Invesco Ltd (IVZ) — Q2 2022 Earnings Call Transcript

Thanks, operator, and to all of you joining us on Invesco's quarterly earnings call. In addition to our press release, we have provided a presentation that covers the topics we plan to address today. The press release and presentation are available on our website at invesco.com. This information can be found by going to the Investor Relations section of the website. Our presentation today will include forward-looking statements and certain non-GAAP financial measures. Please review the disclosures on Slide 2 of the presentation regarding these statements and measures as well as the appendix for the appropriate reconciliations to GAAP. Finally, Invesco is not responsible for and does not edit or guarantee the accuracy of our earnings teleconference transcripts provided by third parties. The only authorized webcasts are located on our website. Marty Flanagan, President and Chief Executive Officer; and Allison Dukes, Chief Financial Officer, will present our results this morning. After we complete the presentation, we will open up the call for questions. Now I'll turn the call over to Marty.

Thank you, Greg. And I'll start on Slide 3, which is the highlights of the quarter. So let me start on that page, if you will. So the market environment we have experienced for the first half of this year has been one of the most challenging in decades. Global equity and debt markets delivered the worst first half returns we've seen in decades as investors reacted to uncertainty associated with rising fears, recession fears, higher inflation, interest rate hikes, and geopolitical tensions. Against this backdrop for the industry and despite seeing the first net long-term outflows quarter in two years, our diversified product line has maintained net inflows in key capability areas, notably ETFs, active fixed income, and Greater China, where we maintain leadership positions. Our global ETF platform generated inflows of $4.8 billion in the quarter, the equivalent of a 7% annualized organic growth rate. Our ETF product suite remains differentiated from competitors with a strong presence in higher revenue, higher growth segments such as smart beta, and we continue to gain market share during the quarter. Our active fixed income business generated net inflows of $2.2 billion with strong flows into shorter duration strategies given the market backdrop. Our business in Greater China delivered $1.8 billion in net long-term inflows this quarter. Growth was driven by our China joint venture, where we saw strong demand for fixed income capabilities as investors sought safer assets. As we showcased previously, our business in China is uniquely positioned as a result of many years of investment and hard work building relationships with our clients and key stakeholders in the region. Growth in China continued despite difficult business conditions, which included COVID lockdowns in major cities. We are optimistic that the economic outlook in China is beginning to improve as COVID shutdowns ease and the government takes steps to boost the economy. As markets recover, we are well-positioned to capture future growth in the fastest-growing market for asset managers in the world. I also wanted to highlight our institutional business, which was in net inflows for the 11th consecutive quarter with $1.5 billion. The channel has been a steady source of growth, and we have made tremendous progress in building the business to nearly $0.5 trillion in assets under management. The channel is well diversified by asset class, led by fixed income and alternatives as well as geography, where we have a significant presence in each of the three global regions. We're proud to serve a broad range of client types, and our pipeline continues to be solid. Our solutions capability remains integral to the success in this channel and enabled a third of our pipeline this quarter. We expect our institutional business to remain a key strength for us in the quarters ahead. Despite broad-based growth and key capabilities, we did see net outflows in equity strategies of $7.7 billion in this quarter, which drove overall net negative outflows in active global equities. In particular, we experienced net outflows as investor preference for risk-off trades led to higher reductions in the quarter, including our developing markets fund, which saw $2.6 billion of net outflows. We look at Invesco's ability to weather this volatile period, and our focus on building a stronger balance sheet has resulted in much greater flexibility. As I mentioned last quarter, we took advantage of the economically attractive opportunity to early redeem $600 million of long-term debt. As a result, the total debt outstanding at the end of the second quarter is at the lowest level since 2015, and our leverage profile has been steadily improving. We've increased cash return to shareholders this year via share buybacks along with a 10% dividend increase we announced in April. The progress we've made on the balance sheet will allow us to take advantage of future opportunities and continue to invest in our business while increasing returns to shareholders over the long term. We met our target of $200 million in annual cost savings from our strategic review. Our focus will now shift to ongoing expense management discipline, and we will be deliberate as a management team in continuing to scale our global business platform and invest in key areas of growth. In this uncertain environment, clients seek an investment manager that can partner with them to meet a comprehensive range of constantly evolving needs and solve their most challenging problems. Our broad set of investment capabilities and the differentiated platform we've built positions us well to continue to meet our client needs and compete in a dynamic market environment. Looking ahead, we will balance managing through near-term volatility while continuing to build a business that can compete and win over the long term. When global industry growth resumes, we are well-positioned to capture demand across a wide range of client types and investment capabilities. Challenging times truly separate great companies from the pack, and we are confident that our unwavering commitment to client needs will distinguish Invesco as one of the top firms in our industry. With that, I'll turn it over to Allison.

Thanks, Marty, and good morning, everyone. I'll start with Slide 4. Our investment performance continued to be solid in the second quarter, with 55% and 60% of actively managed funds in the top half of peers or beating benchmarks on a three and a five-year basis. These results reflect continued strength in fixed income and balanced products, areas where we continue to see demand from clients globally. Moving to Slide 5. We ended the second quarter with $1.39 trillion in AUM, a decrease of $166 billion from March 31st, as significant market declines and FX rate changes contributed to $160 billion of the decline. As Marty mentioned earlier, we experienced our first net long-term outflow quarter in two years with $6.8 billion in net outflows. Despite that, our business has proven resilient, and our relative net flow performance in the period was among the strongest in our peer group. Our passive business continued to grow with $4.5 billion in net long-term inflows. Growth in passives was offset by $11.3 billion of net long-term outflows in active capabilities. The institutional channel continues to demonstrate the breadth and resilience of our platform with $1.5 billion of net long-term inflows in the second quarter. The channel has been a consistent source of growth and has now been in net inflows for 11 straight quarters. We continue to see mandates fund across a diverse range of capabilities, and as I'll discuss later, our pipeline remains solid. Global market volatility weighed on the retail channel this quarter, which experienced $8.3 billion of net outflows, primarily in the Americas and EMEA. ETFs and index strategies remain a key growth area for Invesco and were a source of relative strength in the second quarter with $4.8 billion of net long-term inflows. Excluding the QQQs, Invesco captured 6.1% of industry net inflows, significantly higher than our 3.2% share of total industry assets under management. Moving to Slide 6. We experienced a slowdown in net flows across all regions this quarter amidst exceptional market volatility. Net flows were positive in Asia Pacific, inclusive of $2.2 billion of net long-term inflows into our China joint venture. As we've showcased previously, we are uniquely positioned in China and expect growth to accelerate there as the economy recovers and COVID restrictions ease. Consistent with industry trends, net flows slowed in the Americas and EMEA with both regions experiencing net long-term outflows for the quarter. From an asset cost perspective, we saw strength in fixed income in the second quarter with net long-term inflows of $4.8 billion. Drivers of fixed income flows included our China JV, stable value, and several fixed income ETFs. We experienced net outflows in alternatives this quarter as net inflows in direct real estate mandates and two new CLOs were offset by net outflows in bank loans and our global targeted returns capability. Year-to-date, net inflows into alternatives were $5.9 billion, equivalent to a 6% organic growth rate. Excluding $2.5 billion in net outflows in global targeted returns, organic growth in alternatives is 8% year-to-date. As global markets declined significantly in the quarter, we experienced $7.7 billion of net outflows in equity capabilities. We continue to see higher redemption pressure in some of our larger equity funds, particularly in global and developing market equities, which accounted for $6.6 billion of the net outflows. Now moving to Slide 7. Our institutional pipeline was $24 billion at quarter end, a decrease of about $5 billion from the prior quarter due to fundings during the second quarter as well as normal fluctuations in the timing of client investments. Our pipeline has been running between $25 billion to $35 billion dating back to late 2019, so this is close to the lower end of that range. While the pipeline is strong, we're seeing some delays in mandates funding due to market uncertainty and expect that the typical funding cycle may lengthen by one to two quarters. The pipeline also remains relatively consistent with prior quarter levels in terms of fee composition with an average fee rate running between the mid-20s and mid-30 basis point range. Overall, the pipeline continues to be diversified across asset classes and geographies. Our solutions capability enables 33% of the global institutional pipeline and creates wins and customized mandates. This has contributed to meaningful growth across our institutional network. Turning to Slide 8. The significant declines in global markets over the past several months have impacted our revenue base. Second quarter 2022 net revenue of $1.17 billion was 6% lower than last quarter and 10% lower than the second quarter of 2021. Despite the volatile market backdrop, net revenue remained 13% higher than the second quarter of 2020, the last time we experienced this type of broad market decline. Money market fee waivers abated during the quarter after the Federal Reserve raised rates twice to combat inflation. The net money market fee waiver impact had declined to $12 million in the first quarter of this year, and it was less than $4 million in the second quarter. Moving forward, we do not expect money market yield waivers to materially affect our revenue base. Total adjusted operating expenses of $762 million were up $4 million or less than 1% as compared to the first quarter of 2022 and flat to the second quarter of 2021. The client and employee compensation due to seasonally lower payroll taxes and variable incentive pay were offset by increases in other expense categories. G&A expenses were $17 million higher than the first quarter as we incurred $14 million of fund related expenses during the period that we do not expect to recur in the future. The increase in property, office, and technology expenses can be attributed to additional rent associated with the move of our Atlanta headquarters to a new development in Midtown Atlanta in early 2023. We took possession of our new building in April as we build out the space while continuing to operate from our current Atlanta office. As a result, property and office expense will remain $2 million to $3 million above the eventual run rate for the next four to five quarters. As COVID restrictions eased across North America and Europe, we saw a meaningful return of client activity and business travel, which contributed to increases in marketing and G&A expenses that I will cover on the next slide. Interacting in person again with our clients and our colleagues around the globe is integral to our success as we transition to our new normal ways of working. We remain highly focused on disciplined expense management while continuing to deliver for our clients. Moving to Slide 9. As of the end of the second quarter, we have met our initial $200 million savings goal from our strategic evaluation program. As compared to a normal pre-COVID run rate of expenses, we have delivered $213 million of annualized savings across employee compensation, our facility portfolio, and third-party spend, which includes a lower new normal level of travel and entertainment expense. Since the beginning of the COVID-19 pandemic, our travel and entertainment expense ran at significantly depressed levels as COVID mitigation measures were put into place, and business travel slowed to near zero. Over the past quarter, we saw a meaningful resumption of business activity as restrictions eased across North America and Europe. We spent approximately $14 million on travel and entertainment this quarter. If we look back to the second half of 2019, travel and entertainment expenses averaged around $25 million per quarter in that pre-COVID environment. Given our new normal ways of working and various measures we've put in place, we do not expect to see travel revert to pre-pandemic norms. We believe that our experience in the second quarter is approaching a new normal range for quarterly spending, and we expect to recognize at least $5 million in savings per quarter or $20 million annualized as compared to prior levels of activity. Moving forward, we will continue to focus on maintaining expense discipline and scaling our global business. We employ a continuous improvement mindset and will take full advantage of efficiencies where there are opportunities. In the second quarter, we incurred $5 million of restructuring costs related to this initiative. In total, we’ve recognized approximately $247 million of our total estimated $250 million to $275 million in restructuring costs associated with the program. As a reminder, the costs associated with the strategic evaluation are not reflected in our non-GAAP results. Going to Slide 10. Adjusted operating income decreased $129 million from the second quarter of last year to $412 million, primarily due to lower revenue as a result of the market declines. Adjusted operating margin was 35.1% as compared to 41.5% in the second quarter of last year. EPS was $0.39 as compared to $0.78 last year due to lower operating and non-operating income. In the second quarter, equity and earnings of unconsolidated affiliates was a negative $8 million as a result of unfavorable changes in CLO valuations compared to a positive $40 million a year ago when valuations were increasing. Other gains and losses were negative $29 million this quarter as compared to a positive $25 million a year ago, driven by lower valuations of our seed capital associated with market declines. The effective tax rate was 24.8% in the second quarter. We estimate our non-GAAP effective tax rate to be between 24% and 25% for the third quarter of 2022. The actual effective rate may vary from this estimate due to the impact of nonrecurring items on pretax income and discrete tax items. On Slide 11, you can see how our asset base has evolved over the past two years as client demand has skewed towards lower yielding passive products. We have tailored our product offerings to meet that demand and experienced significant growth in passive and money market offerings. Realizing that our business mix is shifting, we continue to be focused on aligning our expense base with these changes. While the declines in global markets pressured our margins this quarter, an operating margin of 35.1% is within a normal range for where we are in the business cycle and remains above our second quarter of 2020 levels, the last time we experienced a market drawdown of this magnitude. As I mentioned earlier, we will continue to be vigilant in prudently managing expenses and would expect margins to stabilize and eventually expand as markets recover. I'll conclude with a few points on Slide 12. Our balance sheet and cash position was $937 million on June 30th, a decrease of $396 million as compared to last year. The lower cash balance was due to the $600 million early debt redemption in May at economically attractive terms. To help facilitate the early payoff, we carried a balance of $185 million on our revolving credit facility at the end of this quarter. We expect to repay that balance in the near term and begin to build cash again over future quarters. In terms of the benefits, the early redemption resulted in a net $6 million of savings with the make-whole fee and other transaction-related expenses being $5 million in the quarter and interest expense savings of nearly $11 million this year. Second quarter interest expense included the make-whole fee and other related expenses that totaled $5 million, offset by nearly $3 million in interest expense savings. For the third quarter, we expect interest savings of nearly $5 million, and for the fourth quarter, over $3 million. This will result in interest expense being lower by these amounts in the third quarter and the fourth quarter. Our leverage ratio, as defined under our credit facility agreement, was 0.7 times at the end of the second quarter. If preferred stock is included, it was 2.6 times. Both metrics are an improvement over 0.9 times and 2.9 times from one year earlier as our total debt outstanding reached its lowest level since 2015 at $1.7 billion. Overall, the progress we have made in managing our cost base and building balance sheet strength has given us a strong base from which to operate and ample flexibility to navigate the current drawdown in global markets. We're confident that by continuing to execute the strategy we have laid out across our key capability areas, Invesco will continue to grow organically over the long run and be the go-to partner for our clients while delivering value to our shareholders.

I guess maybe first, gross sales slowed, which doesn't seem surprising given market conditions, but the slowdown was particularly pronounced in the Asia Pac region. And I think you commented on some equity funds, but I wasn't sure if it's that region. I was hoping if you could walk through the slowdown in Asia Pac maybe by asset class and by region there? And help us understand how activity levels are developing in the region for the second half of the year?

Let me make a comment, and Alison can pick up, Ken. So we did see, obviously, a slowdown in net inflows in Mainland China, as we've highlighted. But in fact, we continue with net inflows there. I would say the sentiment is turning somewhat more positive from where it was and still challenged. The COVID lockdowns really have a negative sentiment impact in the area, but we are having a greater confidence in sort of the economic rebound and quite frankly, the consumer response to back to investing in the region. But Allison, do you want to make some more specific comments?

I mean I would just say kind of looking at what drove Asia Pacific over the quarter. I mean, certainly, the slowdown put quite a bit of pressure on it. But as we break it down and kind of look at maybe the China JV in particular, continues to be our growth driver inside of the region. Within the JV, we delivered $2.2 billion of net long-term inflows. That was really driven by primarily six new product launches, which drove the majority of those net inflows. Those mostly skewed towards fixed income. So not surprisingly, more demand for fixed income than we would be seeing for equities at the moment there given just some of the overall sentiment pressure. As we look across the region and look at Greater China and Greater China, we did see, I would say, some offsetting net outflows primarily driven by outflows in our maturing fixed maturity products. Australia had an outflow quarter as well, that was primarily driven by outflows in our GTR product, which has remained under pressure, as we've talked about over a number of quarters. And then I would say some of that was balanced by inflows in Japan, where we continue to see strong demand for fixed income products in Japan. So a little bit of, I think, mixed bag in the quarter, strong demand for fixed income, which, of course, we're seeing in a number of places, but certainly in the China JV and in Japan.

And then just on the balance sheet. The way you've pitched it is from a position of strength, you've delevered somewhat or even meaningfully. I think the stated goal, $1 billion of cash in excess of regulatory requirements, which gives Invesco the flexibility sort of when it needs it. How flexible is the balance sheet right now? It looks like the cash is pretty small over that regulatory requirement, but you've got a huge revolver that you can tap. Given you've pursued deals in more challenging times in the past, just walk through how you see the flexibility of the balance sheet right now for your ability to do transactions if interested?

Let me take the first part of that and then let Marty chime in as well. I would say a couple of things. One, the stated goal you mentioned is pretty old. It's been a few years, and candidly, it predates my joining the company. We actually haven't had that goal in a few years. I think I'd shift it to some of what we've been guiding to more currently, which is we're looking to just strengthen the balance sheet overall, and that's not just through cash balances. There's obviously a cost to carrying a whole lot of cash, particularly when we have some debt to take care of at the same time. So I think you've seen a lot of our focus on cleaning up a lot of the contingent liabilities and then starting to manage some of the capital structure at the same time. So I'd guide you towards that just as you think about what our balance sheet objectives overall are, and that's to really put the balance sheet in a place where it's strong, particularly in times like this. I think about how much stronger the balance sheet is now than when we were in the last downturn a couple of years ago. And that's giving us that optionality to do a number of things this year. We did engage in $200 million of share repurchases in the first quarter and then, of course, taking advantage of the opportunity to early redeem $600 million in notes. We want to stay opportunistic and give ourselves the flexibility to do the same for the next maturity, which is in January of 2024. What does that mean though for our overall priorities? I would say our first priority is to reinvest in the business. It is much more cost efficient to grow organically than it is to go out and acquire inorganically. That doesn't mean that there's a change in our strategy from an inorganic perspective. But I think we've really demonstrated over the last couple of years that we have ample ability to invest in our business and grow our capabilities and really thinking about some of our key growth capabilities like private markets, our fixed income platform, our ETF franchise, our China JV, all the areas where you're really seeing us demonstrate consistent growth over the last several quarters. It's because we've been creating that capacity to invest in our business while at the same time keeping our eyes open, should there be the right opportunity. Now, market conditions are certainly going to be rather choppy for that at the moment. But in terms of the opportunity we have with the breadth of our franchise to continue to invest in it, I think we're very bullish on our own opportunity to grow the franchise we have.

Allison, that was well said. I don't have anything else to add. And can I just sum it up with the highlight that we're focused on reinvesting in the business in the areas of growth. We continue to look to reallocate resources where we are growing. It's easy deciding, harder to do, but we continue to make progress there. And right now, we have the greatest flexibility we've had in a good number of years, so we feel like we are in a position of strength.

Curious, about a few comments on being focused on expenses. Allison, you gave some color on T&E normalization and sort of calibrated for what the experience has been so far. But when we think about how much flex there is in the expense side, you guys normally talk about a 30% component that's variable. But is that still the right way to think about the rest of the year? And how much are you thinking about trying to do more given the challenging environment? And would that be more of a back half of the year event, or would it be more like a, well, the budgeting process for 2023 starts in probably just a few months, so it’s better to focus there so as not to be disruptive to investments and try and balance the competitive dynamics? Could you maybe help us think about how you're framing that at this point?

Brennan, let me make a comment, and Allison will also chime in. Look, we've said time and time again, and you followed this sector for a long time. It is very difficult for an asset manager to adjust expenses in the short term to follow such a drawdown in the market. Quite frankly, we don't try to do that. We look at it in two different ways. One, it's in a period of uncertainty, which we are right now. We hit the brakes. We do all the things that you would imagine we would do, look at things that are technical ways to slow investing in the business. We are doing that. And then we look longer term and continue to adjust accordingly, which is largely focused on trying to find ways to reinvest in the areas that Allison talked about where we're seeing growth. It's really a two-pronged approach. And we've done it historically quite effectively, and we'll continue to do that. But Allison, will you please add to that?

I mean, I'd say a couple of things. As you think about our overall compensation expense, about a third of that is variable. So that obviously flexes pretty quickly with the change in revenue for the most part. It's not a perfect relationship, but it's fairly quick given just a variety of incentive compensation plans that we would have driving overall incentive compensation. It's much more difficult to adjust overall compensation nor would we necessarily want to. We want to be really thoughtful about positioning our expense base not just for the short term but the medium term as well. I think that really underscores a lot of Marty's points. So I think probably the essence of your question is where do we go from here? I would say a couple of things. On compensation, compensation tends to fluctuate in that 38% to 42% as a percent of revenue range. You should expect us when revenue draws down as quickly as it has, and we expect it to be under pressure this year, that we'd be on the higher end of that range. Underneath that, we're going to be really thoughtful about making sure we're allocating resources and being very thoughtful about just hiring overall and where we position that next hire and how we really manage against the opportunities we have and what's critical versus not critical. I think that's the essence of how we manage in the short term from here. Certainly, a challenging quarter to have revenue under so much pressure and a return to that kind of wide-open travel environment at the same time. I don't think we ever would have expected those two events to occur in the exact same quarter, and it put enormous pressure on the top line and the expense line at the same time. We do expect that travel normalizes from here, again, the new normal that I talked about earlier. And we'll be really thoughtful about travel in this environment as well. When our clients want to see us, we want to stay in front of our clients as it's as important now as ever in times of real volatility to be in front of our clients. But we can also be very thoughtful about our internal gatherings and some of the discretionary spend we have from there. So it's hard to give you exact answers on all of this, but hopefully that gives you a little bit of color as to how we're thinking about operating and how we're managing in this environment. We do think we're managing from a position of strength, but we're going to be very thoughtful about all of our actions and decisions.

Thanks for that. That's very thorough from both of you. I appreciate it. In the quarter, we also saw Mass Mutual increase their stake. Could you maybe talk about dialog and how dialog with them has progressed, and whether or not you can continue to explore expanding that strategic relationship to potentially bring even more benefits beyond the obvious ownership tie-up?

The thing to look at is they increased our ownership stake in the company, and they have great confidence in the organization. We continue to have very good strategic conversations. They're extremely wide-ranging, and it's just a constant dialog of where can we opportunistically work together, and that continues. So again, I just plan on seeing a deeper, broader relationship in the quarters and months ahead and years to come.

I mean, the only thing I would add is they continue to be opportunistic because I think they have a very long-term view on the opportunity that's there, and there's a really deep partnership that continues to grow and expand. I think this is a mutually beneficial relationship on a lot of sides, and you're seeing that as they continue to take a long-term view on the overall opportunity in the common stock.

Has there been any corresponding adjustment to the positioning on their platform or any shift in how you guys are ranking as far as flows on their platform go or anything like that?

I think we continue to be the second-largest broker-dealer in terms of AUM on their platform. I think we're their largest in terms of sub-advised and DCIO mandate. We manage about $5 billion on their platform and an additional $5 billion in variable annuity and sub-advised AUM. I'd say, in addition to that, we've got about over $3 billion in other investment relationships with them, which consists of their investment in our alternative strategies in terms of their co-investment and our investment strategies and some of our alternatives capabilities. So I mean, it's a rather broad relationship.

And I'd add, Brennan, that's all really valuable, but in particular, them being an anchor tenant and co-investor in our alternative capabilities is really meaningful. It's not just from the money itself but in the investment, but really the credibility it provides as an anchor tenant when we go to market and you, with your background, recognize how important that is.

Just given the market volatility with rising rates, just curious to hear a little bit of what you're hearing from your institutional clients just in terms around asset allocations. What sort of changes are you hearing, your clients thinking about contemplating just given the volatility, the rising rate backdrop? How do you see that also impacting 60-40, which had probably the worst quarter in many decades? So just curious how you see that evolving from here?

I'm sure you're having many discussions with your clients as well. It's quite varied, regardless of whether it's institutional or retail, and these are general observations. For the most part, everyone slowed down at the beginning of the quarter, trying to understand the current situation, its depth, and the direction it's heading. Recently, conversations, particularly with institutional investors, have shifted towards identifying opportunities and considering asset allocation strategies. There's a clear emphasis on how to adjust asset allocation in an inflationary environment. Discussions around duration in fixed income show that some clients are thinking about reducing their exposure to fixed income and increasing their investment in areas like real estate. It's a diverse conversation, and I've had a wide-ranging dialogue with clients that I can't recall happening before. There isn't a common theme for the next steps of any institution. However, the positive aspect is that our extensive capabilities enable us to support any decisions that these institutional clients may make.

And just a follow-up question if I could, just on ESG. I guess two prongs here. One, maybe you could just update us a little bit on some of your initiatives, remind us how much in AUM and flows you guys are seeing. And then just more broadly on ESG, what sort of risk and opportunities do you see from increased ESG regulation but also regulatory scrutiny on ESG products that we're seeing come to the industry?

Let me address the broader points and pass it to Allison. It’s interesting to see how the ESG conversation has changed significantly over the past six months. The discussion varies widely in different regions, with the EU and UK being much further along than the United States and having clearer definitions of ESG and its implementation in portfolios. The positive aspect is that there is a roadmap in place, and there is clarity in those regions. In the U.S., however, the conversation is quite different from one client to another. Our approach has been to eschew a top-down policy regarding ESG; instead, we focus on a client-driven, portfolio management approach supported by an ESG team. Implementing ESG is more challenging in the U.S. due to the lack of a clear roadmap, although we are seeing a regulatory push for more defined climate guidelines. Ultimately, I believe a structured framework will be very beneficial for ESG, but the current landscape is quite challenging. Allison, would you like to continue from here?

As of June 30th, we managed $77 billion in ESG assets under management across more than 200 funds and mandates, which accounts for about 6% of our total assets under management. This figure is notably lower compared to the first quarter, primarily due to market declines and some outflows. We experienced approximately $2.4 billion in outflows within our ESG assets, largely driven by active retail, particularly in our GTR and some quantitative equity strategies. This trend is consistent with the overall outflows we've previously discussed regarding other categories. Furthermore, we aim to achieve a minimal but systematic integration of our ESG strategy across our assets. Currently, about 85% of our assets fall under this definition. Our goal is to ensure that all of our assets reflect this integration approach, with a consistent application of ESG considerations across all portfolio managers in their investment decisions. This initiative aligns with the macro themes that Marty highlighted.

Maybe if I could just focus on some of the investment in the T&E and getting out on the road more and talking with financial advisers on the retail side. Maybe if you could just, I guess, characterize the current environment. Is it similar to what you described on the institutional side, Marty, in terms of sort of initially being frozen? But now obviously, with markets down a lot, there's a lot more opportunity. And do you think getting on the road more and getting out in front of advisers will have a demonstrable positive impact on sales growth in the retail channels? Just maybe your outlook on that as we move forward in the second half.

I've spent time with wealth management platforms, advisers, and institutional clients in the U.S. and Europe. It's clear that interactions with clients vary significantly. We've all noticed this during our experiences. While Zoom helps facilitate discussions and sharing ideas, it doesn't replace in-person engagement. I can't say that it will lead to a surge in sales, but it certainly has a positive effect. As Allison mentioned, we will be careful about discretionary travel within the company, even though we recognize its importance. We can manage without it, as we have over the past few years. However, our commitment to maintaining relationships with our clients remains a priority for our business.

I wanted to follow up on long-term expenses. You're clearly managing expenses carefully in this environment. Could you provide some insight on potential structural expense savings from the migration of custody and back office? I understand you are utilizing the Alpha platform, which is set to convert over a longer period, specifically in stage three. Can you explain how that migration might impact your cost base? Will it have a significant effect when it happens, or is it more of a long-term consideration?

So it is an important undertaking for us, and it's probably two to three years out. We are at the stage of starting the sort of rolling implementation. It is very broad. It's very deep. It's quite complex, as you would imagine, because it is really a total step back on our operating platform. We think it's really meaningful and important for the future of the organization, what we're trying to do with data and et cetera, no different than, again, every organization on this phone. There are other areas, again, Allison had spoke to. We are looking very hard within the organization, and it is sort of a muscle that we have been developing over the last few years that is getting stronger and stronger of challenging ourselves where the dollars are spent, and is that the right spot for the dollar, or should it be reallocated towards growth and driving operating income. Allison hit the areas, you know the areas whether it be China, ETFs, et cetera, and the private markets. That said, there will be times where in that process, we'll say the best place for this dollar to go is to the bottom line. So we are pulling on all of those levers. And we just constantly do it in a downturn where our market doesn't make us wake up and think we should do it; this is core to what we do. And I think, again, as we continue to point out over the last couple of years, you can see with the movement in the effective fee rate and our ability to maintain margins is something we keep pointing to. Again, in this downturn, protecting margins is a much more difficult thing to do. And I would just reiterate the point that Allison had said earlier. Markets will return. And in that period, you'll see the expansion of our margin again, while, in fact, we continue to invest in the future or make the decision to have that next dollar drop to the bottom line.

Thanks for the color. I have a follow-up, and I'll get back into the queue.

So I guess I want to pull out a little more from you in terms of your thoughts on clients. You both mentioned lower gross sales but kind of flat redemptions, which in a way in a market downturn is reasonable. So you have a growing ETF franchise. Do you think as people come back as markets settle eventually, do people come back via the ETF over single stocks and mutual funds in your mind? What have you seen in the past? And then which inflation-protected products and higher interest rate positioning products do you think might see some of that shifting money?

Yes, I have a few thoughts. Firstly, it's challenging to forecast what lies ahead at this moment. However, we strive to do just that. The ETF has emerged as a preferred option. While mutual funds still hold significance, they currently do not have the same emphasis as separately managed accounts and ETFs. Nevertheless, they remain a vital component. We believe this option will continue to play a role in the future. What is crucial is the investment capabilities associated with each of these options. We consider this a key factor when identifying the asset classes that will attract interest in the current environment. Bank loans will remain a focal point, and our organization will keep a close watch on commodities as well. Active funds will be another area of emphasis. Real estate is also a priority for us. As clients seek out various options, we have witnessed increased discussions around retail platforms returning to a focus on value-oriented equity suites, an area that has not garnered much attention recently. Allison, do you have anything to add?

No, I think you covered it.

Again, hard to totally compare and contrast. But look, we've all seen the growth in private markets over the last decade. It continues to be an area of focus for us where we have areas of strength. It continues to be an area of growth and accelerating growth, and we are turning our attention to continuing to organically drive that growth. It is a part of any conversation that we're having with our institutional clients in particular, and now the wealth management platforms looking for ways to find exposure to alternative capabilities for us. The most prominent one that is coming down the path right now is here in the United States on the wealth management platform, and quite frankly, it's been quite successful outside of the United States through a joint venture we've done with UBS. So again, it continues to be an area of focus for us, a continued area of growth as we look forward to the quarters ahead.

I would like to add that we are seeing very strong overall originations and inflows into our private markets capabilities, especially in our direct real estate business recently. There are several factors and events contributing to this, including a potential shift in preference towards real assets in the current environment. At the same time, the downturn in equity markets may have resulted in some overexposure to real assets and real estate compared to benchmarks, which will take time to normalize. Nevertheless, we are experiencing significant growth in client commitments to direct real estate in the first half of the year, mainly from our institutional channel. As mentioned, we are also seeing positive developments with our retail-focused strategies. We have substantial capital available from clients that has not yet been allocated to direct mandates, which is reflected in our not funded pipeline on the institutional side. The increasing allocation to alternatives further indicates growth in our direct real estate business. Overall, we are cautiously optimistic about the potential for continued growth in this area. Additionally, on the senior loan side, as credit spreads widen, there will be a rising interest in exposure there. Currently, we are focusing on managing interest rate exposure, but clients will seek credit risk exposure, which will benefit our platform as well.

I wanted to discuss performance. In relation to your active franchise, are there specific products or categories showing strong performance that could experience faster growth as the market stabilizes or the gross sales environment improves? It seems that your US value has significantly improved. As you evaluate the various products, is there anything that stands out with the potential for further improvement?

If you look at some comments regarding fixed income, the range of products remains strong, and demand continues to be present, especially for shorter duration fixed income at this time. Surprisingly, in the current market environment, the US value franchise has seen a significant improvement in performance. This area has been less favored from an industry perspective, not just for us but for the market as a whole. Over the past several months, I've had many discussions where people are starting to view US value as a viable asset class. If you had asked me about this 12 or 24 months ago, it wouldn't have been on the radar. Another critical area for us is the global equity franchise, particularly in emerging markets, which is currently facing challenges in performance. However, I believe we have some of the most talented emerging markets managers in the industry, and their shorter-term performance is showing strong improvement. This asset class, despite not being favored at the moment, is expected to deliver impressive results for clients and will likely return to net inflows in the upcoming quarters.

And then just a question on China and the backlog or the outlook for new funds. I think that's around six new funds with just under $2 billion in flows in the second quarter. How do you think that's tracking for the back half of the year?

It's difficult to provide a precise outlook. Overall, the second half of 2022 may not differ much from the second half of 2021. To clarify, the second half of 2022 might resemble the first half of 2022 regarding new product launches in China. This largely hinges on the COVID measures and the government's approach to the economy, including any growth stimulus. We will monitor this situation closely and strategize our product positioning accordingly. Compared to 2021, our launches this year are lower and different. Last year, we introduced a mix of balanced and equity-focused products, whereas this year has seen a shift toward more fixed-income products, reflecting current market sentiment and client preferences. It's challenging to predict given the evolving circumstances, but that's our general perspective and focus.

And Dan, here's how I think about it, and you're asking the right question. So where we believe China is in sort of the economic cycle, it's looking towards a rebound, so they're ahead of the United States and Europe. There is a lot of focus on the leadership to stimulate the economy for all the reasons that we know about. So I look at those two powerful forces of reason to be optimistic. The one to be cautious about is just what Allison said. It is still a very challenged lockdown COVID environment, although they are easing. And so is it and let's say, if you sort of model through COVID, you have those other two factors holding true, we continue to look at China as being a contributor and a growing contributor again. Time frames are hard to determine.

So the active bond inflows, I think, were pretty notable relative to what we're seeing in the industry, right, where the active bond flows look like it's going to be one of the worst quarters ever. I saw the comment about short duration in the deck, but it still seems like a pretty dramatic departure from what the industry saw. So anything else you could point to about your mix strategies and/or how you distribute these products that you think caused such a dramatic positive break with what the industry is seeing on the active bond side?

You're right, from an industry perspective, the results are very, very strong. It really is just a reflection of the depth, breadth, and capabilities of the team and the way that they've gained confidence within the channels. I don't know that I would highlight anything more specific than that, but a recognition of the talent and how we are interfacing with our clients. So again, it's wonderful to see when you're relatively outperforming what is a very challenging market environment.

The only thing I'd add to that is China. China definitely helped drive some of the strength in fixed income as well. And I think that points to us again, the underlying strength we have in our positioning in China.

Operator, we have time for one more question.

This is actually Ryan Bailey on for Alex. So the first question I was going to ask was around the net revenue yields. Some of the market headwinds, particularly FX, I think, got worse later in 2Q. So can you give us a sense of what the exit rate was for the net revenue yield versus what was reported for 2Q?

We've determined that revenue yield is influenced by overall averages, particularly average AUM. There isn't really an exit rate involved. When considering what affected net revenue yield in the quarter, it is primarily attributed to the declining equity markets, and secondly, the ongoing shift towards our passive products. There are some positive factors, such as the reduction in money market waivers and an additional day in the quarter, but overall, net revenue yield is primarily explained by the decline in equity markets and the impact of the asset mix change in our AUM. Looking ahead to future quarters, we anticipate continued demand for our passive capabilities. We expect to encounter pressure on our equity AUM due to the exit rates driven by market conditions this quarter. I foresee net revenue yield continuing to tighten slightly. However, I want to emphasize that our focus remains on revenue; net revenue yield is merely a result, not a contributing factor, and does not capture shifts in fee rates. It's primarily driven by the mix shift and market influences. We aim to stabilize revenue, grow it, and efficiently manage our expenses while adapting our business model not only for now but for future developments.

And maybe just to hit on that last comment around expenses. Allison, I think you mentioned that you expect the margin to eventually stabilize and then expand as markets return and that 35% was kind of the right place to be in for the business cycle. I guess just as we think through the dynamics for the next quarter, the challenging market for 2Q, is it fair to think that maybe we slip a little bit below where we were for 2Q as we enter next quarter?

I mean, I do think that when you think about where asset levels were at June 30th and just the entry point into the quarter with asset levels, you can certainly net revenue will continue to be under pressure in the quarter. And so while we are hyper-focused on expenses, as you've heard us talk about, you can't expect what's the overall impact of that. In terms of operating margin, look, if we continue to see equity markets under this kind of pressure throughout the quarter, it will be difficult. But I think it's reasonable to expect operating margins to be maybe at or slightly below where it was in the second quarter. Lots of moving parts and the market being the biggest driver in that, but we're going to continue to stay focused on managing what we can commit, what we can manage, and controlling what we can control. I think we're wrapping up here, but I'll just close with we are operating from a position of strength. We do have expense discipline measures in place that give us the opportunity to be very thoughtful about the margin from here. Our balance sheet is in a strong place, and we have the opportunity to be opportunistic and continue to invest in our business. And that's most important because these markets will stabilize. I think we're really well-positioned in terms of our key capabilities and supporting our clients and growing with them from here.

Well, let me just say thank you for your time, thank you for your questions and engagement. I look forward to being in touch with everybody over the next months before we visit once again next quarter. Thank you.