Lazard - Earnings Call - Q3 2020

Transcript

Operator (participant)

Good morning and welcome to Lazard's Third-Quarter and Nine-Month 2020 Earnings Conference Call. This call is being recorded. Currently, all participants are in a listen-only mode. Following the remarks, we will conduct a question-and-answer session. Instructions will be provided at that time. If anyone should require assistance during the call, please press the star key followed by the zero on your touch-tone phone. At this time, I will turn the call over to Alexandra Deignan, Lazard's Head of Investor Relations. Please go ahead.

Alexandra Deignan (Head of Investor Relations)

Thank you, Holly. Good morning and welcome to Lazard's earnings call for the third quarter and first nine months of 2020. I'm Alexandra Deignan, the company's head of investor relations. In addition to today's audio comments, we've posted our earnings release and an investor presentation, which you can access on our website at www.lazard.com. A replay of this call will also be available on our website later today. Before we begin, let me remind you that we may make forward-looking statements about our business and performance. There are important factors that could cause our actual results, level of activity, performance, or achievements to differ materially from those expressed or implied by the forward-looking statements, including, but not limited to, those factors discussed in the company's SEC filings, which you can access on our website.

Lazard assumes no responsibility for the accuracy or completeness of these forward-looking statements and assumes no duty to update these forward-looking statements. Today's discussion also includes certain non-GAAP financial measures that we believe are meaningful when evaluating the company's performance. A reconciliation of these non-GAAP financial measures to the comparable GAAP measures is provided in our earnings release and investor presentation. Hosting our call today are Kenneth Jacobs, Lazard's Chairman and Chief Executive Officer, and Evan Russo, Chief Financial Officer. They will provide opening remarks, and then we will open the call to questions. I will now turn the call over to Ken.

Kenneth Jacobs (Chairman and CEO)

Good morning. Our third-quarter results reflected strong performance across our businesses as financial advisory and asset management both gained momentum. Our financial advisory results underscored the benefits of our diversified advisory platform. Our strategic and M&A activity accelerated even as our restructuring work continued at a robust pace. In the third quarter, Lazard's global announced M&A volume increased 64% year-over-year compared to the market's increase of 38%. Over the first nine months, our volume rose 5% even as the market's volume declined 24%. Our strong and established footprints in Europe helped drive the gains as our European M&A announcements rose significantly in the third quarter. Our preeminent global restructuring practice had a strong third quarter as we continued to be engaged in a wide range of complex assignments for both debtors and creditors. Year to date, Lazard is number one in the league tables for both announced and completed restructurings.

Our sovereign advisory practice is also seeing increased activity as we work with governments to restructure debt and strengthen balance sheets. In the third quarter, we completed restructurings for both Argentina and Ecuador, and we continue to gain assignments from countries facing unprecedented financial challenges. We continue to see growth opportunities across our advisory businesses. Year to date, in financial advisory, we've brought on 12 new managing directors globally. This includes last week's recruitment of a London-based team with expertise that complements our capital markets and shareholder advisory practices. Our asset management business benefited from strengthening global markets in the third quarter, with average assets under management increasing 8% sequentially from last quarter. Gross flows continue to be strong, and we achieved net inflows in August and September. Net inflows have continued this month, reflecting demand across our platforms.

We are investing in areas where we see high growth potential, including strategies focused on sustainability and ESG, quantitative investing, and alternative and thematic strategies. We recently announced the addition of thematic teams to our global and emerging markets platforms and a long-short credit team on our alternatives platform. We continue to see new strategies and launch funds to meet investor demand. We are also seeing an increase in solutions-oriented mandates as we serve more clients with customized strategies. Firm-wide, our results underscore the strength of our diversified business model, global platform, and a deep culture of client service. Our clients are dealing with unprecedented challenges and uncertainties caused by the ongoing pandemic, and we're providing them with expert advice and innovative solutions. Evan will now provide more color on our financial results then I'll comment on our outlook.

Evan Russo (CFO)

Thank you, Kenneth. Lazard's third-quarter operating revenue of $569 million was our strongest quarter of the year as both of our businesses gained momentum. Financial advisory third-quarter operating revenue of $307 million was 1% higher than last year on increased M&A and restructuring activity, reflecting an acceleration in the business. This quarter's M&A revenue included announcement fees and completion fees for several transactions that were announced and closed during the quarter. Restructuring revenue reflected the continued high level of activity in our global practice. Asset management operating revenue of $261 million was 8% lower than last year, reflecting lower average assets under management as well as an impact from product mix shift as flows trended toward quantitative and fixed income strategies. Average AUM for the third quarter was $226 billion, 8% higher than the second quarter of this year and 3% lower than a year ago.

We finished the third quarter with AUM at $228 billion, 6% higher than the start of the quarter. The increase was primarily driven by market appreciation of $9.5 billion and positive foreign exchange movement of $3.7 billion, with net outflows of $0.2 billion. The quarter's net outflows were driven primarily by local and emerging markets equity strategies. We achieved net inflows across our fixed-income platform as well as in our global and multi-regional equity platforms. As of October 23rd, our AUM was approximately $234 billion, reflecting market appreciation of $4.7 billion during the month, positive foreign exchange movement of $1.2 billion, and net inflows of approximately $0.6 billion. Looking ahead across our franchise, in financial advisory, increasing M&A announcements and high levels of activity across our advisory practices position us well going into 2021. In asset management, we continue to win significant mandates across our multi-regional and global platforms.

We are seeing demand for both our quantitative and fundamental products across our platforms, as well as growing demand for our sustainable and customized solutions. Turning to expenses, in the third quarter, we accrued compensation expense at a 60% adjusted compensation ratio in line with our accrual year to date. Non-compensation expense of $103 million was 18% lower than the same period last year, primarily reflecting a continuation of lower travel and business development costs. Our adjusted non-compensation ratio for the third quarter was 18.1% compared to 21.3% in the third quarter of last year. Our adjusted effective tax rate in the third quarter was 27.9%. For the first nine months, it was 26.9%. We expect an annual effective tax rate for this year in the low- to mid-20% range.

Regarding capital allocation, our business continues to generate significant free cash flow, which supports our goal of returning excess capital to shareholders. Throughout the year, we have been consistent in returning capital through our quarterly common dividend. In the third quarter, we returned $50 million of capital to shareholders. Yesterday, we declared a quarterly dividend on our common stock of $0.47 per share. Lazard's financial position remains strong with ample liquidity and balance sheet flexibility. As of September 30, our cash and cash equivalents were $1.1 billion. Kenneth will now conclude our remarks.

Kenneth Jacobs (Chairman and CEO)

Thank you, Evan. I will provide some perspective on our outlook, and then we'll open the call to questions. The global macroeconomic outlook continues to be uncertain. The shape and pace of economic recovery will depend in large part on the course of the pandemic, its impact on local economies, and ongoing government responses. Nonetheless, corporate strategic activity is growing, and capital markets have been resilient. Our conversations with clients are constructive, and we are cautiously optimistic that the momentum in both our businesses will continue. In financial advisory, the economic impact of the pandemic continues to drive disruption unevenly across sectors. Well-capitalized companies are seeing opportunities to strengthen their competitive advantages through strategic activity. Private equity sponsors are increasingly active as both buyers and sellers. Financially challenged companies are looking to divest assets or restructure, and there is reason to expect restructuring activity to pick up in 2021.

In asset management, we see evidence that dislocations in markets and the dispersion of returns resulting from the pandemic are creating stronger demand for active management. This, combined with investors' desire for customized solutions and sustainable portfolios, should continue to drive demand for our services. Lazard is well-positioned in this environment with a diversified business model, a global client base, and unrivaled expertise in M&A, strategic advisory, restructuring, and asset management solutions. We remain focused on serving our clients well while we manage the firm for profitable growth and shareholder value over the long term. Now, let's open the call to questions.

Operator (participant)

Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that's star one to ask a question. We will now take our first question from Richard Ramsden from Goldman Sachs. Please go ahead. Your line is open.

Richard Ramsden (Managing Director)

Hey, good morning, guys. I am perhaps we can just start a little bit with what you're seeing in the European M&A market. I know if we look at the aggregate data, it hasn't picked up as quickly as what we've seen in the U.S. Can you talk about why you think that's the case and whether you see anything on the horizon that could change that? Perhaps as a follow-on, you are obviously seeing surges and shutdowns across Europe as COVID rates increase. Do you think that will have a material impact on the existing pipelines that you have in terms of your ability to close those deals?

Kenneth Jacobs (Chairman and CEO)

Okay. Two parts of the question. First, Europe. Obviously, the U.S. has seen a quicker acceleration of large deal activity over the course of the last couple of months or so, but there's been a steady pace of what I'd describe as medium-sized transactions in Europe really since June or July. We haven't seen as many of the very large transactions as we've seen in the U.S., but it's been a steady pace of activity, at least for us, during this period of time. As far as the closings are concerned, I guess there's two different parts to that. The first is I think all of us have adapted well to the more restricted environment. Deals are being done effectively virtually and have been in the U.S. largely since M&A activity picked up, and the same for Europe.

The ability to complete deals because people are in confinement, we do not see that much of a change as a result of that. There may be some complexity around some of the government approvals if actually people are not going into government offices to get these approvals, but so far we have not seen much impact from that. In terms of deal activity, look, the differential impact on economies obviously has impact on deals. Again, one of the features of this environment is that most of the deal activity we have seen to date has been driven by the fact that the companies that are engaging in this activity are able to have a little bit better ability to, what I would say, have confidence in their predictions about the future, and that has gotten them confident in terms of their ability to both price and manage transactions.

That is where you have seen a lot of the activity: technology, biopharma, areas where you have companies that are winning because of the environment, because of technology. I should add that probably financial services. Those are areas where we have seen a pickup on activity. That probably does not change too much with the closings. I think where the closings are going to have an impact is on companies that have kind of pushed out financing or while they are waiting for their business models or pushed the financings in place, but their business models or the recovery of their business models are being pushed out because of the second wave or additional wave to the pandemic. Those businesses are going to have a harder time, and that is where we are likely to see a pickup in restructuring activity. We are already seeing that in Europe right now.

Richard Ramsden (Managing Director)

Okay. Perhaps as a follow-on, could you talk a little bit more about the restructuring business? I think I'm right in saying that if we go back and look at the last crisis, restructuring was around 30% of your advisory revenues. What do you think the peak this time could be in terms of contribution to advisory? Based on the pipelines, when do you think restructuring revenues will peak?

Kenneth Jacobs (Chairman and CEO)

That's a great question because a lot of it has to do with what happens with M&A activity. Obviously, to the extent that there's little M&A activity, restructuring is going to be a much bigger proportion of financial advisory revenues. To the extent that M&A activity accelerates, it's going to be as a percent lower, but in terms of absolute terms, maybe higher than it was in the last cycle. What we're seeing right now, what we've seen so far is a high level of restructuring in the first part of this year driven by companies that were already in difficulty prior to the pandemic. Those companies, the restructuring of those companies accelerated with the onset of the pandemic. They had a difficult time getting additional financing. Their business models were immediately challenged by the restructuring: oil and gas, retail being two great examples of that.

That was the first wave of restructuring activity. We saw a slew of companies that were highly leveraged, whose business models were a little bit more resilient at that point, get financing in the first stage of the crisis through the liquidity of the market, to some extent from governments, both here and in Europe. The crisis has probably gone on longer than that financing will last, and the business models have not recovered. That is likely going to be the second wave of restructuring. We are starting to see that pick up in Europe right now. We did not see much in the first wave in Europe, but we are starting to see those companies start to have the need to restructure now.

With the lack of stimulus in the U.S., the depth of the pandemic now in the U.S., we're likely to see a pickup in activity in the second wave in the U.S. This is a restructuring cycle where the restructuring levels in absolute terms for the first part of this year have been high. Our guess is we'll continue to be at that level through the end of this year. That's the roll-off of the first set of restructurings. The real question is, do we see a second wave of activity, which I think we're beginning to see, in fact, the first wave in Europe now. We would expect to start seeing the second wave of activity in the U.S. this fall into the winter, absent some kind of strong recovery and/or another round of very strong stimulus.

In any event, it probably picks up. The unusual feature of this environment where we have a high level of restructuring activity is the acceleration of M&A activity, at least for our business. We saw a real acceleration in the third quarter in announcements and closings. We expect that that likely continues into the fourth quarter or the early part of next year, and then we'll see what happens.

Richard Ramsden (Managing Director)

Okay. Thank you very much. That's very helpful.

Operator (participant)

We will now move to our next question from Michael Brown from Keefe, Bruyette & Woods. Please go ahead. Your line is open.

Michael Brown (Equity Research Analyst of Asset Managers, Investment Banks and Trust Banks)

Great. Thank you, Operator. I just wanted to start with the inflows. I just wanted to confirm, Evan, did you say the inflows was $0.6 billion? Is that correct?

Evan Russo (CFO)

Yes, that's correct, Mike. $0.6 billion as of the end of last week for the month of October.

Michael Brown (Equity Research Analyst of Asset Managers, Investment Banks and Trust Banks)

Great. Where are you kind of seeing those inflows? Just trying to get a sense of where you're seeing some of the strength on the flow side. Any color as to how some of those mandates that you won, how those are starting to flow in? Is that what's kind of driving the net inflows that you're referencing? Is there potential for that to continue throughout the quarter?

Evan Russo (CFO)

Sure. Mike, as we called out at the end of last quarter, we started to see significant activity. We called out that we had a significant backlog of unfunded mandates that we had won for our business spread across really the entire platform. You started to see that come across in August and September, the monthly flows, which were both positive for us and continuing into October, where we have even more accelerated net inflows as of a week ago for the month of October. Yeah, it is a continuation of the theme that we started to see at the end of last quarter as we were building that unfunded pipeline. I'd say that the continuation has continued for us really over that period of time. It is really spread out across a whole slew of areas. There is no one specific area that we started to see.

We had net inflows this quarter, as we called out, in our international strategic net flows positive as well as in our quant and, of course, in our global converts business as well. These are all areas that are performing well and seeing significant flow traction. It is really broader than that. I mean, it is across all of the areas, across all of our platforms. I mean, it is really very much spread apart. That is what gives us a little bit more confidence because it is not just one mandate, one large mandate, or one specific strategy that is doing well. It has been pretty broad-based in a lot of different areas.

Michael Brown (Equity Research Analyst of Asset Managers, Investment Banks and Trust Banks)

Okay. Great. I just wanted to talk about the comp ratio. It looks like you're running at 60% year to date, I guess, one. Is that kind of a fair expectation for the year? As we move into 2021, and hopefully it is a better revenue picture, against that assumption, is it possible to kind of move back to your target range of 55-59%, which you believe is kind of your target for through the cycle? I guess, is that still your target range? I guess, at what point would it be possible to kind of drift back to something like a 55% comp ratio? Is that still a feasible target just given your revenue mix or the competitive landscape?

I'm just trying to understand if that's still a fair way to think about your business kind of longer term through the cycle.

Evan Russo (CFO)

Yeah. Sure. Let's start with the first part of the question, Mike. Third quarter, we accrued compensation at 60%. That's where we've been accruing all year. That's our best estimate for the year. Obviously, we'll continue to develop as we see the final revenues and sort of what hits at the end of this year. It's obviously very revenue-driven. There are also a lot of factors, as you know, that go into the final comp number. Obviously, the business mix for us, the geographical mix of our business, the marketplace for talent. We do a bottoms-up, as we always say, it's a bottoms-up year-end. There are a lot of components that could move that around. 60% is our best estimate at this point in time. It's obviously important to remember, as we always point out, we're a firm of intellectual capital.

Our people are the critical assets of our firm. Our growth is built on hiring and retaining the top talent. As we've always done, we're going to continue to focus on incentivizing our top performers while continuously thinking about balancing and how we balance short-term and long-term outlooks. The second part of your question, when I think about the sort of longer term, we have been managed with discipline for a fairly long time, probably almost the last 10 years, been in the range that we've set out of the mid- to high- 50s%, 55%-60% area where we've been accruing compensation on an awarded basis during that period of time. I think, look, what will drive that next year is going to, first and foremost, as it always is, is the pace of revenues.

As revenues grow, as you get some revenue growth in the business, the natural growth in the business, that's going to help us to remain in that range where we've always been. I think we're still fairly comfortable with the steady-state business, comfortable being in that range. Obviously, a lot of factors that change that. The biggest historically has always been the pace and level of investments that we're making in the business. As we continue to think about where we see opportunities for bigger growth longer term and the investments we want to make there, that could have an impact on our compensation line. The steady-state part of our business, given where we've been, I think we're comfortable with that range.

You said, "When do we get to the lower part of the range?" We were there just a couple of years ago, I mean, during periods of stronger revenues. I think we've proven that when stronger revenues come, we're able to trade at the bottom part of that range. Weaker revenues, we're going to trade at the higher part of that range. We've always sort of managed that whole process with the discipline, but of course, focusing on incentivizing our talent and making sure that we can continue to invest in the business and focus on the growth of the business over the long term.

Michael Brown (Equity Research Analyst of Asset Managers, Investment Banks and Trust Banks)

Okay. Great. Appreciate all the color, Evan.

Operator (participant)

We will now move to our next question from Devin Ryan from JMP Securities. Please go ahead. Your line is open.

Kenneth Jacobs (Chairman and CEO)

Hi, Devin.

Devin Ryan (Head of Business Development and Managing Director of Financials and FinTech Equity Research)

Hi. Great. Good morning, everyone.

Kenneth Jacobs (Chairman and CEO)

Good morning.

Devin Ryan (Head of Business Development and Managing Director of Financials and FinTech Equity Research)

First question here, just on the M&A recovery. What I'm trying to get at here is the drivers behind it and kind of what you guys are seeing or thinking. It just feels like such a quick and strong snapback, which I also think just speaks to how important strategic decision-making is right now, just as the speed of the world continues to pick up. I appreciate there's some macro risks here and with the election next week. There are obviously things that could temporarily disrupt activity. It feels like it's hard right now to hold back M&A, just given how critical it is in kind of strategic conversation. I'd just love to get some thoughts from you guys around what's really driving activity and does that feel like a reasonable thesis here?

Kenneth Jacobs (Chairman and CEO)

Yeah. No, I think that's a great question. I think your thesis is right. Traditionally, we look at M&A activity as a function of three factors: financing, equity market valuations, and CEO and board confidence. Usually, there are a couple of longer-term catalysts underpinning that activity. It remains the same for us today. Financing is widely available at historically low rates. Equity valuations have been, in some sectors, kind of rich, others not. Generally speaking, the cheapness of the financing has offset some of the valuation considerations in many instances. Importantly, with regard to CEO and board confidence, increasingly in industries where you see large levels of high levels of activity, those happen to be industries where boards and CEOs have a better ability to have confidence in their predictions about the future. They are engaging in more activity.

You don't have to necessarily be optimistic, but you have to have some confidence in your predictions. Those industries have been technology, biopharma, increasingly financial services, some of the energy sectors, and such. There are other areas, I'd say, newer energy sectors. There are other areas where the stress on the economy is forced in the activity. That tends to be areas where there's real pressure on businesses, where you're seeing some activity. The catalysts for all this, as best we can tell, are probably twofold. A major catalyst is just that all the trends that were in place prior to the pandemic are being accelerated. The industries that are going to come out of the pandemic in a strong position, technology, biopharma, you're seeing a lot of activity there.

Companies which have stronger market positions, stronger balance sheets, probably are ahead of their competitors in implementing some of the technological change that's going on into their business models are also taking advantage of those positions to improve their position strategically through deals. Weaker companies are finding that there's increasing pressure to deal with many of the challenges in their business through portfolio adjustments and, frankly, in many cases, restructurings. There is a smaller trend, but an important one, at least as far as the fourth quarter is concerned, which is there's some acceleration around activity around selling businesses in anticipation and perhaps of some changes in tax codes if there's a change in administration. I think we're going to see some pickup in activity in the fourth quarter around that as well.

Now, whether that persists into next year remains to be seen, but I think the first catalyst is with us for quite some time.

Devin Ryan (Head of Business Development and Managing Director of Financials and FinTech Equity Research)

Okay. Thanks, Ken. Appreciate the color. Maybe just a quick follow-up for Evan, just on the expense structure, thinking about kind of more holistically as we kind of get back into maybe a more normal business backdrop here. I appreciate some of the on the non-compensation side, some of the expenses are kind of moving targets and travel will likely pick back up. I'm curious kind of how you think about or would suggest kind of framing for us, kind of modeling out, just given that it feels like travel will remain lower in the near term.

As we get back to something that's more normal, is there still some overall, call it expense depreciation, just given that you guys have learned things through the pandemic around the expense base or there's just going to be expenses that maybe don't come back in full force?

Evan Russo (CFO)

Yeah. Sure, Devin. Look, as you said, in the quarter, our non-comp expenses were down approximately $22 million in the quarter. A significant part of that related to the marketing and business development expense, with specifically a big chunk of that being travel and entertainment. $14 million of the $22 million was really related around that number, around for travel. I think it's broader than just travel. I think we've been focused on thinking about expenses this year, given the decline in revenues. We've been thinking about what kind of projects and other expenditures that we had this year, making sure that we're making the right decisions in the context of the environment. Of course, some of this is offset by some COVID-related expenses that we have in our offices, cleaning and PPE and technology and some other areas.

I think it's still a moving target as to how that plays out. I'd say over time, and what we saw in the third quarter relative to the second quarter is we started to see a little bit more in the travel side, a little bit more in the marketing and business development. I mean, it's still slow, but it's starting to come back a little bit higher than we had seen, but certainly nowhere near where we were in 2019. It's going to depend on the sort of the pace of the sort of normalization of the environment. We saw in Europe and Asia-PAC region for us earlier in the third quarter when those businesses were going back to the office at a little more accelerated pace, client activity and client interaction, I should say, not activity, but client interaction was at a more normalized level.

We started to see some pickup in those expenses. Ultimately, look, I think long-term, we would expect there to be some residual effects and benefits of learning to live in this sort of remote and virtual world. It is going to depend on the region. It is going to depend on the clients. Ultimately, clients are getting more comfortable and have become more comfortable executing in this environment. There definitely should be some efficiencies, exactly how that plays out, at what pace it is going to depend. It is important to remember as well that, look, we are a face-to-face sort of business, right? Face-to-face is critical in creating creative deal environments during complex negotiations and certainly relationship building.

I would expect it to come back, probably not to the level that we were at in 2019 that quickly, but I expect that to have some residual benefit going out a couple of years as we think about it. Look, outside of that, there's all the longer-term implications on real estate and other areas where, as we move into a more flexible working environment, which is what we at Lazard are sort of thinking through and how to work with our employees to figure out what is best, not only for our employees, but also for our clients, sort of balancing the two. I would think that's going to take several years to really see through in the non-comp expenses.

I think over time, if you're sort of thinking out the next couple of two to four years, I think we could see the paradigm moving towards a more flexible working environment. Therefore, the need and type of space, sort of redesign, reimagining the space we have, going to change. Exactly what that means in terms of an expense change, I think it's a little too early. It's TBD. We're in the early phases of thinking about this strategically. I think, as we've said before, I think long-term, we want to take the best of what we've learned in this environment and figure out how to apply that and bring it forward with us as we sort of evolve to the future in a post-pandemic world.

Devin Ryan (Head of Business Development and Managing Director of Financials and FinTech Equity Research)

Okay. Thank you for all that color. I will leave it there. Thank you, guys.

Kenneth Jacobs (Chairman and CEO)

Great.

Operator (participant)

We will now move to our next question from Brennan Hawken from UBS. Please go ahead. Your line is open.

Kenneth Jacobs (Chairman and CEO)

Hi, Brennan.

Brennan Hawken (Senior Analyst of Equity Research)

Good morning, Ken, Evan.

Hey, good morning. Thanks for taking my question. First, just to clean up, you guys gave some great color on M&A and restructuring. Were there any pull-forward revenues from October in the 3Q number?

Evan Russo (CFO)

Yeah. Look, pull-forward for us, but we don't disclose the actual number. At this point, Brennan, I think of this as more regular way. There's some transactions that close in the beginning of Q3 that go into our Q2 numbers. There's some transactions that close in the beginning of Q4 that will go in our Q3 numbers. The difference really isn't material. It's sort of a regular way at this point in time. There was nothing sort of out of the ordinary in that respect.

Brennan Hawken (Senior Analyst of Equity Research)

Okay. Great. Thanks. When we think about the asset management fee rate, 3Q was a little bit softer than we were looking for, given the sort of strength in equity markets. You guys spoke a little bit about demand dynamics and some shifting of allocations, which seemed to suggest that that would make the third quarter fee rate a reasonably good one to use as a jumping-off point. I just want to confirm that that's the case or whether or not there was any noise in the fee rate. Based upon what you're looking at as far as the pipeline goes, which, as you talked about, has really strengthened and you're much more optimistic about the flows going forward, how should we think about the fee rate in that pipeline and how that might impact the fee rate going forward?

Evan Russo (CFO)

Yeah. So Brennan, on fee rate, as we call that, look, a lot of this, as we said historically, we sort of expected to see this as the majority of it is really relating to the business mix, right? Moving from some of the higher fee categories, such as emerging markets, being a smaller percentage of our portfolio relative to quant and fixed income and some other areas, which are lower fee general strategies. That really is the reason for the decline. I think that the majority of that decline, look, there's always some deep pressure in our business, as we always know. We continue to innovate, which is the most important thing we can do in our business, coming up with new products, launching new teams, and new strategies across the platform.

I think going forward, yeah, I think it's a reasonable sort of assumption to start using. It's going to move around as it has, go up and down a little bit based on that business mix going forward. Ultimately, it's a fair, I don't think there's anything strange in that number specifically this quarter.

Brennan Hawken (Senior Analyst of Equity Research)

Okay. Thanks for that, Evan. In the asset management business, consolidation remains a theme. I see just a steady drumbeat of not only activity, but pressure from activists, indications from CEOs of large diversified financial services firms looking to add scale to their businesses. You all are of reasonable size in that business, but not huge. How are you thinking about it? It really could go either way. I could see you guys using asset management and the excess capital that you generate in your business to go out and pursue more aggressively bolt-on transactions, given the pressure that the business is under and the fact that smaller firms really are struggling more than ever and need to partner with a firm that has good distribution capabilities and the like. On the other end, of course, there are strategic alternatives as a seller.

How are you all thinking about balancing those two right now, and how are you thinking about executing on that environment going forward from here, at least in the medium term?

Kenneth Jacobs (Chairman and CEO)

Sure. Great question. Look, it's a fascinating environment. It's probably a consequence of all the changes that have taken place around asset management over the last several years. People and firms and companies and people are reacting to that now. From our standpoint, we have a great franchise, a great business that we've been investing in historically, and we see an enormous opportunity to continue to invest in the business now. Just in this quarter alone, as an example, which I think is really a reflection of what this environment is like right now, we brought on three new teams: Coherence Capital, which is a credit team; Bottom Billions, which is a thematic team that complements our emerging market franchise; and a digital health strategy that complements our global thematic platform. That is just an illustration of the opportunity set that is out there, and there are many more behind that.

We've been pretty active over that over the last several months, although it's accelerating right now. It just reflects the fact that, as you said, there are a lot of challenges for smaller and medium-sized platforms, given the pressures around compliance, the pressures around cyber, the pressures around scaling to sell product. The gatekeepers have become more sophisticated for products. Having a more sophisticated platform or a more global platform to be able to distribute through becomes quite attractive, and that creates a lot of opportunities for us in that landscape. I think that we're going to be very thoughtful about the kinds of bolt-on larger transactions. We have to make sure that if we do something, it's adding to the value of the firm, and it also has to be something which we think is a healthy business.

It's hard to fix businesses that are broken in asset management. Finally, the larger consolidations, look, those are things which, as a steward of shareholder value, we always have to consider for both our businesses. At the same time, we're very comfortable with this mix of businesses and the two platforms today.

Brennan Hawken (Senior Analyst of Equity Research)

Great. Thanks for all that extensive color, Ken.

Operator (participant)

We will now take our next question from Gautam Sawant from Credit Suisse. Please go ahead. Your line is open.

Gautam Sawant (VP of Equity Research)

Hey, good morning. I just wanted to follow up on that last question. On your alternatives platform, are you seeing additional demand for firms to join that platform? What is the outlook to be able to bring on, I guess, firms there and to help improve the fee rate with those firms coming on?

Kenneth Jacobs (Chairman and CEO)

That's exactly what I was talking about in the last question. We're seeing increased opportunity to bring on firms onto that platform. As I said, we brought on three this quarter alone. I think we've done five or six in the last year total. Our guess is we'll continue to see more activity there. Look, there's a lot of disarray in that market right now, and that is an opportunity for us. You have to sift through and make sure that the strategies we're bringing on are ones that we can be successful with. It's nice if they come with some assets, which increasingly we've been able to do to make the economics more attractive. We're seeing an increased flow there, and that's something we're very focused on.

Gautam Sawant (VP of Equity Research)

Thank you. Just as my follow-up, on the sovereign advisory business, can you talk to how demand is picking up in different regions there, and how are you positioned to continue winning business, and how does that help drive further business in these different regions?

Kenneth Jacobs (Chairman and CEO)

I mean, this has obviously been a very strong platform for Lazard historically and continues to be today. I think it's easy to say that we have the leading platform in the world in this area, and we're involved in virtually all of the major assignments that are taking place in the market today. It's an area where, unfortunately, the pandemic is having a disproportional effect on many of the developing countries around the world, which is putting pressure on their economies and, as a result of that, pressure on the balance sheets of these countries. That's going to drive increasing restructuring in the future. I think that's an area where we're highly focused and have a highly experienced team and should continue to do reasonably well over time.

Gautam Sawant (VP of Equity Research)

Thank you.

Operator (participant)

We will now take our next question from Steven Chubak from Wolfe Research. Please go ahead. Your line is open.

Kenneth Jacobs (Chairman and CEO)

Hi, Steven.

Brendan O’Brien (Research Associate)

Hey, guys. Hey, guys. This is Brendan O'Brien phoning in for Steven. How are you doing?

Kenneth Jacobs (Chairman and CEO)

Okay.

Brendan O’Brien (Research Associate)

You guys already touched on this a bit earlier, but Europe has obviously been about a month or two ahead of the U.S. in terms of COVID cases and lockdowns. How have dialogues sort of changed with CEOs and boardrooms in Europe over the last month as cases have sort of picked back up and lockdown has become more imminent? What is sort of the appetite for deals to get done or announced as they're now headed back into lockdown?

Kenneth Jacobs (Chairman and CEO)

I'm not sure that much has changed over the course of the last month in terms of dialogue with CEOs in Europe. The dialogues continue apace. Deal activity through the last month has been consistent. We haven't seen the very sharp drop-off that we saw in March and April. In fact, in a couple of markets, we've seen some acceleration over the course of the last month or so. I think it remains to be seen what happens over the next couple of months as the lockdowns have gotten more severe in a couple of countries. We're keeping an eye on that. The cross-border activity, I think, hasn't been as robust. Cross-border transatlantic and also, obviously, from China hasn't been as robust as it has been in the past.

I think a lot of that in the cross-border into the U.S. has been probably dominated, has been impacted by elections and political climates in the U.S. Obviously, tensions between China and the U.S. has probably limited a lot of that deal activity as well. In the European midsize, which is a lot of the financial sponsor activity in the sectors that I referred to earlier, you continue to see a reasonable amount of activity in Europe right now.

Brendan O’Brien (Research Associate)

Great. I guess I have another follow-up. You just mentioned a tax code has not changed and things of that nature. I guess, first, what would be the impact of sort of a higher foreign minimum tax rate in the U.S.? You guys obviously benefited the least on the way down. Would it sort of be a similar, not as big of an impact on the way back up? Also, how much of the private sponsor activity do you feel is sort of a pull forward from a potential change in the capital gains and taxes? Thank you.

Kenneth Jacobs (Chairman and CEO)

On the financial sponsor, let me take that and the tax rate on impact on us. I'll let Evan take. Financial sponsor activity, there seems to be a pickup in activity around the fourth quarter trying to get some deals closed prior to year-end. That seems to have picked up over the last, I'd say, several weeks or so. My guess is that's a positive blip, but probably doesn't change the overall dynamics of the financial sponsor market that much because it's such a robust market at the moment. Evan, you want to take the other?

Evan Russo (CFO)

Yeah, sure. Yeah, I think, as you pointed out, I think we would be a beneficiary on a relative basis, certainly, of tax reform where U.S. tax rates goes up. Obviously, the devil is going to be in the details there, and we do not really have a lot of information other than sort of a theoretical, maybe something might happen depending on what happens next week. A lot of questions, a lot of maybes at this point in time. Yeah, I would think, as an overall sort of 60,000-foot view, I certainly would take the view that if U.S. tax rates go up, we would certainly be a relative beneficiary of it given our current beneficial structure.

Brendan O’Brien (Research Associate)

Thank you for taking my questions.

Operator (participant)

We will now take our next question from Jeff Harte from Piper Sandler. Please go ahead. Your line is open.

Kenneth Jacobs (Chairman and CEO)

Hi, Jeff.

Jeff Harte (Analyst)

Good morning, guys. A couple of cleanups from me. As far as the diluted share count, I think last quarter you guys were talking about 4Q 2020 being something close to 4Q 2019, but it did not change a whole lot this quarter. Should we still be expecting a big increase next quarter?

Evan Russo (CFO)

Yeah. Look, I think it drifted up a little bit this quarter, Jeff. I think our expectations would be that we're going to end the year somewhere in the same range as we ended Q4 2019. I think that still holds today, given that we bought back all the dilution we needed for year-end compensation earlier this year and effectively took the share count down, but ultimately drifting back up through the course of this year to last year's level. Essentially, we've kept the share count flat year over year.

Jeff Harte (Analyst)

Okay. In asset management, as we're looking at kind of the flow outlook, despite the obvious month-to-month volatility, I tend to think of institutional as being more stable directionally, kind of historically. It took a while for the outflows to work their way through the system. Now that we've reverted back to inflows again, should we expect kind of a similar persistent takes a while for the inflows to work their way through?

Evan Russo (CFO)

I’d say, look, institutional business, as we’ve always said, right, it’s a bit lumpy, right? You’re going to get some times where things are going to come and some times where they’ll slow down. I think ultimately, we’re very focused and seeing a lot of great fund flows for us and wins and mandate wins that we’ve had over the last few months that are sort of driving in towards growing our gross inflows for the quarter. Our gross inflows continue to be strong this quarter. Gross inflows are certainly very, very important to us on a quarter-to-quarter basis. It says that we’ve got the right products. It says we’ve got the right teams, the portfolio management teams, and the products are really working their way through. I think this quarter, you kind of saw two themes here.

You had gross inflows, sort of the inflow part of the equation, going up because of some of those unfunded mandates. Jeff, as you pointed out, our gross outflows actually are coming down on a relative basis. You always have some ins and outs, and this time, I think we benefited on both sides of the curve with stronger gross inflows and lowering gross outflows at the same time. I think our outlook, as we have said, we continue to be optimistic given what we have seen and the wins we have had. The wins are continuing to get the unfunded pipeline, which remains fairly strong and quite diversified at this point. I think our products are selling well in the market.

I think clients are potential clients and clients are certainly eager to put some money to work in strategies like ours, and they're really seeing the value of active management today in today's market more than they have in the past. I think all those factors sort of come together to kind of say, "Look, hopefully, it's lumpy. We can get some potential months and quarters where it could turn, but I think we feel pretty good about the business today relative to the last couple of years.

Jeff Harte (Analyst)

Okay. I feel kind of weird asking this close to the end of a recession as we are, but it stands out. Cash is building on the balance sheet, and the environment outlook is getting quite a bit better and improving. At what point do you consider kind of reinstating a more meaningful buyback or potential dividend increases or something along those lines?

Evan Russo (CFO)

Yeah. Sure. Look, as you point out, Jeff, our cash has been building. We know that happens through the year. We accrue cash at this point as we start to gear up for sort of year-end compensation and also for potentially repurchasing shares to offset any dilution, which we normally do at the beginning of the calendar year, so beginning of 2021. Look, we've been a little bit more prudent in this market, to be a little more conservative in this environment given a little bit of the uncertainty. We are letting cash grow a little bit. Ultimately, I think our view is we bought back the number of shares we needed, the minimum amount of shares we wanted to offset the dilution this year. We did it in Q1. We bought the shares back when the market sold off in late Q1.

We did enough to buy back what we needed for the year. Ultimately, I think we're holding on to the excess cash. Any future additional repurchases will come from excess cash generation. It's going to be depending on the pace and the outlook of the business. We're going to keep monitoring it, but ultimately, it's likely to be limited for the rest of this year. I would expect, Jeff, in 2021, if we're heading back to a more normalized environment, if the business continues to strengthen, I would expect us to sort of resume our share repurchases at that point in time in 2021.

Jeff Harte (Analyst)

Okay. Thank you.

Operator (participant)

As there are no further questions, this now concludes the Lazard conference call. Thank you for your participation. You may now disconnect.