Affiliated Managers Group - Earnings Call - Q3 2018
October 29, 2018
Transcript
Speaker 0
Greetings, and welcome to the AMG Third Quarter twenty eighteen Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr.
Jeff Parker, Vice President, Investor Relations for AMG. Thank you. You may begin.
Speaker 1
Thank you for joining AMG to discuss our results for the 2018. In this conference call, certain matters discussed will constitute forward looking statements. Actual results could differ materially from those projected due to a number of factors, including, but not limited to, those referenced in the company's Form 10 ks and other filings we make with the SEC from time to time. We assume no obligation to update any forward looking statements made during the call. AMG will provide on the Investor Relations section of its website at www.amg.com a replay of the call, a copy of our announcement of our results for the quarter, a reconciliation of any non GAAP financial measures to the most directly comparable GAAP financial measures, including a reconciliation of any estimates of the company's economic earnings per share for future periods that are announced on this call and an investor presentation.
AMG encourages investors to consult the Investor Relations section of its website regularly for updated information. With us on the line to discuss the company's results for the quarter are Nate Dalton, President and Chief Executive Officer and Jay Horgan, Chief Financial Officer. With that, I'll turn the call over to Nate.
Speaker 2
Thanks, Jeff, and good morning, everyone. Against the challenging industry backdrop, AMG generated solid results in the 2018, including positive net client cash flows of approximately $1,000,000,000 and economic earnings per share of $3.45 Our results reflect the diversity of our global business and our strategic position in attractive return oriented products, where we continue to see significant client demand for our affiliate strategies and the distinctive investment return streams they create. In terms of third quarter flows, we saw continued strong demand for alternatives, which included another quarter of very significant illiquid product fundraising from institutional clients, partially offset by softness in liquid alternatives in the retail channel, where investors tend to be more sensitive to short term performance. The ongoing strength of our alternative products was partially offset by net outflows from equity strategies, driven primarily by emerging markets products and U. S.
Equity retail outflows. At the highest level, we were pleased with our positive organic growth in the third quarter despite industry headwinds. We benefited from having built a diverse global business, and we're pleased to see a very broad array of product types, affiliates and geographies contributed significantly to our flow composition, as we saw strong sales across Baring Asia, Blue Mountain, Capula, EIG, Campion and PFM within our alternative category, while Artemis, Frontier and Harding Lozner were notable contributors within our equities category. Now looking ahead, I want to address the current market environment and how we have built and continue to position our business. Obviously, it's been a volatile period.
Global and U. S. Equity markets have declined roughly 10% month to date as of Friday, and frankly, that understates some of the underlying volatility we've been seeing. Anecdotal evidence points to some derisking in this environment, and you can see that reflected in this month's retail flow data. In the short run, this obviously creates challenges in various segments of the asset management industry.
But in terms of AMG, we have been evolving the business in anticipation of more volatile and fundamentals driven markets, where the highest quality active managers prove their worth. Volatile markets underscore the need for investors to diversify their equity and fixed income exposure, especially when markets are at elevated levels. Finally, within both traditional and alternative categories, volatile markets create an environment where the best active managers, like our affiliates, can significantly outperform their benchmarks and simplify their products. Looking ahead, I would focus on three aspects of our business and strategic position: one, the diversity of the business we've built over the years two, the opportunities for the best active managers to outperform in this environment and three, the quality of our affiliates and the distinctive return streams they produce. First, on the diversity of our business.
Over the last decade, we have deliberately doubled the proportion of our business in alternatives from approximately 20% in the beginning of 2008 to approximately 40% of assets under management today, spread across a very diverse set of high quality alternative products while increasing our exposure to growing parts of client portfolios at the highly active alpha end of the barbell. This evolution has come from both investments in new affiliates as well as product innovation and development by us and our affiliates. Our alternatives business now has approximately $320,000,000,000 in assets under management, making AMG one of the largest alternative managers with one of the broadest and most diverse ranges of liquid and illiquid alternative strategies managed by leading investors, including AQR, Baring Asia, Blue Mountain, Capula, EIG, First Quadrant, Amphion, PFM, Systematica, ValueAct and Wyndham. In addition, our substantial exposure to uncorrelated alternative strategies should increase the stability and resilience of our business across market cycles, while most importantly, proving attractive to clients, so increasing the long term organic growth potential of our business. Second, turning to the opportunity for active management.
In general, we have found that volatility is good for active managers as opposed to steadily rising indices driven by capital flows. Simply put, a shift to a more fundamentals driven market provides a more favorable environment for the highest quality active managers, such as our affiliates, to distinguish themselves. You can see this in the data from our recently updated study called the Boutique Premium, which will be reissuing shortly. The broad findings remain the same as when we first published the paper in 2015, primarily that boutiques outperform both non boutiques and market indices over most long term periods. Importantly, the data also shows that the outperformance advantage of boutiques was most significant during more volatile periods in the market.
This stands to reason as the elements that drive superior alpha generation by boutiques in the first place, including investment led entrepreneurial culture, meaningful equity ownership by the investment professionals and a long duration alignment with clients and partners, all support a long term perspective, which encourages these firms and their investment teams to maintain their investment processes through volatile periods. Now turning to the third theme, quality and expanding high quality products. Our affiliates have outstanding long term track records of investment performance in attractive return oriented areas. As you know, especially for institutions, medium to long term performance over three, five or even longer periods is important in determining manager selection. Our global equities and alternative strategies, both liquid and illiquids, have excellent long term investment performance records.
For example, approximately 70% of our global equities assets and over 85% of our liquid alternative strategies are ahead of benchmarks over the last five years. While volatile environments contain challenges, they also bring opportunities, and we and our affiliates have been innovating and developing new products with diverse, distinctive return streams, which is, of course, critically important to match evolving client needs. Today, we continue to work closely with our affiliates to invest together in those products, packages and distribution capabilities we believe will provide the highest growth potential. Now we haven't just diversified products but also clients. We've taken a business that was mostly U.
S. Clients and successfully expanded our client base, both through our affiliates business development teams as well as through our global distribution platform, where we first opened an office in Australia, then expanded to The Middle East, Europe and parts of Asia, including Hong Kong and Japan. And today, our global business represents a balanced mix between U. S. And non U.
S. Clients. In the third quarter, we again saw the benefits of diversity in our global distribution strategy as we generated positive net flows across each of our institutional coverage regions. Looking ahead, while there may be short term volatility, our unique distribution strategy, which combines the focused distribution resources at each of our affiliates with the leverageable scope and scale of AMG's global distribution platform, is increasingly effective as leading clients worldwide and the intermediaries who serve them are consolidating their relationships with external managers and looking for more effective relationships and even partnerships with a smaller universe of investment management firms. Now in addition to these elements of organic growth in our existing business, have another proprietary growth engine.
AMG's business model provides a significant opportunity to generate increased earnings growth as well as product diversification through accretive investments in new affiliates. AMG's equity ownership succession solution is very attractive to asset management boutiques that value their independence, want a permanent solution and access to the scale distribution platforms we've built. Every boutique will inevitably have to address their permanent succession issues, and we continue to actively develop our proprietary relationships with leading boutiques. And while the pace of activity is inherently based on the dynamics of each prospective affiliate, we're making meaningful progress with our pipeline while we remain focused on high quality new prospects and disciplined on pricing and alignment, particularly at this stage of the market cycle. While maintaining the financial flexibility to invest in accretive new affiliates and continuing to execute on the other elements of our growth strategy, we also remain committed to consistently returning capital to our shareholders.
As Jay will discuss further in a moment, we demonstrated this disciplined approach to capital allocation again in the third quarter. Looking ahead, we are very confident in our ability to continue to enhance the quality, diversity and earnings power of our business and generate outstanding long term shareholder value. Through our unique business model, we offer a diverse array of excellent focused specialist managers, along with the scale and resources of a global asset management franchise, combined with a twenty five year track record of deploying the cash flow generated by our business to create shareholder value. And with that, I'll turn it to Dave to discuss our results in more detail.
Speaker 3
Thank you, Nate, and good morning. As Nate discussed, we were pleased with our third quarter results, which included positive organic growth against the backdrop of industry headwinds. As we enter the fourth quarter, we believe AMG is well positioned for an evolving macro environment as heightened volatility and risk aversion creates opportunities for the highest quality active managers, such as our affiliates to distinguish themselves. The scale and diversity of our business across asset classes, client channels and geographies, the quality of our alpha oriented product set and the unique structure of our partnerships with affiliates, together enhance the stability of our cash flows. And given our business strength and resilience, we are able to execute on our growth strategy throughout market cycle.
Before turning to the quarter, as Jeff mentioned, we have posted the investor presentation on our website this morning under Investor Relations quarterly results. Going forward, we will be providing this updated presentation simultaneous with our earnings release, so that we can refer to certain information during our call. I would like to call your attention to the incremental information we have provided this quarter in response to investor feedback. On Page nine, we've included aggregate investment investment performance for global and U. S.
Equity products as well as liquid and illiquid products, which we believe best represents our long term track records for these categories. I will be referring to this information in just a moment. In addition, on Page 17 of the presentation, given that we are including selected composites for each product category through the 2018, I will no longer restate this information in my prepared remarks. Now turning to the details for the quarter. Starting with alternatives, which account for 39 of our AUM.
We had a strong quarter of organic growth with $4,500,000,000 of net flows and saw meaningful positive contributions from our illiquid product set, partially offset by outflows in our liquid alternatives in the retail channel. Focusing on illiquids, which includes strategies such as global and regional private equity, co investments, credit real assets, infrastructure and real estate, we had an excellent level of fundings in
Speaker 2
the third quarter, which drove our flows. We continue to
Speaker 3
expect more fundraisings from flagship funds and scalable product line extensions as we look forward. As you can see on Page nine of our investor presentation, AMG's aggregate performance in illiquids is very strong, with 92% of our recent funds outperforming industry benchmarks on a net IRR basis and 79% outperforming on a net multiple basis. In our liquid alternative category, encompassing our multi strategy, fixed income and equity relative value systematic diversified strategies, while we experienced net outflows in the retail channel, where clients tend to be more sensitive to short term performance, we saw positive overall institutional flows into liquid alternatives across a broad array of products. And while AMG's aggregate performance in liquid alternatives was challenged in the quarter and year to date, our long term investment performance remains strong, with 7186% of our assets under management outperforming their benchmarks over a three year and five year period, respectively. Before I leave alternatives, as Nate discussed, October's sharp reversal in equity markets highlights the importance of diversification and the benefits of alternatives in client portfolios.
We have seen this diversity play out for us as our alternative strategies have generated meaningfully better performance than equities in October, with the alternative portion of our market composite as of Friday down only 2% relative to broader market equity markets, which were down approximately 10%. Now turning to equities. In the global equities category, we saw net outflows of $2,000,000,000 in the quarter, primarily from emerging markets and global retail products. AMG continues to have strong long term aggregate performance in this category with approximately 70% of our assets under management ahead of benchmark on a five year basis. In U.
S. Equities, we reported now net outflows of $1,700,000,000 and while negative overall, we continue to see pockets of ongoing opportunity, while at the same time, we are seeing lower levels of redemption. While AMG's performance in U. S. Equities continues to be challenged relative to benchmarks over a three and five year period, we believe a continued shift to a more fundamentals driven market environment will improve relative performance.
Now turning to the multi asset and other category, which accounts for 13% of our AUM and encompasses multi asset and balance mandates within our wealth management business as well as a number of specialty fixed income and multi asset products. Here, we posted another positive quarter with $100,000,000 in net flows as demand trends remain in place for our wealth management business. While we have seen some weakness in our legacy fixed income products, our new products in this category are generating good momentum, especially within systematic fixed income. Finally, turning to our quarterly flows by distribution channel. We saw significant strength within institutional, which represents 58% of our AUM, where we had $5,700,000,000 in net flows driven by alternatives, especially from our illiquid fundraisers.
In the retail channel, which represents 28% of our AUM, we had net outflows of $4,900,000,000 where we saw weakness in liquid alternatives driven by recent performance combined with continued outflows in U. S. Equities. Finally, in the high net worth channel, which represents 14% of our AUM, we reported positive net flows of $100,000,000 where the underlying demand trends remain in place. Now turning to our financials.
As you saw in the release, economic earnings per share increased 1% to $3.45 for the third quarter, which included net performance fees of zero three dollars On a GAAP basis, we reported earnings per share of $2.34 For the third quarter, aggregate fees were flat at $1,300,000,000 from a year ago, while the ratio of aggregate fees to average assets under management declined year over year from 64 basis points to 61 basis points, which was driven in part by a lower level of performance fees and changes in the composition of our AUM. Adjusted EBITDA EBITDA decreased 7% to $237,800,000 from a year ago, primarily due to lower other income, a couple of nonrecurring expenses and investments that we made together with our affiliates in product development and distribution. Relative to EBITDA, economic net income decreased 4% to $184,000,000 from a year ago, reflecting lower interest expense and a lower tax rate, while economic earnings per share grew 1% to $3.45 given lower year over year share count due to repurchase activity. Turning to more specific modeling items. For the third quarter, the ratio of adjusted EBITDA to average assets under management was 11.4 basis points or 11.3 basis points excluding performance fees.
Looking ahead, we expect adjusted EBITDA to average assets under management to be 12.4 basis points in the fourth quarter, reflecting a net performance fee assumption of approximately $0.40 as well as continued investment in product development and distribution capabilities. Our share of interest expense was $19,600,000 for the third quarter. In the fourth quarter, we expect our share of interest expense to remain at approximately $19,000,000 Our share of reported amortization and impairment was $44,900,000 for the third quarter, including $22,200,000 from affiliates accounted for under the equity method. Looking ahead to the fourth quarter, we expect our share of reported amortization impairments to be approximately $42,000,000 Turning to taxes.
Speaker 2
With regard to our tax rate in
Speaker 3
the third quarter, our effective GAAP tax rate was 27% and our cash tax rate was 19.9%. In the fourth quarter, while we expect our GAAP tax rate to be approximately 26%, we expect our cash tax rate to be impacted by a one time benefit in the fourth quarter in the range of 20,000,000 to $25,000,000 primarily from the final disposition of Ivory. Excluding the nonrecurring item, we expect our cash tax rate to be approximately 19% going forward. Intangible related deferred taxes were $12,200,000 in the third quarter. For the fourth quarter, we expect intangible related deferred tax to be approximately $13,000,000 excluding this non recurring item.
Other economic items was $2,000,000 for the third quarter. For modeling purposes, we expect other economic items to be approximately $1,000,000 per quarter. Our adjusted weighted average share count for the third quarter was $53,200,000 and we expect it to be approximately $52,600,000 for the fourth quarter, and we now expect our adjusted weighted average share count for the full year to be approximately $53,700,000 Turning to our balance sheet. In the third quarter, we paid a $0.30 per share dividend and we repurchased $113,000,000 in shares. Looking to the fourth quarter, while we expect to repurchase approximately $100,000,000 the amount and timing will depend on market conditions and potential new investments.
Taking a step back over the past decade, we prioritized flexibility as well as the reduction of balance sheet leverage, which gives us ample capacity. Given that capacity today, we are well positioned to both deploy capital for a full market cycle as we execute on our growth initiatives and deliver on our commitment to consistently return capital to shareholders. Now, we'll be happy to answer your questions.
Speaker 0
Thank you. At this time, we'll be conducting a question and answer session. Session. Our first question comes from the line of Michael Carrier with Bank of America Merrill Lynch. Please proceed with your question.
Speaker 4
Thanks, guys. Maybe first question, just on the alternatives. So clearly, from a flow standpoint, you guys have been doing well. It seems like on the performance and whether it's you guys or the industry, things have been a bit more muted. But I guess just want to get your sense of when we think about when we see the good growth coming in alternatives, how does that like impact the outlook in terms of like E and I?
So whether it's ownership, how that can potentially impact fee rate or even performance fees when you're in an environment where it's obviously weaker than maybe the long term trend?
Speaker 2
Great. So thanks for the question. It's Nate and I'll start and then ask Jay to pick up the second half. So I think the most important thing when you think about our alternative business, if you will, is it really breaks into a number of different categories. So we in our materials we posted on the website, we've broken it into four groups.
So there's a private equity and they behave differently and we're having different experiences within them, which I think points to the benefit of the diversification that we've built. So for example, we have a private equity and real asset, which includes infrastructure and private credit and other things. And that business is behaving one way, which is right now there's an incredible amount of demand. There's really good sort of product development going on. The take up through our distribution and through our affiliates own distribution is fantastic.
And so that part of the business and both Jay and I talked about how that's a part of our flow profile right now, but that's something we also just see continuing to grow and importantly diversify as well. So and when you talk about how that flows through, obviously, performance fee or carry piece of that is, of course, growing, but it's certainly something that grows out into the kind of starts two or three years out and grows kind of thing. So that's kind of one part of the book. Then in the more what we talk about sort of more liquid, we have sort of a fixed income and kind of relative equity, relative value book. And that's a business line that I think generally had industry wide has had kind of more muted returns for a while, but I think in these volatile environments that's performing reasonably well.
I think the multi strat business, not an entirely different story, which is it's been kind of muted returns and query how that will perform going forward. And then we have a systematic diversified business, which you've heard us talk about as having kind of more challenged performance for a while now. And then but with in the current environment, again, it's the kind of thing that you would expect, at least has the opportunity because it contains so many kind of uncorrelated positive expected return streams to have the opportunity to perform. So I think we're very bullish about the fact that we've both diversified the equity business, including all these, as you heard us talk about, but then also the diversity we've been built within this, which over time should provide stability to a bunch of different elements of our business, including the flow profile as well as the earnings profile. I'll just pick up
Speaker 3
and talk about the E and I impact. And starting with a calendar year, any one calendar year, it can be hard to predict in part because of the performance fee opportunity in that calendar year. But if you think about it just over time, the E and I impact of raising more alternatives is generally the positive thing. The management fee typically is higher. Performance fee opportunity, as Nate said, in the private equity vehicles that tends to build over time and we're seeing that happen for us.
Remember, are on method one, so we only report that when it crystallizes. So we are seeing the mix shift longer term be a positive ENI benefit to us. But again, in any one period, it's a little harder because it depends on which one, what the ownership level and what the performance fee is. But I think the best outlook for us is that this private equity and alternative build will play out in our E and I over time.
Speaker 0
Thank you. Our next question comes from the line of Craig Siegenthaler with Credit Suisse. Please proceed with your question.
Speaker 5
Hey, good morning, Nate, Jay. I just wanted to start with a big picture question, business model question, which is actually sort of three parts. So I'll jump back in the queue after this one. But just given the evolving industry backdrop, what do you view as the main benefits now of the multi boutique model? Also, how has AMG's business model evolved over the last five years?
And more importantly, can you remind us the different ways you can leverage the benefits of scale for your affiliates?
Speaker 2
Good morning. Thank you very much for that question. I'm glad that you asked, because I think first, I'm going to speak mostly to our business rather than multi boutiques or maybe wholly to our business as opposed to other multi boutiques because I really do think our business is different in some fundamental ways. And so, let me start there, which is if you think about AMG today across our affiliates, we have incredible level of diversity, and we talked about this in the script, incredible level of diversity. That diversity is of distinctive return streams.
Each of our affiliates is independently producing these return streams. And we believe there's a level of excellence to that, and we talked about that in terms of some of the performance things. So you have diverse, distinct, excellent manufacturing. But then the thing that I think is different about our business is we've been able to achieve that diversity and the scale without having to combine or compromise affiliate culture, right? So each of our affiliates is a truly distinct business, which we think is really important from the standpoint of the manufacturing return stream.
That is a place where generally on the active side, a scale is not a benefit. So diverse, distinctive, excellent manufacturing, we've achieved that scale without having to combine or compromise cultures. And then again, a really important thing to understand is we can continue to add to that scale significantly without having to compromise cultures, right? So it's not just we have a business model that allows us to manage that diversity today, but because of the way we've built it, we're able to continue to add to that scale without, again, combining or compromising cultures. And I don't think there is another business that manages that level of diversity and scale without compromising cultures.
Others may be as large on asset bases, but not with that same level of diversity, really distinct diversity underneath with different cultures. So I think that's kind of a very important point I would hope people internalize. The second piece, which I would go to, which I think is really more your third question, but also picks up some of the evolution. And the real challenge for us and I think for other multi boutiques is how do you bring or how do we bring that diverse excellence scale to bear effectively for clients and intermediaries. So I think that's the challenge.
And here, I'd make a couple of points, right? So first, each of our affiliates very effectively brings their products or services to some market segments and some geographies very effectively by themselves, right? And that's sort of if you're looking backward, that's what's attracted in part what's attracted us to them in the first place, and you've heard us talk a little bit about what we look for in high quality going forward as well. So each affiliate does it very effectively themselves, but there are lots of ways to leverage our scope and scale to more effectively bring the products to different geographies and market segments. And we obviously, for more than a decade now, we've been building out our global distribution platform, We think in a pretty differentiated way, that is an example where we can leverage our scale for the in a very flexible way for the benefits of our affiliates.
And we've got proven success now, again, that we've been building those for over a decade. I do think and this goes to your last five years point a bit, I do think we are making investments not just in building out regional distribution, but also in packaging and distribution operational capabilities as well. And we've talked about that on some calls in a couple of different ways. So one is, I think on the last call, we spent some time talking about how we're doing that in bringing illiquid products into DC and retail. And we talked about working with an affiliate to build a Fortiag fund or to build a CIT.
This past quarter, we closed and the dollars were not the dollars were modest, but we closed our first kind of cedar fund sold into by one of our affiliates sold into a large broker dealer in The U. S. So we're building those capabilities. And these are just examples. I mean, we talked about Japan a bunch last quarter.
These are examples of how we're continuing to extend what we've done with our global distribution platform for the benefit of our affiliates. And again, we're doing it in a very flexible way that allows us to leverage the scale without interfering with those unique cultures. And again, I think we do that at a significant scale, which allows us to get to the level of diversity that we talked about before. Maybe add one more to it, which again goes to what have we been doing recently and how will we take this forward, which is you've heard us talk for a while about this trend of clients and intermediaries trying to consolidate relationships. And that's much more efficient for them as they're trying to manage their business.
And I think, again, because of the diversity and scale, we're at a place where if we do this well, they can get access to all of this manufacturing in a very efficient way. And this is something that we've working on for a while. So the example I'd add is this past quarter, we entered into a Memorandum of Understanding with a large European financial institution to take the next step in doing exactly that, which is bringing our affiliate product to market using our manufacturing combined with their packaging distribution, although obviously we have to support the distribution as well. I don't want make too big a deal out of this because it's not really going to start. We don't think products will start coming online until kind of Q1 twenty nineteen.
But it's an example of we are continuing to work to find more and more effective ways to bring all of that kind of excellent diverse scale, again, truly diverse, not just different product teams, but really people who maintain their own very independent cultures, bring all of that to bear for our affiliates. And so I think for us, that's the competitive advantage of our business model, which is the ability to gather all of that excellent diverse manufacturing and then add to it by being able to bring some of the benefits of scale to bear.
Speaker 0
Thank you. Our next question comes from the line of Alex Blostein with Goldman Sachs. Please proceed with your question.
Speaker 6
Thanks. Hey, good morning guys. I was wondering if you could comment on the buyback and capital return priorities here. So a bit light, I guess, relative to the pace you guys have bought back stock in the first part of the year. Why the pullback?
Jay, think I heard you say another $100 ish million in Q4, given the valuation of the stock and no near term deals, feels like we would expect a little more from you guys. So just some color on that would be helpful.
Speaker 3
Yes. Thanks, Alex. So, yes, you characterized it as a pullback, but I don't think it's a pullback at all. In fact, the last eight quarters, I think we've probably averaged about $100,000,000 So, it seems right in the zone of where we've been. In fact, it's a little more than 113,000,000 a little more than 100,000,000 But just taking a step back, just making a couple of comments here.
We're mindful of the market volatility market for our stock, but also market volatility. We also, as you heard Nate say, we're investing in both new initiatives, but also we're optimistic about our new investment pipeline. And that was in my prepared remarks. I think we're being mindful of that. We're committed to always committed to a disciplined allocation of capital, really includes balancing these growth initiatives with capital return.
And again, it's against the backdrop of an appropriate leverage ratio so that we can invest through a cycle. So, I don't think anything is different, but we have always been committed to a capital return strategy that balances all of those initiatives.
Speaker 0
Thank you. Our next question comes from the line of Phil Katz with Citigroup. Please proceed with your question.
Speaker 7
Okay. Thank you very much for taking the question. And just stay on that capital management
Speaker 2
theme for a
Speaker 7
second as well. I just want to broaden it out. Can you step back a little bit and talk a little bit about how your capital management is evolving against a couple of things? Number one, just sort of
Speaker 2
the shifting of the sort of asset management ecosystem. And is it still sort of credible to continue to
Speaker 7
go out to sort of midsized players at this point in time, number one? And then just sort
Speaker 2
of given the what looks to
Speaker 7
be some pretty elevated multiples in the private market, how are you thinking about that versus buyback right here? Thank you.
Speaker 2
Maybe I'll start just on the part of both the question and a little bit the prior, which is how we're thinking about the M and A environment, because I do think I don't disagree with some of the dynamics, but implicit in your question was both just what kinds of firms we're looking at and then also how we think about the pricing. So maybe it'd be useful to just level set on that one. And so look, we've been running this basic model and approach for now almost exactly twenty five years, which is being try to build a business where we're the best institutional partner to these excellent boutique firms. And I don't think that strategy changes. And I also think generally the firms we're partnering with are not trying do a trade or whatever, but the firms we're trying to partner with are the ones that are really trying to pick a permanent institutional partner, right?
So that's I don't think that's changing at all. Now, of course, we're being disciplined. Here, I agree with part of what was in your question, which is your commentary on some prices that have been paid. And look, when we're looking into investments, we're disciplined across a bunch of different dimensions, right? We're very we're disciplined across the quality of the business.
And we talked a little bit about that last quarter, but that is a bunch of different component parts to it, but we're very disciplined about the quality of the business that we're looking at. We're very disciplined about can we get the right long term alignment with the principles of the business. And of course, we're very disciplined on pricing. And so and also implicit in both this question and I think a little bit prior, when we're talking about this discipline, we're also measuring this, as Jay said in the prior answer, we're measuring this against the opportunities to invest in our business, either in the operations of our business or the shares of our business. So I think we're looking at all of those as when we say discipline, I think we're putting all of those things into it.
All of that said, we think there's an outstanding there continues to be outstanding secular opportunity to partner with the best boutique firms. And look, as we all just say, the timing of an investment is driven by the dynamics. And as I just said, most of these firms don't have to do anything at any specific point in time, but also neither do we. And so look, we're making good progress in these things we're looking at. And but look, fundamentally, I agree with the part of your question, which is looking at some of the prices, I think there are there's definitely questions there.
So maybe I'll add just one more thing, and I don't know, obviously, whether the volatility we're experiencing continues or not. But the other thing I'll say is, I think our experience has been in prior volatile periods, volatile times are good for us as a competitor in looking at making new investments because the strength, scale, track record, importantly, as I said, twenty five years, are more important than ever as prospective affiliates focus on the partner that they're bringing on board as a potentially permanent partner. And so that's, I think, the way I would characterize it today. And so I think, put aside one quarter here or there, I think the secular opportunity for us to continue to invest in just great manufacturing businesses, great boutiques and affiliates, I think, is strong as ever.
Speaker 0
Thank you. Our next question comes from the line of Chris Shutler with William Blair. Please proceed with
Speaker 7
Hey, good morning. Good morning. I think Nate in the prepared remarks as well as in the press release, you continue to use the word proprietary a lot when talking about the pipeline, but we've seen a number of deals, particularly in the alt space, and others are using the I think the phrase permanent capital partner as well in talking about their strategy. So would love to get any comments there and confidence in how proprietary the pipeline really is.
Speaker 2
Yes. So look, I think look, I'd say a couple of things there. So first, we do have a proprietary effort. I think the you should also assume we're looking at all of the transactions that are in the marketplace as they go. And I'd probably just refer to my prior answer, which is, look, some of those businesses don't make any sense for us as they're predicated, for example, in bringing together overlapping capabilities or whatever, and that's kind of one category, sort of the cost cutting consolidation kinds of things.
But the other, we are remaining disciplined across all of those dimensions I talked about, and there may be or have been firms where you look at them and you say, that meets that discipline on one of those dimensions, but not on other of the dimensions. And so we are staying disciplined. On the permanence point, I think and I don't want to comment specifically about any one model here or there. But on the permanence point, I think it's they are unproven models. And I think here, would point you to the fact we've been running effectively this business of being permanent institutional partners to great boutiques for twenty five years through full cycles.
And I think some of those models may not have thought through all the different elements of that. And so again but again, I'm not commenting on any one here or there, but I think that is certainly something we see.
Speaker 0
Thank you. Our next question comes from the line of Dan Fannon with Jefferies. Please proceed with your question.
Speaker 7
Thanks. Good morning. My question is around flows and just kind of the outlook. First off, I appreciate the increased disclosure on performance. But I guess, as we think about October, the derisking, I think you mentioned, can you talk about any change in client behavior?
And in particular, if you could address AQR, which is, I think a focus for a lot of investors given its size and contribution to you in terms of we've seen the slowdown in retail and how we should think about that for the larger component of institutional and whether you as a firm in aggregate can still post you think you can still post inflows if AQR is in fact in a bit of a struggling period?
Speaker 2
Yes. So let me start here and then maybe I'll ask Jay to pick up some of the pieces of it. But look, on your specific question, I would just say, look at the diversity of the business that we've built. And AQR is certainly an important part of our business, a very important part of our business, but it's a part of our business. And so I just pointed to the quarter we just had.
But let address specifically your fourth quarter comment, which is I'll make a couple of observations. So first, at a high level, the trends remain intact, right? So we continue to see good illiquid fundraising, especially in institutional, some retail, and we do see continuing challenging retail liquid outflows. I think those trends will remain intact. As I said, I do think the volatility that we're experiencing and have increasingly experienced will have is having a short term effect some clients,
Speaker 3
so slower decision processes.
Speaker 2
I think that stands to reason, shouldn't be surprising. And then I would just remind folks, think that kind of Q4 is just generally a seasonally weak quarter. Tax law selling and you have the kind of Q4, Q1 effect we've talked about before on single year multi lock vehicles. But in terms of the overall positioning, and I'll come back to the first point on AQR in terms of overall positioning, the affiliate performance, and Jay talked about this, is good. The pace of innovation is really good, both new strategies and extensions of existing strategies.
The pace of activity in distribution, packaging geographies, channels is really good. And I think we're increasingly effective at bringing affiliates into market channels and into places that are looking for more efficient ways to get access to all this manufacturing. So I think all of those trends remain in place. Jason? I was just going to
Speaker 3
pick up on the one component of the conversation, which is just how does it translate into earnings and contribution. I think here, Nate already said it, diversity is really important. It's always been important to us. And I want to make sure we're not confusing a period of time where we have a little bit of soft performance fee outlook in calendar year that we're in as opposed to the long term. So, as it relates to the earnings profile, we do see HUR, but a number of other large affiliates continuing to contribute at a really high level to us.
And in any one year where we have a lower performance fee contribution, it really in no way diminishes the long term value of that performance fee stream. So I think on an earnings basis, it might get conflated, but really AQR is strong, so are a number of our other large affiliates. And of course, we're in
Speaker 2
this period of
Speaker 3
time where we're seeing a lot of follow through from the illiquid private equity style, and that's just building a future sort of pipeline of carry and additional earnings into the future.
Speaker 0
Thank you. Our next question comes from the line of Robert Lee with KBW. Please proceed with your question.
Speaker 7
Thanks. Good morning. Thanks for taking my questions. Maybe Nate, Jay, I'd like to go back to the M and A topic a little bit. As you think about the investment landscape, what's maybe changed, whether it's in terms of size or scope or capabilities of the prospective affiliates you're looking at maybe over the last couple of years.
I mean, not to pick on, say, ivory, but relatively small firm came as part of, I guess, a multi boutique acquisition in a way. But how do you think about kind of the size or type or scalability of the affiliates you're interested in versus maybe what you used to look at or would be willing to do several years ago?
Speaker 2
Thanks for the question. So we talked a little bit, I think, on our last call about this, how do we what do we mean by when we say high quality? And I think you've captured many of the elements, which is which are we're looking for firms that we think have the ability to grow in this environment and the environments we expect to come. Some of that is the orientation of the principles of the firm, right? What are they trying to achieve?
Some of it is what can they achieve on their own? And some of it is what can we do together. And so I think it is we are looking for more complete firms, I'll say it that way, in terms of orientation to grow and evolve, the capability sets that allow them to grow and evolve. But we're also still attracted to firms that are really doing one thing. They're doing it very, very well.
But we have the opportunity, and this is the part that I think has evolved a bit over the past couple of years. We have the ability to work with that firm in ways that are additive to the whole. And so I think we talk about high quality as either that kind of more complete firm or something that together we can grow and evolve and it's additive to the whole, whether it's client dialogue or what have you as well. And so and I think this also relates a bit to the prior question, which is, well, how does that manifest stuff? What does that mean?
And so we do have a we have a set of proprietary relationships. Our pipeline includes conversations that we've been having, in some cases, the better part of a quarter century. And we're building relationships, maintaining relationships, evaluating these firms, and we're looking at them through the screen of the evolving landscape that we're seeing. One other point that I'll make here is, as we've been growing our distribution platforms, as we've been having dialogues with intermediaries and clients who are already or might use multiple affiliates, we're getting better and better at certainly the near side of the demand characteristics we should be looking for. But we think also strategically understanding what these intermediaries and what these end users are looking for as they're trying to solve their evolving challenges over time.
And that just makes us better as we're looking on the front end for prospective new affiliates. And this is something that we're still in the early stages of, but we are getting better and better at all the time.
Speaker 0
Thank you. Our next question comes from the line of Brian Bedell with Deutsche Bank. Please proceed with your question.
Speaker 8
Great, thanks. Good morning, Maybe, Jade, circle back on the coming quarter and the fourth quarter, can you talk a little bit about the performance to date? I know the Alts are doing relatively well. We're measuring about negative 7% on the mutual fund side, I know that's overstating the downside given your alt mix. So maybe if you could talk about it on a firm wide basis.
And then on the fee rate, I think your guidance was the included the $40,000,000 or I'm sorry, $0.04 0 of performance fees. Is that if I'm calculating it right, is that about a stable fee rate ex the performance fees around 11.4%, 11.5%?
Speaker 3
Thanks, Brian. So I'll take your last one first, because that's an easy one. Yes, it's 11.3%, 11.4 So that's stable to the last quarter. So that's an easy one. Maybe I'll take a step back and kind of wrap altogether the guidance that we gave and also include kind of where we are on March through last Friday.
So, I mentioned in my prepared remarks that our the portion the market deposit for the portion that's our alternative book is down about 2%. For equities, it's approaching 10%. That blend with multi asset in there as well is about 5.5%. So yes, it's much better than the 7%. I think it speaks to the diversity.
And I suspect we're doing better than some of our peers or maybe most of our peers in that regard. Obviously, that will have an impact on the fourth quarter, but it has more of an impact on a full year basis as we've already begun the fourth quarter. The guidance specifically on performance fees, maybe I'll step back for a moment and just talk about guidance from our last call to this call on performance fees, which has changed a bit. And specifically, it's around the beta sensitive product. They were tracking to a much higher potential contribution for the year for us.
And in the last call, we also mentioned that certain of our less correlated products, including many of the systematic products were at or below high watermark and were not expected to give us a contribution in 2018. Interestingly, given the significant equity market pullback and the increased volatility in October, we've seen a sharp reversal of these trends affecting our fourth quarter performance fee opportunity. On the one hand, we've reduced our expectation for the beta sensitive performance fees. But on the other hand, we're more optimistic about the improvement in investment performance at our less correlated products. So, we may be too conservative here with the $0.40 This all happened in the last few weeks.
But I think we're seeing those trends. It will take a little more time for our less correlated products to now that they've improved significantly, it will take some time for them to really generate more performance fees. So, we see the outlook for 2019 much improved in that regard. And they may there may be enough performance in the fourth quarter where this number is conservative.
Speaker 0
Thank you. Our next question comes from the line of Patrick Davitt with Autonomous Research. Please proceed with your question.
Speaker 2
Hey, good morning. Some other managers have been highlighting still very strong institutional demand for global and emerging market strategies through the route we saw and even into October. Curious if you're seeing a similar trend. And within that vein, as value has started to outperform, are you seeing increased demand for value equity in The U. S?
Yes. Let me take that. So I do think we have we've been seeing good demand trends generally in so the high level point is the demand trends generally as our impression is sort of remaining intact, which includes demand trends for global equities. I think on the EM side, I don't know. I mean, it's harder for me to see that we have a narrower product set there.
And so I think our judgment is much more idiosyncratic to us. I think the point you make on value is a really good one. I'm glad you raised it, which is included among our affiliates are some just world class value equity managers. And and again, so it's been a long time, right, that value growth disparity. So we can talk, of course, about the various reasons for it.
But we really believe that if we get to or if we are in a more fundamentally driven market, that the value managers we have will have the opportunity to outperform significantly and also open up and take on new flow. Because I think the challenge, I'm just generalizing it, the challenge for many of them was finding enough good opportunities to put capital to work. And so we've had either actually closed or just not people who are not really marketing the product because the challenge was they had to put their existing client assets to work first and had reasonable high cash levels as well. And so whether you look at like a Yachtman, who I think is the number one performing, I think two of their funds are one and two or something, number one number two performing funds in their category or the Treaty Brown funds that are now top quartile. So I mean, like we have just great value managers there.
And so if that market evolution we're much more value heavy, certainly on our U. S. Equity side, but even including in our our global category. And so if that evolution is happening, that absolutely plays well for us. We've seen it in certainly and these are all just early days and all that, but seen it in slowing outflows in a little bit elevated sales.
And so, yes, absolutely, that would be a very positive trend for us.
Speaker 0
Thank you. Our next question comes from the line of Michael Carrier with Bank of America Merrill Lynch. Please proceed with your question.
Speaker 4
Thanks, guys. Just one other one, and this is more just on the model when you think about the outlook. When I think about the industry trends, mostly on the organic growth, obviously, it's been more of a headwind. You guys, from an asset mix, are relatively well positioned. But when you think about some of the things that you can offer to the affiliates, are there other maybe, Nick, areas to focus on to maybe improve the scale or improve the efficiencies, but still maintain the independence of the investment teams and the investment strategies.
Just wanted to get your take, just given that the maybe the top line or the flow growth is different than it has been over the last, say, twenty years?
Speaker 2
Yes. So look, I think there is absolutely more we can do to bring our affiliate the excellent distinctive return streams managed by our affiliates, that kind of diversity at scale without interfering with culture that I was talking about before. There's absolutely more we can be doing. I would say a lot more we can be doing in partnership with them to bring those return streams to market. But I also don't think it's like a switch.
I think this is an evolution that we've been on for more than as I said, sort of more than a decade, twelve or thirteen years now, kind of deliberately building out, paying attention to the pace of change, the level of investment, the returns we get on those investments, but deliberately building out the we've called them global distribution platforms, but it's institutional distribution platforms, it can be retail distribution platforms. Again, we opened Japan, which I think we're very optimistic about. We opened it in partnership with another one of our affiliates, Pantheon. Other affiliates are going to be going to that market together with us. Each market is different.
Each market has its own characteristics, and we need to be doing it in a way that, again, in your question and what I said before, in a way that doesn't interfere with the thing that makes these firms so special in the first place, which is their ability to produce these distinctive return streams. Now we're having an ever increasing pace of conversations with our affiliates on how do they use the capacity of those return streams, how do they use the capacity of their investment processes. And at the same time, we're having more and more of those conversations with large pools of capital and large intermediaries. I kind of quickly referenced in an offhand way. We did enter into a memorandum of understanding, first one for us, with a distribution partner, European financial institution.
Now that would be a new extension. Now it's not going to it will start launching product, we believe, in 2019, but our operations teams and their operations teams are working on it. Our distribution people and their distribution people, both at the affiliate level and at AMG, are working on making this really successful, the way for them to access the scale and diversity. And for some subset of our affiliates and for some subset of their product, this could be a really exciting opportunity. But we're having lots and lots of those conversations.
This just happens to be the first one that's gotten to this stage. But they also require us to do the work ahead of time in terms of selection, and then we have to make sure we execute in an excellent fashion. So all of that goes, I think there's lots we can do. On the efficiency side, look, I do think there are things that we can do there as well and we have done some also for a very long time. So for example, we have a very well developed legal compliance program where we work we have, again, for more than a decade, I think we started at roughly around the same time we started building our global distribution platforms in part because we have to do a good job facing off with each of the regulatory regimes in all of these different places we're bringing our affiliates to.
And so we have been doing things like that. We've been doing things like joint purchasing in areas where we make sense. But we do all of it with an eye towards how do we bring the benefits of scale to bear, but only where they don't interfere with the thing that makes our affiliates so special, which is that diversity and autonomy and independence as part of it with AMG as a permanent institutional partner, so being able to bring all that scale to bear. And so there's lots of things like that that we do as well. But look, at the end of the day, your question captures the challenge, which is, first, each of these firms does a great job bringing it bringing their products and services to some markets and some geographies and some channels in an excellent fashion themselves.
And they're uneven, right? Some will do more of that themselves, some will do less of it. And we've been building deliberately distribution platforms and others because this is a business about how do we help them grow distribution platforms to knit carefully to what they all do in a way that serves the range of affiliates we have, the range of products and capabilities we have and how we bring that to bear, again, very effectively for clients and intermediaries, the people who are going use those returns. And that's where we have an increasing amount of our focus.
Speaker 0
Thank you. Our next question comes from the line of Alex Blostein with Goldman Sachs. Please proceed with your question.
Speaker 6
Hey, guys. Just a quick follow-up on the pharmacies. Jay, can you remind us what percentage of AUM is subject to high watermark, kind of where that bucket stands today as we start to think about next year? And then when it comes to the illiquids, I understand the timing difference, but since you guys have been realizing quite a bit in the last couple of quarters, obviously, it shows up in your AUM. When should we expect the strategies to contribute to performance fees?
Speaker 3
Yes. So let me take the last one first. So we have been in a kind of an eighteen month pretty significant fund raise cycle for us. And as you know, a number of our affiliates, not all, but a number of them we've partnered with in the last, say, five years. When we made those partnerships, we had a lower share of the higher fund contribution.
So, when you look forward, this eighteen months period usually takes three, four in some cases, five years, but three and four years to get through the investment period. At that time, you'll see additional performance fees come through that. I mean, I think for now, it looks to be in that 2020 range, maybe before for some of the bespoke and more single strategy or single separate account type mandate. So, starting to see some next year, see it building into 2020 and certainly 2021. And it's going to be pretty significant, just given the fundraisers that we have just gone through.
And frankly, looking forward, we see that fundraising cycle continue and we way undershot the amount and the duration of that. So, we continue to see that very strong. Going to the performance fee question that you had asked. Look, I gave you the sort of the qualitative answer. I think quantitatively, we don't think the right way to look at it is some percentage of AUM.
It really does depend on lots of different factors, including our share of that affiliate, the sort of magnitude of outperformance in certain cases. So when we think about it, we bucketize it by categories earlier this year, the systematic sort of category was under high watermark. I said that in my earlier remarks. That was really the only category that had that issue. That has changed.
We are going to add around high watermark. And that's sort of the case in all categories. So, we do see the potential for contribution, especially in 2019 from all categories.
Speaker 0
Thank you. Ladies and gentlemen, that concludes our time allowed for questions. I'll turn the floor back to Mr. Dalton for any final comments.
Speaker 2
Thank you again for joining us this morning. We were pleased with our results for the quarter and we're very confident in our ability to create long term shareholder value. And with that, we look forward to speaking with you again in January. Thank you.
Speaker 0
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.