Morgan Stanley (MS) — Q4 2016 Earnings Call Transcript

Good morning and welcome to our 2016 fiscal fourth quarter earnings call and webcast. Here this morning are Tom Faust, Chairman and CEO of Eaton Vance Corp; and Laurie Hylton, our CFO. We will first 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 2015 Annual Report and Form 10-K, are available on our website or at request at no charge. I'll now turn the call over to Tom.

Good morning, and thank you for joining us. Today we’re reporting adjusted earnings per diluted share as $2.13 for our fiscal year ended October 31, down 7% from $2.29 of adjusted earnings per diluted share in fiscal 2015. This year’s lower earnings reflect a 4% decline in revenue and substantially unchanged adjusted operating expenses due to the strong recovery in equity markets since the February lows and the company’s positive internal growth. Our earnings power improved meaningfully over the course of the fiscal year, setting up favorable earnings comparisons in fiscal 2017. As Laurie will detail in a few minutes, we earned $0.57 per diluted share in the fourth fiscal quarter, an increase of 8% from $0.53 of earnings per diluted share in the fourth quarter of fiscal 2015 and about 2% from $0.56 of adjusted earnings per diluted share in the third quarter of fiscal 2016. Income and net gains on seed capital investments contributed $0.01 to earnings per diluted share in the fourth and third quarter of fiscal 2016 and reduced earnings per diluted share by $0.01 in the fourth quarter of fiscal 2015. Performance fees contributed less than $0.005 per diluted share in the fourth quarter of fiscal 2016 versus the contribution of about $0.01 in the fourth quarter of fiscal 2015 and $0.015 in the third quarter of fiscal 2016. We finished fiscal 2016 with consolidated assets under management of $336.4 billion, up 8% from 12 months earlier and at 1% from the end of the third fiscal quarter. Consolidated net inflows of $4.8 billion in the fourth quarter equate to a 6% annualized internal growth rate, matching our organic growth rate for fiscal 2016 as a whole. Excluding our lower fee exposure management business, organic growth in assets under management was 3% for the fourth quarter and 5% for the fiscal year in total. While net flows and organic growth in AUM are standard measures of asset manager business performance, we find it increasingly important to understand and track organic revenue growth. Organic revenue growth as we define it represents the change in run rate management fee revenue resulting from net inflows and outflows taking into account the fee rate applicable to each dollar in or out. In the fourth quarter, we realized organic revenue growth of 2%, the third consecutive quarter of positive organic revenue growth. For the fiscal year as a whole, we had organic revenue growth of just over 1%.

Okay, this is Dan Cataldo. Apparently, our call got cut off, so we apologize for that. We're not sure precisely where we were when it cut off, but Tom is going to go back and start with the update on our custom beta business. Again, we apologize for this and if there are any questions as a result, please don't hesitate to let us know.

Hi, it's Tom again. So, my apologies if we don't pick up where things cut off, which we don't know exactly where it was. I talked about our four key growth initiatives and where we are with those in total and I had some specific comments about two of those, our custom beta and next year's initiative. I'll start on custom beta. For those not familiar, this is a suite of separately managed account strategies that combines the benefits of passive investing with the ability to customize portfolios to meet individual investor preferences and needs. Our custom beta lineup includes parametric core equities and EVM managed municipal bond and corporate bond ladders. Compared to index ETFs and index mutual funds, our custom beta offerings give clients the ability to tailor their exposure to achieve better tax outcomes and to reflect clients' specified responsible investing criteria, factored tilts, and portfolio exclusions. Like ETFs and mutual funds, custom beta separate accounts can pass through harvested tax losses to offset client gains and other investments. Transition costs and taxes may also be reduced by funding positions in kind. Included in our presentation materials is the slide showing the growth of our custom beta strategies offered as retail and high net worth separate accounts over the past five years. As you can see, our managed assets in custom beta strategies have grown rapidly year-over-year, now approaching $45 billion. Fiscal 2016 net inflows of $9.2 billion represented a 28% internal growth rate. Although custom beta fees are well below traditional active management, this is a highly scalable business for which we see huge growth opportunities as we continue to build out the distribution network and product offerings. We recently launched a new website at custombeta.com, which I encourage you to check out. Now turning to NextShares, I'll start by reminding you that NextShares are a new type of fund recently approved by the SEC that combines proprietary active management with the conveniences and potential performance and tax advantages of exchange-traded products. Our NextShares solutions subsidiary holds patents and other intellectual property rights related to NextShares and is seeking to commercialize NextShares by entering into licensing and service agreements with fund companies. The first three NextShares funds were launched by Eaton Vance and began trading on NASDAQ in February and March of this year. Last month, Waddell & Reed launched the first three NextShares funds by an advisor other than Eaton Vance. Also recently, Interactive Brokers, an automated global electronic broker and market maker, began offering NextShares funds to retail investors and financial professionals through its investing and trading platforms. UBS continues to make good progress towards the goal announced in July of offering NextShares funds through its network of 7,100 financial advisors in the U.S. UBS’s plan is to begin offering NextShares on its brokerage platform in the first part of 2017 and then on its advisory platform later in the year. Every indication is that UBS is on schedule and committed to making NextShares a meaningful part of its U.S. fund business. Their support helps to answer the one remaining question that stands in the way of NextShares gaining broader adoption by fund companies, which is, where can we get large-scale distribution? Assuming that everything at UBS remains on track, their support sets the stage for NextShares fund launches by a wide range of leading funds sponsors in 2017. The three NextShares funds we introduced earlier this year now have seven to eight months of live investment and share trading experience, both of which have been consistent with expectations. All three funds are outperforming each share class of the corresponding mutual fund, and their shares are trading at consistently tight bid/ask spreads and narrow premium discounts to fund NAV. As the investment and trading advantages of NextShares are demonstrated over a broader range of funds and experienced by a growing number of investors, we expect to attract more broker dealers and an ever-widening array of fund sponsors and fund strategies to the NextShares opportunity. While true innovation is never easy, we continue to be excited about the potential of NextShares; 2017 promises to be a year of significant progress. In other notable developments, last month we announced the execution of a definitive agreement for Eaton Vance to acquire the assets of Calvert Investment Management. Founded in 1976 and based in Bethesda, Maryland, Calvert is a recognized leader in responsible investing with approximately $12.3 billion in assets under management as of September 30. The Calvert funds are one of the largest and most diversified families of responsibly invested mutual funds encompassing actively and passively managed equity, fixed income, and asset allocation strategies managed in accordance with the Calvert principles of responsible investment. The investment performance for the Calvert funds is generally strong, with 77% of assets in funds with MorningStar ratings of four or five stars as of September 30. Most of Calvert’s investment strategies incorporate consideration of environmental sustainability and corporate governance or ESG issues. The Calvert sustainability research department is dedicated to the evaluation of companies based on the ESG factors most relevant to their businesses. Done well, this analysis can provide value even to funds and accounts that are not managed towards a responsible investing mandate. Responsible investing is widely recognized as one of the leading trends in the asset management industry today, appealing to investors who seek both financial returns and positive societal impact from their investments. Responsible investing has been embraced by many of Eaton Vance’s most important business partners; as two examples, Morgan Stanley and Bank of America Merrill Lynch have each announced major initiatives to support sustainable and positive impact investing. Given that particular appeal to younger investors, it seems highly likely that demand for responsible investing will continue to grow. As part of Eaton Vance, we see tremendous potential in Calvert to expand its leadership position among responsible investment managers. By applying our management and distribution resources and oversight, we believe we can help Calvert become a meaningfully larger, better, and more impactful company. The transaction is subject to fund shareholder approvals and other customer closing conditions and is scheduled to close on or about December 31 of this year. We look forward to welcoming Calvert to the Eaton Vance family. Since the purchase of our controlling interest in Atlanta Capital in 2001 and Parametric in 2003, acquisitions of complementary asset management businesses have been key components of Eaton Vance's business growth. In the acquisition of Calvert, we have significant opportunities to further advance our growth objectives by helping Calvert achieve its full potential as a leader in responsible investing. That concludes my prepared remarks. I’ll now turn the call over to Laurie.

Thank you, Tom and good morning. As detailed in our earnings release, we’re reporting adjusted earnings per diluted share of $2.13 for fiscal 2016 versus $2.29 a year ago. On a GAAP basis, we earned $2.12 per diluted share in fiscal 2016 and $1.92 per diluted share in fiscal 2015. As you can see in attachment 2 to our press release, the $0.01 adjustment to fiscal 2016 earnings per diluted share primarily reflects the closed-end fund structuring fees we paid in the third quarter. The 37% adjustment from recorded GAAP earnings in fiscal 2015 primarily reflects the one-time payment we made to terminate certain closed-end fund service and additional compensation arrangements. Excluding the payment, adjusted operating income declined by 12% year-over-year and adjusted operating margins dropped from 34% to 31%, reflecting a 4% decline in revenue and operating expenses that were substantially unchanged. Our fourth quarter results show modestly improved revenue and profits both year-over-year and sequentially. We’re reporting adjusted earnings per diluted share of $0.57 for the fourth quarter of fiscal 2016, compared to $0.53 for the fourth quarter of fiscal 2015, and $0.56 for the third quarter of fiscal 2016. Adjusted earnings for the fourth quarters of fiscal 2016 and 2015 are the same as reported GAAP earnings. While the $0.01 adjustment from reported GAAP earnings at $0.55 in the third quarter of fiscal 2016 reflects the closed-end fund structuring fees we paid last quarter. Fourth quarter revenue was up 2% versus both the fourth quarter of fiscal 2015 and the third quarter of fiscal 2016. We maintained adjusted operating margins of 32% in the final quarter of the fiscal year, flat versus the prior quarter despite losing $2.9 billion in managed assets due to the October market decline. Although we've seen opportunity from modest margin expansion longer term, we would anticipate that adjusted margins will likely stay in this range for the first half of fiscal 2017 given seasonal compensation pressures. As Tom mentioned, asset growth in fiscal 2016 was strong, with average managed assets up 6% in comparison with the prior fiscal year, reflecting strong net sales and positive market returns for the year. Revenue declined 4% year-over-year trailing asset growth as our effective management fee base continued to trend down. The decline in our average expected investment advisory administrative fee rate from 39 basis points in fiscal 2015 to 36 basis points in fiscal 2016 can be primarily attributed to significant growth in our comparatively lower fee exposure management and portfolio implementation franchises. While strong growth in lower fee franchises will likely continue to exert pressure on our overall average effective fee rates going forward, growth of well-performing actively managed strategies may provide some level of counter pressure and contribute to the stabilization of average effective fee rates longer term. Comparing fourth quarter results to the same quarter last year, 11% growth in average managed assets more than offset the decline in our average effective fee rates and reduction in quarterly performance fees, driving a 3% increase in investment, advisory, and administrative fees. Sequentially, a 4% increase in average managed assets drove a 2% increase in investment advisory and administrative fees. Performance fees, which are excluded from the calculation of our average effective fee rate, contributed approximately $600,000 in the fourth quarter of fiscal 2016, compared to $2.7 million in the third quarter of fiscal 2016 and $2 million in the fourth quarter of fiscal 2015. In the fourth quarter of fiscal 2016, we realized 2% annualized internal revenue growth on 6% annualized internal asset growth, with the revenue contribution from new sales during the quarter exceeding the revenue loss from redemptions and other withdrawals. Despite the persistent pressure on average fee rates, we believe we can continue to sustain positive annualized internal revenue growth provided that withdrawals from our higher fee strategies don't accelerate. Turning to expenses, compensation expense increased by just under 2% in fiscal 2016, primarily reflecting a 4% increase in headcount to support growth of Parametric and new initiatives at Eaton Vance management, partially offset by a decrease in sales base and operating income…

Okay, thanks Laurie. I think we have a good sense now as to where the call cut off earlier, so I think Tom’s just going to make a few more comments and then we will open it up to questions.

Thanks, Dan. Apparently, the one topic that we didn’t cover, that we would like to cover now is the breakdown of our flows, just a little color on the flows in the quarter. In our forward reporting, I think it was observed by us and others that the trends we had in the fourth quarter were generally consistent with the third quarter, perhaps the one exception was Parametric's portfolio implementation business where we had net outflows of about $100 million in the fourth quarter compared to $2.9 billion of net inflows in the prior quarter. All of this decline was attributable to institutional mandates for which the longer-term trends remain strongly positive. Even with the down fourth quarter, institutional portfolio implementation mandates contributed over $4.5 billion to our fiscal 2016 net inflows. Our fourth quarter net inflows into fixed income of $1.7 billion were led by municipal and corporate bond ladders, with support from active high yield and management muni strategies. Alternative strategies net inflows of almost $700 million were driven by sales of our two global macro mutual funds with strong performance records now over multiple periods and equity net inflows, which were modestly positive, had contributions from Parametric and Atlanta Capital managed strategies which were somewhat offset by net outflows from Eaton Vance managed equities. In floating rate bank loans, we had net outflows of $600 million in the fourth quarter versus $500 million in the third quarter. The decision by one major intermediary to reallocate away from bank loans accounted for essentially all the fourth quarter net outflows, meaning that net flows from all other sources were substantially flat. While we continue to be subject to these types of lumpy single decision-maker flows both positive and negative, market sentiment towards bank loans has clearly turned. After a long wait, we’re now seeing consistent daily net inflows into our retail bank loan strategies, no doubt influenced by the specter of rising interest rates. Following back-to-back years of bank loan net outflows totaling nearly $9 billion, we appear to be entering a much more favorable environment for our floating rate income business. In a rising interest rate environment, fixed income investors often look to exit longer-duration vehicles to minimize the impact of rising rates on their principal. Assuming that income generation continues to be a priority, a logical alternative is frequently to invest in floating rates and lower duration income strategies. As shown in our list of four and five-star rated funds, we offer not only a highly competitive lineup of floating rate bank loan funds, but also a range of top-performing short-duration taxable and municipal income funds that are positioned to gain assets in a rising rate environment. We’re now starting to see a pickup in investor demand for these products. Relative to other income managers, our leading position in bank loans and other floating rates and short-duration strategies places us in a very favorable position for business growth in a period of rising interest rates. So with that, we will conclude our prepared remarks and open the floor to questions and again our apologies for the interruption.

Maybe a quick follow-up to the floating rate conversation. I think at the last conference, you mentioned you took in a chunk of money, I think it was $15 billion in the last go-round when rates were going up and it proceeded to flow out over the next three years as people kind of pulled on the idea. I guess I’m curious if we should be expecting the same kind of things right now and is there any way to lock those clients for longer duration? I feel different this time; it feels like it could be more sustained moving rates, but I’m sure we said that before, so just curious the type of clients that bought and sold last time and if there is any way to get them to be longer-term commitments?

Interesting question. I think $15 billion was roughly the amount of net inflows we had into bank loan mandates in fiscal 2013. And as you pointed out, I think we had modest growth in fiscal 2014 and then over the last two years we’ve had net outflows totaling about $9 billion. Most of that volatility, not all of it, but most of it has been on the retail side. We have a mix of clients, some who presumably are using bank loans as a substitute for short-term cash, many of whom are making allocations to floating rate income assets as an alternative to longer-duration fixed income, effectively trying to earn income while at the same time avoiding the principal value loss that happens as rates go up. I wish I could say that our business has changed in such a way that I can promise that everyone who buys our bank loan strategies is a long-term investor. I would think the experience of last time will somewhat inform investors' behavior this time. I would not expect to see that same level of $15 billion followed by roughly two-thirds of that going out over the next three years. It's hard to say though, markets are dynamic; expectations today look pretty convincing that rates are likely to move up, but I would have said the same thing in 2013. At that point, all the pieces seemed to be in place for a period of rising interest rates. We had a falloff in the economy later in that year, which really changed the expectations for where rates were going. No doubt, the accommodative policy of the Fed and other central bank regulators around the world has contributed significantly to keeping rates low. But as we do see it, we're in an environment today where there are signs of inflation picking up, there are signals from the Fed that they're inclined to raise interest rates going forward, likely as soon as December. We think this puts us in a really outstanding position to grow our bank loan business in 2017. No doubt, there will continue to be cycles of inflows and outflows, and we're certainly confident that we're likely headed into a period of inflows in 2017 after a couple of years of the market going the other way.

Fair enough, maybe just a related follow-up on the muni side. Higher rates and the prospect of lower taxes usually is a bad thing on that front; just curious on what your expectations are for demand on the muni side?

I think that's right, most muni mandates, most muni securities that are out there are longer duration. Munis are typically issued with a 20-year term; a 10-year call date is kind of the typical new issue. Our muni business is substantially diversified compared to where we were a few years ago. Our ladder business is certainly one of our fastest-growing parts of our overall company where you have, by the nature of that structure, perhaps less sensitivity to client interest rate expectations there. We also have a range of low-duration and floating-rate muni funds, where we’ve started to see some inflows. So I would expect that, given we're more diversified in our muni exposure with a range of not only longer duration strategies but also laddered short-duration and floating-rate strategies, we're actually pretty well positioned for a period of rising rates. Munis have been on a great run in the last couple of years; we've seen nice inflows not only in our funds but in many competitors' funds and separate accounts. That may take a pause, but I think we're pretty well positioned for that given strong performance across our lineups in a range of duration exposures.

I appreciate that, thanks.

Just a follow-up on the comments around the seasonal first half expenses and margins to be flat. I get these dynamics in the first quarter and kind of the reset of expenses for salaries and some of the one-time stuff, but you mentioned first half kind of pressure and so I just kind of want to clarify your outlook versus the first quarter and then kind of the year for margins.

The significant portion of the pressure is in the first quarter, but it obviously trips over a little bit into the second quarter as well. There we’re talking about things like payroll tax reset, so you reset, and then over the course of the year that starts to follow off for us. The big part of the slide is in the first half, down into the third quarter and that goes as well for our 401(k) match, which is a significant contributor to the increase in comp in the first quarter. So there is some impact on the second quarter; it's largely a first quarter effect.

We do have the day count impact in the second quarter, it's not related to the seasonal expense pressures, but it does put pressure on the second quarter revenues.

Great, and then just a follow-up on NextShares, the annual expense, sticking with expenses— the $8 million or so this past year, just curious as the outlook for that kind of next year, if there is any growth routine to that. And then also with the UBS partnership and their implementation, just curious how much, I guess from the cost perspective, a burden that is, or if that’s been lower or higher than some of the numbers you've talked about previously in terms of getting them fully operable or if that’s just kind of any update there to think about, incremental partners in the cost and maybe the challenges there?

Yes, I think we haven’t spoken specifically about the exact amount of the cost associated with the UBS implementation, but I can comment and say that in terms of our total spend for next year, we do think that it will uptick modestly, but only modestly. I think we're looking at something; this year we closed out with roughly $8 million of expenses associated directly with our NextShares initiatives. I think I would push that up to something around the $10 million range in fiscal 2017, recognizing that we are getting a little bit more steam going in terms of the launch and would anticipate that it will have some uptick in expenses there.

Okay, thank you.

Maybe first the follow-up on Glenn's question about the impact of rising interest rates. So in talking about the floating rate, got that, talked about diverse strategies; maybe can you take it a little more into the muni ladders. I can't quite tell what your expectations are. I know that product has been particularly good; it’s a little bit different, so how might the rising rate environment impact that? And then you haven’t talked about the global macros suite. I think in the taper tantrum, it was a little bit disappointing in terms of the defensiveness of that product. I don’t know if the investment priorities would have changed for that fund following the performance in the taper tantrum. So just has anything changed since the last time rates rose, and what are your expectations for global macro?

Happy to take those, Ken. Just on the—I guess first starting on the global macro, this is an actively managed strategy; it is a country-picking approach where we take long and short exposure to different countries and different market areas based on our view on currencies, rates, and other investment factors in those countries. It’s a little hard to say how we’re going to do in a particular environment; it’s not like a bank loan strategy, where it’s primarily a credit play without an interest rate exposure. So the thing about it is there are long and short economies around the world often with a lot of exposure to emerging markets on the debt side. Our performance has been good; one of the things that is consistently true about the strategy is its strength as a portfolio diversifier. Its return in good market environments and bad are consistently low correlated with U.S. stocks and bonds, and that’s really one of its key strengths. So I would point to the strength of the record over multiple time periods, but particularly in the last couple of years under the current management team and its consistent record as a portfolio diversifier. And remind me again your second question, Ken?

Just on the muni ladders, you mentioned the diversity of the muni franchise; obviously, muni retails are probably under pressure with rising rates. But muni ladders, I don’t have a good sense.

I guess the short answer is we’ll see. We did not have a large muni ladder business the last time rates moved up. What I would expect would be to have less interest rate sensitivity in that business, meaning in the flows of that business, than you would see in a muni bond fund. One of the appeals of ladders is the portfolio construction, where you get the transparency into what’s happening there, you get the assurance that positions in the ladder will be rolling off in a very transparent, rules-based fashion. We think—and I think there is good history on this—that advisors construct ladders, and that clients are more inclined to stay with a ladder-type construction than with a fund, where really all they see month-to-month is the performance volatility that you get in a fund. Here, while it’s true you’re going to have similar volatility in the underlying bonds, because of the nature of the portfolio construction and the mechanism with which that approaches by the advisor and the client, we expect it will show less interest rate sensitivity than traditional muni funds. I would not be surprised though, with changes in rate expectations for the mix of business there to shift somewhat. So for example, the mix between 5 to 15-year ladders versus 1 to 10-year ladders. If your expectation is that rates might move up, likely we’ll see shorter duration ladders, and we’re really indifferent to that in terms of how we approach the business.

Great, thank you very much.

Back to the bank loan discussion, I appreciate the kind of broad guidance on what you've been seeing over recent days, but if you look at the broader industry trend, the last couple of months, you saw a really big uptick at least in the retail data we can see, which you don't appear to have benefited from. Obviously, we saw you benefit from it in 2013, so I'm just curious if you could dig in on maybe what's driving that apparent loss of market share.

Yes, we referenced in my prepared remarks, and I don't know whether this was part that got cut off or not, but we referenced that the outflows we experienced in the quarter that ended in October were essentially a function of one large intermediary making a decision to reallocate away from bank loans during the quarter. We believe we were most of their bank loan exposure, and so there were roughly $600 million of flows, and these came out of our—these were fund; this was not an institutional account relationship. That's the factor we would point to on a net basis to account for our, maybe apparent, share loss during the period you're looking at. That was meaningful. The good news is it's done; we look at our flow results on a daily basis, which are reported, I guess, monthly. So the data is out there; you can look at how we're doing. I would think if you would look at the data over the last months, you're probably seeing us doing better; that's what our internal numbers show. We fully expect, based on our performance where we are in terms of fee rates and our reputation as a long-term leader in this space, that if there is a significant recovery in bank loan flows, we will fully participate in that.

Okay, I heard that. I think that's supposed to adjust for basically flat for the quarter, and at least in September and October, we saw in the industry flow a significant uptick from the previous month.

Patrick, I am reviewing the flow distribution among our various vehicles, and our open-end funds would have performed well in the quarter if not for a specific outflow. Additionally, we experienced negative performance in our institutional loan fund, which isn't visible in public flows. The combination of this negative performance and the allocation out resulted in flat flows for the quarter. Excluding the $600 million in outflows, we had strong positive retail flows for the quarter.

It's probably worth saying that we're not taking it for granted that we'll participate fully in inflows into bank loans; we're working hard to make that happen with quite active, quite aggressive marketing campaigns and roadshows in support of our bank loan business ongoing currently.

Tom, just on the portfolio implementation and flows. You mentioned that the outlook still looks attractive despite the modest outflows in the quarter. Just wanted to get a sense when you think about the portfolio implementation and then exposure management. How much visibility do you have in terms of pipeline and maybe a better point would be just when you think about the market size, the opportunity that you guys are targeting, like how big is that because obviously the growth in those areas has been strong?

Let me break that up into a couple of different areas. What we call custom beta and the slide that appears on our deck doesn’t conform exactly to our reporting of flows by investment mandate. So what we’re calling custom beta and you can see in that slide, a strong long-term trend, most of that is in portfolio implementation; but the fixed income part is not, that’s in our fixed income category. A pretty big chunk of the portfolio implementation category is what we’re calling the equity portion of custom beta and that's showing in that slide. There is also in portfolio implementation a pretty large institutional business and that institutional business is more lumpy, like most institutional businesses, and as we described, the downturn in overall portfolio implementation flows in the quarter was really completely attributable to what we think are temporary factors affecting that institutional business. So, and then I guess the third piece to talk about is exposure management, which is 100% institutional, also lumpy, it's been lumpy in a good way, and we certainly expect that to continue. But I would say that if you look inside portfolio and implementation and exposure management together, the retail and high net worth piece of that, we don’t have good visibility on individual pieces of business generally, but it's a diversified business with very strong momentum. The underlying drivers of that which is then move to passive, which is the value-added that we can provide in terms of tax and customization to reflect responsible investing criteria and other factors and the enhanced service offerings of those products and increased distribution. All of those things argue to us very strongly that that business will continue to grow in a sustained way, and we think the potential of that custom beta business is very, very large. We have, as I said, about $45 billion in assets; they are currently relative to the overall world of passive management as expressed by ETFs or index funds, we’re really just a drop in the bucket. But we think for taxable investors we've got very significant value-add opportunities; even for non-taxable investors, we think there are the reasons to choose a customized separate account as opposed to a fund for long-term index exposures. On the part of the business where we do tend to have some visibility, which is the institutional—and here again, I'm talking about both portfolio implementation and exposure management—we do have a pipeline; we kind of know what's coming. That isn’t always a perfect read, but we have a quite robust pipeline currently that makes us optimistic that we’ll continue to grow there in 2017. This is a lumpy business; there will be periods when things will go the other way, but long term we see all these areas as continuing to provide very strong undercurrents to Eaton Vance’s growth picture. These are very competitively priced, high value-added services where Parametric is a recognized market leader. Most of this business today, an overwhelming portion of that is in the U.S. We’re starting to grow a bit outside the United States. Australia is a market that has good potential where Parametric has been successful; but we’re starting to, we think, see some potential for growth in Europe and Asia and other parts of the world. There is nothing that I see that suggests that we’re close to a saturation point in these businesses. We’ve some visibility that makes us confident that 2017 will be a good year, but beyond that; it’s really looking at the value proposition that we provide with these products and being confident that that will continue to attract investors longer term, as opposed to having a sense of visible pipeline beyond the—say the first half of next year.

Okay, that’s helpful color. Just a small thing, when you talk about the margin and the seasonality in the first quarter and second quarter. It makes sense—I’m just trying to get a sense of when we think about the market strength or weakness, is there a like a certain market environment that that implies? And then just one small thing on the share count. Just given the tick-up, just wanted to understand what’s being driven by either grants versus stock price and then the policy on buybacks to either try to keep the share count flatter, do you have any update there?

So the first question in terms of margin and expectations, we’re generally talking about—largely when I give that guidance, it’s largely on flat markets. I do think that our comp as a percentage of revenues is likely to hang out in that 36% to 37% range in 2017. In terms of our share count, we bought back fewer shares in the fourth quarter than we did in the third. We do have the increase in the stock price, which does affect that sort of treasury stock calculation you have to do for diluted shares outstanding, so you've got two pressures there. We do not have a stated policy in terms of repurchasing shares in order to offset dilution. I think that from a capital management perspective, we look at our capital deployment more in terms of priorities: first to grow the business, so that would be in terms of funding organic efforts as well as potential acquisition, maintaining our dividend, and then to the extent we think is appropriate entering the market to buy back shares. We have been in the market buying back shares; we would anticipate we would continue to do so. But obviously, we stepped back a little bit in the fourth quarter recognizing that we have some cash obligations coming up in relation to the Calvert purchase and obviously we’ve got fourth-quarter bonuses, et cetera. So I wanted to state we will continued to be in the market, but we certainly don’t have a stated policy that we’re going to be out there to offset dilution.

I want a follow-up on the bank loan discussions. How do you feel about capacity in those strategies today? Just thinking that if there is less robust new issuance in a rising rate environment, supply could become constrained, and any thoughts there would be helpful.

Yes, I think we’re at about $32 billion in bank loan assets today. I think our peak was probably $45 billion. When we were at that mid-$45 range, we were starting to talk about the possibility of a close or a pause in accepting new money. We don't see any particular pressures there today. It's certainly possible that if we see robust growth, at some point we'll close this; but I guess it would require a fairly sizeable growth in our business from current levels for us to really entertain those discussions. I was certainly talking a lot about this in 2013 as the business was growing at quite an accelerated pace for a number of consecutive quarters. If that happens again, we will—and if it proves to be the right thing for our clients, we will contemplate closing the strategy. But from our current size and given the further build-out of the bank loan asset class, we don't think we're anywhere close to that being a current concern.

Okay, makes sense. And on NextShares, just wanted to get your updated thoughts, Tom, on how the conversations are going with larger fund managers. Are they telling you they want to see another one or two large distributors? What are kind of the gating factors to get them more engaged?

I think we're getting pretty close in that the gating factors are a couple of things. One is this real? Do these things work? Are there performance advantages that come from the structure? Will they trade acceptably? When we launched our first products back in February and March, pretty much the focus was on demonstrating to the market, both fund companies, broker dealers, and others that this is real; that there is a performance advantage that can come from NextShares; and that these things will trade in a fully transparent way with premiums and discounts that are acceptably narrow by market standards. That's been pretty much done. We haven't covered every asset class, but we intentionally chose the first three to cover a range of domestic and international and equity and fixed income strategies. The second requirement, which is really the one you touched on in your question, is distribution access. When we launched those first funds, the only distributor for NextShares was Folio Investing, which is a small online broker-dealer. Since then, we've added Interactive Brokers, which is now up and running and available. You can buy the Eaton Vance and the sponsored NextShares funds today both at Folio and at Interactive Brokers. The big announcement, the big development over the course of the summer was the announcement that UBS was planning to offer and is supporting its business partners to offer NextShares. I would guess of the top 20 largest fund companies, none of them have either Folio or Interactive Brokers as one of their top five distribution partners. I would guess a substantial majority of those companies have UBS as one of their largest distribution partners. The way things work in our business frequently is demand drives product recreation, and if UBS is engaging with its business partners to encourage them to offer NextShares, I think it's highly likely that will happen. The barriers to launching NextShares are pretty low; we provide significant technical support for the process, the path to regulatory approval is well established and quite short at this point. We don’t think it will take a lot of encouragement from UBS and potentially other broker dealers in 2017 to convince major fund companies to launch new products. We've had conversation over the last maybe two months about new share classes being offered, being created and to be offered by fund companies in response to demand from broker dealers. If there is demand for NextShares from UBS and potentially other broker dealers, which I think we should expect to see, major fund companies will line up to launch strategies in that structure. We’re working hard to make that happen. Certainly, the commitment of UBS to this is a real game changer for us and puts us in a position where we see a much broader range of companies launching NextShares products in 2017.

Alright. Thanks a lot.

I guess maybe to stick with NextShares as my first question, I'm just curious, I mean, are there any kind of time pressures you face to try to kind of monetize this? I mean, some of you have some underlying patents and whatnot, but patents to grant for a certain period of time and then they kind of open up. So is there anything—because these were obviously developed before you bought it: you've owned it for a few years before you got the approval and it's taking some time to kind of monetize it in the marketplace, so do you feel comfortable that you have enough time to monetize this and kind of reap the benefits before there is some pressure on what's proprietary about it?

Good question. I would say our primary driver to get this done is we're spending a fair bit of money. We're spending $8 million, Laurie said in the range of $10 million next year, we think. That's the primary motivation from an economic standpoint. I would say more broadly, there is a real sense of mission that we have here, that this is a better way to invest and actively manage strategies. It's partly driven by that sense of mission that we continue to invest in this and continue to push hard to make NextShares a reality in the marketplace. As you pointed out, there are part of the basis for this business is patents that were issued I believe initially in 2005 or 2006 timeframe. Those patents right there will expire, but we've not surprisingly as we've invested in this business, we've also invested in newer technology and have been working on additional patents as well that we think our protection here will likely extend well beyond that 2026 period that you would normally expect given the 20-year cycle on patents application. So we think there is a significant enough window here to justify this as a quite attractive commercial proposition for Eaton Vance. But our enthusiasm for this is not unending; at some point, if this is not going to work, the market will demonstrate that to us clearly. We’re very focused on achieving success here, but are mindful that not all great ideas work. But we want to push this as hard as we can, and we’re very committed to doing that throughout 2017.

Great, and maybe the follow-up or two on Calvert. So expected to close hopefully by the end of the year. Where do you see kind of the initial opportunities with that? How quickly can you kind of, for example, plug their funds into your distribution? Is that something that can happen relatively quickly, or do you see there is more of an institutional opportunity? I mean, how do you think about the path of accelerating their growth?

It’s something we’re very focused on. I would say first on the time of the closing, the key gating item is the approval of fund shareholders, so there is an approximately that’s been sent out; there’s a shareholders meeting that’s been scheduled for I think December 16. There is some possibility that if they don’t get to vote in time, that the closing gets pushed out somewhat, but certainly the early returns are supportive of the vote. But there is a requirement in these things that at least 50% of the outstanding shares cast their vote, and sometimes it’s a challenge—maybe particularly at this time of the year—to get people to cast their vote even if they don’t necessarily have any objections to what’s being proposed. On the distribution side, we’re very focused on that. One of the things that we have done is entered into an agreement between Eaton Vance distributors and Calvert for Eaton Vance to begin marketing, ever prior to the closing. We have an agreement in place, so Eaton Vance salespeople will be out, I think starting next week, actually starting this week, excuse me, talking about Calvert funds, making the case for why Calvert is a stronger and better company as part of Eaton Vance. The growth opportunities we see here really extend across a pretty wide range. Calvert’s growth today is primarily on their equity index products. Through working with people at Parametric, we think they can potentially broaden the range of index strategies and continue to grow there. Their fixed income side of the business has a number of high-performing strategies, including quite interestingly some short-duration and also short-duration products that are four and five-star rated, that we think with given what’s happening with rates and given the interest at getting a wider range investors have today and shortening up their fixed income portfolio, could be really exceptionally well positioned. It might probably be useful to understand that Calvert has had three field salespeople, all of them are based on the West Coast. They have had nobody covering the rest of the country, and in fact, they’ve had a couple of phone reps covering the rest of the country. Eaton Vance will take what was three sales reps and replace that by something north of 75 sales reps. Now there are some other things as well, but we think that the amount of conversations that will take place in the warehouse channel and the independent channel and in the RIAs channel about Calvert's strategies and about responsible investing will go up by, I would say, at least an order of magnitude as a result of this transaction. On the institutional side, we think there are some low-hanging fruit. We have a wide range of high-performing reputable strategies, primarily on the fixed income side where being able to offer a responsibly managed version of, for example, the Eaton Vance high yield strategy or the Eaton Vance bank loan strategy or the Eaton Vance core bond plus strategy. Those are all things that we're focused on doing quite soon after closing where we think there is essentially untapped market demand there. While there’s been a fair bit of movement of assets into responsibly invested and sustainably invested equity strategies in a growing range of companies that would claim to have at least some level of proficiency there, there isn't much happening to date on the fixed income side, and we're actually taking inbound calls from clients and consultants who are interested in saying, “Hey, can you offer XYZ strategy, high yield, bank loans, core bond plus? Can you do that in a responsibly managed fashion in combination with Calvert?” Our answer of course is yes. We expect to make those strategies a key part of our institutional focus right out of the box in 2017. So things are starting to happen on the retail side; this week on a preliminary basis, we're getting our sales force exposed to these products; we're making sure that they're out there making the case to the advisors they work with that this is a good transaction; that what comes out of this is a stronger Calvert, not a diluted Calvert. But we're also very hopeful that we'll see meaningful flows on the institutional side next year. Calvert has had very little sales and marketing resources to devote to institutional markets in recent years. They've really been a resource-constrained organization and one of the key things we bring is the resources and reach into essentially all segments of the market, both retail and institutional.

Great, thank you very much for the helpful color, appreciate it.

Great, and thank you, thank you all for joining us this morning. We wish you all a happy and safe Thanksgiving and look forward to reporting back to you at the end of our first fiscal quarter. Thank you.