Morgan Stanley (MS) — Q3 2015 Earnings Call Transcript

Great. Welcome to our 2015 fiscal third quarter earnings call and webcast. Here this morning are Tom Faust, Chairman and CEO of Eaton Vance, and Laurie Hylton, CFO of Eaton Vance Corp. We will comment on the quarter and then we will take your questions. The full earnings release and charts we will refer to during the call are available on our website eatonvance.com under the heading Press Releases. Today’s presentation contains forward-looking statements about our business and financial results. The actual results may differ materially from those projected due to risks and uncertainties in our business, including but not limited to those discussed in our SEC filings. These filings, including our 2014 Annual Report and Form 10-K, are available on our website or upon request at no charge. I will now turn the call over to Tom.

Good morning. July 31 marked the close of our fiscal 2015 third quarter. These three months were a period of considerable turmoil around the financial world, whether focusing on China, Greece, Puerto Rico, Russia, energy markets, commodity prices generally, currency movements or the Federal Reserve; there was no shortage of new information for the markets to absorb. Though it all, U.S. stock and bond markets traded with moderate volatility and ended the period roughly where they began. We finished the quarter with a record $312.6 billion of consolidated assets under management, had $3.9 billion of consolidated net inflows and made progress on advancing a number of important corporate initiatives. But this was not our best quarter from an earnings perspective. We reported adjusted earnings per diluted share of $0.57 for the third quarter, down $0.01 from the preceding quarter and down $0.06 from the year-ago quarter. As noted in the press release, this quarter’s earnings per diluted share were reduced $0.04 by compensation and other costs in connection with closing our New Jersey-based affiliate, Fox Asset Management, and other compensation costs attributable to our clustering of retirements, terminations and additions to staff during the quarter. Adjusting for inter-period differences in these cost items, third quarter earnings per diluted share were up 3% sequentially and down 6% year-over-year. The decline in earnings versus last year’s third quarter reflects a 3% drop in revenue and higher compensation and other expenses. Laurie will provide more detail on our financials, including fee trends by product category in her remarks shortly. Net flows of $3.9 billion in the quarter represented a 5% annualized internal growth rate. The quarterly flow results include two large flows from our Seattle-based subsidiary, Parametric, one negative and one positive. First, as discussed on our second-quarter call back in May, Parametric lost a $3.4 billion emerging market equity mandate with a sovereign wealth client, and in July, Parametric began managing a new $5.8 billion centralized portfolio management or CPM assignment for a multi-manager mutual fund platform. The $6.4 billion of portfolio implementation, that inflows we are reporting for the quarter includes not only that assignment, but also over $800 million of net new inflows into Parametric's tax managed custom separate accounts, a product category that continues to be in very strong demand in both retail and wealth management channels. As a reminder, tax managed core accounts seek to match the pretax return of the client-specified benchmark and add incremental return on an after-tax basis through systematic tax-loss harvesting and deferral gains. For the fiscal year-to-date, net flows into Parametric's tax managed core totaled $3.4 billion. Parametric's customer exposure management business had net outflows of $800 million in the third quarter as rebalancing away from existing clients more than offset new client inflows. Even with this decline, our exposure management business nearly doubled in size in the 31 months since we acquired it at the end of 2012. New business momentum and customer exposure management remains strong, with 2016 now coming into view as likely to be another good year. Within Eaton Vance management, we realized $1 billion of net inflows, our strongest growth quarter of the past two years. EVM positive flow results were driven by fixed income with $2.2 billion of new flows. Within fixed income, we had over $500 million of net flows into each of high yield, multi-strategy and municipal bond ladders. Driving the growth of multi-strategy fixed income is the Eaton Vance short duration strategic income fund. This five-star rated fund competes in one of the largest Morningstar categories, short-term bond, and has over $290 billion of net assets and nearly $75 billion of annual sales. For the calendar quarter ended June 30, we moved up to become the fourth best-selling fund in the category with a 5% share of new sales for the period. The three funds ahead of us in sales were all many times our current $3 billion size, and none of them matches our performance. As a top performer in a larger and growing fund category, we continue to view the short duration strategic income as an exceptional growth opportunity for Eaton Vance. In floating rate income, net outflows of $500 million in the quarter were a significant improvement from the $6.2 billion of cumulative net flows over the preceding four quarters. The trend of floating rate flows is actually better than the quarterly numbers suggest, since they include $200 million of outflows related to scheduled wind downs of CLOs we manage and over $400 million of outflows from third-party sponsored funds for which we manage a bank loan sleeve. Excluding those, our bank loan business expressed modestly positive flows for the quarter. We continue to believe that the loan asset class is poised to gain favor with investors as short-term interest rates start to rise. The fundamentals of the asset class remain very solid, and year-to-date performance has been strong, better than both investment-grade bonds as reflected in the Barclays Aggregate Index and high yield as measured by the BAML high yield index. While I am not predicting a return to positive floating rate flows in the fourth quarter, I do expect to see continued improvement in investor sentiment towards the floating rate asset class given strong performance and growing anticipation of near-term Fed action. In alternatives, we saw $150 million of net outflows in the third fiscal quarter, driven by nearly $200 million of redemptions from the Eaton Vance Commodity Strategy Fund. It made for a very challenging environment for commodities investing, and the sub-advised fund's net assets have fallen to just $100 million. For our global macro franchise, we saw net inflows of $150 million in the quarter, both Global Macro Absolute Return Fund and particularly at sister Global Macro Absolute Return Advantage Fund, that produced quite strong relative and absolute performance over recent periods. As of July 31, Global Macro Advantage Class-I is the second best performer of 352 funds in the Morningstar non-traditional bond category for one-year performance and a top performer over three years. Global Macro-I is also a top performer within its category over the past year. The broader uncertainty across the global markets plays into the strength of these funds, which historically have provided low volatility, high risk-adjusted returns and low correlations to U.S. equity and fixed income asset performance. Like short duration strategic income, they compete in a large fund category and compare favorably to the sales leaders in terms of performance. A catalyst for the emergence of our high-performing Global Macro Absolute Return Advantage Fund as a sales leader in its category may be reaching a five-year track record, which comes at the end of this month. Looking at our entire suite of income and alternative offerings, we are fortunate to have a broad range of high-performing strategies, many at the lower end of the duration spectrum. We have included a slide in the presentation highlighting the top-performing low duration funds we offer. Given where we are today in the bond market, we believe investors are increasingly looking for ways to generate income in their portfolios without taking significant interest rate risks. Few fund companies are as well-positioned to offer that as Eaton Vance. In equities, our flow challenge this quarter was to overcome the previously mentioned loss of a $3.4 billion Parametric emerging market equity mandate. Although we did not achieve positive flows for the quarter across equities overall, outside Parametric emerging markets, we had net inflows of $500 million. Equity performance remains a good story, with the improving record of Eaton Vance management equity group particularly noteworthy. As of July 31, our large cap value fund Class-I was 125 basis points ahead of its Morningstar peer group average over the past year and also ahead of the category average over three and ten years. Although large cap value net flows were $200 million negative in the quarter, the asset we believe we have experienced here over the past four years is certainly showing signs of coming to an end. Favorable performance is driving a pickup in sales for Eaton Vance Balanced Fund and Eaton Vance Focus Growth Opportunities Fund, which we hope to build upon in coming quarters. Our largest equity fund, Atlanta Capital SMID-Cap fund, is having a terrific performance year as of July 31; its Class I shares were up over 12% year-to-date and it continues to rank as a performance leader in its category overall in time periods. In fact, strong performance is widespread across our fund family. As of July 31, we offered 45 mutual funds with at least one share class having an overall Morningstar rating of four or five stars. This includes a diverse line of equity income, alternative and multi-asset strategies. As of July 31, 71% of our fund assets were in funds beating their Morningstar peer group average over the past year. Before turning the call over to Laurie, I would like to talk about two important strategic initiatives: the expansion of Eaton Vance Management Global Investment capabilities and the continued development of next year’s exchange traded managed fund. You may recall that last quarter we announced that Christopher Dyer and Aidan Farrell will be joining our London office as Director of Global Equity and Global Small Cap Portfolio Manager, respectively. Both Chris and Aidan come from Goldman Sachs Asset Management and are now on the job at Eaton Vance, working with colleagues in Boston and soon to be in London and elsewhere to oversee the management of global and international equity portfolios. Although it’s still early days for this revamp and expanded team, I am confident this will prove to be an exceptional group of investors and the realization of a long-term goal to make Eaton Vance management a relevant player in managing global equities. Although the costs in connection with this initiative were not insignificant, I am confident this will prove to be a highly worthwhile investment. Turning to NextShares, the three months coinciding with our third fiscal quarter and the 19 days since have certainly been eventful. As a reminder, NextShares are a new type of actively managed fund designed to provide better performance for investors. As exchange traded products, NextShares will have built-in cost and tax efficiencies. Unlike conventional active ETFs, NextShares will protect the confidentiality of fund trading information and provide buyers and sellers of shares with transparency and control of their trading costs. Our NextShares business plan includes both introducing a family of Eaton Vance sponsored NextShares funds and licensing the underlying intellectual property and providing related services to other fund groups to enable them to offer NextShares. Since the beginning of May, we have hit a number of milestones critical to the success of this initiative. In late June, the SEC approved the listing and trading of 18 initial Eaton Vance NextShares funds on the NASDAQ exchange. With this approval, the only remaining regulatory step required for us to launch NextShares is clearing final disclosure language. On July 30, we filed with the SEC revised registration statements for each of the 18 funds. Regarding licensees, there are 11 firms, including Eaton Vance, that have indicated their intent to offer NextShares funds by entering into preliminary agreements with Navigate and filing requests for exemptive relief with the SEC. These 11 firms collectively manage approximately $500 billion in mutual fund assets and sponsor approximately 200 funds currently rated four or five stars by Morningstar. For firms other than Eaton Vance, the SEC has issued final exemptive applications permitting the offering of NextShares funds to five of them and given a notice of its intent to provide a request for exemptive relief to the other five. Following the expedited filing and review process established for NextShares, the time from filing to notice of approval has averaged about a month. We continue to be in active dialogue with other fund companies. Just last week, we signed a preliminary agreement with a major fund sponsor, which will become our largest to date in terms of mutual fund assets. We expect them to file their SEC exemptive application within the next few weeks, at which time their identity will become public. On the intermediary front, you may have seen the press release issued yesterday by Envestnet, Inc. announcing their initiative to make NextShares available to financial advisors through their wealth management network. For those not familiar with Envestnet, they are a leading provider of unified wealth management technology and services to investment advisors, serving over 41,000 advisors, almost 3 million investor accounts and over $700 billion in total client assets. They are an innovative high growth company whose mission is to help advisors deliver top-quality investment services in the most cost- and tax-efficient way possible. It fits squarely with what NextShares seeks to provide. In many ways, they are ideal partners for NextShares. Not only do they provide deep access to the rapidly growing RIA market, but their model-based portfolio solutions eliminate most, if not all, of the implementation challenges of NextShares. Adding NextShares to existing models and creating new NextShares-based models doesn’t require educating investment advisors about how to buy NextShares or tweaking systems to accommodate advisor-enter NextShares trades. For the advisor using a model portfolio that includes NextShares funds, it is no different than how they use models today. Following this approach, implementing NextShares on a platform can be quick, easy and inexpensive. Eaton Vance has not been asked or made commitments to provide financial support for the investment initiative announced yesterday. While we are excited to be working with Envestnet, we are also engaged in discussions with other intermediaries to support the offering of NextShares, and hope to be in a position for other announcements soon. In those discussions, one new avenue we are pursuing is making the case that, as at Envestnet, adding NextShares to model portfolios can be a quick and easy way to introduce the product without meaningful system enhancements or advisor training. Increasingly, model portfolios are essential to help all types of financial advisors serve their clients. NextShares can fit there extremely well. In closing my remarks, I want to reiterate our target of launching the first NextShares funds by the end of this year. We are confident they will be ready by then and understand NASDAQ will also be ready. I do want to acknowledge, however, that other forces could push the initial launch into early next year. With that, I’ll now turn the call over to Laurie.

Thank you and good morning. As Tom mentioned, we are reporting adjusted earnings per diluted share of $0.57 for the third quarter fiscal 2015 compared to $0.63 for the third quarter fiscal 2014 and $0.58 for the second quarter of fiscal 2015. Adjusted earnings for all quarterly periods presented were the same as reported GAAP earnings. As we noted in the release, costs associated with closing our Fox Asset Management, LLC subsidiary and other employee costs relating to retirement, terminations and new hires reduced earnings per diluted share by $0.04 and drove our operating margin down to 33% from 35% in the prior quarter. Employee costs relating to retirement, terminations and additions to staff reduced earnings per diluted share by $0.001 in the second quarter of fiscal 2015 and $0.02 in the third quarter of fiscal 2014. Third quarter total revenue decreased 3% year-over-year despite a 7% increase in average assets under management, primarily reflecting a decrease in our blended investment advisory and administrative fee rate and a decrease in assets subject to distribution and service fees. Sequentially, total revenue increased by 1% reflecting a 2% increase in average assets under management, an incremental $1.6 million in third quarter performance fees, and an increase in fee days in the quarter, partially offset by a modest decrease in our effective investment advisory and administrative fee rate. Performance fees for the third quarter of fiscal 2015 totaled $1.7 million compared to a little over $900,000 at third quarter last year and essentially zero in the prior quarter. Going forward, our effective investment advisory and administrative fee rate will continue to be driven primarily by the mix of business among mandates with different fee levels, with swings in performance fees and the number of fee days in the quarter also contributing to short-term variability. In the third quarter of fiscal 2015, we realized average effective management fee rates of 65 basis points in equities, 63 basis points in alternatives, 54 basis points in floating rate income, and 43 basis points in fixed income, modestly above the prior fiscal quarter in most categories due to this increase in fee days in the quarter. Portfolio implementation, which includes Parametric's tax managed core, specialty index and centralized portfolio management services, had an average effective fee rate of 15 basis points in the quarter in the third quarter of fiscal 2015 compared to 17 basis points in the prior fiscal quarter, reflecting the impact of the large EPM win that funded in July. Parametric's exposure management business had an average effective fee rate of 5 basis points in the quarter, largely unchanged from the prior quarter. So long as exposure management, portfolio implementation and other low fee mandates continue to grow faster than the company as a whole, you can expect our overall average fee rate to continue trending downward. The key to achieving overall growth in management fee revenues in the face of declining average fee rates continues to be avoiding declines from the managed assets of our higher fee businesses. Shifting from revenue to expense, compensation expense increased 6% compared to the same quarter last year and 4% sequentially, reflecting headcount-driven increases in base compensation, employee benefits, and stock-based compensation, a modest increase in operating income-based incentive accruals, and incremental stock-based compensation expense associated with retirements and terminations. Compensation expense as a percent of revenue increased to 35% for the quarter from 34% last quarter and 32% in the third quarter of last year. As I noted earlier, employee retirements, terminations and additions to staff to support growth initiatives collectively had a significant impact on the quarter, contributing approximately $5.8 million to compensation expense this quarter. Adjusting to remove these costs from the compared quarters, third quarter fiscal 2015 compensation expense would have increased 4% year-over-year, been flat in comparison with the prior quarter, and would have equaled 33% of revenue. As we continue to build out our global equity team in London, add staff to support other initiatives and see more retirement, these costs won’t go away, but are not expected to recur at levels similar to what we experienced in the third quarter. Distribution-related costs, including distribution and service fee expenses and the amortization of deferred sales commissions decreased 11% in the third quarter of fiscal 2015 from the third quarter of fiscal 2014, primarily reflecting lower closed-end fund-related payments and reduced asset-based intermediary marketing support payments. Distribution-related expenses increased modestly on a sequential quarter basis, reflecting an increase in marketing and advertising spend related to our NextShares initiative. Fund-related expenses were largely flat year-over-year and up 6% sequentially, primarily due to an increase in fund subsidies and other fund expenses, partially offset by a decrease in funds of advisory expenses. Other operating expenses were up 7% in the third quarter versus the same period a year ago and up 6% sequentially, primarily reflecting an increase in travel and certain professional services and other corporate expenses, including the acceleration of approximately $500,000 of amortization expense related to the closing of Fox. Expenses related to our NextShares initiative totaled approximately $2 million in the third quarter of fiscal 2015 compared to $1.8 million last quarter and are expected to total approximately $8 million for fiscal 2015 as a whole. Net income and gains on seed capital investments had no impact on earnings in either the third quarter of fiscal 2015 or the prior sequential quarter, compared to a contribution of roughly $0.001 per share in the third quarter of fiscal 2014. When quantifying the impact of our seed capital investments on earnings each quarter, we take into consideration our pro-rata share of the gains, losses, and other investment income earned on investments and sponsor products, whether accounted for as consolidated funds, separate accounts or equity method investments, as well as the gains and losses recognized on derivatives used to hedge those investments. We then report the per share impact of the net non-controlling interest expense and income taxes. Changes in quarterly equity net income of affiliate, both year-over-year and sequentially reflect changes in net income and gains recognized on sponsored products accounted for into the equity method. Our 49% interest in Hexavest, which has reported net of tax and the amortization of intangibles and equity in net income of affiliates, contributed approximately $0.02 per diluted share for all quarterly periods presented. Excluding the effect of CLO entity earnings and losses, our effective tax rate for the third quarter of fiscal 2015 was 38.9%, 38.5% in the third quarter of fiscal 2014 and 38% in the second quarter of fiscal 2015. We currently anticipate that our effective tax rate, adjusted for CLO earnings and losses, will be just north of 38% for fiscal 2015 as a whole. In terms of capital management, we repurchased 1.7 million shares of non-voting common stock for approximately $68.5 million in the third quarter of fiscal 2015. When combined with repurchases over the preceding three quarters, our average diluted share count for the first nine months of fiscal 2015 was down 3% from the same period in fiscal 2014. We finished the third fiscal quarter holding $433 million of cash and short-term debt securities and approximately $328 million in seed capital investment. Our outstanding debt consists of $250 million or 6.5% senior notes due in 2017 and $325 million or 3.625% senior notes due in 2023. We also have a $300 million five-year line of credit which is currently undrawn. Given our strong cash flow, liquidity and overall financial condition, we believe we are well-positioned to continue to return capital to shareholders through dividends and share repurchases. This concludes our prepared comments. At this point, we’d like to take any questions you may have.

Great and good morning everyone. Kathy, I just have one question on expenses. Can you just clarify? I mean you talked about the $0.04 of potential, I don’t know if I’d call it non-recurring. I mean, should we think of that as non-recurring or—I think you kind of suggested that some of that could be carrying forward. I’m just trying to get a better feel for kind of the run rate of the comp.

Yes, I think we quantified it as a $5.8 million contribution to compensation expense this quarter, and really what we’re talking about are very specific quarterly impacts that are not necessarily recurring, but that will—if you got severance for example, you would anticipate that you won’t have the same level of severance next quarter, but you’ll likely have severance next quarter or signing bonus. So we’re trying to sort of isolate the things that were sort of a deviation from what we would consider to be our run rate compensation and that’s what we quantified in the $5.8 million this quarter, and that really was breaking down into one-time events related to closing Fox and then certain employee retirements and terminations that were very specific to this quarter.

Okay, great, thanks. And then Tom, I don’t know—I mean, obviously the portfolio implementation has been very strong. You cited some things with Parametric, but can you maybe update us on if you look across the business, kind of the institutional RFP activity, kind of maybe pipeline, kind of any color around where that stands and maybe drill down a little bit, particularly outside of the Parametric business, the progress you may or may not be seeing.

Yes, so institutional just maybe to step back, our key strategies that we offer institutionally, Parametric aside from their service and implementation-oriented businesses, their primary strategy that they sell institutionally is emerging market equities. On the Eaton Vance side, the primary strategies that we focus on currently include high yield, bank loans, certain other flavors of equities, certain other flavors of fixed income in certain markets and also Hexavest as being a primary focus of ours on the equity side. I would say a few things are not particularly working well at the moment, starting with Parametric emerging market equities. I think you’re probably aware of the challenges that asset class has faced in terms of performance, so it’s just institutions. Sophisticated though they may be, don’t always allocate new assets to underperforming asset classes, which is where emerging market is at the moment, including lots of headlines about China. We have in that strategy also suffered from a bit of underperformance over the second half of last year and the first part of this year. That has largely turned around; the key driver of that performance was an underweighting to China. The way that portfolio was built, we systematically underweight large market exposures in the interest of greater diversification, and that really hurt us during that time period, but of course as the Chinese market has turned over, that’s now working to our favor. On the Eaton Vance side, high yield is certainly an area where we funded a large institutional mandate during the quarter and where the pipeline and activity level is quite robust. I would say on bank loans we are still in this market environment where we kind of scratch our heads that we had net positive flows for us in normal institutional business, but we had a pretty significant allocation that I highlighted out of a sub-advisory account that pulled the overall numbers down. Our case there that we’re making is that bank loans should be a core asset class and that they have diversification benefits and return characteristics that should make them a core holding and we’ve had some success with that, but that’s a long-term build. I would say other areas, Hexavest, Hexavest is a top-down oriented goal equity manager that has been bearish on the markets generally; that’s been their investment point of view. Bearish has meant that they’ve struggled to keep up with the markets, so last year they did outperform. They are just about equal to the markets currently based on the strong last couple of months as they’ve experienced stronger relative performance, but it’s been hard for them to really build a compelling performance track record because they hold high cash levels at the moment consistent with their bearish views. I would say similarly we’re a little out of favor in terms of our multi-sector income strategy run by Kathleen Gaffney. Great performance out of the box. She has been aggressive and has underperformed less aggressive managers for most of this year. We’ll see how that resolves itself, but we’re getting close to the point where she has a three-year track record, which over the time of her experience here she’s really had in total exceptional performance, though this year is not particularly good. So to summarize, I would say it’s okay. We don’t have a compelling pipeline, but we don’t have a bear pipeline either, and we don’t certainly have visibility to significant institutional net outflows.

Great. And then maybe just one more question or a pair of questions on to our NextShares. First, assuming when you are ready to launch the Europe product, Euro advance NextShares products, do you anticipate that you’ll have some other firms ready to go kind of at the same time? And then what are your current expectations around seed capital and need for those funds? Do you think it’s going to be mainly reallocating existing seed or are we likely to see some increased use of cash or debt? I’m just trying to get a kind of update on your thoughts around that.

Yes, first on the product introduction, our plan has been and continues to be to launch as part of a consortium of sponsors. We highlighted these companies—they are on our website that have filed. I mentioned them in my remarks, but there are 11 sponsors. I would say eight relatively large fund sponsors included in that group. We’re putting together what we’re calling a consortium of sponsors. We have an initial meeting of that consortium that’s been scheduled for next month and our goal would be to launch products in conjunction with other companies. Unfortunately, we don’t control the timing of what they do, so we don’t have complete control over that, but it’s our understanding that that’s what everyone wants to do and it will come to market together, and everyone sees the benefit of doing that. I would say for Envestnet and how they see NextShares fitting into what they are doing, there’s two primary things: one is potentially introducing NextShares funds as a complement to an existing multi-manager strategy, so that could be alongside mutual funds or with ETFs, but it could be all active, it could be all passive, or it could be into a formerly all-passive strategy. But we can blend, and that doesn’t necessarily require a consortium to be available, but they would also like to offer a range of NextShares-only strategies, and most likely they would not want that to come from any single advisor. So that needs to be offered in conjunction with a consortium of funds introducing NextShares. In terms of seed capital, I would say that’s not something that we have a definitive answer to. I think as you know the general primary requirement for seed capital and the mutual fund has been requirements that have been imposed by broker dealers to say if you want to be offered on our platform, you have to have some level of either a track record of assets in the strategy. We have not gotten to the point in our discussions with major broker dealers where that’s been fully decided. It’s certainly one of the things that’s important to us, is to make the case that if it’s an existing proven strategy, there shouldn’t be a requirement for that to be worth their attention that it have a certain amount of seed capital. I get for a new strategy that doesn’t have a track record why that same logic would apply, but we would certainly make the case that we shouldn’t need to put $25 million or $50 million into a fund just because that’s an internal requirement. That would be something that we would expect to be part of a negotiation in terms of gaining access for NextShares on our particular dealer's platform. From an exchange perspective, the requirement is much lower than that. I don’t know the specific number; maybe it’s $1 million or a couple of million dollars, something like that, but the primary broker dealer requirement, we would hope and expect that it wouldn’t be the same as a brand in your mutual fund offering.

Great, I appreciate you taking my questions. Thank you.

Yes, thanks Rob.

Good morning. This is Will Cuddy filling in for Ken today. Thanks for taking our questions. So just some thoughts; Precidian filed who refilled their application last week, what do you guys think of that new filed application? I guess there are some concerns raised in people.

Well, I guess I’ll start by saying some people thought I spent too much time on this topic a couple of weeks ago, so I’m not going to go into a whole lot of detail, but there are a couple of things I would assert. First, since 2001 when the SEC put out what they call a concept release on actively managed ETFs, the possibility of this, their primary focus has been on how well will these trade? Will they trade at tight bid-ask spreads and will there be all premium discounts and particularly how they will trade during periods of market stress and volatility? As I look at the Precidian filing, this version actually moves a step away from that in that it takes away information that would have been provided in the last iteration. So I guess why you could say that they made progress in addressing certain issues. To my thinking, they possibly have moved away in the other thing. I continue to believe, and I’m not going to decide this, we’re not going to decide this, the SEC is going to decide this, but it remains my view that all of these various proposals—and there are a couple of other ones in addition to the preceding ones—all of them are likely to face an uphill challenge. The SEC is trying to look for evidence that these things will trade consistently well, and it’s hard to see that in the historical record of existing ETFs and, particularly, existing active ETFs and knowing and understanding that these will trade less well, because they provide market markers with less information. I think it’s going to be very hard for the SEC to get comfortable here, but again, I’m not in a position to decide this. This is just one person's opinion. The other thing I would say—and I think people sometimes lose sight of this—is that the specific Precidian proposal applies only to funds whose holdings consist entirely of two things: U.S. listed securities and cash. If you look at that market for actively managed mutual funds today, that’s about 3% of the fund market. In other words, 97% of active mutual funds hold something other than U.S. listed stocks and cash and it’s possible that they could address a larger market than that over time, but their specific filing, as it is in, and as in the old version, is just U.S. equity funds and just U.S. equity funds that do not have any holdings outside the United States and any holdings other than cash, and that’s a very, very small potential market. So that’s my view and I’m sticking to it, but we don’t get to decide.

Okay, thank you for the view.

Okay, thanks very much for taking my question just now. To just come back to maybe comp and margins on a go forward basis, could you frame out where you might be in terms of the European build-out? It seems like you’re in your earlier days for sure. Can you quantify maybe how much more incremental spend there might be and then how long it might take to get to scale? I guess the question is, when could you start to anticipate some kind of flows on the back of the investment spend?

Let me maybe talk about the scale. So scale in terms of spend that is having the team built out, we really expect that to happen probably in the current quarter or certainly by the end of the year. We’ve hired some more people that have not been announced in terms of who they are, although that will be expected shortly. There are a couple of more open positions that we’re likely to fill over time, but this is a major initiative for us. This is a multi-million dollar expense item that we thought was necessary and appropriate to expand our footprint as an equity manager to include a full-fledged, robust global equity offering. Some of those expenses are of an ongoing nature, but some of them also are of a one-time nature and the two leaders of that team were onboarded in the current quarter. So any compensation we paid them of a one-time nature in terms of signing bonuses or the initial recognition of the value of an equity grant, those all hit in the current quarter. On a run rate basis, those costs are going to go down. Now, over time we’re going to have some new people that are going to come on, but the way we tried to frame the discussion of this topic is that we think that over coming quarters generally this category is going to go down. It won’t go to zero, we got new people we’re going to be hiring in the next quarter and maybe some more in the quarter after that, but you should expect to see substantially less than $0.04 a share of spending related to this and related topics; and remember the $0.04 was not just this. It was also the closing of Fox Asset Management, which is a business that we’ve been supporting. We acquired Fox in 2001. They haven’t made money in quite some number of years, and over time, the money we spent to shut down that operation in the current quarter will help our earnings going forward because they were just not an economically scaled business. Now you are correct that the business we’re creating in London is not at the moment generating incremental revenues equal to the incremental expenses. Sadly, that’s not the way our business works. We do think, however, that we are in a position to start winning new clients relatively soon. The people that run that team, Chris Dyer and Aiden Farrell, are well known in the marketplace. Particularly Aiden is a recognized player in the global small-cap world, and that’s an area where there has been generally strong demand for active management and also an area where, due to capacity constraints on existing established market leaders, often there is an appetite for new managers. But this is—a mean, I think you’re right to focus on this. This is an expense item that is not going to go away. The one-time cost will go away, but the cost to support that team. But as we look at it, we look at the potential to bring in, potentially over time, multiple billion dollars of actively managed assets that doesn’t exist today. But we look at the breakeven assets we need to support this team, and we see this as a highly probable win for us, not guaranteed, but highly probable to be a win for us. Just looking at putting the pencil to paper in terms of what does it cost to support this team and what would it require in terms of incremental assets raised for this to be a positive. That’s not the only reason we are doing it, but certainly making money is a key objective in terms of that initiative.

Okay, that’s helpful color. And then just a follow-up question on NextShares, and thanks for the extra color and congratulations on the Envestnet win; it’s very interesting. Could you talk a little bit about that win in particular and just trying to reconcile your conversation with, I know your comments are proceeding with the uphill battle, which I appreciate, and negotiations with the broker-dealers maybe do—maybe don’t have to put some seed capital up against kind of from the track record. From their perspective, have they provided and how quickly they think they would push the NextShares portfolio and maybe some of the consortium of funds through their system? What kind of track record might they need? That’s sort of part one, and the second part is, as you mentioned, you’ve had some more negotiations with other broker-dealers or other distributors. Could you maybe give a broad profile of the type you are interfacing with, where you’re most advanced? Is it another sort of online player or is it more of a traditionally managed broker-dealer that maybe we’ll think about like a Merrill Lynch or Morgan Stanley? Thank you.

As I understand, and I’ve been involved in some discussions with them, but not all, implementing new strategies on their models is a relatively straightforward process. I mean many of those models are overseen and built by their own in-house teams; there is a vetting process for that. But we are not talking about bringing out NextShares funds that are normal strategies. We are talking about bringing out NextShares funds that effectively replicate the investment track record of—replicate the strategy of an existing mutual fund run by the same team, holding the same assets where it is a very small leap to say that if that same strategy can be offered in a lower cost structure and one that has potential tax advantages that they shouldn’t be ready to adopt that. But is I think consistent with the spirit of what was announced yesterday, that they are not going to take a wait-and-see attitude for us to see how these things perform. Buying any new strategy involves a bit of a leap of faith, but that leap of faith here, I would argue is extremely small in that we are dealing with proven managers, proven strategies with proven track records in a structure that where I think most people would say that the potential benefits in terms of performance, lower costs, etc. are quite clear and doesn’t, wouldn’t be too hard for people to get comfortable with. So we don’t have specific time commitments that I’m aware of on the part of Envestnet. We don’t have product approved yet; other companies don’t have products approved yet. But everything from my understanding of what they’ve said is that when these products are available that they will look to add them to their portfolios, and when that proves to be ultimately will drive the timing of their implementation, that’s my understanding. In terms of the types of intermediaries that we are talking to, I want to be careful there, because we are in discussion; I said a couple of weeks ago, that we don’t want to compromise some discussion that may be sensitive points. I guess I’ll say advisors serving all market categories; we do not see the potential appeal of NextShares as limited to a particular distribution channel. For example, only registered investment advisors or only independent advisors, or only broker-dealers. Our business is quite broad-based. We have good distribution arrangements across all types of firms; warehouses, independent, banks, registered investment advisors, and we are having discussions involving NextShares with all of them. I would say on an overall basis, something like 75% of our mutual fund sales is in Class-I shares where there is no 12B fee paid, no front-end load, no back-end load, and for that business, it is a fairly straightforward transition from that to NextShares in terms of the business economics. So I think I guess I would count to you to think about NextShares fitting in everywhere that Class-I mutual funds fit in, in terms of distribution economics, and that’s almost the entire advisory channel, both advisory within broker-dealers and advisory within independent advisors. All of those customers are primarily using Class-I mutual funds. Here we are offering something that has very similar economics, but potentially better performance characteristics for investors.

Okay, thank you, Tom.

Hey guys, good morning. First of the NextShares initiative, do you think that you will be profitable by the end of ’16 in that or is it just too early to say?

I would say unlikely. This is a long-term initiative. Thinking about it you’d have to kind of – the math isn’t very hard. We’ve talked about what our spending is. I think we’ve also talked about what our fee rates would be. A little math and you can come up with what our average assets would have to be in 2016 to cover that spend. Maybe we’ll get there, but we are not doing this because we expect to make a lot of money in 2016. We are doing this because we think this is a better product for investors, and we think over time that all the various slings and arrows that we’ve taken along the way ought to be at some point rewarded to Eaton Vance shareholders for having done this.

Yes, totally understand. And then on the Envestnet deal, Tom, clearly as an effort it seems like on their part to bring down cost for advisors and then investors. But just curious, is there any other way that Envestnet benefits from offering NextShares relative to mutual funds?

I’m not sure what you are getting at.

No, I just didn’t know if there was any kind of additional cost or revenue opportunity for them associated with that. I didn’t think so, but I just want to make sure.

Yes, I think their business model is a pretty straightforward, transparent business model in which they charge fees for services to their customers. One of the things they try and offer to those customers in exchange for those fees is access to the best products. And how they grow and how they compete is by offering a—I’d say a relatively unconflicted, if not completely unconflicted set of tools and advice on making advisors better in what they are trying to offer their clients, and offering NextShares, which has we think compelling cost and tax advantages. It fits very well with how their business works. I don’t think it’s more complicated than that.

Thanks very much. One housekeeping question and one question related to NextShares. My first question relates to your flows. When you recorded $8.4 billion of gross outflows, just outflows in your equity area, does that include or exclude the loss of the sovereign business from Parametric?

It includes it Eric.

So the loss of the Parametric business that you referenced in your prepared remarks would be included in the equity asset outflows?

That’s right; it’s all during the month of when was that? May, I think.

Right in the middle of May, so.

Good. Here is a broader question about NextShares. Tom, could you elaborate on your comments regarding model-based investing? It would be helpful if you could explain what you mean by model-based investing, which has gained popularity in this country. What distinguishes model-based investing at Envestnet affiliated advisors from that at Merrill Lynch?

Okay, let me see if I can explain this. So think about a financial advisor's traditional way you build portfolios; you’ve got an advisor who sits across from Mr. and Mrs. Jones and they discuss what stocks, bonds, mutual funds, ETFs, or NextShares funds, they are going to put in their portfolio, and based on that discussion and maybe with some ongoing consultation over time, an advisor will build and manage a portfolio for Mr. and Mrs. Jones that may have some of those, and it’s essentially built on a one-off basis and maintained for Mr. and Mrs. Jones, where the advisor is putting in one by one orders to buy individual securities and to sell offsetting amounts of individual securities. So we’ll call that the traditional model. I mean the traditional approach so that we don’t confuse, sorry, so that’s the traditional approach. A model-based approach would be to say—think about a financial advisor that doesn’t have one customer that he or she is serving, but has a menu of customers, and for the interest of efficiency and risk control. We’ll put those different customers into different categories where depending on where Mr. and Mrs. Jones fall relative to Mr. and Mrs. Smith, they might have different risk profiles. But rather than just simply doing this—I’ll assume the advisor is a he for this purpose—but rather than that advisor just on his own building and maintaining these multiple portfolios for multiple clients in a world where efficiency is increasingly demanded, there have developed what are called model-based approaches to portfolio construction and management, where building on this application or building on this example, an advisor would potentially put the Smith’s in one category, the Jones in another category and would either set up models that he himself would run, saying I’m going to put this groups of clients in this model and this group of clients in this other model, or perhaps the advisor says, you know what, I might be better off letting someone else who does this full-time for a living figure out what sort of asset allocation is appropriate for clients of a different risk profile and what particular managers and strategies and structures I should own in that. So models can be constructed and managed either by an individual advisor or by a team of advisors or by a firm or by a third-party expert, and there are all kinds of different model construction and oversight methodologies that are in wide practice today, and it applies absolutely to all types of advisors, not just independent advisors, not just ROAs, not just warehouse advisors, but really across the board. This is a very common way for financial advisors to serve their clients, and it’s certainly growing more popular because of the obvious efficiency advantages that it offers over a one-by-one, every trade one at a time kind of approach. In terms of the relevance of this to NextShares and the ease of implementation of NextShares, what’s different about NextShares versus a traditional ETF, if we’ll use that as a benchmark, is really only one thing, which is that when you buy NextShares fund, the price of that trade is not set until the end of the day, and that involves perhaps some system changes, what a limited order means in that context, there is something slightly different, and there is a terminology that goes with that in terms of putting in orders and handling of orders. So if an advisor were to work individually with the Jones’s and the Smith putting in those orders, that advisor would have to be educated on the subtle distinctions that exist between how you enter an order for NextShares versus an order for an ETF, and also the systems that are built to accommodate advisors would also have to have some safeguards to make it difficult for the advisor to make mistakes. Imagine a world, though, where an advisor doesn’t enter orders. Imagine a world in which an advisor says I’m going to put these models together, and I’m going to turn over the implementation of that to some central group, and that’s really where investment would come in, which is to say that they both build and manage and maintain models where effectively the trade order entry in the case of their particular models is done by a small team where they do only that. So that any training or any systems modifications that have to be done to accommodate NextShares is done versus to serve a very small group of implementers, two, three, four, five people, as opposed to 41,000 people if we were to make this available to all the customers that Envestnet serves. So it’s much, much easier. Much similar to say financial advisor; you are still involved in asset allocation and asset allocation; you are still involved in securities and manager selection. But in terms of the specific implementation, through a model that’s done by somebody else who focuses on that as their job and that the beauty of this is that all the complexity of buying and selling NextShares—and I don’t want to emphasize that; it’s not huge, this is not insurmountable. I could, I think, teach anyone how to do this inside of five minutes. But all that goes away if you have a centrally implemented approach like models do, and it is not just in Envestnet. It is pervasive across the industry.

Really clear and really helpful. Thank you very much.

All right, thank you.

Thanks. Laurie, just a question on expenses. So you gave the color around comp, just on the other expenses it seems like it was a bit elevated. I think you mentioned, somewhat with the acceleration, the amortization related to Fox, and then maybe a little bit of an uptick in NextShares, but I just wanted to get some outlook there. And then when you think about the fee, like the mixed shift trend, when you think about some of these investments that are taking place right now. Where do you think the margin can kind of settle into maybe over the next year versus longer term? Obviously, as you scale that international business, you can see some improvement.

Yes, in terms of expenses outside of compensation, I think that they were somewhat limited in terms of unusual events this quarter. I think to your point earlier, we have roughly $500,000 in accelerated amortization associated with effectively closing down Fox. Outside of that, we had some legal costs associated with our global initiatives and some incremental marketing associated with the NextShares initiative, which was already built into the $1 million estimate that we had given for the year, so not a lot of noise in terms of our other operating expenses. Given the environment that we are in right now and recognizing that we’ve got these significant growth initiatives and the market’s been a little bit small to us and has taken away some revenue that we would certainly like to keep, I am not going to attempt to forecast what margins going to look like next quarter. I will tell you that we are now going into our budgeting cycle and our initial review cycle and that we are doing everything we can to really, very carefully manage our expenses. We are mindful of the impact these initiatives have on our margin, we are mindful of the fact that this is a difficult time to be making these investments, but we are also—we feel very strongly that this is the time for us to do it, to position ourselves for the future. So I wish I had a crystal ball and could tell you exactly where the margin was going. I will tell you that we are being very, very careful about spend, maintain it in the range that we are in, but I can’t tell you what it’s going to look like for next year.

Okay, all right. I guess I was going to say that we have two major initiatives in NextShares and this global expansion that are both multi-million expenses that annually, that we have taken on that have the effect of lowering our earnings, lowering our margins today. But these are both investments that we think have huge potential, different types, but both investments of a similar scale that have the potential to have enormous payoffs over time. So there is a short-term pain with a potential certainly for a long-term gain in terms of our business. But you had another question, Michael.

Yes, okay, that makes sense. And then just a quick one just on NextShares, so on the asset management side, you certainly make some good progress, and then on the distribution side, teams like yours, you’re starting to gain some traction. When you think of the distribution platforms and in your conversations, like what is maybe the— I don’t want to say delay, because there was no real expectation of when you would get them onboard. But when you think about, like the pushback, like technology investment that the platforms have to make, is it the liquidity of the funds? Is it just the meetings that have to take place and they have to make the decision, which doesn’t happen overnight? Just trying to get a sense of how you see that progressing and what are some of the pushbacks that you’re getting from the distribution process.

I guess I would say the main—I think you hit upon what I would consider the key issues. Probably the biggest is focus, priorities, you got the Department of Labor out there with the fiduciary standard initiative. Where does this fit? The top part about this is that it affects—if a broker dealer imagines this becoming meaningfully successful, it doesn’t affect just one little part of their business. It’s embracing NextShares—potentially could be a pretty big deal decision for a broker dealer or anyone else providing intermediary services, and that how it fits into their revenue model, what new revenues it would offer, what revenues might go away, is fairly central to their business. It’s not terribly complicated. You can easily identify sort of the pros and cons. All of these firms recognize that they exist to serve clients and that we get zero pushback on the idea that this is a better product for clients than the alternatives of a mutual fund and in a very broad range applications. But it’s really kind of getting people that are at a level of seniority in the organization that have a broad enough view that they can see and think about how this impacts their business, getting them to focus on this—that’s really the challenge for us. We don’t get pushed back at senior levels that people that say, this is bad for our customers or this is bad for our business to a person. They say that this is interesting to a person; they say this is disruptive, but working this through a process and some of this is maybe reluctance to be first. We’re grateful to our friends at Envestnet for stepping up and willing to be first. We believe that as we make progress here, making further progress gets easier and easier, and so we’re working at it and we share the frustration of those that want to get this done tomorrow. I’m certainly in that camp, but we have to work a process and have to be respectful that we’re not the only thing that these firms have to think about. These are generally large complex organizations, and these are fairly interesting times where there are some major shifts going on in the offering and distribution of investment products, principally the shift that’s ongoing from active mutual funds to ETFs. Every broker dealer that offers that serves retail investors and offers funds is experiencing that. How does this fit into this? Does it help them or hurt them to introduce NextShares? I don’t think there’s a lot of debate about that, but what priorities should that get versus other possible initiatives that they might have.

Okay, that’s helpful. Thanks.

Hey guys, good afternoon. So first, once some of these broker-dealers have sort of the infrastructure in place and are able to start trading the ETMF, just based on your current roster of third-party managers that have signed up to launch the funds, just curious to get your expectations for related AUM growth in the first one to three years.

Yes, we don’t— I mean, so there are a lot of unknowns here, right. You’re going to have to I think build your own model in terms of timing. I think we can give a lot of guidance on how big the market is; we can give a lot of guidance on what revenue and cost expectations might be, revenue in terms of fee rates. But the big question in this and the big modeling question is what’s the uptick? When does it happen? How big is it? I can make a case where this should be a very rapid conversion. If you look at what happened with passive investing, it took 20 years for ETFs to get a 50% share of the passive business, but that was an environment where for the first eight or ten of those years there was extremely limited product offerings. The first half dozen of those years was essentially one or two funds available. As I see it, given the historical pattern of acceptance of ETFs, the fact that people know what an ETF is, also the fact that there will be many, many fund companies out there talking about this, the fact that from the get-go, it’s approved for all asset classes. If this takes off, that’s a big if; it should not take 20 years to get to a 50% market share. So I don’t have a great answer for you in terms of what AUM will be at the end of 2016 or 2017. I think if this takes off, it can take off relatively quickly, but we’re not going to be where we hope to be by the end of 2016 or 2017. There’s a lot of advisor education. There’s a lot of money that’s in strategies and products that will have to migrate to this. Everyone can believe this is a better mouse trap, but still that doesn’t mean the assets will all move overnight. So sorry I can’t help with the modeling questions.

No, I appreciate the color. And then just on the equity side of the business, just wondering if you could talk about sort of the dynamic between adverse demand trends across the industry, particularly as it relates to actively managed domestic strategies versus improving investment performance track records as you look across your platform and maybe the opportunity to gain some market share.

Yes, I guess I would say, and I’m not particularly proud of this, but at the moment we don’t have a whole lot to lose in terms of traditional active assets invested in U.S. equities. We had a one time a quite large cap value franchise that is—I think it’s around $8 billion today versus a peak of something like $34 billion. I would assume that to some degree the continued outflows we’re seeing despite a pretty good performance record has to do with that broader trend from active to passive. So to some degree we’re being hurt by that. It’s harder to sell active strategies today than it was two, five or eight years ago, because I think there’s a greater attitude of skepticism about the ability of active managers to sustain outperformers than would have been there prior to the long period now we’ve had with our performance generally for passive over equity and large-cap U.S. equity. So I guess I see us, for our business where we sit today, the balance is far more to the opportunity side in large-cap U.S. equities than it is to the risk side. We have a balanced fund. It has a five-star rating for all time periods. It’s a top—I believe top decile performer, certainly a top quintile performer year-to-date, one, three, five, and ten. It’s an enormous category. Balanced funds don’t go there every month, but there’s a large audience of potential investors for that fund. We can have a much bigger balanced fund than we did today in the $300 million range. There’s no reason that even with the adverse trends in our business that that fund couldn’t be some multiple of its current size relatively quickly, just by taking share from other managers. Our focused growth opportunity fund, also strong performer, still relatively early in the slide. I think we hit our five-year anniversary sometime in the next year I think, but it’s got very strong performance, focus strategies appeal as a good application of active management. But our industry generally faces—I feel like a pretty huge threat. When I say our industry I really mean active managers in this case from passive. But the threat to Eaton Vance is relatively small because that threat is greatest in large-cap U.S. equity, and that is today a pretty small part of our business. When I say that I’m excluding specialty products like host and funds and exchange funds where we don’t place the normal type of competition like we saw in large cap value, for example.

Got it, okay. Thanks for taking my questions.

Great. Thank you for joining us this morning and afternoon, and we hope you enjoy the remaining days of summer and we look forward to reporting back to you this fall. Thank you.