Artisan Partners Asset Management - Earnings Call - Q4 2016

Transcript

Speaker 0

Hello and thank you for standing by. My name is Amy and I will be your conference operator today. At this time all participants are in a listen only mode. After the prepared remarks management will conduct a question and answer session 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 Mikayla Taphorn, Director of Management Reporting at Artisan Partners.

Speaker 1

Thank you. Welcome to the Artisan Partners Asset Management business update and earnings call. I'm joined today by Eric Holson, Chairman and CEO and C. J. Daley, CFO.

Before Eric begins, I would like to remind you that our earnings release and the related presentation materials are available on the Investor Relations section of our website. Also, the comments made on today's call and some of our responses to your questions may deal with forward looking statements, which are subject to risks and uncertainties. Factors that may cause our actual results to differ from expectations are presented in the earnings release and are detailed in our filings with the SEC. We undertake no obligation to revise these statements following the date of this conference call. In addition, some of our remarks made today will include references to non GAAP financial measures.

You can find reconciliations of those measures to the most comparable GAAP measures in the earnings release. I will now turn the call over to Eric Colson.

Speaker 2

Thank you, Mikaela, and thank you all for listening to the call. In 2016, it was particularly important for us to maintain our business discipline and fortitude. This year was filled with surprise and disruption. The Brexit vote and U. S.

Presidential election were the biggest headlines. Disruption was also a major theme in our industry. Asset flows into passive products continued to accelerate. The availability of these products and the perception that they are low for cost and in many cases lower risk is impacting all aspects of the investment management industry. Likewise, the many regulatory initiatives aimed at increasing transparency and reducing conflicts of interest also continued to disrupt industry practices and business models.

Lastly, technology continued to cause disruption as well, enabling investors and innovation, but also exposing everyone to constantly evolving security threats. In analyzing these and other changes and what they mean for us, we always start with who we are as a firm. Artisan Partners is a high value added investment management firm designed for investment talent to thrive in a thoughtful growth environment. By remaining grounded in who we are, we are better able to capitalize on long term opportunities created by disruptive change and avoid chasing fads. With that in mind, in this presentation, want to communicate three main points.

First, Artisan Partners investment teams have added significant investment value for our clients. If our teams continue to add value, we are highly confident that net sales and AUM growth will follow over the long term. There is plenty of demand for active managers to deliver differentiated results with integrity. Second, as a high value added investment manager, we welcome disruption in the industry that causes investors to scrutinize their managers and advisors to determine whether value is being added, fees are transparent and rational and the client's experience comes first. We believe we are well positioned to benefit from the ongoing shakeup of the traditional active industry as well as the increasing frustration of hedge fund investors.

Third, our competitive advantage will continue to be the unique combination our investment talent, business model and culture. For over twenty years that combination has delivered positive long term outcomes for clients and investors, partners and shareholders and our talented professionals. We believe that our people, model and culture will continue to do very well. Slide two illustrates the value our investment teams have added over the long term. The chart shows the growth of a hypothetical portfolio consisting of $1,000,000 invested at the inception of each of our 15 existing and historically marketed strategies.

The hypothetical Artisan portfolio would have grown from a $15,000,000 initial investment to approximately $65,000,000 at the 2016. The $65,000,000 is after subtracting approximately $6,100,000 in management fees. So after fees, the RSM portfolio would have returned almost $23,000,000 or 55% more than a portfolio consisting of each strategy's corresponding passive index. If you flip to slide three, you will see the strategy specific returns that are the primary drivers of the aggregate outcome on slide two. Slide three shows the growth of $1,000,000 invested at inception in each of our nine largest strategies with at least a five year track record compared to the returns of their benchmark indices.

The percentage in the gray box for each strategy is a percentage of five year rolling periods in which the strategy has outperformed the index. Taking the non U. S. Growth strategy as an example, we launched the strategy with Mark Yockey in January 1996. Dollars 1,000,000 invested at inception would have grown to about $6,000,000 net of fees.

Dollars 1,000,000 invested in the EFI Index on the same date would have grown to a little more than $2,000,000 Within the twenty one year period, there were 193 rolling five year periods. Net of fees Artisan's non U. S. Growth strategy outperformed the EFI Index in 155 or 80% of those rolling five year periods. The information on the slide shows that at Artisan multiple investment teams with different decision makers have applied their investment philosophies and processes to generate long term value for clients and investors across multiple inception dates and time periods.

Not only have those investment teams beat their benchmarks, they have delivered these results with integrity. These results are not the product of a centralized research process or a firm wide CIO or investment committee. These results are the outcome of our autonomous investment teams working within our distinct business model, something I'll come back to later. Turning to slide four, long term investment results do not translate into positive net flows each quarter or year. During 2016, we experienced firm wide net outflows of $4,800,000,000 We don't believe that our 2016 experience is particularly helpful in understanding the long term health and prospects of our business.

Instead of reacting to a single period changes, we focus on longer term trends that help us to separate information from noise, avoid overreaction and align our business with long term durable changes. On this slide, we've summarized our net flows over the last four years, basically since our 2013 IPO when many of you began to follow Artisan. Over that time period, firm wide, we have had $2,700,000,000 in net outflows. Unpacking that $2,700,000,000 we see three big picture themes. First, investment performance remains the primary driver of net flows for the Artesyn investment strategies.

Over the four year period, we experienced net outflows of $17,000,000,000 from strategies managed by our U. S. Value and emerging market teams, both which experienced prolonged periods of underperformance and difficult market environments for their respective investment philosophies. During the same period, across our five other investment teams, we saw net inflows of over 14,000,000,000 Investment performance remains the primary driver of net flows. That's good, because we believe that the combination of our talent, model and culture will continue to deliver the kind of long term results I discussed on the last two slides.

This also shows how the diversity of our investment teams stabilizes our business. As some teams have struggled for periods of times, others have thrived. That balance allows each of our teams to maintain their discipline and focus on delivering long term outcomes for clients and investors. The second theme on the slide relates to our defined contribution business. In the DC market, we are clearly facing structural headwinds, even outstanding long term investment performance cannot insulate us from continued outflows in the DC space.

Over the course of our firm's history, open architecture DC plans have been a perfect fit for our strategies. As a percentage of total AUM, DC assets peaked in 2009 at about 25% of our AUM. In recent years, DC plans and beneficiaries have accelerated the shift in assets towards proprietary target date and passive products, which has reversed our historical DC experience. It hasn't helped that our DC assets were and remain heavily weighted towards our U. S.

Mid cap value and mid cap growth strategies, neither of which have strong three and five year relative performance. At year end, our DC assets were 15,200,000,000 representing 16% of our total AUM. While we expect to continue to see net outflows in our DC business, we think the DC business will eventually turn back in our favor. At some point, we believe that plan sponsors will look to best in breed active managers to deliver alpha and consistency within customized DC solution. That will take time.

In the current environment, the combination of strong recent returns and index funds and legal risk will continue to drive DC plans away from active managers, even those who have generated outstanding long term performance for plan participants. Slides two and three give an idea of the potential opportunity cost of the passive approach. We understand the incentives for DC plan sponsors to take the passive approach, but it's worth asking participants whether that approach will maximize outcomes for plan participants over the long term. The third theme on this slide is the continued growth of our intermediary channel and our non U. S.

Business. In 02/2009, when our defined contribution AUM peaked as a percentage of total AUM, the intermediary channel and non U. S. AUM were $11,300,000,000 and $900,000,000 respectively, representing 242% of our total AUM. At the 2016, the intermediary channel and non U.

S. AUM were $27,900,000,000 and $17,800,000,000 representing 2918% of our total AUM. Like the stability provided by multiple autonomous investment teams, our distribution model, channels and geographic diversity help stabilize and balance our business. While we expect our intermediary channel to continue to grow as demographic changes push more assets into the wealth management space, in 2016, we saw net outflows in the intermediary channel and our institutional channel with its longer duration clients was a primary source of stability. The last point that I want to make on this slide is that we've had periods of prolonged organic contraction before.

From 2005 to 02/2008, we experienced net outflows in four straight years. During that period, we have evolved our investment strategy lineup in light of our investment team capabilities and our views about long term demand from sophisticated investors around the world. We launched the core of our second generation strategies, value equity, global opportunities, global value in emerging markets. Since inception, those strategies have combined net inflows of $19,600,000,000 and it's today account for 30% of our AUM. Over the last several years, we have launched the first of our third generation strategies, High Income and Developing World, both of which have gathered assets at record rates within our firm.

We are in the process of launching our thematic teams first strategy and plan to launch additional third generation strategies during 2017. We are designing and launching these strategies in light of disruptions and changing client preferences, which takes me to the next slide. The diagram on this slide, which should look familiar, reflects the ongoing disruption in the investment management industry that we expect will continue to play out for some time. Investors are trading out of traditional active products in favor of passive products on the left side and alternative strategies on the right side. The asset allocation curve is flattening for a number of reasons.

First and foremost, an oversupply of traditional active strategies resulted in too many products, hugging indexes and not delivering value. As less expensive passive products came online, offering the same exposure at a substantially lower price, a large migration of assets was inevitable. That's somewhat obvious and sensible trade though does not explain what we have seen with the proliferation and popularity of narrow and or more complicated passive products such as ETFs providing narrow sector exposures or significant leverage. How those products will ultimately work out for investors remains to be seen. Looking at the right side of the diagram, the migration of assets from traditional active to alternatives is primarily about risk reduction.

Investors have moved assets into alternative products in search of returns that are less correlated to broad markets, strategies actively hedge risk and the optical risk reduction resulting from price smoothing in the most illiquid asset classes. After the Bernie Madoff scandal and other hedge fund scandals, many investors realized that their efforts to reduce investment risk may have exposed them to increased operational and legal risks. That led, we believe, to investors flooding into the most well established alternative investment firm. The flood of assets has in turn resulted in investment returns that have failed to meet client expectations and in recent net withdrawals in the space. So we see two types of disruption working in our favor over the long term.

First, we expect investors to continue to shift away from traditional active managers who have hugged benchmarks for too long. Not all of those investors will go passive. Our experience over the last several years supports our belief that many of those investors will select managers who offer differentiated strategies with high degrees of investment freedom and strong investment track records. We have seen this in particular with our global strategies as well as our high income and developing world strategies. As the $28,000,000,000,000 number at the bottom of the page indicates, the opportunity set is massive.

The reallocation of even a small portion of that well in favor of strategies like ours will work well for us. Second, we believe that there is a good opportunity to attract assets away from hedge fund managers who have failed to meet to manage capacity, rationalize fees or provide the transparency and control that investors increasingly demand. Of the estimated $8,000,000,000,000 invested in alternative products, about $3,000,000,000,000 is invested in hedge funds. Some of the strategies we have in development will be classified as hedge funds, while others will be offered through more traditional vehicles. Whatever the classification, we see these products fitting into the gray shaded area on the chart attracted to investors looking for strategies that are differentiated and outcome oriented with greater degrees of freedom and more tools for risk management.

We believe that offering these strategies within our firm's culture and environment will be very compelling to sophisticated clients and investors. While some of the terminology and classifications may be different, these efforts are just an extension of what we have always done, launch and manage strategies that help clients and investors achieve their goals over the long term. Turning to Slide six, my confidence that our investment teams will continue to deliver value over the long term is based on the historical performance I discussed earlier and our commitment to who we are as a firm. Artisan Partners is different than other investment management firms. At Artisan, talent fits within a business model and culture that are consciously designed and managed for investment talent to deliver positive long term outcomes for our clients and investors.

Much of what makes Artisan unique stems from our autonomous investment team model. Autonomy empowers our portfolio managers to create their own bespoke investment teams and invest on the basis of their own research and philosophy. With empowerment comes accountability. In our model, there is no hiding behind somebody else's investment philosophy, research or decisions. Combination of empowerment and accountability attracts entrepreneurial investors to Artisan.

Individuals who believe in themselves, their philosophies and their abilities so much that they're willing to leave behind comfortable and lucrative positions to build something new and different with Artisan. It's a different kind of investor than you will find at most management firms. Artisan's distinct business management team enhances investment team autonomy. Our job as a management team is to create the best environment for the investment teams and help them develop from a group of individuals into an investment franchise with multiple decision makers and strategies. The fact that we are not ourselves investment professionals minimizes the risk that a centralized or uniform world view taints or waters down the philosophies of each of our teams.

Our approach to economic alignment is also unique. Each of our investment teams participate in a straightforward revenue share. That's the same across teams and across time. This approach increases predictability and enhances stability, which are both important characteristics of our environment. We also align our investment team's interest with those of partners and shareholders through equity grants.

As CJ will discuss in greater detail, last month, we made our annual equity grant. Consistent with our standard practice, 90 of the grant was made to investment team members and about 50% of the equity granted is in the form of career shares, which remain subject to forfeiture until the end of a recipient's career. Arison's culture is also very important to outcomes. We embrace our status as fiduciaries. It's a remarkable thing to be entrusted with the wealth of others.

If we lose trust, we lose everything. We also appreciate that in our industry, with great responsibility comes many obligations, both from regulators and clients. Complying with those obligations is not only the right thing to do, it's a smart thing to do. Lastly, we strive to be transparent. As part of going public in 2013, we naturally became much more transparent as a business and a firm and that is a good thing for us.

It's consistent with the expectation of clients, shareholders and regulators. As technology continues to enable people to access and digest more and more information, the demand for greater transparency will continue to grow. Firms like ours that rely on trust better get comfortable with this and we are. We reject the argument that transparency forces short term thinking and decision making. Since our IPO, we have not changed our long term mindset.

The continued success of our business will primarily turn on our investment teams continuing to deliver long term outcomes for clients and investors. For the reasons I've been discussing, we expect they will continue to do so. In turn, we expect that our business will also do well over long term and will continue to deliver positive long term outcomes for our shareholders, our partners and our talented professionals. I appreciate your time. And I'll turn it over to CJ to discuss our fourth quarter and 2016 financial results.

Speaker 3

Thanks, Eric. I'll begin on slide seven. Our earnings release and this presentation disclose both GAAP and adjusted financial results, but I will focus my comments on adjusted results, which we as management use to evaluate our profitability and the efficiency of our business operations. Revenue in the fourth quarter was $181,500,000 down 1.4% from the previous quarter and the adjusted operating margin was 35.8%, down from 37.3% in the previous quarter. For the year, revenues were $720,900,000 down 11% from the previous year and our adjusted operating margin was 36.4% compared to 40.3% the previous year.

Our results in 2016 reflect overall net client outflows and slightly lower ending AUM amidst the secular trends that Eric discussed, including ongoing demand for low cost market exposure and structural changes in the DC markets. A combination of these trends and performance challenges in some of our mature strategies resulted in firm wide net outflows during the year. Taking a look at our AUM on slide eight. We ended the year with $96,800,000,000 of assets under management, which was down $3,000,000,000 or 3% compared to both last quarter and last year. The decrease in the quarter was due to approximately $2,800,000,000 of market depreciation and $231,000,000 of net client cash outflows.

The decrease in the year reflected $4,800,000,000 of net client cash outflows, partially offset by $1,800,000,000 of market appreciation. Taking a closer look at cash flows by team. The growth team had net client cash inflows of $800,000,000 in the quarter, primarily due to a large non U. S. Institutional win in the Global Opportunity Strategy, which was partially offset by net client cash outflows in the MidCap Growth Strategy.

For the year, the growth team had net client cash inflows of $450,000,000 reflecting net inflows of $2,700,000,000 in the Global Opportunities Strategy, offset in part by outflows in the MidCap Growth Strategy of $1,900,000,000 While the Global Opportunities Strategy continues to see strong demand from clients outside The U. S, the mid cap growth strategy continues to face headwinds, particularly in the DC space. The Global Value team had net client cash inflows of $600,000,000 in the quarter, primarily from non U. S. Clients.

For the year, the Global Value team had net client cash inflows of $1,500,000,000 or 5% organic growth in both of their top performing global value and non U. S. Value strategies. Our two newest teams, the credit team and developing world team continued to see net client cash inflows with two twelve million dollars in the quarter and $1,200,000,000 in the year. These two teams continue to build strong performance track records, which should go well for future cash flows.

In the quarter and for the year, the Global Equity team had net client cash outflows of 1,700,000,000 and $4,000,000,000 respectively, primarily in the non U. S. Growth strategy due to reduced EFI allocations and strategy underperformance. These net client cash outflows follow a three year period with $7,500,000,000 of net cash inflows or an average of 12 annualized organic growth when intermediaries were increasing their EFI allocation and the strategy had strong one and three year outperformance. We expect the non U.

S. Growth strategy will continue to experience net redemptions until performance improves. The U. S. Value team had $158,000,000 of net client cash outflows in the quarter and $3,600,000,000 of net client cash outflows for the year, primarily in the MidCap Value strategy due to previous underperformance.

During 2016, U. S. Value team had a very strong performance. The MidCap Value strategy posted an annual gross return of almost 24% and outperformed the broad market index by over 1,000 basis points. Moving on to financial results for the quarter on slide nine.

For the quarter, both average AUM and revenues declined 1% compared to the previous quarter and four percent and five percent respectively compared to the same quarter last year. For the year, average AUM decreased 10% and revenues were down 11% compared to the prior year. In 2016, we experienced a modest one basis point decline in our average fee rate as a result of a greater redemptions in pooled vehicles compared to longer duration institutional minded clients. We believe that the longer duration of institutional clients offset the lower fee rates yielding a better return over the long term. Slide 10 shows expenses on an adjusted basis.

Operating expenses net of pre offering related compensation expense were up 1% sequentially and year over year due to higher compensation expense, which I will comment on shortly. Operating expenses net of pre offering expense for the year were down 5% compared to the prior year, due primarily to lower compensation and third party distribution expenses, the majority of which vary directly with revenue offset by increased investments in technology. As previously guided, we continue to invest in technology to among other things support our new and existing investment teams with increased data and mobility capabilities. On slide 11, we've broken out compensation and benefits expenses, which comprise close to 80% of our total operating expenses. Compared to the prior quarter, compensation and benefits expenses excluding pre offering related compensation expense increased $1,100,000 or 1%.

Incentive compensation in the quarter increased due to incentive compensation expense associated with the onboarding of the Matic team and our Chief Operating Officer of Investments. Equity based compensation declined in the quarter following an elevated September due to accelerated awards. Year over year comp and benefits expenses excluding pre operating related compensation expense decreased $16,400,000 or 4 percent. Incentive compensation was down 11% in line with revenues. Equity based compensation increased as we layered in the expense for equity grants granted in January 2016.

Our compensation ratios for the quarter and the year were 5049% respectively. The increase from prior periods was primarily a result of lower revenues and increased equity based compensation expense, which accounted for about 600 basis points of the 2016 compensation ratio, up from four fifty basis points in 2015. Moving on to slide 12. In the quarter, adjusted operating margin decreased to 35.8% compared to 37.3% last quarter and 39.7% for the prior year quarter, primarily due to the onboarding expenses discussed earlier and lower revenue levels. For the year, the adjusted operating margin declined to 36.4 from 40.3%, primarily due to lower levels of revenues and the increased investments in our business, which I have already discussed, including equity based comp, our newest team and technology.

Adjusted net income in the quarter was $39,300,000 or zero five three dollars per adjusted share and in the year was $158,700,000 or $2.13 per adjusted share. On to slide 13. In late January, we announced that our Board of Directors declared a quarterly dividend of $0.60 per share and a special dividend of $0.36 per share, both payable on February 2837 to shareholders of record on February 14. Quarterly and special dividends declared in the last four quarters totaled $2.76 per share, a yield of approximately 9.5% based on where our stock price has been trading over the past several days. The $2.76 represented more than the cash we generated from earnings in 2016.

The amount declared also includes cash retained from prior year earnings as well as tax savings after payments under our tax receivable agreements. With respect to our ability to maintain the $0.60 quarterly dividend, we continue to generate cash in excess of the $0.60 quarterly dividend. Our calculation of quarterly cash generation principally includes the zero five three dollars per share of adjusted earnings plus the non cash post IPO equity based comp expense. And similar to last year and considering the amount of this year's special annual dividend, we elected to retain approximately $0.25 per share of previously generated cash and TRA related cash savings to cushion against downturns we may experience in levels of AUM and earnings over the next several quarters. Slide 14 shows our balance sheet highlights.

Our balance sheet remains strong with healthy cash balance and modest leverage at 0.6 times. Looking forward to 2017, in the near term, we expect to continue to see net outflows due to short term underperformance and some of the structural headwinds we've discussed. While these headwinds are real, our long term record of outperformance in the active strategies we manage along with our new teams and strategies and global product offerings position us well to return to growth organically over the long term. Specifically related to comp expectations, just a reminder that our comp ratio runs higher in the March of each year due to increased equity based comp expense from January equity grants and seasonal compensation costs. In January 2017, we granted 1,300,000.0 restricted shares to our employees, which will add approximately $1,200,000 in expense to the 2017 and $1,700,000 in future quarters.

Offsetting the incremental equity comp expenses will be the roll off of approximately $1,500,000 of one time expenses in the fourth quarter related to the onboarding costs I discussed earlier. Before I finish up, a couple of points on employee partner liquidity. As you are aware, our employee partners are restricted from selling more than 15% of their pre IPO equity in any one year period. The one year period resets in the first quarter of each year. After the reset this year, Employee Partners will have the right to sell an aggregate an additional 2,200,000.0 shares.

Combined with the shares that previously became eligible, but have not yet been sold, Employee Partners will hold 3,600,000.0 shares eligible to be sold. They are not required to sell any shares and we don't know how many shares they will choose to sell. That concludes my prepared remarks. We look forward to your questions. And I will now turn the call back to the operator.

Speaker 0

The first question comes from Robert Lee at KBW.

Speaker 4

Great. Good morning, everyone. Thank you. I guess my first question maybe, C. J, if you could just I want to make sure I had it right.

The $1,500,000 of one time expenses in Q4 was that I believe that was related to Thematic. Is that you're referring to the incremental comp expense?

Speaker 3

Yes. Well, on boarding you obviously have to bridge the gap of people coming to the firm. So the $1,500,000 of additional cost for thematic was in the fourth quarter and then our run rate as the team has built up will be about 1.25 to 1.5 ongoing per quarter. So quarter to quarter, it's about flat for the thematic.

Speaker 4

Okay. Just wanted to make sure I had that right. I mean, thinking about capital management, I believe you do have a tranche of debt that comes due this summer. So just as you think about cash on the balance sheet and stuff, is it kind of your current intention to kind of use some of the excess cash to pay down debt or leave it or refinance it? I mean, are you thinking about that as part of Capital Management?

Speaker 3

Yes. I mean, we certainly have a lot of flexibility and optionality given our strong balance sheet and the amount of cash that we retain. But given the current markets and favorable environment, most likely we'll refinance the entire $60,000,000 that's coming due.

Speaker 4

All right. Great. And then maybe just one last one and just kind of more of a big picture. Mean given a lot of the challenges that as you pointed out and headwinds that traditional active managers have faced, particularly in kind of the intermediary and some of the retail channels. I mean, you is there any have you thought at all about changing fee structures?

Maybe there's been some talk about, gee, maybe more funds should have fulcrum fees as a way to kind of try to attract more attention. What are your any thoughts around that? Or what are you thinking about maybe altering some of the pricing constructs not so that if you perform over time you earn the same or more fees, but in the short term maybe you give something up?

Speaker 2

Yes, Rob, it's Eric. We think about fees quite a bit obviously given the environment. We first and foremost just look at the performance and the results we've delivered over the long term. And as we step back and look at the structural trends, as you said, a big picture, We look at what's changing and vehicles won. I mean, just the massive movement of assets to ETF signals assigned towards the mutual fund structure.

And then you saw last year a shift within artisan of adding the third share class. So we have three mutual fund share classes now. And that change shifted assets of close to $10,000,000,000 in a twelve month period all in the mindset of trying to reduce third party fees. So there is scrutiny going on and there needs to be more transparency around the total fee structure but we feel good about the returns that we're delivering and the management fees that we're charging.

Speaker 4

Okay. Thanks for taking my questions.

Speaker 0

Next question is from Chris Schulter at William Blair.

Speaker 5

Hey, Good afternoon. Maybe first, could you just talk about the I think, Eric, you mentioned third generation strategies you plan to launch in 2017. I know there's the thematic team. I'm guessing maybe more from the high income team. So just any more details on what the additional strategies could be or at least what teams?

Speaker 2

We certainly see that shift in preference by clients and advisors and consultants looking for more differentiated strategies. We highlighted that on the call. Clearly the thematic team's front and center there. So we have a mutual fund in registration for the thematic team that we expect to launch by the March. That will be a highly concentrated, long oriented fund managed by Chris Smith and our new thematic team that we've built out.

After we launch that, we are looking into a variety of private funds or LPs that were under construct now to bring out in twenty seventeen. We don't have any specific details on launch dates for those. But 2017 looks like a good year to push forward on with a couple of teams.

Speaker 5

Okay. A couple beyond the Thematic team?

Speaker 2

The Medic team and one other team for sure and it could be a third. Those are we'll see how we can phase those out. All of our teams are in the mindset of higher degrees of freedom that we mentioned on the last call. Each of the teams are looking to use their talent and their philosophy and their process to add to a differentiated approach to meet client demands.

Speaker 5

Okay. And then secondly on the Global Value team, how much more AUM do you feel like they can take on before you consider closing that again?

Speaker 2

The strategies of international and Global Value and I guess Global Value in the pooled vehicles, we've been managing that flow. We've been fairly judicious on the inflows and we're going to continue to manage that. So I would not expect much asset growth out of those two strategies. We're managing capacity there and we're keeping a mindful eye on flows. So I wouldn't put much into any big movement in flows there.

Speaker 5

Okay, makes sense. And then lastly, CJ, just on the expense trajectory in 2017, how should we be thinking about some of the more fixed expense line items, so occupancy, tax, G and A, etcetera?

Speaker 3

I would say stable to slightly up. The big movements we've had over the last couple of years have really been in our technology spend and that while it might increase slightly should level off. And then the other expenses should be relatively stable. We are doing a bit of some office build out, but not major expenses. And we're largely built out from an infrastructure standpoint to fill a good portion of the capacity we have.

Speaker 5

Okay, great. Thanks a lot.

Speaker 0

The next question is from Bill Katz at Citi.

Speaker 6

Okay. Thanks very much for taking my questions this morning. Appreciate all the extra color, Eric, particularly just want to think about the cross currency industry, very helpful to get that perspective. Just sort of sticking with that theme for a moment, as I sort of listened to your commentary and think about your franchise, there does seem to be a lot of different cross currency, whether it be product, geography or even distribution line. So as you look ahead, is it more of an institutional and non U.

S. Opportunity that might drive it? And on the retail side, I guess the corollary is it seems like distributors continue to narrow down the number of players. And if you do the math, I think you're saying about $30,000,000,000 or so of assets in sort of the more traditional retail side. Is that a platform that even with good performance just could be maybe too small to really capture any type of incremental growth?

I'm just trying to understand longer term growth drivers here a little bit.

Speaker 2

Certainly, there is quite a bit of crosscurrents as we stated. And to hit on your first point, it has been an institutional oriented story. Certainly last year with the global opportunities and the global value strategies, we made good strides outside The United States with long term oriented institutional clients. We think that that really gives us a much longer duration. And at the competitive fees that we're getting, we think that gives us a really high present value on that client compared to some of the shorter term channels that you look at even though you're getting a slightly better fee.

And as we think forward, we're thinking more and more about the wealth management channel as a whole globally. And when you look at that next generation strategy that differentiates quite a bit from the index, brings in a little bit more risk management. And it more than likely has a strong fit in wealth management, would be high end retail, family office, into the intermediary and also into the more sophisticated institutional client that fits their asset allocation. And even though the capacity might be slightly lower, you pick that up on the fee. So that's our mindset over the next few years or longer term as you said.

Speaker 6

Got you. Underneath that, I think high yield comes into a three year track record, if not this quarter very soon. What sort of the pipeline behind that do you think? And then conversely, are there anything that's closed right now that might be available to open up more broadly to potentially offset some of the management on the Global Value team?

Speaker 2

Yes. The high yield is coming upon its three year track record, gives is usually a tipping point for many advisors. They like to see that three year track record. Fortunately, we've had a little bit of a head start given the history that Brian Krug brought with him and his track record. We believe there's a good institutional pipeline building with advisors and consultants.

It's a little bit kind of a tale of two stories. On one side, the strong performance of the high yield marketplace of think it was 17%, 18% on the index, somewhere around there. It's going to attract quite a bit of people just from the strong absolute performance. Others may look at that and say, we'd like to see that reverse a little before we move back into the high yield. So we've had mixed interest on those type of clients given the strong last year.

And we on closed strategies, the only thing we've done is we've opened up the mid cap value strategy as we see the performance starting to stabilize and move back in. I think we're in the early phases of that. We never look at the reopening of a strategy as a way to just attract immediate assets. We think it's a longer term story. That's the strategy that has reopened.

The rest we'll manage in a diligent manner.

Speaker 6

Okay. All right. Thank you for taking my questions this morning.

Speaker 0

The next question is from Surinder Thind at Jefferies.

Speaker 7

Hi, Eric. Just to kind of touch base on the DC space. How are you guys thinking about the DCIO opportunity kind of given the challenges in that space kind of the near term versus the longer term? I mean, when I kind of look across more broader industry comments, some of your competitors are kind of touting this as a significant opportunity while it seems you guys are fairly cautious over what I would probably characterize what seems in the next couple of years.

Speaker 2

Yes, I certainly think it's an opportunity for us. We've done very well in the defined contribution market. We expect that the defined contribution market will remain a more sophisticated market with institutional advisors helping to structure those plans. But in the short run, we continue to see that push towards target date funds that remain closed or proprietary and even on top of that, a push towards passive. I don't think every plan will move to those.

Some clearly want the diversification. And on top of that, I think some of the third party fees are under pressure into that channel. And the combination of those third party fees coupled with the current run on passive results, I just think the opportunity gets pushed out outside of 2017 for a real opening up of defined contribution solutions. We think inevitably it will occur. It happens the first go around in the 04/2001 proprietary model moving to open architecture and to the DCIO.

And we think it'll happen again. It's just a timing. And 2017 looks like there's still continued pressure on those plan advisors.

Speaker 7

Understood. And then just kind of a question about strategy here. When I kind of look at some of the different products that are offered by each of the teams, it appears that there's maybe some meaningful correlation in investment performance between products that are maybe managed by the same team, you know, thinking of the U. S. Value team, the global equity team in this situation.

Kind of any color around this? And is it potentially an issue from a sales perspective? Or how do you guys think about that?

Speaker 2

Our expectation is it should be highly correlated within teams. For the most part when you look across our equity teams, they're all investing in public equities. And they're all using the exact same philosophy and process. And so within teams, that's gonna generate a high correlation that's what we expect. And in fact, we'd expect some decent security overlap in some of these teams as well.

So the mindset we have, it's gonna be highly differentiated among the autonomous teams to give the firm diversification. But within team, it should remain correlated.

Speaker 7

So does that generally present a sales challenge then? So for example, if one of the funds starts underperforming, seems like the rest of the remaining funds might be underperforming as well. I guess that was kind of the heart of the question here.

Speaker 2

It sometimes brings up a sales challenge but when you really dive into the different indexes, clients and consultants can quickly understand that. So if you look at the growth team specifically with the strong outperformance in global opportunities and then the underperformance in the mid cap growth and small cap growth in the short run, it does bring up a question. Then you look at the absolute return of all three strategies over the last five years and if you look at those strategies, the mid cap growth strategies at 13%, The US small cap growth strategy is at 13%, and global opportunities is at 14.5%. So the factors and the type of companies that they look for are prevalent across all three of the strategies. The real differential is the makeup of the index and that gets to passive investing.

And that's a whole other topic that I don't think I want to open up right now. But we do get back to talking about the consistency of these strategies across any team quite frequently.

Speaker 7

Understood. And then C. J. Maybe just a quick question for you. You know, I was a little bit surprised that you guys did top off the quarterly dividend this year.

But I also understand it sounds like you guys have generally held back about $0.25 to top things off in case there is a kind of a shortfall in the quarterly dividend. How are you guys thinking about that reserve level meaning that it seems like it's about a 10% of the annual dividend? Is that kind of the way you guys are thinking about it? Or are you guys just trying to think about it to make sure that you guys have enough for a couple of quarters and then there might be an adjustment at that point if there is a meaningful downturn in the markets? Or how should we think about that?

Yes. I mean, it's more

Speaker 3

of the latter. We've been covering our quarterly dividend, not by a huge amount. So the thought process is exactly what you're suggesting. Let's kick out enough cash, but reserve a bit that we can go a couple of quarters not covering the dividend before we would take any action. And so that's sort of been the general philosophy.

And the $0.25 is, as you can imagine, very subjective and you know, there's no specific science to it.

Speaker 7

Sure. Thank you. That's helpful. That's it for my part. Thank you.

Speaker 0

The next question is from Michael Carrier, Bank of America Merrill Lynch.

Speaker 8

All right. Thanks a lot. Just given the strength in the separate account inflows this quarter, just wanted to get a sense on the traction that you're seeing in that area of the business. And it seems like you mentioned some of the international where we've seen strength, just any traction from the distribution channels?

Speaker 2

The primary traction that we have seen is in institutional separate accounts, primarily outside The U. S. With a global orientation. The global value, the global opportunities, the global equity, and more recently even a higher degree of interest in developing world and emerging markets as that asset class picks up in performance. All those strategies are very well suited for non US oriented clients.

And we're getting strong traction there. And as you can see on our presentation, you saw that the differential and flows of U. S. To non U. S.

Since the IPO. And so we continue to see that pickup. During that period, I think we've had an exchange of kicks in the intermediary space with the first couple of years being positive and then some rebalancing there. We just see continued back and forth in the intermediary space. And then as we mentioned long term DC, we hope that turns around, but we think that's unlikely in 2017 and it's probably pushed out more to 2018, 2019.

Speaker 8

Okay. And then just within Global Equity, just given some of the flow pressures that we're seeing, just wanted to get some sense, if you have it, particularly on the non U. S. Growth strategy of the makeup like the clients? Meaning because the long term track record is still remains strong.

Obviously, the one three year is under some pressure. But just maybe how, I don't know, volatile the assets are versus maybe the longer term like clients?

Speaker 4

Yes.

Speaker 2

That's been a client base that's been around for numerous years on the Op C with the team and strategy being kicked off in 'ninety five and the fund being launched in 'ninety six, you can imagine that some of these clients have been around with us for many years. So we have really good diversification on inception date. And the further you go back and you look at anything past four or five years, I mean, the five year return on the non U. S. Strategy is at 7.5% above the EFI Index by a full 100 basis points.

It really is those shorter term clients under that five year. And when you get into the retail and some of the lower end of the intermediary space, you have a little bit more turnover with shorter duration clients. But the bulk of that asset base is a longer duration book.

Speaker 8

Okay. All right. Thanks a lot. The

Speaker 0

next question is from Alex Blostein at Goldman Sachs.

Speaker 9

Thanks. Good morning, everybody. A question for you guys around some of the new strategies. So I guess as you consider launching different types of products, particularly focused around some of the alternatives, can you talk a little bit about any incremental infrastructure that you guys would need to build out? So thinking sort of similar to what you had to do in fixed income a couple of years ago.

And then it sounds like the launch of these strategies will be kind of later on in 2017. So just thinking through the expenses and the kind of building the expense base to accommodate the new setup into 2018 and beyond? Thanks.

Speaker 3

Yes, Alex. We've been building that out in anticipation of bringing on a thematic team and launching hedge funds. And so we did a lot of that work last year. So I wouldn't expect anything material based on what we have on board today going forward.

Speaker 2

Okay. Thanks.

Speaker 0

This concludes our question and answer session. Would you like to make any closing remarks?

Speaker 2

Amy, I think we're good. Thank you everybody for joining in the call.

Speaker 0

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.