Morgan Stanley (MS) — Q2 2018 Earnings Call Transcript

Good morning. And welcome to our fiscal 2018 second quarter earnings call and webcast. With me this morning are Tom Faust, Chairman and Chief Executive Officer of Eaton Vance; Dan Cataldo, our Chief Administrative Officer; and Eric Stein, our new Treasurer and Director of Investor Relations. As many of you are likely aware, Eric joined Eaton Vance last month to replace Dan as Treasurer and Director of Investor Relations following Dan's promotion to Chief Administrative Officer upon the retirement of Jeff Beale. Welcome Eric and congratulations Dan on your new responsibility. In today’s call, Tom and I will first comment on the quarter and then 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. Just a reminder, that 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 2017 Annual Report on Form 10-K, are available on our website or upon request at no charge. I'll now turn the call over to Tom.

Thank you, Laurie, and good morning everyone. Earlier today, Eaton Vance reported adjusted earnings per diluted share of $0.77 for the second quarter of fiscal 2018, which is up 24% from $0.62 of adjusted earnings per diluted share in the second quarter of fiscal 2017, and down 1% from $0.78 in the first quarter of fiscal 2018. For the first six months of fiscal 2018, we reported adjusted earnings per diluted share of $1.54, an increase of 34% from $1.15 in the first half of fiscal 2017. Of the $0.39 per diluted share increase in first half adjusted earnings, $0.23 was attributable to growth in operating income, $0.12 is the net effective lower income taxes and the remaining $0.04 reflects the lower interest expense and other non-operating items. We ended the fiscal second quarter with $440.1 billion of consolidated assets under management, up 14% or $53.1 billion from a year earlier. The year-over-year increase in consolidated managed assets reflects net inflows of $28.6 billion and market price appreciation in managed assets of $24.5 billion. Consolidated assets under management declined 2% from the end of the fiscal 2018 first quarter, reflecting second quarter consolidated net inflows of $4.4 billion and $13.6 billion of market-driven price declines in managed assets during the quarter. The $4.4 billion of consolidated net inflows in the second quarter equates to 4% annualized internal growth in managed assets. Excluding the $3.6 billion of net outflows from exposure management mandates, which are both lower fee and more volatile than the rest of our business, we had $8 billion of consolidated net inflows in the second quarter, an increase of 7% over last year’s second quarter and up 43% from the first quarter of fiscal 2018. Reflecting strong inflows into a number of higher fee strategies, we generated annualized internal growth in consolidated management fee revenue of 7% in the second quarter, matching the first and second quarters of fiscal 2017 as the highest quarterly organic revenue growth rate we’ve posted since we began reporting this metric a couple of years ago. As we define organic revenue growth, it is the change in our consolidated management fee revenue, resulting from inflows and outflows, taking into account the fee rate applicable to each dollar in and out and excluding the impact of market action and acquisitions. By this measure, we believe Eaton Vance is among the fastest growing of U.S. listed public asset managers. A key contributor to our continuing strong internal growth is favorable investment performance. As shown on Page 14 of the call slides, at the end of April, 50% of our U.S. mutual fund assets were in funds ranking in the top quartile of the Morningstar category on a three-year basis, and 55% of our U.S. mutual fund assets ranked in the top quartile among pure funds on a five-year basis. We ended the second quarter with 67 U.S. mutual funds rated four or five stars by Morningstar, including 23 five-star rated funds. As we highlighted last quarter, our second key contributor to our strong quarter results is the broad range of high-performing strategies we offer in investment areas, having particular appeal during periods of rising interest rates, such as we are now experiencing. These include our floating rate income, short-duration fixed income, and absolute return strategies. At the end of April, we had two floating rate bank-owned funds, four short-duration income funds, and a global macro absolute return fund, all rated five stars by Morningstar. Each of these strategies is a current focus of our sales teams. Digging into our quarterly net flows by investment mandate, the three leading categories were floating rate income, fixed income, and portfolio implementation, all with between $2.2 billion and $2.4 billion in net inflows for the quarter. Within the floating rate loan category, second quarter net flows were well balanced between retail and institutional and between U.S. and non-U.S. clients. Japan remains our most important market for bank home mandates outside the U.S. and contributed significantly to second quarter net flows. Within fixed income, the largest flow contributor was the laddered bond separate accounts, which had $1.5 billion in net inflows during the quarter. Other leading contributors to fixed income category net inflows were high-yield bonds, emerging market debt, and short-duration U.S. government inflation-protected and strategic income mandates. On an overall basis, we grew fixed income across funds and separate accounts, and with both retail and institutional clients. In portfolio implementation, net flows in Parametric Custom Core separate accounts offered to retail and high net worth investors, continued to dominate the category, accounting for $2 billion to $2.2 billion total category net inflows in the second quarter. After a slowdown in the first fiscal quarter, likely related to uncertainty about the new tax bill while it was being deliberated, net flows in the custom core mandates rebounded sharply in the second quarter, increasing by nearly 40% sequentially. As in other recent quarters, flows in our alternative asset category were driven by Global Macro Absolute Return mandates, which had net inflows for the quarter of just under $0.5 billion. Within equities, leading contributors to quarterly net inflows included EVM Growth, Parametric Defensive Equity, Calvert Emerging Markets, and Calvert Responsible Index Funds. As previously mentioned, our exposure management business had net outflows of $3.6 billion in the second quarter of fiscal 2018. This compares to net inflows of $5.4 billion in last year's second quarter and $1.5 billion of net inflows in this year's first quarter. As a reminder, this Parametric offering applies financial futures and other derivative instruments to help large institutional investors efficiently manage the equity, duration, currency, and other market exposures within their portfolio with Parametric serving on either a discretionary or non-discretionary basis. The exposure management outflows we experienced in the second quarter reflect net withdrawals from client positions on which we earn a management fee. Substantially, all of the net flow outflows are attributable to declining balances and continuing client accounts rather than loss of clients. Despite the volatility of this business contributing to our quarterly reporting and fee rates averaging only 5 basis points annually, we continue to view exposure management as a core offering with solid profitability and good growth prospects. Having a strong exposure management franchise also helps us establish and maintain closer relationships with a client roster that would be the envy of any asset manager. In many cases, Parametric client relationships that started with exposure management mandates have migrated to also include other strategies. In recent investor communications, I’ve talked about Eaton Vance’s five strategic priorities for fiscal 2018, which are; capitalizing on our strong investment performance and favorable positioning to grow in active management; extending the success of our Parametric Custom Core and EVM bond laddered separate account franchises in passive and quasi-passive management; becoming a more global company; leveraging the Calvert acquisition we made at the end of 2016 to become a leader in responsible investing; and finally, positioning NextShares to become the vehicle of choice for U.S. investors in actively managed funds. Here's a brief progress report on each of those initiatives. As I mentioned earlier, we view our broad lineup of high-performing funds and separate accounts and our leadership in investment strategies that are well positioned for a rising interest rate environment as presenting significant opportunities for Eaton Vance to grow in active management, even as the overall market for active management continues to decline. Our confidence in the growth potential of our active strategies was borne out in the second quarter. During the quarter, net flows into our actively managed funds and accounts totaled $4.2 billion, equating to 8% annualized internal growth in managed assets. Based on results for the first three weeks of May and visible pipeline, we expect positive active strategy flows to continue in the third quarter. In the marketplace and internally, we sometimes refer to our Parametric Custom Core and EVM bond laddered separate account strategies offered to the retail and high net worth market as custom beta; these high-value strategies continue to demonstrate broad market appeal and significant growth. During the second quarter, net flows into our custom beta separate accounts totaled $3.5 billion. This equates to 18% annualized internal growth in custom beta managed assets. As with our actively managed strategies, results to date and the pipeline of not funded new business give us confidence that strong growth of our custom beta franchise will continue. Our business outside the United States remains significantly underdeveloped, representing only about 6% of our consolidated managed assets. Both in terms of globalizing our investment offerings and expanding our distribution reach outside the U.S., we continue to pursue growth opportunities. During the second quarter, net flows into funds and accounts managed for Eaton Vance clients outside the U.S. were $1.4 billion, which equates to 22% annualized internal growth in assets managed for non-U.S. clients. As we near the 17 months in our ownership of Calvert, we feel good about what we've accomplished and even better about the opportunities ahead of us to capitalize on Calvert's leading brand and expertise in responsible investing. While we are still in the early stages of repositioning Calvert beyond its historical roots in the U.S. retail market, Calvert branded strategies have generated just over $500 million of positive net flows in the second quarter, which equates to 14% annualized internal growth in managed assets. With a host of new business initiatives now in progress at Calvert and investor interest in responsible investing continuing to build, we are confident that Calvert's best growth lies ahead. Finally, with NextShares, our focus continues to be on achieving commercial success for our distribution relationship with UBS, and using that success as a springboard to gain broader distribution reach and enter into licensing arrangements with more fund sponsors. There are currently 17 NextShares funds from eight fund families listed for market trading, including those from six unaffiliated fund groups: Brandis, Causeway, Gabelli, Hartford, Ryan Hart, and Allen Ried. About half of those 17 funds are currently available for purchase at UBS with the balance working their way through UBS’s due diligence. Sales today at UBS have been modest, just beginning to open as more funds clear due diligence, more advisors complete required product training, and more wholesale retention gets devoted to NextShares. In the long journey to commercialize NextShares, the coming 12 months will be pivotal. We now have an initial range of approved NextShares funds and a major distribution partner committed to working with us to bring these funds to market. Now it's the time to begin translating that potential into sales success. In closing, these continue to be good times at Eaton Vance. Our business has strong current momentum, driven by high-performing investment franchises well positioned for the current market environment, a range of specialty offerings with broad and growing market appeal, and strong distribution and client service. Longer term, we believe that Eaton Vance is a culture inheriting the capital structure distinctively supportive of continued business success as the management industry evolves. That concludes my remarks. And I'll now turn the call over to Laurie.

Thank you, and again good morning. As Tom mentioned, we’re reporting adjusted earnings per diluted share of $0.77 for the second quarter of fiscal 2018, an increase of 24% from $0.62 of adjusted earnings per diluted share in the second quarter of fiscal 2017, down 1% from $0.78 of adjusted earnings per diluted share reported in the first quarter of fiscal 2018. Second quarter’s seasonal factors, primarily reflected three fewer fee days and three fewer payroll days in the quarter, reduced earnings by approximately $0.02 per diluted share sequentially. As you can see in attachment two to our press release, adjusted earnings trailed GAAP earnings by a penny per diluted share in the second quarter of fiscal 2018 due to the reversal of $1.9 million of net excess tax benefits recognized from the exercise of employee stock options and investing in restricted stock awards during the period. Adjusted earnings per diluted share matched GAAP earnings per diluted share in the second quarter of fiscal 2017 and exceeded GAAP earnings in the first quarter of fiscal 2017 by $0.15 per diluted share, reflecting the impact of tax law changes, a newly adopted accounting standard addressing the treatment of stock-based compensation, and the expiration of the Company's options to acquire an additional 26% ownership interest in our 49% owned affiliate tax vest. Our operating income in the second quarter fiscal 2018 was up 13% from the second quarter of fiscal 2017, down 2% sequentially. Our operating margin was 32% in the second quarter fiscal 2018 versus 31.5% in the second quarter of fiscal 2017, and 32.2% in the first quarter of fiscal 2018. Operating margin for the first six months of the fiscal year improved from 30.6% in 2017 to 32.1% in 2018. Ending consolidated managed assets of $440.1 billion at April 30, 2018 were up 14% year-over-year, driven by strong net flows and positive market returns, and down 2% sequentially, primarily reflecting market price declines in February and March, partially offset by strong net inflows. Average managed assets in the second quarter of fiscal 2018 increased 17% from the second quarter of fiscal 2017, driving an 11% increase in revenue. Revenue growth trails growth in average managed assets year-over-year, primarily due to the decline in our average annual management fee rate from 34.7 basis points in the second quarter of fiscal 2017 to 33.3 basis points in the second quarter of fiscal 2018. This decline in our average annualized management fee rate is primarily attributable to outsized growth of our lower fee portfolio implementation and bond ladder businesses. Our average managed assets for the second quarter were up 2% from the first quarter of fiscal 2018. Second quarter revenue was down 2%, reflecting the impact of three fewer fee days in the second quarter and a modest decrease in our average annualized management fee rate. The sequential decline in our average annualized management fee rate from 33.7 basis points to 33.3 basis points primarily reflects the continuing shift in our business mix, driven by strong net flows into our lower fee portfolio implementation and bond ladder businesses. Strong net inflows into several higher fee strategies in the second quarter helped mitigate the mix-driven fee rate decline. Performance fees, which are excluded from the calculation of our average management fee rates, reduced earnings by $0.5 million in both the second and first quarters of fiscal 2018, and were negligible in the second fiscal 2017. Tom noted, in the second quarter of fiscal 2018, our annualized internal growth in management fee revenue of 7% outpaced our annualized internal growth in managed assets of 4%, primarily reflecting the impact of net inflows into higher fee strategies during the quarter. This compares to 7% annualized income growth in management fee revenue on 14% annualized internal growth in managed assets in the second quarter fiscal 2017. A 5% annualized internal growth in management fee revenue on 7% annualized growth in managed assets in the first quarter of fiscal 2018. Based on current sales trends and the visible pipeline of pending flows, we continue to be optimistic about our ability to achieve positive organic growth in management fee revenue over the balance of fiscal 2018. Turning to expenses, compensation expense increased by 9% from the second quarter of fiscal 2017, reflecting higher headcount, year-end increases in base salaries, increases in our corporate 401(k) match, and other benefit costs, increases in operating income and performance-based bonus accruals, and higher stock-based compensation, partially offset by a decrease in sales-based incentive compensation. Sequentially, compensation expense decreased by 5% from the first quarter fiscal 2018, reflecting lower stock-based compensation, a decrease in operating income-based bonus accruals, lower sales-based incentive compensation, and a decrease in base compensation, driven by fewer payroll days in the second fiscal quarter. Non-compensation distribution-related costs, including distribution and service fees and the amortization of deferred sales commissions, increased 4% from the same quarter a year ago, and decreased 3% sequentially. The year-over-year increase primarily reflects higher marketing and promotion costs, higher commissions and amortization for private funds, and increases in intermediary marketing support payments, mainly driven by higher average managed assets. The sequential quarterly decrease primarily reflects reduced intermediary marketing support payments and lower distribution and service fees, driven primarily by lower average managed assets and share classes that are subject to these fees, and the impact of three fewer fee days in the second quarter. Fund-related expenses increased 29% and 3% versus the second quarter of fiscal 2017 and the first quarter of fiscal 2018, respectively, primarily reflecting increases in fund subsidy accruals and higher sub-advisory fees paid. Other operating expenses increased 14% and 10% versus the second quarter of fiscal 2017 and the first quarter of fiscal 2018, respectively, primarily reflecting increases in information technology spending, as well as higher facility, professional services, and travel expenses. We continue to spend approximately $2 million per quarter in connection with our NextShare initiative. Net gains and other investment income on seed capital investments contributed a penny and $0.02 for earnings per diluted share in the second quarters of fiscal 2018 and fiscal 2017 respectively, and were negligible in the first quarter of fiscal 2018. When quantifying the impact of our seed capital investments on earnings each quarter, we take into consideration our pro-rata shares of gains, losses, and other investment income earned on investments in sponsor strategies, 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 these investments within the per share impact, net of income taxes and net income attributable to non-controlling interest. We continue to hedge the market exposures of our seed capital portfolio to the extent practicable to minimize the associated earnings volatility. Net gains and other investment income in the first quarter of fiscal 2018 included a $6.5 million charge to reflect the expiration of the Company's option to acquire an additional 26% ownership interest in Hexavest under the terms of the option agreement entered into when we acquired our initial 49% ownership interest in 2012. We excluded this one-time charge from our calculation of adjusted net income and adjusted earnings per diluted share for the first quarter. Consolidated CLO activity contributed $800,000 and $1.6 million to non-operating income in the second and first quarters of fiscal 2018 respectively. Turning to taxes, our effective tax rate for the second quarter fiscal 2018 was 26.7% versus 37.5% in the second quarter of fiscal 2017, and 36.3% in the first quarter in the first quarter of fiscal 2018. The Company's effective tax rate for the second and first quarters of fiscal 2018 reflect net excess tax benefits of $1.9 million and $11.9 million respectively related to the exercise of stock options and investing in restrictive stock awards during those periods. New accounting guidance adopted in the first quarter requires these net excess tax benefits to be recognized in earnings. The Company's income tax provision for the first quarter of fiscal 2018 also included a non-recurring charge of $24.7 million to reflect the estimated effect of U.S. federal tax law changes enacted in the first quarter. As noted previously, our calculations of adjusted net income and adjusted earnings per diluted share remove the effect of the net excess tax benefits recognized in the second and first quarters in connection with the new accounting guidance and the non-recurring impact of the tax reform recognized in the first quarter. On this basis, our adjusted effective tax rate was 28.2% and 26.7% in the second and first quarters of fiscal 2018 respectively. On the same adjusted basis, we estimate that our quarterly effective tax rate for the balance of fiscal 2018 and the fiscal year as a whole will range between 27.5% and 28%, and our fiscal 2019 effective tax rate will range between 25.3% and 25.8%. During the second quarter of fiscal 2018, we used $36.2 million of corporate cash to pay quarterly dividends of $0.31 per share, and repurchased 1.3 million shares of non-voting common stock for approximately $73.1 million. Our weighted average diluted shares outstanding were $123.8 million, up 7% year-over-year and substantially unchanged from the first quarter. We finished our second fiscal quarter holding $791.4 million of cash, cash equivalents, and short-term debt security, and approximately $369 million in seed capital investments, and with outstanding debt obligations of $625 million. We continue to place high priority on using the Company's cash flow to benefit shareholders. Even as we support strong business growth, we maintain significant financial flexibility. This concludes our prepared comments. At this point, we'd like to take any questions you may have.

The fee rate, particularly in floating rate, came down a little bit more than we would have expected. Are there any timing issues around when flows came in and out, or is there anything you want to point out? And in particular, is there a mix shift within the floating rate bucket driving that to come down so much?

The main development during the quarter was continued growth in the institutional segment of the business, which typically has a lower fee rate compared to our recent products. You may notice that this rate fluctuates, primarily due to the mix of retail and institutional. I mentioned that we experienced good growth offshore in the second quarter, mainly in bank loans, and that growth was mostly institutional. I hope that provides some insight.

And then on the pipeline commentary, I appreciate that. Could you maybe scale that relative to last quarter and this point last year?

So that's on pipeline on our business generally or on specific…

I think you're talking about…

I don't have that on my fingertips, I don't recall where that was last quarter versus or the year ago quarter. We're looking for the quarter on the order of $3 billion or so of net flows for which we see a visible pipeline. Understand that includes a mix of both active and passive businesses, and a fair bit of that is Parametric business, including that exposure management where we do expect net inflows. But I would say on an overall basis, the pipeline is robust. We've got multi-hundred-million-dollar visibility and to growth macro absolute return franchises, Parametric emerging markets, high-yield bond, custom core sense of equity, and exposure management.

This is Geoff filling in for Mike, thanks for taking our question. So just looking at the $800 million of cash and equivalents in the short-term investments. How much of that would you say is free to return versus tied up due to regulatory or other needs? And then maybe longer term is there a total payout ratio that you typically target?

Well, we don’t have in our precise number on what cash is tied up in regulatory. But we feel like we can comfortably run the business with $200 million in cash. It's probably something close to 100 that would be tied up due to regulatory…

Included within that 200.

Exactly, yes. The second part of your question was?

So I think on the total payout ratio over the long term…

Yes, it's certainly something we look at each year when we review our dividend for the upcoming 12 months, and that typically is done mid-October. So it’s definitely something we consider in addition to cash needs to support the growth of the business.

And I would say that on an overall basis long-term it’s 100%, we have no other reason for being than to earn cash and cash flows for our shareholders, and returning that to shareholders either through dividends or stock repurchases is certainly a long-term goal and strategy and consistent with the history of the Company. The fact that we’ve seen a buildup in cash over the last several quarters doesn't reflect the change in that philosophy.

Question for you just in terms of flows, and appreciate the last comments, so seeing across the range of the platform. Could you fill in maybe one level deeper and give us a sense of maybe where you’re seeing the volumes coming from? Is it from other places with lesser performance or is there any mix shift that you’re seeing in terms of allocations whether it be on that retail gatekeeper side or on the institutional consultant side?

It may be useful to break this down further. The situation differs between our active and more passive businesses, starting with the active sectors. In bank loans, we’re benefiting from two main factors: first, bank loans have attracted significant investments due to expectations and realities surrounding rising interest rates; second, our strong performance has helped us gain market share among bank loan managers. This is a combination of an expanding sector that reflects cyclical trends, potentially alongside some secular growth, and a robust performance profile for Eaton Vance. I want to highlight our absolute return strategies, particularly in global macro absolute return, which gain from the trend of investors seeking to diversify away from fixed income and duration risk into strategies that invest mainly in emerging market currencies and short-term debt instruments. We are likely gaining market share in this area, as Morningstar categorizes us in non-traditional bonds. Notably, we've increased our market share in this category over the past few quarters. This trend generally holds for our other short-term income strategies as well. We have a short-duration government fund, a short-duration strategic income fund, and a short-duration inflation-protected fund, all experiencing net inflows, supported by strong performance. I believe all these funds are five-star rated and are well-positioned to cater to investors looking to lessen their duration exposure within fixed income. On the more passive side, mainly consisting of what we call custom beta, we are benefiting from a couple of factors. On the equity side, we offer customized index-based separate accounts as alternatives to index ETFs and indexed mutual funds. This custom exposure allows people to implement responsible investing criteria or desired portfolio tilts, along with better tax treatment of holding individual securities instead of investments in a fund. The primary advantages are two-fold: first, the ability to fund positions without selling and realizing taxable gains; second, the ability to currently harvest and pass along the value of realized capital losses, which cannot be done in a fund context. In fixed income, our separate accounts for laddered municipal and corporate bonds are primarily sold through broker-dealer channels, capitalizing on the trend of migration from brokerage accounts to advisory relationships, especially in fixed income and laddered bond accounts. We believe we hold a leading position in this market, with industry-leading relationships, performance characteristics, and service levels. Overall, it's challenging to separate market and share developments. While we have solid data on our fund side, we lack detailed data on market share outside of this. However, we feel we're gaining market share in key categories while benefiting from substantial market trends that are directing business towards areas we prioritize, such as short-duration or floating-rate income and our custom beta strategies.

And then maybe a follow-up for Laurie, I may ask this question quarter-after-quarter, I do apologize for the repetition of it. Can you give us a sense of how you’re thinking about margins from here? And I am trying to understand the interplay now it looks like great comp leverage within the other line a little bit sequentially. So you look out into the second half of this year or maybe longer term. Do you still think you can drive some operating leverage? And maybe is the way to think about the incremental margin, just trying to get a sense of how much incremental room there might be for margins to move higher here quickly given the great growth?

Looking ahead, I wish I could confidently predict our trajectory for 2019, but that would likely be an overestimation of our forecasting abilities at this time. As we consider the upcoming quarters, I expect to remain within our current range. I still believe there is an opportunity for operating leverage. However, February and March were particularly challenging for us due to significant market volatility, which negatively impacted our asset performance. This has created a bit of a headwind, but if the market improves, it could help us gain some leverage. Otherwise, I foresee staying in this range, possibly seeing a modest increase of about 50 basis points, but I wouldn't expect an abrupt surge in our operating margin.

I guess just to follow up on that last question. Can you talk maybe about the differences in the profitability or the scalability of certain of your businesses? So if we think about, we know the fee rates but the exposure management how we think about that or this in terms of incremental margin, how you want to characterize it versus say your traditional fund business?

It's important to make sure we're talking about the same thing, we're talking about margins. So just to be clear, we're talking about operating income as a percentage of revenue not operating income expressed in basis points on assets. So expressed in basis points on assets we make significantly less on exposure management because we clear with 5 basis points not starting with 30 or 50 or 75 on some of our mandates. In terms of margin profitability per dollar of revenue, that's a very good business. It's probably approaching the corporate average. It's not substantially below this is a scale of business very efficiently run. A portfolio manager and implementation business doesn't command the same compensation level as a portfolio manager does in a stock or bond picking business. It is highly scale-dependent and we have a large scale there and excellent systems to support that business. So while I would say it's not particularly the margin, I don't think we would say it's higher than our average margin, but it's in the range of most of our businesses. If you look across our businesses, the key driver of profitability is scale. If you look at things like bank loans, where we've got a very large business, we have higher profitability. And things that we do in limited scale, either because we're trying to grow the business or hope brings eternal and we're hanging on. Those kinds of businesses have lower margins. So big picture our approach to growing the profits of Eaton Vance is developing and cultivating through scale a range of market-leading franchises. And typically the bigger the franchise, both the easier it is to sell all else being equal and the more profitable it is from a margin perspective, again all else being equal. So the goal is always to build scale to the extent reasonable and to the extent we still have the ability to manage money flexibly and efficiently at that scale. But the goal is to build scale across franchises and if you want to know relative levels of profitability of our business starting with revenues is probably a good place to look. And things that we have good revenues in, we tend to have good margins in. And things that we're trying to build revenue we don't tend to have attractive margins. This is fundamentally a people business; it takes a certain amount of people to run any kind of investment business, the more assets you manage the more revenues you generate likely the higher the fee is going to be from that business. And that holds pretty true across the board in our business.

Thanks that's helpful. And I guess just another question around M&A you guys have been successful in deploying capital and adding on businesses. I guess at this point of the cycle, how do you think about M&A in terms of that versus repurchasing your own stock or other capital return methods?

We certainly look; there have been some transactions that have happened to our business. We think asset management is right for consolidation. We think Eaton Vance has many of the characteristics of a successful acquirer, including as you point out having a record, having done this successfully in the past and a fair bit of financial flexibility to allow us to finance a transaction. We're particular about what we might acquire. While in the past, we've been successful in growing our business and expanding our footprint within asset management through acquisitions, we are also mindful that this is a fairly hazardous business going out and buying someone else's asset management business and inheriting their culture and their people. So we wanted to do it very carefully. We are price-sensitive, we don't tend to win auctions, because really we're not going to put the highest valuation on a business. But we do think that we bring a lot to offer here and we do devote a fair bit of attention to at least thinking about that. So I think we it's not a large team, it's mostly Laurie and myself and other people in the finance group. This is not a significant activity for people in our sales organization or people in our investment or admin group. But in terms of the senior levels of legal and finance and general business we do look a fair bit at things that might be of interest. I would put the kind of things that are possibly of interest to us into three or four categories. One that would be consistent with things that we've done in the past are what I'll call both on acquisitions where we had distribution firepower, we brought on our business mix and helped our business grow to scale, adding more distribution resources than that company could likely afford to do on their own. That's been our traditional growth path. We have also looked at acquisitions that would expand our footprint geographically; only about 6% of our assets today are outside the United States. We think there could be opportunities for us to accelerate the growth of our business outside the United States through transactions that involve cross-border linkups. And then finally there are the scale type transactions that involve both opportunities for revenue synergies, but also cost synergies and those are if done at scale significantly riskier in a financial sense and in a corporate culture sense, but we also certainly kick the tires on those. Again, we do believe there should be and there will be consolidation in our business and we want to participate that and that at least at a level of looking and if the fit is right and if we put the highest value on something. It's possible that we will be active there as well.

I want to return to the fee rates. From what you explained, it seems the floating rate is being influenced by a shift towards institutional setups. Also, I believe you mentioned that the lower fee rates seen in the fixed income laddered bond portfolios were a factor as well. Craig, if I'm mistaken, please correct me. Additionally, could you provide insights on the equities segment and how the portfolio implementation relates to the decline in fee rates? Do you anticipate that this is a solid starting run rate as we approach the second quarter, or do you think the mix might shift back?

I agree with your observation. To start with fixed income, we noted during the call that we experienced $1.5 billion in net inflows within fixed income, particularly in laddered separate accounts, which typically have fee rates around 15-16 basis points. As this business grows, it tends to lower the average fee rate in the fixed income category, which is the main factor affecting that segment. According to our press release, the most significant year-over-year decline was in fixed income, where fee rates dropped by 7% from 38.5% to 35.8%. This decline is largely due to the robust growth of our laddered separate account business at those lower fee rates. We also discussed floating rate income. On the other hand, alternatives showed growth. Our global macro absolute return advantage strategy commands a higher fee rate, and both this strategy and its counterpart, the macro absolute return fund, lead the alternatives category in terms of asset inflows. The inflows have been skewed towards the higher fee version of that strategy, resulting in a 9% increase in average fee rates year-over-year in the alternatives segment. In equities, the mix shift primarily reflects the growth of our defensive equity or volatility risk premium strategies, which utilize derivatives and focus on selling calls. These strategies are contributing significantly to our growth. Other higher fee strategies in equities have also been growing, but the overall fee decline is mainly due to the rapid expansion of these options-based strategies. Regarding portfolio implementation, it's unclear if the fee changes are purely a result of mix or if they stem from enhanced client relationships that provide us with more pricing power. In competitive situations, fees on some business segments have been reduced. Overall, we interpret our business as experiencing about a 1% annual decline in fees, stemming from fee concessions and breakpoints in fee schedules. In my experience of over 33 years, I can't recall ever increasing prices for any of our strategies; the nature of our business typically leads to lower fee rates as client mandates scale up. This trend continues, although it's relatively modest, with approximately 1% of the 4% year-over-year decline in average fee rates being genuine price reductions, while the rest is due to the faster growth in lower fee businesses.

I believe you mentioned $3 billion, and I wasn't clear if that was what you were referring to as the pipeline for the current quarter's outlook. Could you confirm that? Additionally, could you discuss the situation in the broker-dealer channel, particularly regarding platform consolidation? How are you performing in terms of market share, and does portfolio implementation play a role in your dealings within broker-dealer channels?

To clarify, the $3 billion number I provided refers to our weekly pipeline report of new business that is not yet funded. While these commitments from clients may not always materialize, they represent our sales team's best assessment of potential new business that we expect to fund in the upcoming period. For the remainder of the second quarter and through the third quarter until the end of July, we are looking at approximately $3 billion in pending pipeline, which includes around $1 billion related to Parametric exposure management and $2 billion associated with other generally higher fee strategies. Regarding the impact on our broker-dealer platform consolidation, we are experiencing success with some of our strategies being fully utilized for current sales in the broker-dealer channels, especially as they reduce the variety of funds they offer. If a fund is small, it becomes difficult to justify its continued existence if flows are not strong, and we're not immune to this trend. Some of our funds are being removed from platforms, but typically, the assets remain on the books, despite the prohibition on new sales. There's still a chance for funds that have been removed to return if there is demand from advisors. During this quarter, we had instances where several smaller Calvert strategies were taken off the platform, but they were later reinstated when it became apparent that they aligned with a large corporate initiative supporting responsible investing, and these funds are high-performing in their categories with growth potential. In terms of our non-fund business, including our separate accounts and the Parametric custom core implementation, we haven't seen much impact from the consolidation of offerings. This primarily affects funds, not separate accounts, which has been influenced by historical practices when large broker-dealers made all funds available. The separate account and retail managed account business is relatively new and has never operated under that model.

Great, I mean that there are a few there potentially gain share in the portfolio implementation process as other funds are cut from the platform?

That's absolutely right, we're positioned to grow our business in portfolio implementation generally as money moves from active to passive and quasi-passive. We just picked up a custom core availability in a single contract in the last of the major warehouse broker-dealers. So we have got full coverage now for both single contracts and into contracts across the landscape of the warehouses that just happened in the last two weeks.

Similar to one of the previous questions I'm curious with all this growth and reasonable operating leverage, just thoughts on the share count going forward, I think we're up 7% year-over-year?

I think that we kind of have a very slightly more opportunistic and systematic share repurchase program. We're fairly heavy users of stock-based compensation. We recognize that puts pressure on our diluted share count. But we really think about our share repurchase program in terms of our total capital management strategy and address that on a quarterly basis. And this quarter we did mean in, we repurchased what was $73 million worth of stock this quarter, and hopefully that will be helpful as we look at our share count for next quarter. But I don't have guidance to give in terms of what we anticipate we will do throughout the rest of the year outside of saying that we would certainly anticipate that we will be active in the market and that we do view share repurchase as a significant tool in our quiver as we think about ways that we can return value to shareholders.

Okay. And then if I could just get a follow-up comment or clarity on the comment you made earlier on exposure management as a product of declining client balances not clients leaving, is that just if you can think of it as runoff of previous money less that you guys are just going to run this course is that the comment?

Let me explain again what this business is. Imagine you are a large institutional investor with a couple of billion dollars managed by various outside managers, such as a pension fund, endowment, or foundation. One way to manage parametric exposure is to invest the cash that sits in your different accounts with these managers. For example, if your actual cash in these portfolios is 3.5% while your target cash is 0.5%, you would hire Parametric to take long equity exposure through futures that equals 3% of that billion-dollar portfolio. We base our operations on the outstanding exposures. If the client changes their actual cash or target cash, the management fee balances will increase or decrease in that quarter. We've tried to enhance the management of the Parametric business to determine how it correlates with market conditions, including market strength, weakness, high volatility, or low volatility. However, we have found limited correlation between our reported flows and these market factors. Some of our larger clients experience meaningful flow impacts with even a 1% or 2% change in their target cash or their use of parametric exposure management. In this particular quarter, many large clients were reducing their exposures. We view this business as a long-term growth opportunity. We didn't lose any significant clients this quarter; rather, for reasons beyond our control and difficult to predict, we had more clients reduce positions than add them. I don't anticipate that next quarter will mirror this one, as we have generally seen growth in this business, both in client numbers and average exposures. The best measure of success is the number of client relationships, which has been steadily increasing. How clients use our services and the degree of usage depend not only on our range of services but also on their portfolio positioning. Factors like excess cash they aim to monetize, and their use of futures to manage duration or currency exposure all affect our net positions in this business and, in turn, our revenues and flows. The situation is somewhat complex and doesn’t lend itself to straightforward forecasting like the rest of our business. Nevertheless, despite low fees and some flow volatility, we continue to view this as a strong, profitable business, growing while fostering deep relationships with major institutions that support our overall growth in Parametric.

I totally appreciate all that Tom. The only follow up I had is, if the foundation of this is to put idle cash to work and to eliminate cash drag even if it's temporary. As rates rise, does that start to just become a bigger drag or a competitor to the product in and of itself?

I would estimate that institutions I interact with are not targeting allocations to cash. Although cash returns have increased, they remain significantly lower than long-term returns from equity or fixed income assets. Most institutions feel they cannot afford to hold a lot of assets that earn very little. While rates around 1% exert less pressure than when rates were at zero, it’s uncertain whether this will change how institutions view cash. If cash rates were at 8% and people were pessimistic about the returns from long-term financial assets, we might not be equitizing cash. However, we could also be reducing equity or income exposure, as this process isn’t one-dimensional. The advantage of derivatives lies in their flexibility; they allow for not only equitizing cash but also adjusting equity exposures, switching between emerging and developed markets, and modifying duration, currency, and commodity exposure. These are powerful tools for various portfolio strategies. We remain optimistic that as the demand for returns increases, people will seek to manage their portfolios more efficiently. These tools enhance portfolio efficiency by enabling managers to target their asset allocations tactically, without disrupting relationships with underlying managers. We believe this business will continue to be relevant. While there may be arguments suggesting reduced attractiveness at higher interest rates, I suspect there are larger factors that outweigh this consideration, especially concerning the additional flexibility our services provide to clients beyond simply equitizing cash.

We just want to thank you for joining us this afternoon. And we look forward to catching up with everybody again when we release our third quarter results in August. Thank you.