Franklin Resources - Q3 2023
July 28, 2023
Transcript
Operator (participant)
Welcome to Franklin Resources Earnings Conference Call for the quarter ended June 30th, 2023. Hello, my name is Joanna, and I will be your call operator today. As a reminder, this conference is being recorded and at this time all participants are in a listen-only mode. I would now like to turn the conference over to your host, Selene Oh, Head of Investor Relations for Franklin Resources. You may begin.
Selene Oh (Head of Investor Relations)
Good morning, thank you for joining us today to discuss our quarterly results. Statements made on this conference call regarding Franklin Resources, Inc., which are not historical facts or forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a number of known and unknown risks, uncertainties, and other important factors that could cause actual results to differ materially from any future results expressed or implied by such forward-looking statements. These other risks, uncertainties, and other important factors are just described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including in the Risk Factors and the MD&A sections of Franklin's most recent Form 10-K and 10-Q filings. I'd like to turn the call over to Jenny Johnson, our President and Chief Executive Officer.
Jenny Johnson (President and CEO)
Thank you, Selene. Hello, everyone, and thank you for joining us today to discuss Franklin Templeton's results for the 3rd fiscal quarter of 2023. As usual, I'm joined by Matt Nicholls, our CFO and COO, and Adam Spector, our Head of Global Distribution. Over the past several years, we have been intentional in building a diversified company that offers a broad range of investment expertise and capabilities across asset classes, investment vehicles, and geographies to benefit a broad range of clients through various market conditions and cycles. We believe our corporate model of preserving the investment autonomy of each of our Specialist Investment Managers, combined with the resources of a global firm, meets the demands of our diverse client base and produces strong long-term results. This quarter, long-term net flows turned positive. Investment performance remained strong and adjusted operating income improved by 8%.
Financial markets in general, staged rebounds in the first half of the calendar year. The S&P 500 index's concentration in five companies is at its most extreme level in more than 30 years. A challenge for those seeking to outperform the index while managing for concentration risk in their equity portfolios. Also an opportunity for skilled and disciplined active managers with a long-term horizon. Client focus has always been a hallmark of Franklin Templeton. We've been actively engaging with our clients to assist them in navigating this complex environment. As our industry and client preferences continue to evolve, there is strong demand for asset managers to have a full range of investment options that span geographical regions, both in public and private market strategies. We generated interest in our alternative and multi-asset strategies in particular, which both saw positive net flows during the quarter.
In addition, we experienced strong flows in ETFs, SMAs, and the high net worth channel, and flow trends continued to improve across all geographies benefiting from our regional sales model and strategy. Our EMEA and Asia Pacific regions both reported positive long-term net flows. That's the second consecutive quarter of net inflows for Asia Pacific. While we're always focused on organic priorities, we have previously stated our interest in distribution-led strategic transactions that would further diversify our business and accelerate growth in key markets. With the vision of offering more choice to more clients in important sectors, we were pleased to announce the establishment of a long-term partnership with the Power Corporation of Canada and Great-West Lifeco this quarter.
As part of the relationship, we will acquire Putnam Investments, which managed $136 billion in AUM as of April 30, 2023, from Great-West for approximately $925 million, primarily funded with equity. Great-West will make an initial incremental asset allocation of $25 billion to our Specialist Investment Managers within 12 months of closing, with that amount expected to increase over the next several years. Great-West will also become a long-term shareholder in Franklin Resources, and of the equity issued to Great-West, shares representing 4.9% of our common stock are subject to a 5-year lockup. This is a compelling transaction for both firms, and we're looking forward to actively partnering to develop additional opportunities that will be realized over time.
The agreement aligns with our focus to further grow insurance client assets and expands the existing relationship between Franklin Templeton and the Power Group of Companies in the key areas of retirement, asset management, and wealth management. The transaction will also enable us to further increase our investment in retirement and insurance to better serve each and every client in these important segments. Our clients will benefit from expanded and complementary investment capabilities across key asset classes with strong long-term track records. Specifically, the acquisition of Putnam will increase Franklin Templeton's defined contribution AUM to almost $100 billion. As a reminder, the acquisition of Putnam is expected to be modestly accretive to run rate adjusted EPS by the end of the first year after closing, adding approximately $150 million of run rate adjusted operating income in the first year post-closing, inclusive of cost synergies.
The acquisition remains on track to close in the fourth calendar quarter of 2023, subject to customary closing conditions. Turning now to our specific numbers for the quarter, starting first with assets under management and flows. Ending AUM increased to $1.43 trillion, primarily due to market appreciation, and we shifted into positive long-term net flows of $200 million, inclusive of reinvested distributions. Our long-term net flows continued to benefit from a diversified mix of assets in the quarter, led by record net inflows of $4 billion into alternative strategies. Our three largest alternative managers, Benefit Street Partners, Clarion Partners, and Lexington Partners, generated a combined total of almost $5 billion in net inflows. This included raising over $1 billion in secondary private equity in the wealth management channel under the Alternatives by Franklin Templeton brand.
Today, alternative assets are $257 billion or 18% of our total AUM and contribute more significantly to our financial results. In terms of other areas of activity in the quarter, our multi-asset strategies generated another quarter of positive net flows with $2.3 billion. Our solutions team has been gaining success with large institutions building customized solutions across our broad array of investment strategies. Equity net outflows improved to $3 billion this quarter, including the funding of a previously disclosed $3.2 billion institutional mandate. While active equities continued to be impacted by the risk-off environment, we saw positive net flows into international, large cap core, emerging markets, all cap value, and small midcap equity strategies. Fixed income net outflows were $3.1 billion.
Despite market uncertainty, we experienced increasing demand for fixed income, and we benefited from having a broad range of strategies with non-correlated investment philosophies. Client interest continued with net inflows into multi-sector, core bond, enhanced liquidity, and tip strategies. Our regionally focused sales model and strategy resulted in improving flow trends across all of our geographies compared to the prior quarter. As mentioned earlier, the EMEA and Asia Pacific regions generated positive long-term net flows. From a vehicle perspective, ETFs generated net inflows of $1.1 billion, representing the third consecutive quarter of net flows of approximately $1 billion, and AUM totaled $16.2 billion at quarter end. In the quarter, we also launched 2 thematic ETFs in Europe in both future of food and health and wellness, 2 areas where we expect to see strong client interest.
Separately Managed Account AUM ended the quarter at $116 billion and generated positive net flows. We continue to expand our SMA offerings in important growth categories and new market segments to provide clients choice in how they access our investment expertise across the breadth of our products. This quarter, we had important launches focused on customization, such as tax-managed overlay and SMA key flagship strategies, including the Franklin Income Fund. Canvas, our custom indexing solution platform, continued its trend of net inflows in each quarter since the platform launched in September 2019, and its AUM has doubled to $4.5 billion since the announcement of the acquisition. This past quarter, Canvas generated net inflows of approximately $300 million and continues to have a robust pipeline.
Canvas allows financial advisors to build and manage custom indexes in SMAs that are individually tailored to the client's specific needs, preferences, and objectives. We believe custom indexing represents the next progression of direct indexing and ETFs and is a significant long-term growth opportunity. Turning now to investment performance, which we're pleased to say remains strong. 63%, 53%, 67%, and 63% of our strategy composite AUM outperformed their respective benchmarks in the 1, 3, 5, and 10-year periods, respectively. For mutual fund investment performance, 44%, 58%, 66%, and 51% of our AUM outperformed their peers on a 1, 3, 5, and 10-year basis. This represents improvement in the 3-year and 5-year periods from the prior quarter due to strengthened performance in equity and certain fixed income strategies.
The 1-year decline was primarily due to one of the largest funds managed for income, which was overweight utilities and financials, which generate higher yield and underweight technology compared to the S&P 500. Touching briefly on our financial results, ending AUM increased by 0.7% to $1.43 trillion as of June 30th from the prior quarter, reflecting market appreciation and positive net flows. Average AUM was flat from the prior quarter at $1.42 trillion. While our effective fee rate remains stable, adjusted operating revenue increased by 3% to $1.56 billion. Adjusted operating income increased by 8.3% to $476.8 million from the prior quarter. Adjusted operating margin was 30.5%, compared to 28.9% in the prior quarter.
We continue to maintain a strong balance sheet with total cash and investments of $6.9 billion as of June 30, 2023. To wrap up, we have worked through another quarter of complicated markets, our progress and success would not be possible if it weren't for our dedicated employees around the world. I would like to thank them for their many contributions and for their unwavering client focus. Let's turn to your questions. Operator?
Operator (participant)
Thank you. If you would like to ask a question, please press star one on your telephone keypad. The confirmation tone will indicate your line is in the question queue. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. We request that you limit to one initial question and one follow-up. First question comes from Alexander Blostein at Goldman Sachs. Please go ahead.
Alexander Blostein (Managing Director and Senior Equity Analyst)
Hey, good morning. Thanks for, thanks for the question. Maybe we could start with some of the trends you're seeing in the alternative asset management space. First, I was hoping we could get a little bit more color on how much capital Lexington raised in the second quarter in their flagship fund, and as you highlighted in the deck, continuing to fundraise here. How large do you think the size could ultimately of that fund be? When you expand a little bit broader into private alts, generally, what else is in the pipeline that you expect to come in over the next 6-12 months?
Jenny Johnson (President and CEO)
You know, I think we publicly disclosed that Lexington's raised $18.2 billion so far on their latest fund. I think in the quarter, it was about. It was a little over $3 billion, maybe $3.4 billion. Of that, I think what we're incredibly proud of is the fact that we raised a little over $1 billion in the wealth channel and first-time fund. I think the expectation was that if we raised $500 million, you know, that would be pretty good for a first-time fund. You know, we've talked on these calls before about how complicated it is to raise alternatives in the wealth channel because it requires not only retraining of your own sales team, but actually training of the financial advisors.
We put a lot of effort over the last 18 months. We built out a 40-person, Alts Wealth specialist team. We've used our academy to train our own internal sales folks, as well as helping to train the financial advisors. That was a big part of it. I think the, the, the fund can raise up to $20 billion and, you know, I think it's quite possible that that will happen.
Alexander Blostein (Managing Director and Senior Equity Analyst)
Great. Then just as far as the pipeline of other things that are in the hopper as you look out over the next 6-12 months?
Jenny Johnson (President and CEO)
In specifically in the alt space, I mean, so, you know, private credit, we still think is just a great opportunity. You know, our view is that banks are gonna even lend less than they've been lending. You know, it is definitely from deploying capital, it's been slowed down by the fact that M&A has slowed down. Just read an article yesterday where somebody was talking about they are seeing M&A pick up. That will make a difference. We're thrilled because having BSP at $78 billion, you know, we cover both the U.S. and Europe. In addition to that, you know, one of the things that's actually really important in these times is having the knowledge and expertise in special situations where you could work out deals.
You know, if you have an underlying credit that is struggling because of, you know, the, the, maybe they can't cover their rates, being able to restructure it is really important, and BSP has, you know, has that expertise internally. The, the biggest issue there has been around deploying, but they're seeing, you know, continue to see very good deals. They're, they're seeing their underlying companies be very strong, and where there are some stresses, they've been able to handle those workouts. Again, we think as M&A activity picks back up, they're gonna be able to deploy more capital. They've said, you know, they're seeing the best deals since they've seen since the global financial crisis. In the case of real estate with Clarion, probably the biggest issue is price discovery.
I think everybody knows the office story. Unfortunately, Clarion has just about 10% exposure to office, so that's not been a big exposure for them. You know, their, their focus has been on industrial space, you know, data centers, and things like that, which with AI, frankly, will only get bigger and more demand, but also, multifamily. I think the story about the, the underbuilding of multifamily is important. The, the issue has been a little bit around the bid and ask on just, you know, the sellers being willing to accept lower prices and the, and the buyers being willing to, to pay up. As we see that smooth out, I, I think you'll see more, you know, more movement in the real estate space.
They, they just the, on the, you know, redemption queue, just a reminder, their clients are mostly institutional, and so they don't have the kind of, requirement to do redemptions, because the institutions don't want, you know, any kind of fire sale, and so they have more flexibility on their redemption queues, which equates to less than, I think, you know, 2% of AAV. Adam, it looks like you wanna add something there?
Adam Spector (EVP and Head of Global Distribution)
Sure. I was gonna say a couple of things, Alex. One, I think we see strong fundraising in the traditional markets that they've been in, but with stronger public markets, the denominator effect is less of an issue, so we're feeling really good about the, the raise for all of our alternatives firms in the private markets. I would also say that in the wealth channel, it's not just the Lexington flagship we're offering. We have Clarion products in there, like CPREIF and Opportunity Zone, that are going well. Launching BDCs and interval funds for BSP, our venture funds in the wealth channel, so feeling good about that.
Then the Alcentra acquisition has been very positive for us, and having the ability to launch a European-managed product in Europe, Europe through our distribution force there, we think will be a very positive add as well.
Matthew Nicholls (Co-President, CFO and COO)
Then one, one other-
Adam Spector (EVP and Head of Global Distribution)
Great, thanks.
Matthew Nicholls (Co-President, CFO and COO)
One other data point, Alex. In terms of dry powder, BSP has in excess of $4 billion, and over the next 12 months, they expect to raise several billion dollars more.
Alexander Blostein (Managing Director and Senior Equity Analyst)
Got it. Super helpful. Just a quick follow-up, staying on the alts for a second. It's a little bit of a nuanced question, but when we look at the roll forward in the AUM table, it looks like the alts had a negative mark, and I'm a little surprised, just given that, you know, the mark-to-market dynamics generally have been positive in other places. Is it a lag, or is there something idiosyncratic that drove the negative mark to market in the alts bucket? Thanks.
Jenny Johnson (President and CEO)
I think we had positive marks in, in BSP and Lexington, and the slightly negative, it might have been realizations in real estate. I'm not sure, but it may have been redemption or something. I'm not sure. I'm not sure what you were referring to, Alex.
Alexander Blostein (Managing Director and Senior Equity Analyst)
Okay. We can circle back. All right, it's probably real estate.
Jenny Johnson (President and CEO)
Okay.
Alexander Blostein (Managing Director and Senior Equity Analyst)
All right, I appreciate it. Thanks.
Operator (participant)
Thank you. Next question comes from Glenn Schorr of Evercore. Please go ahead.
Glenn Schorr (Senior Managing Director and Senior Research Analyst)
Hi, thanks very much. I wanted to drill a little further in Putnam. It's interesting because after Benefit Street and Lexington, I think our minds were all focused on the old world. I like the partnership you formed with them. I like the $25 billion they're investing you, with you, the 5-year lockup on the stock. I'm curious, on the insurance and the retirement channels, were they growing there? Which strategies? Then, more importantly, with your broad, diverse side offerings, what do you expect that you can actually sell into that channel to, like, lever that distribution?
Adam Spector (EVP and Head of Global Distribution)
Sure. It's Adam here. A couple of things. I would say, one, with Putnam, we get tremendous investment performance. I think they're the only firm that had their fund family in the top 10 for, like, the 3-5 and the 10-year period. Good investment performance across the board. They bring a few investment capabilities that we did not have before. Target dates is a good example, where they have $6.5 billion, and given that about a third of the assets in DC go into things like that, we're feeling that that gives us a real leg up. Stable value and ultra short are two other areas where they're quite strong.
They have been very strong in both insurance and the DCIO market. Our plan there is to really integrate those two distribution teams so that we will be stronger in each and every client that we partner with. We have a broad range of clients in the insurance and DCIO space, and we think together, the two teams will be able to serve all of them in a much more effective way.
Jenny Johnson (President and CEO)
I just, I mean, I'm looking at the Morningstar flows. I think it's something like four of the top 10 flowing categories are target date funds. Having a good performing target date with really what Putnam brings is the expertise on, you know, selling into the retirement channel that we're really excited. We think that that will benefit all the retirement platforms that we do business with. Then as, as Adam mentioned, just having, you know, two great products from the stable value and the target date will be nice to add to our suite.
Matthew Nicholls (Co-President, CFO and COO)
Glenn, the only thing I'd add on Putnam is just to make the point that obviously it's been a month ago, or actually over a month now, since we announced the transaction. Their AUM is up slightly by 2%-3% based on the, you know, market, but flows have been stable. The performance is still as strong as Adam just outlined. We've got team agreements in place with all the key investors and our planning process around the acquisition, and what we expect to get out of the acquisition from both a financial perspective and a strategic perspective, as Adam and Jenny just mentioned, we feel like we're very much on track as we communicated at the time of the acquisition announcement.
Glenn Schorr (Senior Managing Director and Senior Research Analyst)
All righty. Thank you for all that.
Matthew Nicholls (Co-President, CFO and COO)
Thank you.
Operator (participant)
Thank you. The next question comes from Michael Cyprys at Morgan Stanley. Please go ahead.
Michael Cyprys (Analyst)
Hey, good morning. Thanks for taking the question. Just wanted to ask about capital deployment. The cash balance continues to rise here. Cash investment, $6.9 billion, nearly $7 billion. Just curious how you're thinking about putting that to work from here. Sounds like a little bit of debt paydowns, buybacks, limited to offset share dilutions. It seems like a meaningful capital put to work at M&A. Just curious how you're thinking about that opportunity set as you look out from here.
Matthew Nicholls (Co-President, CFO and COO)
Yeah. I think, I think our, our capital management strategy is gonna remain consistent with what we communicated in the past. You know, number one is maintaining the trajectory of our dividend that we've had over many, many years. Number two is organic growth opportunities in the business. Number three, as you alluded to, it's hedging our employee grants. It might look like we're a little bit behind on that front in the context of the shares we've repurchased to date, but we will catch up on that this quarter and make sure that we are very much in line with that communication that we've, that we've been consistent about. We obviously have debt that we need to service.
We paid down $300 million of debt in July, as announced, and where that was the term loan that we had in place, and we, we paid that off. We're saving about $4.5 million by doing that, but we're retaining the exact same amount of liquidity by replacing that $300 million term loan with a larger revolver. We've taken our $500 million revolving credit facility and the $300 million term loan, which was $800 million in total, paid off the $300 million term loan and replaced it with 1 single $800 million 5-year revolving credit facility. We've actually enhanced our liquidity and financial flexibility by doing that and saved $4 million-$5 million in the process.
Then opportunistic share repurchases on top of that in M&A. I think Jenny mentioned several times, you know, we're very interested in, in, the infrastructure space, around M&A, and the alternative asset space in particular. In terms of the opportunistic share repurchase, the way I would describe that is as a consequence of how we decided to fund the Putnam acquisition. We're issuing 33.3 million shares, when, when the closing date occurs, and we expect to start repurchasing those shares, in a methodical manner, all else being equal, in fiscal 2024, obviously after the date that we've closed the transaction. We certainly expect to pick up share repurchase consequence of doing that transaction.
Michael Cyprys (Analyst)
Great. Thanks. Just a quick follow-up question. More broadly, AI, generative AI, getting a lot more attention these days. So just curious how you're thinking about the potential and opportunity from AI. Is this a revenue or an expense benefit? What sort of impact do you think this could have on the competitive landscape? Maybe you could talk a little bit about how you're experimenting to what extent with that today.
Jenny Johnson (President and CEO)
Yeah, so I mean, fortunately, I think this is probably one of the benefits of being headquartered in Silicon Valley. We've been actually doing some work in AI for the last four years. You probably have heard about our Goals Optimization Engine tool that's all built on AI. You know, we're, we're doing what others are doing around you know, we use AI for early, early warning systems, so things like risk management, business intelligence, intelligent automation. We have a proof of concept or a pilot going on where we have our You know, it's sort of like a portfolio research assistant, so it's summarizing 10-K's in annual reports for our PM teams.
You know, one of the most important things you have to do is to build a fence around your data so that you're not training the world on your own data. We've had that undergoing. We're working on things like conversational AI, too, for our help desk, you know, hoping to respond within 10 seconds. We've got a pilot going on to generate a draft fund commentary. You know, again, it's all training the models to be able to see how good generating marketing material. We're using both Azure and Amazon because we're, we're not quite sure what's the best for us from the language model. I, I think the message is we've got quite a bit going on here.
We've been early in it because the Go product sort of got us in there, and we think it'll be both. You know, I think initially it's more of an expense benefit, an efficiency benefit, but you hope that it makes your portfolio managers and your research assistants more efficient, and then things like Go are revenue-generating tools.
Michael Cyprys (Analyst)
Great. Thank you.
Operator (participant)
Thank you. The next question comes from Patrick Davitt at Autonomous Research. Please go ahead.
Patrick Davitt (Senior Analyst)
Hey, good morning, everyone. Sorry if I missed this, but has there been any change to your expectations for expenses this year, and do you have any early thoughts on how to think about the path in, into fiscal 2024 as we enter the fourth quarter? Thank you.
Matthew Nicholls (Co-President, CFO and COO)
Yeah, thank you. I'll go through what we expect in the fourth quarter in terms of a guide, and then that will lead to what the full year guide is essentially. Firstly, in terms of our AFR rate, we expect it to remain around 39 basis points. I think it might be slightly higher than 39 basis points in the fourth quarter, but let's call it around 39 basis points. In terms of comp and benefits, again, this is all fourth quarter. For modeling purposes, I would assume $50 million in performance fees, as we've described in the past. That would lead us to approximately $740 million in comp and benefits.
IS&T, we put that similar to what we described last quarter at 120, very consistent. Occupancy in the mid to high 50s. We guided a high 50s last quarter. We came in a little bit lower than that. We expect to be roughly the same again. G&A, we expect to be in the mid $140s, inclusive of continued normalization of T&A for the quarter. In terms of what that means for the year, you know, due to higher assets under management, better performance, increased fundraising related compensation and expenses, our overall guide increases slightly to just over $4 billion.
Very similar to what I described last time, but maybe slightly higher, than that, certainly on the high end of $4.08 or something like that, $4.09 billion. Again, that's all- that's assuming the market stays where it is today, and it's assuming those, that perform... Excluding performance fees, that is, as I described. I mean, then in terms of the margin, though, and I think you've asked about this several times in the past here, it's obviously difficult to guide on the margin, because that means we're guiding on revenue essentially, but all else remaining equal, we expect our operating margin to be stable in the 30% area in the next quarter.
Patrick Davitt (Senior Analyst)
Thank you. Any thought, any thoughts on next year, or is it still too early?
Matthew Nicholls (Co-President, CFO and COO)
It, it's, it's too early. The only thing I'd say, it's an interesting question, obviously, because we're, we're going to be in the process of implementing or, or integrating the Putnam acquisition. I think as we've dug further into this, post-announcement and as we get into the integration work and execution work that we're quite familiar with by now, I think we, we can say two things. One, you can expect from us, continued meaningful expense discipline going into 2024. I think you can see from us potentially more potential with the acquisition of Putnam as we integrate, because we found other areas within Franklin Templeton that we can be more efficient in as a consequence of, of the transaction.
We've highlighted in the past that one of the benefits of M&A is, you know, we always focus on the growth areas. That's what drives our acquisitions. The second sort of derivative of the transactions that we've chosen to pursue, it has helped us on the expense and efficiency side, to reexamine how we do things and reexamine how we can be better and do things better. As a result of that, I, I think you'll find that our expense discipline in 2024 will be, will continue and perhaps, outperform what we've communicated in terms of what we get out of the Putnam acquisition.
Patrick Davitt (Senior Analyst)
One quick housekeeping. Could you give us the exact amount of the catch-up fees and then how much offsetting placement fee was in expenses? Thank you.
Matthew Nicholls (Co-President, CFO and COO)
Yeah, the way, Patrick, I would look at that for this quarter is that essentially an operating income zero. In other words, the revenue associated with the catch-up is practically the same as the expenses. In fact, the expenses might have been slightly higher, like $1 million or something like that. It's an operating income neutral. Of course, going-
Patrick Davitt (Senior Analyst)
We can kind of get to the run rate of management fees.
Matthew Nicholls (Co-President, CFO and COO)
Like $33 million, something like that.
Patrick Davitt (Senior Analyst)
Okay.
Matthew Nicholls (Co-President, CFO and COO)
Yeah.
Patrick Davitt (Senior Analyst)
Thank you.
Matthew Nicholls (Co-President, CFO and COO)
In the low to mid 30s.
Patrick Davitt (Senior Analyst)
Got it. Thanks a lot.
Matthew Nicholls (Co-President, CFO and COO)
Thank you.
Operator (participant)
Thank you. The next question comes from Craig Siegenthaler from BofA. Please go ahead.
Craig Siegenthaler (Analyst)
Thanks. Good morning. On the Putnam transaction, I, I know it's going to bring $25 billion of flows in 12 months after closing. I, I want to come back to, you know, what could happen from some of the cost cuts, because you're cutting a lot of costs out of the company, I think $150 million. Maybe, provide some perspective on the potential for merger-related dyssynergies, or outflows on Putnam's $140 billion AUM base.
Matthew Nicholls (Co-President, CFO and COO)
Yeah, the $150 million guide that we gave as we announced the transaction, that is inclusive of some modest attrition across the company. That, that's how we've got that. I think we, we again, have a history. We don't want to jinx ourselves on this, of course, but we're extremely focused on asset retention as well as the potential growth. The overlap is, is relatively modest in this transaction, given the, the complementary investment strategies that Adam outlined at the beginning. Therefore, we expect modest, you know, modest attrition from this transaction across the board, which frankly.
We think that any attrition that we get, above what we had expected, would be more than offset by, other potential, operating income and operating expense reductions in, in the transaction. Again, we stay, we stay very firm on the 150, and we think there's potential to be higher than that.
Adam Spector (EVP and Head of Global Distribution)
Craig, the other thing I would add is that given the number of transaction we've done and the continuity of portfolio management teams post-transaction, we're getting very good reactions from clients that they feel that their investment teams will be stable, and they don't make intend to make any shifts, which which is very positive.
Matthew Nicholls (Co-President, CFO and COO)
Thank you, Adam. I would just also add that, you know, I would never understate, ever, the complexity of integration and implementation and working across a firm involving a new, a new acquisition. The 150 is 30% margin. Okay, so, so, so it's not a hugely aggressive margin objective from that business. We should be able to get to that and exceed it over time. Our guide, remember, is on the first year. After that first year, all else remaining equal, we certainly see, you know, other opportunities to go, to go beyond that.
Craig Siegenthaler (Analyst)
Thank you, Matthew and Adam. One follow-up on the SMA business. You got a great business here. It's inflowing. I think you highlighted that Franklin Income Fund is one of the flagships that's driving this and also direct indexing. What are some of the other funds that are driving flows into the SMA business? When you look at sales, what does the mix look like across channel? Is it heavily wirehouse? Is it heavily RIA? I'm curious to see what it looks like.
Adam Spector (EVP and Head of Global Distribution)
Sure. I think the way to think about that is, one, look at the legacy business, and two, look at the projection of the business going forward. If we look at the legacy of the business, it really was strongest at the old Legg Mason, which means that a significant portion of the assets are with Western and ClearBridge, and those firms tended to be stronger in the wires. If you look at the trajectory of the business, it's really adding new products like our income fund to the SMA platform. We're already now since recently launching it on six broker-dealers and a number of RIAs there. That's where really where a lot of the momentum is.
The other place I would say that we have huge opportunity is in our in, in the SMA business, is in munis, where we've seen about a 30% increase in our AUM there year-over-year, and I think that's a place where we can really grow as well. Again, the strategy is to make sure that we give our clients vehicles of choice. For all of our key strategies, we'd like to be able to offer them in both a fund format and an SMA format, and that's what we're building out right now.
Craig Siegenthaler (Analyst)
Thank you.
Operator (participant)
Thank you. Next question comes from Brennan Hawken at UBS. Please go ahead.
Brennan Hawken (Managing Director and Senior Equity Analyst)
Good morning. Thanks for taking my questions. So, just wanted to follow up there on the catch-up fees in Lexington. Number one, this was, you're still raising, it sounds like. And do you expect there'll be further catch-up fees at the actual formal close? And I was just running the math on the 33, and that made me a little confused about your prior comment on fees being expected to be flat quarter-over-quarter. Do you think there'll be more catch-up fees in the coming quarter? Because it seems as though the catch-up maybe contributed about a basis point this quarter, so wasn't quite sure about that. If you could clarify.
Matthew Nicholls (Co-President, CFO and COO)
Yeah. Yeah, thanks, Brennan. Firstly, I, I, I did-- I said 33, but I was just using that as a midpoint. That's not the exact number. We're not going to guide on, you know, where our catch-up fees are going, but I'll just say a couple things. In terms of the fundraise, I think Jenny mentioned this at the beginning, you know, where a couple of things we're allowed to say around the fundraise. Number one, you know, we're ahead of target. Number two, we're at $18.2 billion right now. That was what was announced or filed recently. Number three, we're still fundraising, which means, to answer your question, we may have another closing, you know, in the next quarter.
We don't know exactly, but I think it's likely we have some form of closing in that quarter, and that could have a positive impact on our effective fee rate. Even without, just to be clear about this, because I think this is a question that Patrick was getting at earlier. I think even without the catch-up fee in the fourth quarter, our EFR, we would expect it to be around 39 basis points. We're not, our 39 basis points is not reliant upon the catch-up fee, per say. That's I think I think that's the question you were trying to get at, Brennan, correct?
Brennan Hawken (Managing Director and Senior Equity Analyst)
Yeah. Yeah, yeah, yeah. Thank you. Appreciate that. Just wanted to try to understand some of those mechanics, so thanks for laying that out for me.
Matthew Nicholls (Co-President, CFO and COO)
Then obviously, after the, you know, after the moment in time when we do a closing, and we have a catch-up fee, and then we have expenses associated with raising the funds, after that, of course, we don't have those one-off expenses, but we do have the normalized alternative asset higher fee rate against the assets that we're raising, on the entire AUM, which is, as, as you know, you know, around the one basis of 1% area. That, that, that's the, that's the aspect of the fees that I would focus on that helps out EFR on the, on the long, you know, the long term. That, that's what helps us remain around that 39 basis points.
Brennan Hawken (Managing Director and Senior Equity Analyst)
Oh, for sure. Yeah, yeah, yeah. This is just sort of noise and whatnot. I just wanted to understand it for modeling purposes. Thank you for that.
Matthew Nicholls (Co-President, CFO and COO)
Yeah.
Brennan Hawken (Managing Director and Senior Equity Analyst)
You guys flagged in your comment document, I believe is what it is referred to, that there was some improving performance in taxable fixed income strategies, which led to the lift in the investment performance versus benchmark. Just wanted to confirm that's Western, and whether or not you're seeing any impact from this improving performance on either RFP activity or client dialogue, and what drove the reversal? Thank you.
Jenny Johnson (President and CEO)
Yeah. Significantly improved performance at Western, in core, Core Plus and macro ops. You know, I mean, trying to remember the numbers exactly, but it's first quartile year to date. What we've seen is, you know, significantly improved net flows to the point where I thought we might be positive this month at Western. I, I'm not sure it'll be quite, but, you know, it, it's, it, it feel like they've kind of turned the corner there. I wanna address one other just performance, because on the one year mutual fund, ETF performance, you know, at 44%, I think it's really important to understand how significant the Franklin Income Fund can be in swinging this. That's 14% of the mutual fund ETF number.
The Franklin Income Fund, there's no such category for multi-asset income in the retail channel at Morningstar. There is an institutional category. If you were to compare it to the institutional category, they would be in the 11th percentile. The peer average yield in that category is about 4.25, versus the Income Fund at 5.75%. The peer average in the retail category yields 1.84% versus 5.75%. If there were an income category at Morningstar, they would be in the top quartile, and that would swing us up to 58th percentile. Because it's so significant, I just feel like it's important to understand there just isn't a category.
Fortunately, the $1.5 billion in flows that we've had, net flows in the Franklin Income Fund, proves that the income strategy is as relevant today as when my grandfather started it 70+ years ago, despite the fact that there are no true peers in that space.
Brennan Hawken (Managing Director and Senior Equity Analyst)
Thank you for that color.
Adam Spector (EVP and Head of Global Distribution)
To that, I just might add, since your question was about RFPs and pipeline and such, what we're really seeing is, if you think about a sales pipeline, a significant buildup in late stage opportunities. What we're not seeing is the conversion to that as quickly as we would expect to won but not funded. That is really because we believe a number of institutions are waiting for the interest rate cycle to settle in. Are we gonna have one more hike? What will happen to inflation? That last stage of deployment and final contracting is a little slower, but we do see a bit of a bulge building up in those late stage opportunities.
Brennan Hawken (Managing Director and Senior Equity Analyst)
Got it. Thanks very much.
Operator (participant)
Thank you. Next question comes from Kenneth Worthington from JPMorgan. Please go ahead.
Kenneth Worthington (Analyst)
Hi, good morning. When commenting on the improvements in multi-asset product flows, you mentioned solutions as a contributor. To what extent are alternative investment capabilities important to growing Franklin Solutions AUM? To what extent are your existing alternative products already integrated with your public market capabilities within the solutions, you know, ecosystem?
Jenny Johnson (President and CEO)
You know, I would say that that depends more on the client. For example, FTIS has won mandates in model portfolios in the retail channel, and very few of those have so far included alternatives in those model portfolios. On the other hand, they've also won insurance mandates that have some combination of alternatives in there. I think that's more a... I, I think that question, it, it, it depends more on the channel that FTIS is Franklin Templeton Investment Solutions is serving than that how that group performs.
Adam Spector (EVP and Head of Global Distribution)
The, the other thing, Jenny, that I would add to that, is that we, we can really build, traditional only, a mix, or what we're starting to do now is to build alts only solutions as well, where if a client wants to have a single source for private equity, venture, private debt, real estate, I think we're one of the few firms that can build those for clients.
Jenny Johnson (President and CEO)
Actually, one thing is we also have been working with some retirement platforms who are interested in trying to figure out how to bring alternatives to retirement and building sleeves to go into say, managed accounts and some models in there. We think that's a real opportunity.
Kenneth Worthington (Analyst)
Okay. Solutions really isn't about combining these different capabilities together and providing a solution that results from the combination. It's really solutions in single silos marketed out?
Jenny Johnson (President and CEO)
No, I don't-
Kenneth Worthington (Analyst)
Is that right?
Jenny Johnson (President and CEO)
You know, it might be that somebody wants an income solution model portfolio, right? Or a LDI type in. They will go in, depending on what the client, you know, desired outcome is, and they will use multiple of our managers to bring that, you know, ultimate solution to the client.
Kenneth Worthington (Analyst)
Okay, thank you.
Jenny Johnson (President and CEO)
It's like in, you know, in some cases, it's a real OCIO type situation. They even do. They have a team that researches outside managers. Most of their solutions include multiple of our SIMs.
Kenneth Worthington (Analyst)
Great. Got it. Thank you.
Operator (participant)
Thank you. Next question comes from Dan Fannon of Jefferies. Please go ahead.
Dan Fannon (Analyst)
Thanks. Good morning. Wanted to clarify on performance fees, what the funds or affiliates that were the contributors, and I know, I hear the guidance, and you've been consistent with that, but you've also consistently been above that in terms of the results. As you think about where high water marks sit, and we think about fourth quarter and even potentially into December, which has some other crystallizations, how we should think about maybe where performance sits for that performance-eligible AUM?
Matthew Nicholls (Co-President, CFO and COO)
Yeah. This quarter it was, and it has been for the last few, I mean, even, even though we received performance fees from several of our specialist investment managers, in particular on the alternative side, you know, there has been, you know, a meaningful portion of it driven by our Clarion specialist investment manager on the real estate side. 80% of the performance fees is driven by multi-year performance thresholds being hit by clients that invested, you know, 5 years ago, where a 5-year performance threshold has been hit. We expect going into next quarter, performance fees, I think, you know, we continue to guide at 50 because it's so hard to predict this with any form of accuracy.
You know, we'd guide between $50 million and $60 million for the quarter. As you mentioned, going into our first fiscal quarter, which is the last last calendar quarter, the fourth calendar quarter, that's sort of a little bit more widespread across the Specialist Investment Managers, and we may experience a little bit more performance fees then. We'll, we'll provide more guidance on that next quarter when we get to that point.
Dan Fannon (Analyst)
Okay, thanks. That's helpful. Then, Adam, just a broader question on distribution. Given all of the acquisitions over the last several years, I was hoping you could update us on how much of the AUM is actually utilizing the centralized distribution at this point, and, and where you are in terms of onboarding, you know, whether it's some of the specialist managers or acquisitions that, you know, that are more recent in terms of closing, in terms of fully onto that platform, to think about the momentum and where you are in that process?
Adam Spector (EVP and Head of Global Distribution)
Sure. I think, you know, let me go back to where the starting point was, which was that the central distribution team was responsible for globally, all institutional and all wealth management, raising, and client servicing for legacy Franklin Templeton. On the Legg Mason side, again, it was more the, the SIMS handled a large portion of their institutional asset management, especially in the U.S. What we've seen over the last two years is a gradual movement towards more coordinated global efforts. I would say that movement is quicker at a smaller firm like a Martin Currie, where the benefits of centralized resources are much more significant.
If you look at the other end of the spectrum, at a Western, that has a massively well-built-out global distribution capability of their own, it's really more episodic, where the central distribution team is raising assets for them. It does depend on the side, but on the size, but the movement has been to find more places to cooperate. We're also seeing a lot of benefits in the alternative space, where the generalist salespeople are able to make introductions, that then the alternative firms can close on their own.
Dan Fannon (Analyst)
Is there any way to put numbers around that in terms of, like, what still is held at the affiliate manager level versus-?
Adam Spector (EVP and Head of Global Distribution)
Yeah.
Dan Fannon (Analyst)
What moves.
Adam Spector (EVP and Head of Global Distribution)
I can tell you, I shy away from that because what we're trying to build is a culture of cooperation, where these teams work together. Numbers imply that one team did it or the other team did it. What we're really trying to move towards is where it's a collaborative effort.
Dan Fannon (Analyst)
Okay. Thank you.
Operator (participant)
Thank you. The next question comes from Brian Bedell at Deutsche Bank. Please go ahead.
Brian Bedell (Director)
Great. Thanks. Good morning, everyone. Just want to hop back on the Franklin Income Fund for one second. I think that's in that moderate allocation Morningstar category. I, I agree with what you're saying about, you know, the performance and the sort of mischaracterization of it, but, do financial intermediaries use that Morningstar, or have you seen them use that Morningstar categorization in terms of, I guess, you know, just, recommending the fund? Because I, I do see it's still in inflows despite the improved performance.
Jenny Johnson (President and CEO)
Well, I actually think it's been, it's been, net flows. That's why I said there was about $1.5 billion in net flows. Look, you know, it, it is a frustration. When interest rates were zero, he was in the 80% equity category, because of course, he, you know, looked for, dividend-yielding, equity because he couldn't get anything in income. As he's, as we've been able to, to, you know, earn money in fixed income, he shifted. Now he's in the 50%-70%. Yeah, it's, it's honestly, it's a discussion I personally had with Morningstar on it, and they're just the problem is there's no real, competitors in the, in the wealth channel that so they can't build a big enough peer group.
So, you know, we often point to the institutional one and his outperformance there. So to answer your question, yeah, I'm sure there are some situations where he gets screened out. On the other hand, he has a he, the, the team has tremendous following and loyalty. You know, one of the challenges has been as the world went to fee-based, it's harder for some financial advisors to buy and hold the Income Fund for 10 years like they used to do. That's why we really pushed to get it on the SMA platform, because they can hold it in a, you know, on an SMA platform, and they do. They, they love it. They'll put a client in there and, and sit through the client's retirement.
It's a message that we continue to try to get the story out, and I, I just think that because it's 14%, it is important that people understand how much it will swing our 1-year category or any of the categories it can. He's going to manage it, or the team's going to manage it for yield, which is what the clients expect.
Operator (participant)
Thank you. This concludes today's Q&A session. I would now like to hand the call back over to Jenny Johnson, Franklin's President and CEO, for final comments.
Jenny Johnson (President and CEO)
Great. Well, I just want to thank everybody for participating in today's call, and, you know, again, we'd like to thank our employees for their hard work and dedication, and we look forward to speaking to you all again next quarter. Thank you.
Operator (participant)
Thank you. This concludes today's conference call. You may now disconnect.
