Invesco Ltd (IVZ) — Q1 2018 Earnings Call Transcript

Thank you very much; and thank you, everybody for joining us. And if you're so inclined, you can follow along the presentation, which is on our website. As has been our practice, I'll hit some of the highlights of the business during the first quarter; Loren will go into greater details within the financials of the quarter; I will then spend a few minutes talking about some of the key differentiators of our strategy and put that in the context of growth opportunities; and then, of course, we'll open up to Q&A. So, let me begin by highlighting the operating results for the first quarter. Long-term investment performance remained strong during the quarter. We had net inflows of $300 million. We did see the impact of market volatility, impacting investor behavior, which negatively impacted net flows during the quarter. The adjusted operating margin for the quarter was 37.3% versus 39.6% in the prior quarter. We returned $120 million to shareholders through dividends during the quarter. Reflecting the strength of the business and the focus on providing returns to shareholders, we are increasing the quarterly dividend to $0.30, which is a 3.4% increase. Turning to page 5, you'll note the investment performance continues to be strong on a three and five-year basis, with 68% and 70%, respectively. Although the long-term investment performance remained strong, we did see headwinds in one-year numbers, with the short-term numbers being impacted by some relative underperformance in some of the larger strategies in the U.S. and the UK. Regarding inflows, we saw quite a bit of demand for our passive capabilities, which are very robust, particularly strong in our commodity ETFs, both in Europe and the United States during the quarter. On the active side, our retail business faced a somewhat challenging flow environment due to the uptick in volatility, particularly in U.S. and UK equities, as well as outflows from our sub-advised REIT in Japan. As an offset, we did see strong institutional demand and solid flows in areas such as stable value, Global Targeted Return, and a number of our quantitative strategies globally. With that, as a summary, let me turn it to Loren to delve into more detail on the financial results.

Thanks very much, Marty. So, quarter-over-quarter, our total AUM decreased $3.4 billion or 0.4%. That was driven by market losses of $12.2 billion. We saw outflows from non-management fee earning AUM of $0.4 billion. These factors were somewhat offset by a positive foreign exchange impact of $7.9 billion. We observed reinvested distributions of $0.6 billion positive. Inflows into our institutional money market products came in at $0.4 billion; and then we had long-term net inflows of $0.3 billion. Our average AUM for the first quarter was $951.3 billion, up 2.3% versus Q4. Our annualized long-term organic growth rate for the quarter was up 0.2 percentage points compared to negative 0.8 percentage points in the fourth quarter. So, before turning to net revenue yield, I just wanted to provide a quick update on a change this quarter to our presentation of AUM in response to investor feedback to provide greater transparency into the composition of changes in our AUM. We reverted to our historical presentation of sales-driven long-term flows and presented reinvested distributions on a separate line item in our AUM tables. You will see that in the back. We have also restated the third and fourth quarters of 2017 for consistency. Now, let's turn to the net revenue yield discussion. Our net revenue yield came in at 40.3 basis points, while our net revenue yield excluding performance fees was 39.9 basis points, decreasing 1.4 basis points versus Q4. We saw two fewer days in the quarter, which reduced the yield by 0.9 basis points. The change in asset mix and reduction in non-fee earning AUM lowered the yield by 0.7 basis points, and a new revenue recognition standard reduced it by 0.2 basis points. A decrease in other revenues further reduced it by 0.1 basis points. These factors were offset somewhat by a positive foreign exchange impact on the mix, which added 0.5 basis points. Given these changes and the continuing shifts in our asset mix, along with our focus on strategically pricing our products to remain competitively positioned with new and existing clients, we expect our net revenue yield for the remainder of 2018 to be approximately 40 basis points, about 1 basis point less than our original guidance, assuming flat markets and foreign exchange from today's level. Slide 9 provides our U.S. GAAP operating results for the quarter as is customary. My comments today will focus exclusively on the variances related to our non-GAAP adjusted measures, which you'll find on slide 10. Before discussing these results, I want to briefly touch on the impact of the new revenue recognition accounting standard on our revenues and expenses. Overall, this standard changed how we present specific revenue and fund-related expenses, impacting many of our revenue line items. The method we adopted did not require us to restate prior periods. Our Q1 2018 results are presented under the new guidance, while the Q4 2017 numbers are under the old guidance, impacting the variances quarter-over-quarter, as we'll discuss. We have included a slide in the appendix showing the line item impact of the new standard on our revenues and expenses for Q1 2018. You'll note that the changes decreased gross revenues by $19.6 million. However, the overall impact on our operating income margin and net revenues is immaterial. Now, let's proceed to the non-GAAP operating results on slide 10. Net revenue decreased by $46.9 million or 4.7% quarter-over-quarter to $958 million, including a positive foreign exchange impact of $16 million. The revenue recognition impact reduced net revenues by $4.2 million. Excluding these impacts, net revenue decreased by $58.7 million. Adjusted investment management fees decreased by $52.4 million or 4.7% to $1.07 billion. The revenue recognition impact reduced adjusted management fees by $53.8 million, but FX increased them by $16.8 million. So, excluding these two changes, our adjusted investment management fees decreased by $15.4 million quarter-over-quarter, primarily due to two fewer days in the quarter, partially offset by higher average AUM. Our adjusted service and distribution revenues increased by $28.6 million or 13.1%. The revenue recognition impact increased adjusted service and distribution revenues by $32.4 million. Excluding these changes, our adjusted service and distribution revenues decreased by $3.8 million, primarily due to fewer days in the quarter.

Thank you, Loren. Again, if you're following along, I'm on page 14. I want to discuss our strategy in the context of the opportunities and competitive advantages we believe we are creating. Many of you have been owners of the company for years and have a good understanding of the foundational elements and key strengths of our company. However, I would highlight four key growth drivers that are significantly improving our competitive position. These are ETFs, factors, solutions, and digital advice, which includes Jemstep. Building these growth drivers continues to be a primary focus of our organization, improving our competitive advantage and leading to greater growth opportunities. The combination of our comprehensive range of investment capabilities, global presence, and focus on both retail and institutional channels sets us apart and positions us for growth and success over the long term. I will spend a moment discussing each of these growth drivers and how they come together to create a competitive advantage. Regarding ETFs, we have significantly expanded our ETF business over the past year; it now ranks as the fourth largest in the U.S. and globally. In total, our ETF business has grown sixty-fold over the past 12 years. Being first to market offers a clear advantage in the ETF space. We have more than 50 funds with assets greater than $500 million. Earlier this year, we decided to move to a single brand, Invesco, throughout all global operations, strengthening our brand positioning and consolidating our marketing spend behind our growth drivers. We've been a pioneer in smart beta since 2003 and are now second in market share in smart beta assets under management globally, trailing the market leader by only $9 billion. There's less than a 3-percentage-point gap between us and the number one position. Turning to factors, our aspiration is to be a global market leader in factor investing, leveraging our significant expertise and experience, along with strong investment capabilities across both retail and institutional channels. The existing and long-term market potential for factor investing is substantial. It is vital to develop and maintain specialized skills and expertise to deliver the results clients expect. Having the infrastructure to educate financial advisors, RIAs, and partner with institutions and others on using these capabilities appropriately is crucial. Our focus on education is enhancing our relationships with platforms and key institutional clients, broadening our market opportunities. Invesco has over 40 years of experience in factor investing across various investment teams, providing a solid foundation for client relationships and assets under management. We are committed to executing a global integrated plan for factor investing that encompasses client needs, analysis, product development, and further expansion in this market. Now, on solutions, our solutions capability is both a growth driver and an enabler within our business. We are enhancing our ability to design, implement, and manage custom portfolios and investment solutions using our comprehensive range of investment capabilities, which strengthens relationships with advisors and clients. Importantly, one cannot be a credible solutions provider without a broad and deep set of investment capabilities, which we possess. Our Solutions team also supports our Distribution teams with investment and analytical expertise that enhances client partnerships and deepens relationships. Invesco is among a small number of firms that can be truly product-agnostic in developing outcome-oriented solutions to meet client needs. Our goal over the past few years has been to build one of the strongest solutions teams in the industry, fully dedicated to helping clients achieve their investment objectives. Finally, regarding digital advice, we are in the process of fully developing the Jemstep digital advice platform. Our position as one of the first digital solutions in the market for advisors and our emphasis on providing an open architecture platform allows us to build this capability substantially. We are live with a major bank in the U.S. and 20 smaller clients, currently onboarding two more major banks and a leading insurer within this year. We are well-positioned to be a market leader in providing services to banks and credit unions and are witnessing solid emerging demand in the RIA channel. Our focus for 2018 and beyond is to extend this capability globally. A significant advantage of our digital advice initiative is that it enables us to reach a broader range of clients and enhance the distribution of our investment capabilities. We are currently pursuing impactful combinations of these key capabilities that will unlock extensive opportunities for Invesco by allowing us to serve key markets in new ways.

Thanks, guys. Loren, maybe first one, just on the expense line items, I guess, just curious, given some of the moves, any update on how we should be thinking about 2018 relative to like the guidance that you gave on the last call, just whether it's by line item or just overall how we should be thinking about the expense?

Good question. We would expect the guidance to be largely intact except for compensation, which is going to flex down in the sense that revenues are down; compensation flexes down, too. Without getting too explicit, I think we'll see where that goes. It is probably about $10 million less than we had guided previously—so somewhere in the $400 million to $405 million per quarter range through 2018. The other one would be G&A, which has the revenue recognition impact—the $4.2 million has moved from G&A up to the revenue line items, reducing G&A by $4.2 million. Those would be the two I'd point to. Obviously, we will continue to look at being more effective and efficient with our resources. It really depends on the market environment we're in, which has been rather volatile. But people should understand that we are currently flexing down compensation due to lower revenues.

Okay, thanks. Just a follow-up, Marty. I think you pointed out a lot that the investments being made are in products that reflect the demand you're seeing in the industry. As you think about transitioning from 2018 to 2019 and beyond, Loren mentioned you're sort of getting to that 3% to 5% new growth rate. How should we think about what this means for fee rate and revenue growth in the next couple of years, and also, like the incremental margins? I'm trying to translate a lot of the investments into their strategic impact, ultimately affecting the financials longer term.

We approach this with high conviction about the direction of the market. Feedback from clients and platforms indicates they are consolidating their partnerships with fewer firms. Strong investment capabilities are critical, but that is becoming table stakes. We are witnessing greater traction as we enhance our solutions and engage with large, sophisticated institutions. Therefore, we see these elements driving growth. The overall effect of fee rates will depend on where clients build their portfolios. As we expand our factor capability in ETFs, the relative fee rates may be lower compared to alternatives or high conviction active products. So, I can't give a specific fee rate outlook, but I believe growth and profitability will improve our earnings going forward.

For this year, we're still near our historical range of 40% to 50% incremental margin. The long-term view remains closer to the 50% to 65% range. We will continue to evaluate the changing landscape as we enter new areas like digital advice. Overall, I am optimistic on the incremental margin story.

Hi. Thanks for taking my questions. Marty, you highlighted that Invesco is top two in smart beta in terms of AUM. What we'd really like to see is Invesco rank top two in sales of smart beta. So, you're buying, you bought two positively selling firms, Source and Guggenheim, that helps. But it doesn’t quite get you to top three in the U.S. So, are the aspirations to be top three? Can you provide specifics about the path to breaking into the top one, two, or three?

Our aspiration is to be the leader in smart beta and factor capabilities. We believe it's where we can have the most significant impact for clients. The acquisitions of Guggenheim and Source are important steps towards this aspiration. We are currently in the process of ensuring these products are available on key platforms to drive growth. While I can't specify a timetable, we've met with important platforms and received positive feedback.

Okay. In terms of the April outflow number, $3.5 billion from the sovereign wealth fund and sub-advised. Can you elaborate on the regions impacted and the asset classes involved? What led to this?

The large sovereign outflow occurred in our EMEA region, specifically in active equity sub-advised U.S. active equity products. These were not performance-based decisions but rather client-based decisions. Our performance in these products has been strong, and the sub-advised shift stems from different investment models.

Got it. And just a quick question, Loren. Based on Guggenheim's ending AUM and the recent fee reductions and tax code changes, how do the IRRs look for the Guggenheim deal now? Have they gone up or down?

It's early days to determine if we can improve our growth trajectory beyond our original modeling. Currently, we anticipate a slightly lower IRR due to fee reductions, but the impact is modest—probably around 1 percentage point lower, still solidly in the 20s regarding IRR. EPS creation may be affected by about $0.01 in 2018. Overall, it's a minor adjustment, and hopefully, we can compensate with higher growth.

Good morning. Thanks for taking the question. Could you walk us through the factors driving your lowered expectation for revenue yield going forward?

We started with an original guidance of 41 basis points. AUM mix growth led to a decline in non-revenue-generating assets, reducing yield by about 0.5 basis points. We also saw revenue recognition changes impact our guidance by about 0.3 basis points. Strategic pricing initiatives have likely added another 0.1 basis point, with foreign exchange making a similar negative contribution. Overall, these factors drove our yield expectation down to 40 basis points.

Thank you for that. Regarding fee rates, how do you see continued fee pressure influencing the revenue potential at Invesco, particularly in light of increased transparency in Europe and MiFID?

Our view on fee pressure has not changed. The market is increasingly focused on value for money. Being competitive on pricing is crucial, and we are witnessing a broader trend towards cap-weighted indexes, factors, high conviction active, and alternatives. Ultimately, where clients decide to allocate their assets will determine overall revenue trends.

That helps, Marty. We believe you are positioned well to retain assets despite continued fee pressure. The question remains whether clients' shifts toward smart beta will impact your earnings. Is that fair?

That is correct. We are optimistic about our ability to retain assets. While fee pressure exists, it is coupled with opportunities in smart beta, which we believe will ultimately drive growth.

Thanks. Just to clarify, Loren, regarding this year's growth rate, I believe you mentioned a trajectory similar to what we've seen thus far, which is slightly positive for the first quarter. Are you including April in that assessment?

Absolutely. April was an anomaly due to specific events. Institutional pipeline remains strong despite a general uptick in redemptions, making us somewhat cautious about achieving a higher growth rate than historically experienced. Opportunities to generate sales are still present, so it is reasonable to expect growth similar to recent history.

There’s a noticeable unease about the future direction of equity markets. We’ve observed a more defensive mindset among clients. However, these decisions can change rapidly; it's difficult to predict when clients will shift their portfolios. While we know there’s a strong pipeline of opportunities, external factors may hinder growth.

I understand. Regarding the sub-advised loss, this is at least the second time you've flagged this in recent months. Can you provide context on the size of the overall sub-advised U.S. book? Do you expect it to shrink over time or remain stable?

The total sub-advised book is over $30 billion, so it's a substantial amount. This is not a trend but rather specific client decisions. While a few data points indicate outflows, we don't anticipate a significant ongoing trend that could erode this segment.

Thank you very much. Could we revisit Jemstep? Can you give us a sense of how to potentially size the revenue or flows and the timing of how this might translate into unit growth?

The timing has not changed; we expect to start seeing an impact in 2019 once these institutions are onboarded. We anticipate a gradual build-up in flows, with the potential for substantial assets given this helps us pursue a larger client base. As we progress further, we will discuss this in more detail as we gain greater conviction.

This is unrelated, but on the $3.5 billion—sorry to keep returning to that—but could you provide context on the one-offs involved? Also, regarding pricing pressure in the European ETF market, how do you view your positioning with respect to possible revenue degradation?

The $3.5 billion break-down consists of approximately $2 billion from the sovereign wealth fund and $1.5 billion from sub-advised products—all with decent fees. Regarding pricing pressure, we believe it is more pronounced in the smart beta and general ETF space. Our focus is to ensure that our products are competitively priced against similar offerings. For active products, if we maintain strong capabilities, there's less need to adjust pricing, as they are generally aligned with competitors.

Thanks. I wanted to start on Jemstep. I appreciate the insights provided on slide 12. How should we consider the net flow potential in 2019 from the six large financial institutions scheduled to go live this year?

Estimating the potential size of flows is challenging at this time. While institutions are large, we anticipate gradual building of flows once they are onboarded. We believe that even with modest penetration post-implementation, we could see substantial assets aggregating over time.

As a follow-up, regarding the SEC allowing more asset managers to self-index and potential new rules that could reduce entry barriers for ETFs, do you believe this will increase competition? Or is it true, as Dan Draper stated, that ETFs have a low barrier to entry but a high barrier to succeed?

We believe it's the latter. While more ETFs may emerge due to regulatory changes, success in the market is not guaranteed. Providing a compelling ETF requires a well-defined strategy, substantial investment, and deep market understanding. Our firm’s experience and capabilities position us strongly for long-term success.

Hi, thanks. Observing the increase in sales and redemptions activity, do you think this is primarily due to market volatility and changing macro outlook? How significant is the effect of the broker/dealer channel's consolidation and focus on model portfolios?

The fluctuations you see in gross and net flows are largely driven by changes in client sentiment, particularly during periods of volatility. While the narrowing of broker/dealer platforms prompts motion in client portfolios, not every fund removal translates into immediate redemptions; it often takes time for these decisions to manifest in tangible outflows.

I appreciate that. One follow-up: you and other players have noted the importance of capturing flows as client sentiment shifts. As this occurs, do you feel you are effectively capturing those flows, given the ongoing churn?

We believe there's room for improvement in capturing those flows. Our approach has shifted towards predictive analytics, enabling us to anticipate where financial advisors are directing funds. While this effort is in its early stages, we expect to see improved outcomes with time.

Regarding the targeted organic growth range of 3% to 5%, what asset categories do you expect will outperform or underperform this range? Which categories will be the biggest contributors to this growth rate?

It really depends on market conditions. Generally, we expect passive to continue growing at a faster rate than active. Lands may vary across asset classes. However, we believe alternatives will surpass traditional categories regarding growth potential.

Understood. Lastly, with the recent additions to the Global Solutions team, what efforts are underway to attract more insurance clients? We note that competitors have shown growing interest in this space.

The insurance industry represents a significant growth opportunity for us, and we’ve been successful in this area. We're expanding our focus here, leveraging the specialized expertise we've built internally. We anticipate it will become one of our more robust institutional business segments.

Great, hey Marty. Good morning, Loren. I wanted to revisit the Guggenheim discussion regarding recent fee rate reductions. While I understand your intent is to be more competitive, are we largely done with reductions, or do you foresee any further pricing adjustments in either that product or the broader PowerShares brand?

Our ETF pricing discipline has strengthened significantly. We prioritize value for money in our offerings and are not positioned to be the low-cost provider. We are assessing the entire ETF lineup post-acquisition, but nothing specific is in front of us right now; we’ll remain competitive in the market.

Regarding the cost-cutting program, we are approximately 70% done. We will continue to identify opportunities as we enhance efficiencies, but this program will be completed within 2018. Our focus will shift to leveraging new opportunities in technology and outsourcing in the years ahead.

Thanks for taking my questions. I wanted to discuss the smart beta franchise. Given the slower net flow environment, what do you believe are the biggest drivers for turning that momentum around? How do you see market conditions and positioning affecting demand for smart beta versus active and passive products?

You raise a crucial point; while smart beta has gained traction, its adoption is not at the level that it could be. Financial advisors require education on how to implement these strategies effectively. We are focusing on this educational component as part of our strategy in positioning smart beta as a valuable solution.

We are also exploring natural language tools to analyze filings, as well as AI applications for macroeconomic views. These tools can enhance decision-making for our fundamental teams.

Hi. Good morning. Could you provide an update on the Great Wall JV in China? How's the recent regulatory environment affecting your approach?

We maintain a strong position in the Great Wall JV. The business has seen steady growth, and we have gained valuable insights in utilizing technology and retail strategies. As regulatory changes offer new opportunities, we feel optimistic as we continue our development in that market.

Currently, the joint venture is around $20 billion in size and growing rapidly. We are also focusing on our Wholly Foreign Owned Enterprise (WOFE) as part of our greater China strategy.

Hey, guys, good morning. Could you outline your capital allocation priorities and where acquisitions fit into that mix right now?

Currently, our priority is paying down the credit facility, ensuring we return to pre-acquisition leverage levels by the end of 2018. Post that, we'll focus on investing back into the business, increasing our dividend, and reallocating to buybacks at an appreciated stock price. As for acquisitions, we will keep an eye on opportunities but are focused primarily on leveraging our recent acquisitions at this juncture.

Good morning. Is Jemstep structured in a way where advisors can choose from among competing asset managers, or does your platform take precedence?

Advisors typically select one digital platform for their operations. We aim to establish partnerships with firms, serving as their digital advice platform, ensuring they make informed choices to serve their clients effectively. Our focus on providing tailored solutions allows us to build beneficial relationships with these clients.

Lastly, there was recent news regarding a fee dispute with the enhanced income trust in the UK. Could you provide total AUM exposure to these types of trusts and whether this indicates a broader trend?

The exposure is relatively small, around $5 billion or less. Various trust products have gone through fee adjustments successfully in the past. This specific dispute appears to be more of an anomaly than a consistent trend.

Thank you very much on behalf of Loren and myself and the Invesco team. Thank you for your time and interest. We look forward to talking with you soon. Have a great rest of the day.