Artisan Partners Asset Management - Q2 2023

Transcript

Operator (participant)

Hello, and thank you for standing by. My name is Jason, and I will be your conference operator today. At this time, all participants are in a listen-only mode. After the prepared remarks, management will conduct a question-and-answer session, and conference participants will be given instructions at that time. As a reminder, this conference call is being recorded. At this time, I will turn the call over to Artisan Partners Asset Management.

Brennan Hughes (Director of Finance and Head of Investor Relations)

Welcome to the Artisan Partners Asset Management business update and earnings call. Today's call will include remarks from Eric Colson, CEO, and C.J. Daly, CFO. Following these remarks, we'll open the line for questions. Our latest results and investor presentation are available on the investor relations section of our website. Before we begin, I would like to remind you that comments made on today's call, including responses to questions, may include forward-looking statements. These are subject to risks and uncertainties and are presented in the earnings release and detailed in our SEC filings. We're not required to update or revise any of these statements following the call. In addition, some of our remarks today will include references to non-GAAP financial measures. You can find reconciliation of those measures to the most comparable GAAP measures in the earnings release. I will now turn the call over to our CEO, Eric Colson.

Eric Colson (CEO)

Thank you all for joining the call or reading the transcript. Artisan Partners is a high value-added investment firm designed for talent to thrive in a thoughtful growth environment. Since our founding in 1994, we have methodically delivered quality outcomes for clients, quality business growth, and quality returns for our shareholders. The power of compounding underlies each of these outcomes. Compounding client capital in excess of benchmarks and peers extend client duration and grows our AUM. Compounding business outcomes with each successful investment team, strategy, and asset class increases our future opportunity set, as well as the quality and probability of those opportunities. Success begets success. As we compound client capital and business outcomes, our shareholders are the residual beneficiaries. Compounding requires time, and time requires trust. Trust is established by communicating who we are and what we plan to do.

Trust is maintained by staying true to our word and by sticking to our philosophy and process. We strive to do this day in and day out, over and over again. The development of our fixed income capabilities shows how we compound our business. The performance of our six credit-oriented strategies is shown on slide two. This performance is net of fees. We launched the credit team 10 years ago in 2013 on the basis of our foundational success in equities. We partnered with portfolio manager Bryan Krug to methodically build a premier credit franchise. In turn, the credit team has methodically generated high value-added returns for clients. Over 9+ years, the Artisan High Income Strategy has generated average annual alpha of 186 basis points after fees. That is, on average, a return of 50% more per year than the strategy's benchmark index.

The Artisan High Income Strategy has also outpaced peers. Since inception, the Artisan High Income Fund is ranked number 5 out of 330 funds in the Lipper High Yield. On the foundation of our credit team's success, we recruited Mike Cerami, Sarah Orban, and Mike O'Brien to Artisan Partners in 2021 and established the EMsights Capital Group. With EMsights, we launched our second credit-oriented team and further expanded our investment platform into sovereign credit, FX, and greater use of derivatives. Each of the 3 EMsights strategies has passed its first anniversary. The team's early performance and reputation in the marketplace are translating into a healthy level of early interest. On July 1, they received their first large institutional mandate, a $425 million investment in the Artisan Emerging Markets Local Opportunities Strategy.

We are making significant progress towards similar foundational investments in the team's EMDO and Global Unconstrained Strategies. Slide three shows the year-to-date AUM growth of our credit-oriented strategies. As of July 15th, between the credit team and EMsights Capital Group, we have raised a net $1.1 billion from clients and investors. The pipeline for both the credit team and EMsights Capital Group is strong, and we expect strong business development throughout the remainder of 2023 and beyond for both teams. It's also worth noting that these investment teams are winning business as differentiated alpha generators, not as providers of benchmark-hugging exposure in hot dot asset classes. Based on mutual fund data, year-to-date, high-yield bonds, bank loans, emerging market debt, and non-traditional bond funds are all in net outflow. That's in contrast to the headline-generating flows into money market and investment-grade bond funds.

This is consistent with who we are. We are investing with great talent in spaces where they can differentiate and compound capital to deliver absolute return over extended periods of time. We believe that demographic change and expanding credit opportunity sets bode very well for both the credit and EMsights teams. In short, we believe we are in the early innings with both these investment teams, with considerable opportunity in front of us. 1 year ago, we showed the information on slide 4 during our 2Q earnings call. Since our founding in 1994, there have been 12 calendar quarters in which the indexes to which our strategies are compared have declined by more than 10%. On average, a 10% quarterly drawdown occurs about every 2 years, though not evenly distributed over time. On the way down, assets tend to sell off across the board.

Things become highly correlated, making it more difficult to generate differentiated outcomes in the short term. Higher correlation on the way down, though, creates opportunity for active managers with extended time horizons. Historically, our investment teams have taken advantage of that dynamic. A year ago, we observed that our firm-wide asset weighted performance had exceeded benchmark performance in 8 of 11 twelve-month periods, following a greater than 10% quarterly drawdown. We can now update that to 9 of 12. Markets have rebounded from a year ago, and in the aggregate, we have outperformed. Looking at three-year periods following a greater than 10% quarterly drawdown, we have outperformed in 8 of 10 periods, with the outperformance averaging 308 basis points. The important point is that Artisan Partners is built for the uncertainty and volatility of financial markets.

In the midst of last year's drawdown, we continued to methodically invest in our investment platform, in particular, the build-out of the EMsights Capital Group. We were patient and played the long game. We have come out the other side with a healthy, diversified business and multiple vectors for future growth. Slide five shows the since inception performance of our 10 strategies with more than 10 years of performance. As you go from one year to three year to 10 years and beyond, our record of investment success becomes stronger and stronger. This is not a surprise. High value-added investment results require talent, plus degrees of freedom, plus time. We attract and retain exceptional investment talent by designing and operating our firm as an ideal long-term home for investment talent.

We provide talented investors with a broad and growing opportunity set of asset classes, markets, and instruments, increasing the available levers for generating return and managing risk for clients. We extend duration by clearly and repeatedly articulating our long-term horizon to all of our stakeholders, and by putting our money where our mouth is, supporting investment teams through market cycles. This slide is a good summary of the quality of our investment business. It shows the breadth of performance across teams, categories, and time, and the repeatability of our business philosophy and process. What gets us particularly excited is that we are applying the same business philosophy and process to the 15 Artisan strategies not shown on this slide, strategies that have yet to reach the 10-year mark.

We expect our newer teams, asset classes, and strategies to compound client capital with similar success. We expect high-quality client outcomes will continue to translate into high-quality outcomes for our business and our shareholders. I will now turn it over to C.J. to discuss our recent financial results.

C.J. Daly (CFO)

Thanks, Eric. Our results in the first half of the year have been strong, driven by higher assets under management, which ended the quarter at $143 billion, up 12% from the beginning of 2023. These results reflect the quality of our client and investment-centric business model. Far this year, our investment teams have generated over $3 billion of excess returns for clients, about 250 basis points above the weighted average benchmark returns, compounded client assets as markets rose, adding over $14 billion of wealth to our clients' portfolios and returned $2.3 billion of capital back to investors. During the second quarter of 2023, global equity and debt markets increased, contributing $5.7 billion to our AUM compared to last quarter.

These investment returns were partially offset by $1.1 billion of net client cash outflows, primarily reflecting outflows in separate account global mandates. Average AUM was $139.3 billion for the quarter, up 3% compared to last quarter and down 3% compared to the prior year June quarter. Year-to-date average AUM was $137.4 billion, down 10% from last year. As indicated on Slide 8, there were no material changes in our weighted average management fee or AUM mix by asset class or vehicle. Financial results are presented on Slides 9 and 10. Our complete GAAP and adjusted results are presented in our earnings release. Revenues in the quarter increased 4% compared to last quarter on higher average AUM and one more day in the quarter.

Compared to the second quarter of 2022, revenues were down 3% on lower average AUM. Performance fee revenues were negligible for all periods. Adjusted operating expense for the quarter increased 1% sequentially due to an increase in incentive compensation expense in line with higher revenues, partially offset by a decrease in certain compensation-related costs that are seasonal in nature. Seasonal expenses are always highest in the first quarter of each year. Adjusted operating income and adjusted net income per adjusted share both increased 11% in comparison to the previous quarter and declined 10% compared to last year's second quarter. Year-to-date, revenues were down 10% compared to 2022 on lower average AUM.

Adjusted operating expenses decreased 3% from the 2022 6-month year-to-date period due to a decrease in incentive compensation expenses on lower revenues, partially offset by an increase in fixed compensation costs related to a 6% increase in our number of employees compared to June 2022. The increase in employees has been in line with our strategic growth plans. Travel expenses continued to increase during the quarter, driven by client activity and the hosting of our annual investment forum, which attracted approximately 300 clients to interact with our investment teams and discuss investment perspectives. As a result of lower revenues, year-to-date adjusted operating income and adjusted net income per adjusted share were down 23% compared to the 2022 year-to-date period. Full-year expense projections remain consistent with the guidance I provided on the February earnings call.

We remain committed to our dividend policy, which returns capital to shareholders on a consistent and predictable basis through quarterly cash variable dividend payments and a year-end special dividend. Consistent with our dividend policy, our board of directors declared a quarterly dividend of $0.61 per share with respect to the June 2023 quarter, which represents approximately 80% of the cash generated in the quarter. During the quarter, S&P announced the addition of Artisan Partners to the S&P SmallCap 600 Index, effective June 19th. The announcement, in addition to the index, drove a noticeable increase in the trading volume of our stock, and along with strong equity markets in June, contributed to the 23% share price return experienced in the quarter. That concludes my prepared remarks, and I will turn the call back to the operator.

Operator (participant)

Thank you. We will now begin the question-and-answer session. To ask a question, you may press star, then one on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. In the interest of time, please limit yourself to two questions. At this time, we'll pause momentarily to assemble our roster. Our first question comes from Alexander Blostein from Goldman Sachs. Please go ahead.

Alexander Blostein (Managing Director and Senior Equity Analyst)

Hey, good afternoon. Thanks for, thanks for taking the question. First, I was wondering if you could comment a little bit more around the institutional pipeline that you guys are seeing, especially across some of the newer strategies, kind of third-generation products that you launched over the last couple of years. Specifically, C.J., to the mandate that you guys won, the $475 million or so, any way to frame the fee rate around that? Thanks.

Eric Colson (CEO)

Great, Alex. This is Eric. Hey, we've been having a little bit of technical issues. Can you hear us?

Alexander Blostein (Managing Director and Senior Equity Analyst)

Yep, I can hear you guys great.

Eric Colson (CEO)

Perfect. Thank you. Yeah, the, you know, across the board on the newer strategies, you know, primarily the MSCI, given the credit orientation and the current outlook on credit, I think we've all seen the news around the credit cycle. Our discussions with clients and consultants around capital market forecasts to asset allocation decisions, to manager structure have all been positive. We've been pleased with the dialogue and activity, especially around the MSCI team and as well as the credit team with Brian Krug, as we stated. The MSCI were coming off of a pretty good outflow into the emerging market debt category last year.

I think it was the largest outflow in the history of Emerging Markets Debt allocations. We're starting to see that creep back in, which is nice timing for us. We has announced a $425 million allocation. We have a few other fundings that we believe are on track that will help launch the Emerging Markets local only as well as the Global Unconstrained Strategies. We continue to have a very active dialogue around our Credit Opportunities, with continued flow into the High Income Strategy. Beyond the MSCI, the earlier strategies, you know, hasn't been as uniform and homogenous as you see in the credit.

It's been a lot of gives and takes, and we see lumpy results around that, primarily, you know, with some of the regulatory changes out there, some of the customization. It seems that, you know, the performance or the rate or the tenure of that client doesn't matter as much as, you know, some of the non-investment related. You know, we think those are always short-term issues. Structurally, if you get the investment right, you get the long-term compounding correct. We're pleased about where we're at on a performance, especially off the rebound of the drawdown a year ago. We think across the board, the newer strategies are well on track.

I think we also-- you know, the 425 funding was a good funding for the MLO strategy. I think we, we hit both your questions there.

Alexander Blostein (Managing Director and Senior Equity Analyst)

I got you. Sorry if I missed, but the fee rate, on that one, and, you know, I don't, I don't know if any comments around, like, the, the fee rate being relatively consistent with the institutional business, kind of higher or lower on, on the 4251 one?

Eric Colson (CEO)

Yeah, it's a, it's a large, separate account mandate. The, the fee rate is lower than our expectation on an average fee rate, given the, the size and the initial funding. It doesn't change our outlook on how we're modeling it and looking it forward. Sometimes you fund strategies that come through the intermediary strategy and come through a pooled vehicle, and sometimes you launch with a, a large separate account. This is a large separate account, and it is, you know, below what we would expect.

Alexander Blostein (Managing Director and Senior Equity Analyst)

I got you. Great. Thank you, guys.

Operator (participant)

The next question comes from John Dunn from Evercore. Please go ahead.

John Dunn (Managing Director and Senior Equity Research Analyst)

Thank you. Maybe just a little more on the institutional channel. Could you talk a little bit more about, typically outside of credit, just kind of the temperature of consultants and temperature of clients, and where they might be looking outside of credit, and kind of willingness to, you know, to commit to strategies?

Eric Colson (CEO)

Yeah, the, you know, the institutional channel, we've seen this year to date, a bit more of an outflow, a little bit more on the, the separate accounts, especially some large separate accounts in Australia, where you've seen a bit more regulation around the superannuations. We've seen some outflow in Europe around some customization and the, you know, importance of ESG. In some cases, some asset allocation away from active equity, but I think that's been muted a bit. Outside of the, the, the pure performance, the institutional separate account is, you know, balancing a regulatory environment, a customization, ESG. You know, we, we think in the exchange at Kynex, that's more on the short-term side.

At the end of the day, if you deliver quality performance, and what we mean by quality is a investment team with stable leadership, a process with integrity that leverages investment degrees of freedom to create a differentiated portfolio, you have a very secure position in the overall asset allocation long term. The current, you know, short term is still battling non-investment, you know, inputs on the institutional side.

John Dunn (Managing Director and Senior Equity Research Analyst)

Gotcha. Then maybe could you update us on capacity? Has there been any changes, you know, more, more or less, over the different strategies?

Eric Colson (CEO)

No, we, we, we haven't had a whole lot of change on any capacity discussions, you know, from the last quarter or year to date.

John Dunn (Managing Director and Senior Equity Research Analyst)

Great. Thank you.

Operator (participant)

The next question comes from Kenneth Lee from RBC Capital Markets. Please go ahead.

Kenneth Lee (Managing Director and Senior Equity Research Analyst)

Hi, good afternoon, and thanks for taking my question. Just wondering if you could provide any updated outlook in terms of seed capital needs over the near term. What, what's sort of like the outlook for any sorts of new product development down the pipeline? Thanks.

Eric Colson (CEO)

Yeah, with regards to new product development and the demand for seed capital, we've over the last few years, probably launched more strategies than we've done in past years. We highlighted that we have 15 strategies below the 10-year mark, and if you look at strategies with less than 3 years. We're putting quite a bit of emphasis on the current strategies, aligning resources. We've done a bit of hiring on the current investment teams. If you look at the uptick in headcount, it's primarily been on our existing investment teams as opposed to going out and finding new teams. We, we think there's quite a bit of opportunities out in the marketplace, but the bar is quite high right now, with our mindset on delivering on what we've created.

I don't see any real short-term movement around new teams or seed capital for new teams. However, there are some in- interesting investment opportunities that are falling out of the current teams we have today and, and the strategies that we've launched. We, we certainly need some funding around some investment opportunities over the next year, based on ideas generated out of our new-- our current teams.

C.J. Daly (CFO)

Ken, you know, from a balance sheet perspective, we have capacity to, to do more from the existing balance sheet. We've always said the special to dividend is a year-end decision. Last year, we held back $20 million from the special to increase, increase our capacity to, to seed new products. You know, we, you know, likely will, will do similar amounts. If capacity or need for seed, you know, exceeds that, you know, we have quite a bit of room left in the special to, to invest for future growth, which, you know, excites us about the ability to, to put more of our balance sheet to use, to grow the business in the future.

Kenneth Lee (Managing Director and Senior Equity Research Analyst)

Gotcha. Very helpful there. Just one, one follow-up, if I may, just on Antero Peak. Were there any particular drivers for the net outflows that you saw over the last, you know, call it 2 quarters or so? Is it, you know, just related to the sentiment and market? Thanks.

Eric Colson (CEO)

Yeah, I, I wouldn't say there's anything specific on the team as much as the, the concentration in the U.S. equity markets over the last quarter. You know, they've even been coined a name with the Magnificent Seven. When you coin a name and there's concentration in an index, I think just the, the competitive landscape over the last quarter, is, is probably the main driver there.

Kenneth Lee (Managing Director and Senior Equity Research Analyst)

Gotcha. Very helpful. Thanks again.

Operator (participant)

The next question comes from Michael Brown, from KBW. Please go ahead.

Michael Brown (Equity Research Analyst)

Okay, great. Thank you for taking my questions. Maybe just a question on the margins here. I guess, first, is there any other major investment required around the EMsights team, or is that mostly done at this point? Then, you know, longer-term question there, how do you think about the ability to improve the margin from the current levels over time? When you look forward, can that margin get back to that mid to high 30% over time?

C.J. Daly (CFO)

Mike, I'll take that one. Yeah, certainly we've, you know, we've invested in future growth, growth, across, you know, you know, the insights team as well as, you know, new strategies. We've seen our margin decline during that period. There is absolutely the ability to, to grow the margin, given the amount of capacity that exists in the system. And, you know, largely, you know, from an investment perspective side, we've, we've done the heavy lifting on the investment. We've got more spend on the distribution side. I don't think that will... I don't think you'll see, you know, a huge, noticeable chunk of spend that will, will stand out, but we'll continue to invest in distribution.

You know, we saw what can happen to our margin, you know, when our assets spiked during the COVID, and we went from, you know, mid 30s up to 44, just from, you know, the market action. You know, that certainly could happen again. Given the fair amount of capacity that's left in the system, if we're able to capitalize on that capacity, we definitely should see the margins, you know, back in the high 30s.

Michael Brown (Equity Research Analyst)

Great, thank you. I guess, you know, AI is, of course, one of the, the hot topics in the financials landscape these days, and certainly sounds like, asset managers have been trying to figure out how to kind of use the generative AI more in the process. How, how do you guys think about, you know, your data, data management, and the potential for AI in your processes and how the teams, you know, may want to use it? Is that something that has already been implemented, or is it something that could be a potential opportunity for you guys?

Eric Colson (CEO)

I think there's opportunity in how we run the business, how we run distribution, and certainly with regards to some of the investment teams. As you know, with the, the 10 autonomous investment teams and how they incorporate data, quantitative tools, and eventually more AI will really be, you know, based on each investment team's leadership and their process and their value they, they see from leveraging AI. With rega to the, the business, and distribution, you know, we're, we're clearly, you know, there's pockets from, you know, development within programming, there's pockets in writing, there's pockets in leveraging more data into the distribution. I, I, I think there's great efficiency that can be brought across the business.

As you get back to the margin, I don't think you'll see, you know, a, a big savings on, like, a headcount in the near term, but the ability of individuals to do more, given the data and tools available, will be highly productive for the organization. Then investment teams that really want to leverage and move into higher use of data and incorporating AI, we will, through our investment services group in the middle, bring those services to bear to optimize the investment teams. It's, it's a hot topic. It's in the early innings, and we're looking at it in probably three different ways.

Operator (participant)

Okay, very interesting. Thank you. This concludes our question-and-answer session. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.