Earnings Calls 4Q15

Current Events

Year-end 2015 closed out a quarter of elevated market volatility and falling asset prices in the traditional asset management industry. The year was marked by a rising flight to passive strategies and overall falling net inflows that pressured margins, causing many managers to take a hard look at their expenses and compensation structures going into 2016. Looking ahead, traditional asset managers are also facing headwinds from a slowdown in the global market, and a subdued (but cautiously optimistic) outlook at home. As we did last quarter, we take a look at pacemakers in the traditional asset management industry and outline four key themes we believe are expected to define 2016.

Theme 1: Increasing volatility has shifted focus to long-term investing and allowed active managers to differentiate themselves.

  • From the depths of the great financial crisis in March 2009, investors have enjoyed a strong rebound across capital markets with a lower than normal level of volatility. It appears that volatility is now back and likely to be with us for a period of time. (Brian Casey, WHG)
  • While we don’t have good visibility into 2016, we remain optimistic that we are in the midst of a classic cycle with value poised to rebound. […] The flight to passive strategies in the anti-value environment are cyclical. […] This was probably the worst year globally for value that you can find in a long time. (Rich Pzena, PZN)
  • Investor preference for passive products, especially in core categories, and rapid changes in active categories that are in favor have provided for an unfamiliar distribution landscape for active managers. We, of course, believe in active management and its capacity to reassert itself versus passive. (Thomas W. Butch, WDR)
  • We believe that this environment also presents an opportunity for active managers to demonstrate their value over passive strategies that have benefited from the generally up-moving market since 2009. […] as challenging in this environment has been, we have actually had a lot of our products doing incredibly well during this period of volatility with markets being down 3% or 4% in one day and some of these less volatile products being flat. So, we do think that having products that help you address the uncertainty around volatility, particularly if you have a shorter horizon, are important. (George Aylward, VRTS)
  • So I think the takeaway from investment performance is that during the volatile year an active manager such as ourselves has an opportunity to differentiate itself on an absolute basis and on a risk adjusted basis and we took good advantage of those opportunities I think. (Dick Weil, JNS)
  • Ironically, the choppy market backdrop which led to mark to market losses which are not realized generally among the funds we manage, that has actually created what we believe to be more attractive opportunities for us to get capital to work. (Josh Harris, APO)

Theme 2: Market conditions and falling revenues have forced managers to take a hard look at their expenses and compensation structures.

  • In light of our diminished asset base, to fund these priorities, we have challenged every level of our organization to aggressively manage expenses. This is an important balancing act. We must be vigilant in managing costs while funding initiatives we believe critical to our future. (Henry John Hermann, WDR)
  • For us to actually cut expenses, we would either have to cut some of these initiatives or make some cuts that would not be consistent with the number of accounts that we are managing. We’re already pretty lean at this point. So most of our flexibility comes in the actual level of sales comp and bonuses. (Rich Pzena, PZN)
  • We will update our thinking in terms of the market conditions, but it is important to note that we have been very selective in terms of any headcount changes, and the changes that we called out were not in the base salary or the fixed portion of employment. It was sales base. […] Our model is variable in nature and we have variable compensation plans, but going beyond the first quarter is not something we could do at this point in this market. (Mike Angerthal, VRTS)
  • I actually expect to see a slight pullback in the G&A line and that’s really a combined effect of a lot of smaller cuts that are just being prudent in light of really volatile markets. (Jennifer McPeek, JNS)
  • What you have happening right now is probably bit of a mismatch or a timing element that’s coming into play with our margins and we had some downward pressure on the margins given the client asset outflow and corresponding revenue drop mismatched against the way we pay our research team, which is largely absolute return oriented. […] We had more difficult markets last year and the beginning of this year has been quite volatile. So as those absolute returns start to push their way out of the compensation structure, which is a three-year rolling period, you should start to see more alignment with the comp structure that would push our margins upwards some. (James Mikolaichik, MN)

Theme 3: Maintaining cash flows for dividends, buybacks, and share repurchases has remained a priority for managers.

  • We do think it’s important to have a meaningful return of capital to shareholders and continue to invest in the future growth of the business in the form of future products, and we have a very strong balance sheet that allows us the ability to do both. (George Aylward, VRTS)
  • Our dividend is the top priority. Our model shows that we generate sufficient free cash to fund operations, maintain our dividend and offset the dilution from our annual equity grants. We will continue to be opportunistic with share buybacks. (Henry John Herrmann, WDR)
  • So while we have seen some decline, we are able to manage our return to capital in response to changes in cash flow generation. And we tried to be tactical in managing that so it’s not something you can predict with great certainty quarter to quarter. But we have a lot of levers we can pull to react to changes in cash flow and frankly that’s one of the reasons that we like share repurchases is they give us that flexibility. (Jennifer McPeek, JNS)

Theme 4: There is a growing fear of a global slowdown due to negative market sentiment, but cautious optimism that US growth will remain stable and the global economy will turn around.

  • As you all know, emerging markets have struggled in recent years with performance significantly below returns posted by developed markets. We do not believe this to be a secular trend but more so a function of the volatility that we’ve seen over time in the relative performance of emerging market. History has proven that times like this provide investors with an excellent entry point into a part of the global economy that has potential to provide strong growth in the future. (Brian Casey, WHG)
  • The current fears around China reflect the continuation of a trend of slowing that is now quite advanced. […] The meltdown in commodities, energy, and related industrial cyclicals is a telltale sign that markets are anticipating a recession, or at best a significant slowing of the global economy. […] As markets sold off, valuation spreads widened to what are now provocative levels, most notably in the US, we’re finding very attractive investment valuation because of the fear in the global investment community. […] The markets are basically telling you that we are afraid that the world economy is slowing down, and we don’t want to be exposed to anything that has economic sensitivity. (Rich Pzena, PZN)
  • Since the point of the global financial crisis, the markets have reacted well to monetary stimulus, but the extent to which monetary stimulus can have the desired impact of faster economic growth is perhaps met the limit of its efficacy. We think that, in the days ahead, there will be more emphasis focused on fiscal stimulus, but that probably is within the purview of the next legislative executive cycle. In the meantime, we’re probably in for a difficult period. (Michael L. Avery, WDR)
  • From our point of view, the fundamentals of the market remain similar to what they were last year, but the sentiments got negative and the sentiment can certainly turnaround. There’s also a lot of quantitative easing globally. (Martin Kelly, APO)