Invesco Ltd (IVZ) — Q4 2019 Earnings Call Transcript

Good morning and thank you all for joining us. As a reminder, this conference call and the related presentation may include forward-looking statements, which reflect management's expectations about future events and overall operating plans and performance. These forward-looking statements are made as of today and are not guaranteed. They involve risks, uncertainties and assumptions, and there can be no assurance that actual results will not differ materially from our expectations. For a discussion of these risks and uncertainties, please see the risks described in our most recent Form 10-K and subsequent filings with the SEC. Invesco makes no obligation to update any forward-looking statements. We may also discuss non-GAAP financial measures during today's call. Reconciliations of these non-GAAP financial measures may be found at the end of our earnings presentation.

Thank you very much, and thanks everybody for joining. This is Marty Flanagan, along with Loren Starr, our CFO, and Andrew Schlossberg, Head of the Americas. And if you're so inclined, the presentation is on the website if you want to follow along. That said, we're going to follow the format that we did last quarter where much shorter prepared remarks so we can get to Q&A. Loren will give a brief overview of the business results before we get into the questions though. As we've discussed on previous calls, we view this combination with Oppenheimer's multi-year growth story as something that deepened our relationship with Invesco clients, expanded the capabilities offered globally, and scaled the business for both the benefit of our clients and shareholders, and we're already seeing that. This expansion meaningfully enhances our ability to grow our business, achieve very strong operating results, and compete in the ever-increasing dynamic market environments. Importantly, this is a long-term growth story. That said, we are seeing real and meaningful signs of the power of the combined firm. We ended the year with just over $1.2 trillion in assets under management. That's a 38% increase year-over-year. That's a record high for the firm. We also have higher assets under management across all channels and all regions as we ended the year. Long-term outflows for the year were $34 billion. That's an 11% improvement from the prior year. We hit record levels of revenue and record levels of operating profits for the year ended 2019. We also achieved significant expense savings delivering ahead of schedule at $551 million, which is more than $25 million ahead of the synergy target that we talked about at the time of the combination. And we'll continue to look for additional synergies in 2020. Lastly, and importantly, we returned $1.2 billion to shareholders in 2019. Looking ahead, we believe we are well on the path to continue to make progress towards moving into positive flows in 2020. The key factors that we've looked at include improving equity performance and several capabilities that are in high demand, continued very strong fixed income performance, meaningful progress on the integration of our U.S. sales team, strong momentum in our growing China and ETF business, a very strong institutional pipeline, including large solutions, and finally, the clarity on Brexit will help investors who have backed away due to a risk-off mindset, and we are beginning to see that. So, I'm going to turn it over to Loren to give our results.

Thank you, Marty. So, I'd like to spend the next few minutes highlighting some of the key items regarding flows, expenses, and capital management. Starting on flows, as you can see on Slide 7, we're seeing year-over-year and quarter-over-quarter long-term net inflow improvements in the regions of EMEA ex-UK and our Asia-Pac area. The Q4 net flow growth in EMEA ex-UK was driven largely by our ETF business and our direct real estate business. For example, we saw $0.9 billion in the S&P 500 UCITS ETF and $0.7 billion in real estate. The Q4 growth in Asia-Pacific is largely centered in Greater China and is driven by strong flows into our joint venture, with the JV flows at $2.6 billion across many asset classes, fixed income contributing $1.7 billion and followed by balanced with $0.8 billion. We are also seeing quarter-over-quarter improvement in our UK business, with positive net flows in our institutional business, driven primarily by direct real estate and fixed income where we had $1.3 billion in real estate and $1.1 billion in fixed income. Our retail flows do remain somewhat challenged. You'll see that the majority of the $16 billion in net outflows in Americas was attributable to the retail business, driven by $9.4 billion in outflows from some of the legacy OFI funds, with some of the largest outflows including OFI global equities at $3.9 billion and OFI senior loans at $2.2 billion. We didn't see a natural redemption out of maturity of our BulletShares with $1.7 billion out of that activity. There was $0.8 billion from Invesco International Growth, $0.7 billion from stable value, and $0.6 billion from global asset allocation. I'd like to note that about $2 billion of these outflows is due to the previously disclosed New Mexico 529 plan. It was a deal-related redemption that we discussed earlier. So, on the next page, let's drill down a little bit on net inflows in the Americas. On Slide 8, we show the 2019 history of AUM monthly gross sales and net flows for Invesco and the OFI U.S. active retail products combined, which includes periods both pre and post close. First, both the legacy Invesco and OppenheimerFunds have maintained AUM levels aided by the market. Net revenue yields are stable across the timeframe. Second, our gross sales post close are still well below pre-close levels, and they did dip in Q4; although we did see a stronger December. We've made progress with the integration of the two sales teams and we are working to provide the tools they need to hit the ground running in 2020, but we are not fully operational yet. We do have Andrew Schlossberg, as Marty mentioned, the Head of our Americas business here with us on the call today, and he'll be able to elaborate on this during the Q&A session. Third point I'd like to make is net outflows have been elevated post-close, largely a function of the abnormally low gross sales levels combined with performance challenges we have in some of our active equity portfolios. In Q4, outflows were impacted due to the previously announced $2 billion deal-related redemption of the New Mexico 529 plan. As we get to the second half of 2020, we expect the U.S. retail net flows to be on an upward trend, driven by improved gross sales levels and moderating redemption rates on many of our portfolios that have recently seen a significant uptick in investment performance. Next, let's get to expense management and the P&L. On Slide 9, we set out our revenues and expenses. You'll see revenues included $52.2 million in performance fees in the period compared to $18.7 million in Q3, primarily coming from our real estate business. Expenses are up $36 million in the quarter driven by several factors, including the impact of foreign exchange rates and global markets. Despite these factors, we maintain our focus on expense management and achieving our synergy targets discussed last quarter. On Slide 10, we provide additional information about our expenses, highlighting the foreign exchange and market impacts that drove Q4 expenses above Q3 levels. The FX and market both increased expenses in the quarter by $21 million. We saw a strengthening of the pound and the euro against the U.S. dollar during the quarter, with the pound up 7%, euro up 3%, and other currencies like the renminbi up 3%. Additionally, markets increased significantly, with the S&P 500 up 8.5%, MSCI Emerging Markets Index up 11.4%, Russell 2000 up 9.5%, and MSCI All Country Index up 8.5%, all impacting our variable expenses. We realized $3 million in integration savings in the quarter but had $9 million more in savings related to compensation from the decline in our bonus pool and departures related to confirmed exits in Q4. These savings, however, were offset by about $6 million in property, office, and technology costs. We also had about $9 million of operating expenses in Q4 due to elevated seasonal expenses, primarily related to marketing spend. The fourth item is non-recurring items, with about $9 million in expenses that occurred in the quarter largely in G&A. The resulting $755 million represents an average quarterly run rate for operating expenses for 2020, and there will be some quarterly variation around this average. For 2020, we are confident in our ability to maintain this expense level based on year-end 2019 market and FX levels, which means we are achieving our targeted cost synergies of more than $500 million. We will continue to update you regarding our ability to generate greater cost savings as we move through 2020.

Maybe despite the start out with in talking about the trajectory of new sales in the U.S. I mean, you've talked about the integration of the sales force and product performance. But maybe I'm just kind of curious how long you think the lag is between you've had the combine forces now for, I guess, going on about six months and what's kind of the lag between when you get it together and you get out in the field and they start talking to advisors that you think you can really start to see get back to where you - the combined firms you are pre-deal. And then maybe you also have a little more granularity if there's in the U.S. kind of the handful of products that you think could really kind of drive that demand, where you think you could really kind of leverage sales?

All right. Andrew?

Maybe it's rather important to kind of take a step back for a minute. While we did put the two companies together six months ago, it was one of the largest asset management transactions in history, as you know. We started putting the teams together then, and we're just kind of getting them on the field now. One of the really important strategic decisions that we took when we integrated the companies was to rapidly change the distribution force to meet where client needs are moving to. We took a holistic look at all of our resources and took a real sense of urgency to make changes and fully integrate systems and people. In the last six months, we've made significant progress, and we are positioned to start to hit the ground running here in 2020 and see that progress throughout the year. As Loren said, we believe we will see improvements in the back half of 2020 in a real way. About your question, I think there are three key reasons why we're confident in the progress we've made. Firstly, we've established what we believe is the leading distribution force in the U.S. wealth management intermediary industry. Secondly, we've built out a single fully integrated team and product line by the end of 2019, which is important. Lastly, we've created a truly relevant platform for top U.S. wealth managers. As you know, they are consolidating those relationships rapidly at the asset management level. Let me add a little detail and then I'll pause for your second question. To establish a leading distribution force, we selected a team at close that was about 50/50 from Oppenheimer and from Invesco. So, we have top talent. We achieved the synergy targets, but we also repositioned the firm toward growth trends. We focused on high net worth or IVs, digital data, while honing in on key clients and segments like regional broker dealers and home office platforms. We feel like we've built out an integrated team and product line by 2019. We announced the mergers of our products, ETFs and mutual funds in December— that was a big milestone. We've set territories and training in place, a lot of which was done in the second half of last year to get started in 2020. Finally, concerning having a relevant set of products for top U.S. wealth managers, we have significant assets under management. We have over $600 billion in client AUM with many clients being above $25 billion, and we have a top 10 position in the largest active fund categories and largest alternative beta ETF player. We believe we have everything aligned for success in 2020.

Maybe just a quick follow-up. This is a somewhat conventional way of looking at it, but I guess I've always historically thought that any distribution forces would focus on a handful of strategies or products to drive sales. So, trying to get a sense of what you think those products are this coming year?

Yes. No. I'd say the first and biggest driver of our net flows success in the U.S. is going to be in the fixed income space—both active and passive. Our fixed income performance, as Marty mentioned, is quite strong across the board. Those products are capable and ready, particularly in the muni space, core plus multi-sector across active and ETFs. That’s a big area of focus for us. The second is ETFs in general and factors. We had strong momentum in 2019 and achieved about $16 billion in positive net flows globally in ETFs. Income and volatility mitigation strategies will continue to be important. Lastly, we are looking at slowing the redemptions on the active equity strategies while improving performance, particularly in international equity and certain U.S. equity strategies. Coupled with the product integration clarity, we are targeting redemptions to improve in 2020.

I think there's been a little confusion on the comment you made in December on inflows and what you said today. So, is the view that you could be in inflow by the end of 2020, or could the full year actually be an inflow year? More specifically, you mentioned a strong pipeline and solutions wins—could you help frame that more specifically? Within that, how should we think about the $11 billion solutions coming through over the next few months?

Great question. We're not talking about just the end of the year—we view it as 2020. We believe we see a clear line of sight for inflows for the year, considering everything we've been discussing today. You'll start to see it pretty quickly here.

I think in terms of the institutional pipeline, we've seen continued growth in the pipeline. Quarter-over-quarter, it grew about 4% to 5% both in AUM and revenue basis. Much of that is driven by real estate and traditional areas, but we are also competing in RFP opportunities for solutions that we haven't done in the past, leading to larger scale win opportunities. The $11 billion reference is likely to be occurring around the second quarter of this year. We expect to see similar opportunities generated as inflows in the current year. We are witnessing significant success in bringing our solutions capability to clients now in ways we haven't previously.

Just a follow-up on whether you have any updated thoughts regarding potential incremental expense synergies. I want to gauge any relative confidence you have on achieving incremental synergies. When you originally broke out the categories for the synergies, there were some longer-tailed areas such as property and office, as well as G&A. Are those areas where you see potential incremental synergies?

Yes. Ken, thanks very much for asking. Yes, absolutely. We first talked about this transaction, noting that there would be a long tail to the integration that would take us through 2020, largely relating to technology and back-office elements. I referenced the $6 million that stepped up in this quarter, related to outsourced admin costs, and some of that should diminish later in the year. If you look at the numbers, there is something on the order of $10 million to $14 million that could likely be generated in synergies. We feel confident those numbers will be delivered. However, we are still evaluating how much of that will drop to the bottom line versus being reinvested in high growth areas, such as China or digital.

Just one follow-up question if I may. On that slide showing the U.S. retail active net revenue yield ex-performance fees, it looks like it's been pretty stable lately. Can you give us some color on any relative impacts from either mix shift or changes to gross fee rates?

Yes. The core mutual fund products don’t see huge shifts, especially between mutual funds. The biggest shift we've observed has been between mutual funds and ETFs. Even with increased sales in fixed income, I don’t expect a material impact on these fee rates. However, there will still be some expected fee declines for the firm driven by continued growth in ETFs.

An important point often overlooked is that levels of fee rates shouldn't be correlated to profitability. The ETF business is incredibly profitable for us.

Can you talk a little about the balance sheet? Loren, you mentioned the paydown of the credit facility and reprioritizing the balance sheet with regards to capital management. What does that mean? How aggressive do you want to be here on the balance sheet? Are there any targets or goals that you can share with us in terms of deleveraging or debt paydown or a couple of ratios?

You should expect us to uphold our commitment of the buybacks, which we've previously discussed, approximately $1.2 billion. We have completed about $950 million so far since the announcement. So, there's around $200 million remaining that we're looking to complete in 2020. This can adjust depending on market reactions. In terms of how you should expect us to operate, it will probably resemble a steady normalized buyback pattern, rather than the accelerated purchases we executed when the deal was announced. We want to build up cash—we aim for $1 billion in excess of regulatory capital levels. We’re not quite there yet, leaving room for growth.

Following up on some previous questions regarding the Oppenheimer deal, the original target was organic growth of around 1% to 2% for Oppenheimer’s business in 2020. Is that still realistic? Can you walk us through by distribution channel or highlight a few big products and how you envision getting from recent outflows to that 1% to 2% organic growth?

We still think that will remain typical; this is very much an issue of timing. You can't foresee relative performance when beginning these initiatives. Loren pointed out significant headwinds around bank loans, and one of our international funds. Performance is improving in international. We think with slower redemptions and the broader opportunity in our platform, we believe we have many opportunities outside of the United States.

We have been active in the transition phase. We are still operating below the gross sales we had as two individual entities, so merely returning to those levels will get us on that growth trajectory. We are focused on active U.S. retail, but the ETFs will serve as a critical accelerator, and we have more resources focusing on that growth now.

Improvement in product performance will be key. We are seeing improvements on core products, like international growth, which will really help us achieve better levels.

This is actually Shaun Calnan on for Mike. Just going back to the product offerings, in 2019, we saw a significant pickup in industry ESG flows and anticipate more focus on this from competitors and investors. So I'm curious to know about your current offerings and plans moving forward.

We've been investing in the ESG space for some time. Our primary focus is ensuring that sustainability and ESG factors are included in our active strategies. Most client demand focuses on inclusion portfolios rather than exclusion portfolios. We've incubated strategies across our entire platform. We have been running sustainability-focused ETFs since 2005. We expect to see increased demand in the coming year.

The impact has been largest in Europe. Companies not focused on ESG inclusion will encounter serious business challenges, regardless of their standpoint. In the U.S., this has been more discussion-based. It represents a real opportunity and something pervasive that's emerging in the industry globally.

In Europe, we launched new ESG-focused ETFs in Q4 of last year. We have bank loan capabilities that are ESG-focused, and the robust solution we discussed was focused on ESG.

Can we just go back to the organic growth trajectory and the positives relating to that? You mentioned institutional pipeline growth. The $11 billion mandate funding in Q2 looks promising. Could you expand on that and outline the specifics regarding Brexit and product launches?

Yes. To summarize—there is continued rapid growth expected in China, we anticipate that continuing. The ETF business is strong, as Andrew has mentioned, and we expect to see positive flows globally. We’ve seen a recovery in our UK business in Q4, and the first signs of positive activity on the continent have emerged following the initial round of Brexit. You will see this reflected in our numbers quickly; multiple factors are at play.

The solutions space is considerably growing within our institutional pipeline. Direct real estate and bank loans will also contribute positively.

We introduced four Oppenheimer capabilities in Q4, marking the beginning of this effort, and we've had interest from large institutions and retail outside the U.S. in regard to local equities and capital investments.

Could you re-highlight the $3.02 billion expense guidance? Does that factor in market returns in 2020, considering your discussion around newly realized cost savings?

No, it does not include any market returns that have occurred in 2020. It is based on December 31 levels. Incremental cost savings projects are also not included at this time.

Talking about the 2020 expense guide, how would equity markets being up by around 8% affect your outlook?

Based on current quarters, that could equate to about $10 million that could be theoretically attributable to an 8% market lift.

Regarding Brexit, it seems like signing a deal would eliminate some uncertainty, but the nature of the new relationship raises additional concerns—what are your insights regarding potential investor outlook?

It's a good question. It's crucial to note that there is a subsequent layer of Brexit uncertainty—the trade deal and its consequences. However, you can sense an enormous relief among investors in the UK and on the continent due to the preliminary deal being set. You’ll observe significant cash reserves sitting on the sidelines, presenting a unique opportunity for us as rates remain unfavorable. People are starting to show more interest as cash is not yielding returns. While I can't predict the next round of negotiations, we believe that the initial agreement is a major step forward.

Regarding expenses, while I understand the focus on synergies, I want to know what adjustments you've made considering the lesser-than-expected performance. Are there other strategies aside from integration that can help manage expenses moving forward?

We've been focusing on the deal and related synergies, but our focus goes beyond just that. We're actively trying to enhance the entire organization's efficiency and effectiveness. We're evaluating how to simplify our technology and systems, particularly those relevant to investment support. Additionally, we're looking at opportunities to streamline our infrastructure and move towards cloud-based solutions.

Can you elaborate on the MassMutual relationship—the contributions and expectations for 2020 through that channel with advisors?

Yes, I can share insights on our interaction with the 8,500 advisors onboard. We're introducing capabilities that haven't previously been available, as well as offering alternatives for their general accounts and portfolios. This partnership is set to exceed its importance as we commence business together.

On the advisor side, we see considerable opportunities in model portfolios and ESG strategies. We're prepared to offer a comprehensive portfolio designed for the advice channel. This is a substantial opportunity for us in 2020 and beyond.

This is Adam Beatty in for Brennan, just focusing on China. It appears things are going well there. I appreciate the flow breakdown. What are the expected financial contributions from the business there? Are there regulatory updates you could provide, particularly about increasing stakes in the joint venture? How is the competitive climate?

We provide detail in our press release about the revenues and expenses of our joint venture. Generally, the margins there range from 40% to 55%—this quarter, the margin dipped a bit, but it remains favorable overall. In terms of financial contributions, this business continues to positively affect our overall margin as it scales.

In regards to shareholding, discussions for increasing our stake are ongoing, although we have management control and operate effectively as a combined firm. The competitive environment is intense, with significant expectations for flows in the future, especially in China, which accounts for half the expected industry growth over the next decade. We are leveraging our deep expertise and experience since 1992.

The investment performance of our products is very strong, allowing us to launch products fairly rapidly and maintain a competitive edge.

I wanted to pivot the discussion from AUM growth to fees—can you speak to the fee rates on the $11 billion expected to fund in Q2? Given your comments regarding positive flow predictions for the year, what are the expected fee rates on that pipeline—how do you expect organic fee growth for 2020 to look?

For solutions, we typically see fee rates in the low single digits. Many of our capabilities will be in ETFs, resulting in a similar fee structure overall. Consequently, it’s hard to predict the evolution of fee rates due to ongoing mix fluctuations, particularly between active and passive products. Despite this, our fee rates shouldn't dramatically reduce profitability as our ETF growth rates remain strong.

On the non-U.S. growth dynamic, especially in the UK and Europe, what’s your insight regarding whether cash reserves will return to active versus passive products?

Our ETF flows were substantial in Europe, achieving near-record inflows, and this momentum should continue. Early post-Brexit, we see a renewed focus on active investments from investors. While we anticipate inflows across instruments, the growing ETF segment will attract significant interest.

It's likely a mixed bag, although we expect a large volume of ETF-related flows. We have excellent performing products in Europe that should bolster the active side, contributing positively to fund flow.

Cash levels are extremely high; investors that have avoided equities during rough years may shift toward both active and passive strategies. Additionally, discussions around alternatives are also gaining traction.

I want to return to the positive net flow commentary you mentioned, specifically regarding the Oppenheimer International fund given the trailing performance. Why do you believe flows will improve in the coming quarters?

The one-year performance of that fund has significantly improved, indicating that we are progressing in our goals. We’ve moved to the 32nd percentile on a one-year basis, which is an improvement over prior results. This doesn't mean that flows will change overnight, but it will assist in preventing significant redemptions.

It's a reputable team with strong conviction. Money has begun to return to the international equity space, especially as headwinds dissipate. With our improved performance levels, we are optimistic about achieving better redemption rates.

Actually, my follow-ups were asked and answered. Thank you.

Great, good. Well, thank you everybody, and have a good rest of the day. We will be sharing with you soon.

Thanks, everybody.