revenue was due to changes in average assets in our business mix during the period.
Operating expenses were $28.9 million in the quarter, an increase of $1.1 million compared to the previous quarter, and an $8.3 million decrease compared to the fourth quarter of 2019. Compensation and related costs increased by approximately $550,000 or 3% compared to last quarter. The increase was driven by finalizing our analyst bonuses as well as one-time severance costs from reductions in our workforce. Our compensation and related costs as a percentage of revenue was 57%.
Distribution, servicing and custody expenses decreased by $190,000 or 7% during the quarter, the change can be explained by a 4% decrease in average mutual fund and collective trust assets as well as changes in the overall funding collective business mix. These expenses continue to represent approximately 18 basis points of average funding collective trust assets.
Other operating expenses were $7.4 million in the quarter, an increase of $708,000 from last quarter. The majority of the increase is attributable to activity from last quarter and specifically the one-time $1.2 million gain recognized last quarter that was reported as a reduction of other operating expenses. These expenses represent 22% of revenue for the quarter.
Non-operating income increased by approximately $550,000 for the quarter, predominantly due to investment returns on our invested cash. As a result, on a GAAP basis, we reported pretax income for the quarter of $5.7 million compared to $4.8 million last quarter. After accounting for approximately $750,000 of strategic restructuring costs, we reported economic income, a non-GAAP measure of $6.4 million.
Our non-GAAP effective tax rate for the quarter was 10.4%, resulting in economic net income of approximately $5.7 million. The effective tax rate was down from our usual rate in the low 30% range and from the 39% reported during the third quarter. The reduction was due to a number of factors specific to the fourth quarter, including the discrete tax benefit recognized during the quarter from the RSU vesting and options exercised during the period, coupled with a higher-than-projected taxable income for the quarter and updated tax impacts of IRS Rule 162(m) based on final regulations issued in December.
As a reminder, our effective tax rate is a non-GAAP measure that is intended to represent the taxes that we would incur if all of our earnings were taxed as C Corporation. Considering current federal and state tax rates, we continue to assume that our future effective tax rate will be in the low 30% range. However, as we learned during 2020, this rate may change from quarter-to-quarter as events unfold. All told, we reported fourth quarter economic net income per adjusted share of $0.26, a $0.12 improvement from $0.14 per adjusted share last quarter.
With that, I will summarize our full year results. We reported revenue of $127 million, down 7% from $136 million last year, with overall revenue margins of 67 basis points. Operating expenses were $113 million, a $20 million decrease or 15% from last year, with reductions in compensation and other operating costs driving the overall decrease. Compensation-related costs of approximately $74 million decreased by $6.6 million since last year and represented 59% of revenue. We finished 2020 with 276 employees down from 307 at the start of the year.
Other operating expenses decreased by $11.2 million when compared to last year. The decrease compared to 2019 was due to a combination of a few factors: most notably, reductions in operating costs stemming from the COVID restrictions that existed for much of the year, the third quarter expense reimbursement I just mentioned, and a reduction in expenses related to our digital transformation compared to 2019.
As a result, on a GAAP basis, we reported pretax income for the year of $13.8 million. After accounting for strategic restructuring costs, we reported economic income of $16.7 million and economic net income of $14.4 million, with economic net income per adjusted share of $0.33. On a pro forma basis, using our adjusted shares outstanding as of December 31, 2020 earnings would have been $0.64 per adjusted share.
Before wrapping up the call with some comments regarding our balance sheet and ownership, I'll reiterate a few final points on our outlook for AUM, client flows in the P&L. We anticipate further improvement in growth client inflows and net flows and continued stabilization of overall AUM during 2020, given our investment results, our strengthened delivery of comprehensive wealth management solutions and anticipated easing of COVID-related restrictions that have limited prospecting efforts for the last year.
Similarly, we expect continued improvement in top line revenue, operating margins and free cash flow as we work our way toward our stated goal of $20 million of operating income. We will recognize incremental revenue as a result of the wealth management pricing changes that Marc mentioned earlier. So, we do not expect that to materially impact our overall revenue margins in 2021.
Fixed compensation costs should continue to decrease as we continue to reduce the size of our workforce. Also noteworthy, we recently implemented a deferred compensation plan, whereby a fraction of incentive compensation for our most highly paid employees will be invested into our investment strategy invested over a multiyear period. Implementing this plan is an important step in increasing employee investment in our strategies and will provide additional P&L relief during 2021.
I'll begin to wrap things up with some comments on our balance sheet and ownership. For year-end, we reported approximately $81 million of cash and investments with no debt. The increase in September 30 was driven by cash from operations, including earnings during the quarter and changes in operating assets and liabilities. The strength of our balance sheet and expectations for free cash flow this year were factors in the decision to announce the repurchase of stock that Marc mentioned earlier.
Our Board of Directors authorized the buyback about $10 million of stock for the rest of 2021, which will be funded by our existing cash position and free cash flow that will be generated this year. The return of capital to shareholders has always been a priority for us. And as our operating results continue to improve, we feel it is important to restart this effort in the form of a share buyback.
Regarding ownership, our adjusted share count increased from 22.2 million adjusted shares outstanding as of September 30 to 22.7 million shares as of December 31. The increase is driven by previously issued stock options invested during the quarter. The 22.7 million adjusted shares outstanding as of December 31 includes approximately 16.9 million Class A shares, 2 million privately held units held by legacy shareholders, 760,000 vested stock options and 3 million unvested stock awards issued under our long-term incentive plan.
As of December 31, our employees and directors own approximately 33% of the adjusted shares outstanding, including unvested awards. As Marc mentioned, earlier this month, we issued $6 million of long-term incentives to key employees as part of our year-end cycle. These awards will invest over the next five years and will be reflected in our adjusted share count as of March 31.
Delivering equity has been a meaningful tool for us to recognize and retain our key employees and the long-term characteristics of these awards have helped to ensure alignment between our employees, our clients and our shareholders. Retaining key employees by utilizing awards from our equity compensation plan has been a long-standing objective.
These key contributors are delivering solutions for clients while providing a framework for future growth and shareholder value creation. However, it has not been our intention to create significant dilution to our existing shareholders in the process. As we look at our balance sheet and capital structure, there is now an opportunity to create value for shareholders through share buybacks.
By returning capital to shareholders, while ensuring that we are retaining our key contributors, we are positioned to deliver best-in-class solutions to our clients while driving growth and value creation for our shareholders.
That concludes today's call. If you have any questions on the topics addressed today, please contact us using the inquiries portal on our Investor Relations website, and we will promptly address your equity. Thank you for listening and for your interest in Manning & Napier.
And I'll now turn the call back over to the operator. Erica?
End of Q&A
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.