Morgan Stanley (MS) — Q4 2018 Earnings Call Transcript

Thank you and good morning and welcome to our Fiscal 2018 fourth quarter earnings call and webcast. With me this morning are Tom Faust, Chairman and CEO of Eaton Vance, and Laurie Hylton, our CFO. In today's call, we 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. In 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 uncertainty in our business, including, but not limited to, those discussed in our SEC filings. These filings, including our 2017 Annual Report and Form 10-K, are available also on our website or upon request at no charge. I will now turn the call over to Tom.

Good morning. Thank you, Eric, and thanks to everyone for joining us. Earlier today, Eaton Vance reported adjusted earnings per diluted share of $3.21 for the fiscal year ended October 31st, reflecting a 29% increase from the $2.48 adjusted earnings per diluted share reported for fiscal 2017. In the fourth quarter of fiscal 2018, we reported adjusted earnings per diluted share of $0.85, which is a 21% increase from $0.70 per diluted share for the fourth quarter of fiscal 2017 and a 4% increase from $0.82 per diluted share in this fiscal year's third quarter. Both the annual and quarterly results we reported today set new record highs for the company. While lower income taxes have significantly contributed to this year's earnings growth, pre-tax adjusted operating income increased by 14% for fiscal 2018 overall and was up 4% in the fourth quarter compared to the same quarter last year. We concluded fiscal 2018 with consolidated assets under management of $439.3 billion, a 4% increase from the previous year. All our AUM growth in fiscal 2018 was due to net inflows, which totaled $17.3 billion, equating to 4% internal growth in managed assets. Excluding exposure management, which typically has lower fees and more volatile flows, net inflows were $25.6 billion for fiscal 2018, corresponding to 8% internal growth in managed assets, nearly matching the $26.4 billion of net inflows from fiscal 2017. Fourth quarter consolidated net inflows amounted to $2.1 billion, reflecting 2% annualized internal growth in managed assets or 5% annualized internal AUM growth, excluding the $2.5 billion of exposure management net outflows during that quarter. While net flows and internal growth in managed assets are conventional measures of an asset manager’s organic growth, we also focus on internal growth in management fee revenue. Our organic revenue growth, as defined, measures the change in consolidated management fee revenue resulting from net inflows and outflows, considering the fee rate applicable to each dollar involved and excluding the impact of market actions, adjustments in fee rates for ongoing managed assets, and acquisitions of managed assets. In fiscal 2018, organic management fee revenue growth was 5%, slightly above our 4% organic growth in managed assets for the year. In the fourth quarter, organic management fee revenue grew at an annual rate of 2%, consistent with the quarter's organic AUM growth rate. Although peer companies generally do not disclose organic revenue growth figures, we believe Eaton Vance ranks highly among public asset managers by this measure, with the fourth quarter of fiscal 2018 marking our 11th consecutive quarter of positive organic revenue growth. Several factors have contributed to Eaton Vance's sustained positive organic revenue growth, beginning with robust investment performance. As of October 31, we had 66 U.S. mutual funds rated four or five stars by Morningstar for at least one class of shares, including 28 five-star rated funds. In total return measures, 50% of our U.S. mutual fund assets ranked in the top quartile of their Morningstar peer groups over a three-year period, 63% over five years, and 56% over ten years. Amid the rising interest rate environment in 2018, our floating-rate bank loan franchises attracted significant interest, generating net inflows of $5.9 billion for the fiscal year and $2 billion in the fourth quarter, representing annualized internal growth in AUM of 15% and 18%, respectively. For both the fiscal year and the fourth quarter, our bank loan flows were driven mainly by strong sales of our floating-rate income mutual funds within the U.S., where we hold the market share leadership. Our suite of fixed-income mutual funds, categorized as short or ultra-short duration, has also attracted interest in 2018, yielding $1.8 billion of net inflows for the fiscal year, which translates to 29% internal growth in managed assets. In the fourth quarter, annualized internal growth in managed assets surged to 40% with net inflows of $700 million. Our leading funds in this category include the five-star rated Eaton Vance short duration government income and Eaton Vance short duration municipal opportunities funds, which are well-suited for income investors concerned with interest-rate risk and exposure to corporate credit markets. Our offerings in custom index equity and laddered bond separate accounts for retail and high net worth investors also played a significant role in our fiscal 2018 growth. We frequently market Parametric Custom Core equity strategies in conjunction with EVM-managed customized municipal and corporate bond ladders, collectively referred to as custom beta. Managed assets in our custom beta strategies rose by 24% from $68.3 billion at the end of fiscal 2017 to $84.3 billion at the end of fiscal 2018. The $14.8 billion of net inflows for the full fiscal year and $4.3 billion in the fourth quarter equate to 22% and 21% annualized internal growth in managed assets, respectively. These leading offerings merge the advantages of passive investing with the ability to tailor portfolios to meet individual preferences and needs. Responsible investing remains a prevailing trend in asset management and a key growth driver for Eaton Vance. Following our acquisition of Calvert Investments in December 2016, we aimed to apply our management and distribution resources to enhance this established leader in responsible investing. Now, less than two years later, we’re realizing that vision. Total Calvert managed assets, including those managed by other Eaton Vance affiliates, grew by 14% from $12.9 billion on October 31, 2017, to $14.7 billion at the end of fiscal 2018. Since the close of the Calvert transaction, Calvert strategies' total managed assets have increased by 24%. Net inflows in the Calvert strategies reached $1.9 billion in fiscal 2018, representing 15% internal growth in managed assets. Fourth quarter net inflows of $600 million correspond to 16% annualized internal growth in AUM. Although the appeal of responsible investing extends beyond performance, having competitive returns certainly helps. As of October 31, 2018, 15 Calvert funds received four or five stars by Morningstar for at least one class of shares, reflecting strong performance across various equity and multi-asset categories. While Calvert is central to our responsible investment strategy, our commitment to responsible investing extends further. In fiscal 2018, our investment teams launched initiatives to incorporate responsible investing criteria into their fundamental research processes, leveraging proprietary research provided by Calvert. Atlanta Capital is also deeply committed to responsible investing, and Parametric manages over $20 billion of assets guided by client-directed responsible investment criteria. The Parametric responsible investment offerings integrate portfolio screens and tilts, along with index customization capabilities, allowing investors to align their investment holdings with their values. We firmly believe that responsible investing will endure and present a significant growth opportunity for Eaton Vance. While fiscal 2018 was strong for Eaton Vance in many aspects, the year also presented challenges. In equities, two major Parametric franchises experienced notable outflows as their investment strategies lost favor among investors. The Parametric structured emerging market equity strategies had net outflows of $2.6 billion for the entire fiscal year and $900 million in the fourth quarter. Net outflows also affected Parametric's single stock and portfolio call writing programs, totaling $800 million for the fiscal year and $500 million in the fourth quarter. Despite these managed asset declines, we remain optimistic that the outlook for these strategies may be improving. After a phase of below-average returns, the Parametric structured EM equity strategy has recently performed well relative to peers. By the end of October, Class I shares of both Parametric emerging market equity mutual funds ranked in the top decile of their Morningstar peer groups for three-month, year-to-date, and one-year total returns. Although covered call writing programs are not easily comparable in terms of performance, we believe that the market appeal of equity call writing, which essentially serves as a risk management strategy, will likely improve as equity markets become more defensive amidst heightened market volatility. Another area facing performance challenges and declining flows is global macro, which constitutes most of the assets and flows reported in our alternative assets category. Managed by the EVM global income team, our global macro absolute return and global macro absolute return advantage strategies take long and short positions in currency and short-duration sovereign debt in emerging and frontier market countries, aiming for returns that are largely uncorrelated with global equity markets and U.S. interest rates while outperforming short-term treasury yields. Performance weaknesses coincided with issues in some emerging and frontier markets where we held long positions, resulting in global macro strategies facing net outflows of $700 million in the fourth quarter, reversing the $1.5 billion net inflows recorded in the first nine months of the fiscal year. Another franchise with notable net outflows is exposure management. This is primarily a Parametric offering of futures-based overlay strategies designed for institutional investors to adjust, add, or hedge market exposures in a transparent, efficient, and customized manner without disrupting their core investment holdings. With an average fee rate of 5 basis points, this is our lowest fee business, but has historically contributed to company growth. Since we entered this business through the Clifton Group acquisition in late 2012, we have more than doubled assets in this franchise from $32 billion to $78 billion. Although exposure management faced net outflows of $8.3 billion for fiscal 2018 and $2.5 billion in the fourth quarter, it’s important to note that these outflows don't signify the loss of clients but rather lower average balances within existing client relationships. We do not forecast changes in the average balances of our exposure management clients, which can vary significantly due to alterations in portfolio cash levels or other investment factors. In most years since entering this space, existing clients have typically increased their Parametric overlay exposures, though that was not observed in fiscal 2018. Nevertheless, our roster in this strategy grew, with a net addition of nine new or significantly expanded relationships established in the fourth quarter alone. Despite quarterly and yearly asset flow volatility, we regard exposure management as a crucial franchise for us and a key driver of future growth. A cornerstone of Eaton Vance's long-term success is our ability to expand higher-fee actively managed investment strategies while simultaneously growing our lower-fee passive businesses. Our active investment strategies, covering a variety of equity, fixed, and floating-rate income along with alternative and multi-asset capabilities, saw net inflows of $10.6 billion for the fiscal year, reflecting 5% internal growth in managed assets. Growth in actively managed strategies was complemented by progress in passive strategies, including Calvert index funds, Parametric portfolio implementation, exposure management strategies and services, and EVM's laddered bond separate accounts. Excluding exposure management, our passive strategies garnered $15 billion of net inflows in fiscal 2018, which translates to 12% internal growth in managed assets. As we approach fiscal 2019, Eaton Vance is concentrating on five strategic priorities: first, enhancing and safeguarding our leadership position in specialty strategies and services for high net worth institutional investors; second, leveraging the current interest rate environment to strengthen our market position in floating-rate and short-duration fixed income strategies; third, broadening our leadership in responsible investing; fourth, expanding our global investment capabilities and distribution outside the U.S.; and fifth, positioning Eaton Vance to take advantage of a shifting asset management industry landscape. The investment industry has always been marked by constant change, characterized by evolving market conditions, demographic trends, fluctuations in investor sentiment, technological advancements, shifts in business strategies among wealth advisory firms and investment consultants, and new tax and regulatory initiatives. Ultimately, successful investment management organizations distinguish themselves by how they navigate change. They must provide strategies and services that adapt to the evolving needs of clients and partners and evolve their business models to address the opportunities and risks within the asset management sector. Although change is a constant in asset management, the pace appears to be increasing. Ensuring Eaton Vance's continued success amidst rapid industry changes is our leadership team's primary focus and informs all our strategic decisions. With the successful fiscal 2018 behind us, we look forward to the challenges and opportunities of the upcoming fiscal year. That concludes my prepared remarks, and I'll now hand the call over to Laurie.

Thank you and good morning. Tom mentioned fiscal 2018 was a record year for Eaton Vance in terms of revenue, net income and earnings per share both on a U.S GAAP and adjusted basis. As you can see in attachment two of our press release, we are reporting adjusted earnings per diluted share of $3.21 for fiscal 2018, an increase of 29% from $2.48 of adjusted earnings per diluted share in the prior fiscal year. Adjusted earnings exceeded U.S GAAP earnings by $0.10 per diluted share in fiscal 2018, reflecting the add back of $24 million of income tax expense recognized in relation to the nonrecurring impact of the tax law change that became effective in January and a $6.5 million charge recognized upon the expiration of the company's options to acquire an additional 26% ownership interest in our 49% owned affiliate Hexavest. These add backs were partly offset by the reversal of $17.5 million of net excess tax benefits that new accounting guidance requires us to recognize in connection with the exercise of employee stock options and vesting of restricted stock awards during the year. In fiscal 2017, adjusted earnings exceeded GAAP earnings by $0.06 per diluted share, reflecting the add back of $5.4 million of costs associated with retiring the company's senior note that were due in October 2017, $3.5 million of structuring fees paid in connection with the 2017 initial public offering of a sponsored closed-end fund and $0.5 million related to increases in the estimated redemption value of noncontrolling interest in our affiliates redeemable at other than fair value. Adjusted operating income, which excludes the closed-end fund structuring fees paid in fiscal 2017, increased by 14% year-over-year. On the same adjusted basis, our operating margin improved to 32.6% in fiscal 2018 from 31.8% in fiscal 2017. As Tom mentioned, we’re also reporting record quarterly adjusted earnings per diluted share of $0.85 for the fourth quarter of fiscal 2018, up 21% from $0.70 in the fourth quarter of fiscal 2017 and up 4% from $0.82 in the third quarter of fiscal 2018. GAAP earnings exceeded adjusted earnings in the fourth quarter of fiscal 2018 by $0.02 per diluted share to reflect the reversal of $2.4 million of net excess tax benefits recognized from the exercise of employee stock options and vesting of restricted stock awards during the period. In the fourth quarter of fiscal 2017, adjusted earnings exceeded GAAP earnings by a penny per diluted share, reflecting the add-back of $0.6 million related to increases in the estimated redemption value of noncontrolling interest and affiliates redeemable at other than fair value. GAAP earnings exceeded adjusted earnings in the third quarter of fiscal 2018 by a penny per diluted share to reflect the reversal of $1.3 million of net excess tax benefits recognized from the exercise of employee stock options and vesting of restricted stock awards during the period. Operating income in the fourth quarter of fiscal 2018 increased by 4% from the same period a year ago and 2% sequentially. Our operating margin was 33.1% in the fourth quarter of fiscal 2018 versus 34.1% in the fourth quarter of fiscal 2017, and 33% in the third quarter of fiscal 2018. Ending consolidated managed assets of $439.3 billion at October 31, 2018 were up 4% from the end of fiscal 2017 driven by positive net flows. Consolidated managed assets were down 3% from the prior quarter end, reflecting positive net flows offset by the market price declines experienced in the final month of our fourth fiscal quarter. The decrease in our managed assets due to market price declines in the month of October totaled $20.1 billion, effectively wiping out market-driven gains of the previous 11 months. Despite a difficult October, average managed assets in fiscal 2018 increased 16% from the prior fiscal year, driving a 12% increase in management fee revenue. Growth in management fee revenue trailed growth in average managed assets during the fiscal year due to a 3% decline in our average management fee rate from 34.5 basis points in fiscal 2017 to 33.5 basis points in fiscal 2018. This decline in our average management fee rate is primarily attributable to the shift in our business mix year-over-year as lower-fee portfolio implementation and bond ladder businesses grew as a percentage of our assets under management. Performance fees, which excluded from the calculation of our average management fee rate reduced income by $1.7 million in fiscal 2018 and contributed $0.4 million to earnings in fiscal 2017. As Tom noted, our fiscal 2018 internal growth in management fee revenue of 5% outpaced our internal growth in managed assets of 4%, primarily reflecting the impact of net inflows into higher-fee strategies during the year. This compares to 7% internal growth in management fee revenue and 11% internal growth in managed assets in fiscal 2017. Comparing fourth quarter results to same quarter last year, a 10% growth in average managed assets drove an 8% increase in management fee revenue. Sequentially, average managed assets increased 2%, driving management fee growth of 1%. Our average annualized management fee rate of 33.4 basis points in the fourth quarter of fiscal 2018, down 1% from 33.9 basis points in the fourth quarter of fiscal 2017 and substantially unchanged from 33.5 basis points in the third quarter of fiscal 2018. Although strong flows into our lower-fee strategies continue, net inflows into higher-fee strategies helped mitigate the overall fee rate decline. Performance fees reduced income by $0.3 million in the fourth quarters of fiscal 2018 and fiscal 2017, and reduced income by $0.4 million in the third quarter of fiscal 2018. In the fourth quarter of fiscal 2018, we realized 2% annualized internal growth in management fees and 2% annualized internal growth in managed assets. This compares to 5% annualized internal growth in management fees and 8% annualized internal growth in managed assets in the fourth quarter of fiscal 2017, and 5% annualized internal growth in management fees, and 3% annualized internal growth in managed assets in the third quarter of fiscal 2018. The deterioration in our annualized internal growth in management fee this quarter was driven by reduced net inflows in a less favorable mix of higher-fee and lower-fee strategies within our inflows and outflows. Turning to expenses. Compensation expense increased by 9% in fiscal 2018, primarily reflecting higher salaries and benefits associated with increases in headcount and year-end salary increases from the previous fiscal year, higher operating income and performance-based bonus accruals driven by increased profitability and an increase in stock-based compensation, partially offset by lower sales-based incentive compensation. Compensation expense as a percentage of revenue decreased to 35.5% in fiscal 2018 from 36.2% in fiscal 2017. We anticipate the compensation as a percentage of revenue in the first quarter of fiscal 2019 will be closer to 36%, given seasonal pressures associated with payroll tax clock reset 401(k) funding and year-end based salary increases. Controlling our compensation costs and other discretionary spending remains top-of-mind as we moved into the new fiscal year, particularly given the more challenging market environment of late. Non-compensation distribution-related costs, including distribution and service fee expenses and the amortization of deferred sales commissions increased 4% in fiscal 2018. The increase primarily reflects higher marketing and distribution related costs, mainly driven by higher average managed assets and open-end funds and an increase in service fees and commission amortization for private funds. Backing out the closed-end fund structuring fees paid in fiscal 2017, which we do in calculating adjusted operating income and adjusted earnings per diluted share. Our non-compensation distribution-related costs in fiscal 2018 were up 6%. Fund-related expenses increased 32% in fiscal 2018, primarily reflecting higher fund subsidy accruals and sub-advisory fees, driven by strong asset growth in certain Calvert and Global Macro strategies, and an increase in fund expenses borne by the company on funds for which we earn an all-in fee, partially offset by $1.9 million in fund reimbursements made by the company to certain funds in fiscal 2017 that were one-time in nature. Other operating expenses increased 13% in fiscal 2018, reflecting higher information technology spending attributable mainly to expenditures associated with the consolidation of our trading platforms and enhancements to Calvert's research system. Higher facilities expenses related to an increase in rent expense due to the expansion of space and the acceleration of $1.59 of depreciation expense in the second quarter of fiscal 2018, and higher professional services expenses, primarily attributable to an increase in corporate consulting engagements and external legal costs. We continue to focus on overall expense management and identifying ways to gain operational leverage. Net gains and other investment income on seed capital investments contributed a penny to earnings per diluted share in each of the comparative quarterly periods presented. When quantifying the impact of our seed capital investments on earnings each quarter, we take into consideration our pro-rata share of the gains, losses and other investment income earned on investments in sponsored 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. We then report the per share impact net of income taxes and net income attributable to noncontrolling interests. 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 fiscal 2018 included a $6.5 million charge related to the expiration of the company's Hexavest option in the first quarter of fiscal 2018. Non-operating income expense in fiscal 2017 included $5.4 million of debt extinguishment costs incurred in connection with retiring the remaining $250 million aggregate principal balance of the Company's 6.5% senior notes that were due in October 2017. These one-time charges are excluded from our calculations of adjusted net income and adjusted earnings per diluted share for the fiscal years in which they occurred. The $3.9 million decrease in interest expense year-over-year reflects the impact of last year's debt retirement, partially offset by the April 2017 issuance of $300 million of 3.5% senior notes due in April of 2027. Non-operating income expense in fiscal 2018 also includes $1.6 million of income contribution from consolidated CLO entities. Net gains and other investment income in fiscal 2017 included a $1.9 million gain recognized upon the release from escrow of payments received in connection with the sale of the Company's equity interest in Lloyd George management back in fiscal 2011. Turning to taxes. Our effective tax rate was 28.8% in fiscal 2018 and 37% in fiscal 2017. The Company's income tax provision for fiscal 2018 includes a nonrecurring charge of $24 million to reflect the effects of the U.S federal tax law changes that were enacted in the first quarter. The tax increase associated with the nonrecurring charge was partially offset by net excess tax benefits of $17.5 million related to the exercise of stock options and vesting of restricted stock awards during fiscal 2018. Accounting guidance adopted in the first quarter requires these net excess tax benefits to be recognized in earnings. As shown in attachment two to our press release, our calculations of adjusted net income and adjusted earnings per diluted share removed the nonrecurring impact of the tax law changes and the net excess tax benefits recognized under the new accounting guidance. On this basis, our adjusted effective tax rate was 27.6% in fiscal 2018. On the same adjusted basis, we estimate that our effective tax rate will range between 25.9% and 26.4% for fiscal 2019. We estimate that the reduction in our statutory U.S federal income tax rate due to the enactment of the tax law changes resulted in tax savings of approximately $59.7 million or $0.49 per diluted share for fiscal 2018. Excluding the impact of these tax savings, our fiscal 2018 adjusted earnings per diluted share would have been approximately $2.72, an increase of 10% from the $2.48 of adjusted earnings per diluted share in the prior fiscal year. During the fourth quarter of fiscal 2018, we used $35.3 million of corporate cash to pay the $0.31 per share quarterly dividend declared at the end of our previous quarter and repurchased $2.1 million shares of nonvoting common stock for approximately $100.6 million. Weighted average diluted shares outstanding were $122.9 million at fiscal 2018, up 6% from $116.4 million at fiscal 2017. We finished our four fiscal quarter holding $873.4 million of cash, cash equivalents and short-term debt securities and approximately $358.8 million in seed capital investments. These amounts compare to outstanding debt obligations of $625 million at fiscal year-end. We continue to place high priority on using the Company's cash flow to benefit shareholders. Fiscal discipline around discretionary spending will remain top-of-mind in fiscal 2019. We are very mindful of the more difficult market environment it's now upon us, and the associated pressure on revenues that this brings. Given our strong liquidity and overall financial condition, we believe we are well-positioned to continue managing our business for long-term growth, but also continuing to return capital to shareholders through dividends and share repurchases. This concludes our prepared comments. At this point, we would like to take any questions you may have.

Great. Thanks. Actually, Jerry O'Hara sitting in for Dan this morning. Just a question around fee rates and specifically the alternatives. It looks like that segment despite some outflows that you cited has continued to kind of march forward or higher with that fee rate, perhaps you could give a little color or context around that dynamic?

Yes. So the assets in that category are unusually concentrated in the global macro absolute return and global macro absolute advantage mutual funds. The fee rate on the advantage strategy, which has effectively built-in leverage is significantly higher than the base strategy. So as Eaton Vance global macro advantage grows relative to Eaton Vance global macro absolute return fund, which has happened, you will see the fee rate in that asset category move up.

Understood. That's helpful. Could you provide some insights on Hexavest flows as seen on Slide 7? It appears to be somewhat inconsistent. Additionally, if you could share any updates on quarter-to-date flow trends, that would be appreciated since I know it’s still early. Thank you.

Yes, maybe I will add. Laurie or Eric, take the quarter-to-date, but just on Hexavest, Hexavest is a top-down global equity manager based in Montreal. We own 49%, acquired that position in 2012. Since then, they’ve for the most part been pretty defensively positioned and certainly have been over the last, I will say 2.5 years. Not surprisingly, that meant that until recently they’ve lagged the market in terms of their performance, and again, not surprisingly, given that they lag the market, they’ve seen harder times winning new business and have seen some acceleration of outflows not surprising, but given that they’re defensively positioned and that’s well known to their clients, we'd think that performance during the market rallies of 2017 and earlier parts of this year. It shouldn't have been, it shouldn't have been a surprise. Given the turn in the market recently, not surprisingly, they’ve been performing better. They’ve had good performance, well above market performance since the market started to correct. May not happen immediately, but certainly our expectation is that as that happens, they will see less pressure on outflows and potentially be in a position to see a greater trend of new business won as well.

Great. Thanks. Go ahead.

Go ahead.

No, I was just going to say then any additional on quarter to date would be helpful.

This is Laurie. We don’t have a lot of visibility into the current quarter to date, given that we are only a couple of weeks into it, but I think that as Tom noted, their performance has improved significantly. We are waiting to see how that’s actually going to play out in largely institutional business.

Hi, good morning and thanks for taking my questions. On the bank loan product, it seems like the industry is focusing maybe a touch more on the credit deterioration more so than higher interest rates, and at least we’ve seen a reasonable step up in the outflows from the bank loan ETFs. To what extent do you think the ETF outflows is sort of a leading indicator for what you will see in floating rate products? And then maybe just how are the floating rate products holding up more recently given what we are seeing elsewhere?

Focusing on the U.S. mutual fund business, we have observed outflows from the bank loan categories. Similar to what has been noted in the ETF space, recent industry data shows that bank loan flows have been negative over the past four weeks. This seems to stem from rising concerns about credit, and we have also experienced some outflows in our bank loan strategies on several days this month. This marks a shift from the strong inflows we saw throughout fiscal 2018. It's difficult to determine the extent to which these current concerns will have a lasting impact. Although there has been slight price volatility in the bank loan sector, which can be seen as a positive, there is a concern that as new loans come to market, they do so with tighter spreads. Furthermore, as the market softens, we believe this may help alleviate some of the downward pressure on spreads. However, with increased anxiety about credit, spreads on new issues may be more favorable for buyers, but in the short term, we are observing some retail flows related to these growing credit market concerns. Examining the underlying fundamentals, our team has not identified any issues in our portfolios that imply a change in credit market conditions. While we acknowledge that the current economic cycle is lengthy and are aware of the potential for change, we do not see anything in our portfolio that would validate the market concerns or the recent price softness observed in loans, which has been quite minimal and not unexpected given the flow dynamics we have experienced.

Thank you for that. Could you provide an update on NextShares? I believe one of your partners either announced or dissolved two of their NextShares funds during the quarter. Can you explain what happened there? Also, what were the expenses you incurred for NextShares this quarter? If you have already addressed this, I apologize for missing it.

The announcement you mentioned did not occur during the quarter. It was announced last week that Gabelli plans to convert two of their four NextShares funds into mutual funds. This change hasn't taken place yet, but they have indicated it will happen in the future. The reasoning behind this move seems to be their disappointment with the sales performance of those strategies, leading them to believe that they might achieve better sales using a conventional mutual fund structure. This isn't surprising to us, as we have closely monitored the inflows into all NextShares funds, including those of our licensees, and we have noted a lack of activity, which reflects the limited distribution we’ve experienced. As discussed in the previous quarter, due to the absence of significant sales, we have been decreasing our marketing efforts and reducing expenses related to NextShares, currently spending between $2.5 million and $3 million annually.

Thank you for taking my questions. Tom, could you elaborate on your comments regarding positioning Eaton Vance for a changing environment? I would appreciate some details on specific initiatives you have in place to address this. Also, has the rapidly changing environment influenced your perspective on M&A? You've executed bolt-on transactions in the past, like with Calvert and others, but has anything changed in your approach to M&A considering the shifts in investor behavior?

Yes, thank you, Rob. There are several factors related to changes in the industry dynamics that I would highlight. Firstly, the recent market sell-off has had an immediate impact on revenues, prompting us to tighten certain spending initiatives in response, although we don't anticipate large changes in our expenses. Our strong financial position, margins, and cash reserves provide us the flexibility to invest during market downturns, and we intend to continue this approach. Regarding new initiatives that respond to the changing industry, our offerings of customized index and laddered bonds and separate accounts align with key market themes, such as the growing trend towards passive versus active investment and the rising demand for customized investment options among investors and intermediaries. As a market leader in these areas, we are committed to maintaining our leadership position despite increased competition, which we view as a significant growth opportunity. Another key initiative is our focus on responsible investing, particularly following our acquisition of Calvert. We believe we are still in the early phases of enhancing our responsible investing capabilities, which are becoming increasingly vital to our business. This aspect is somewhat cyclical, but we are seeing strong growth in various income strategies designed for investors concerned about rising interest rates, as a result of decisions made four or five years ago anticipating the end of a prolonged bull market in bonds. This led us to incorporate more short-duration options into our portfolio, positioning us well to benefit from this market trend. As for industry consolidation, I firmly believe our sector is primed for it. Our key intermediaries face much more demand from firms seeking shelf space than there are available opportunities, which will likely lead to further consolidation. The passive investment segment favors economies of scale, indicating that market share will become more concentrated, although this is less applicable to active management. We expect that reduced opportunities in that space will also drive consolidation. Regarding the specifics of the Invesco transaction, I won't comment on that; however, acquisitions are evaluated based on their market reception as well as their potential to enhance our earnings power or strategic standing. It’s crucial for us to consider both the immediate and long-term value an acquisition can add to our franchise. A deal that boosts earnings but hampers long-term growth isn't appealing. Conversely, if we can pursue transactions like the one with Calvert, which strengthens our strategic position and is beneficial for earnings, that would certainly align with our interests.

I mean, would it be fair to say that you don’t feel that you particularly have say a scale issue in the U.S mutual fund business or anything that you feel kind of your size and scale that’s good?

I feel like our size and scale is good, not in the context of $500 billion is necessarily at scale. It might or might not be. What we believe is more relevant is the scale of our leading investment franchises. We are certainly at scale world class by any measure in bank loans. We are certainly at scale world class in the Parametric Custom Indexing business and their exposure management business, in the muni and corporate ladder business with Eaton Vance, our global income business, our high yield business, certain of our equity strategies, we could go on. But that to us is critical is that when an advisor or gatekeeper or consultant is thinking about introducing an asset class into a client's portfolio, what providers are on the short list of names that they consider while performance is important there, so also is scale. You need to have a critical mass to be on that short list and in places where we are active, by and large we think we are big enough to be on that shortlist. We are looking to diversify our business. A key part of that is playing into the trend and responsible investing that continues to emerge. But if I had a choice of doing an acquisition that took Eaton Vance from, let's call it $500 billion in AUM to a trillion in AUM, that did nothing for us in terms of our growth rate and did nothing for us in terms of our current earnings power, I wouldn’t see a lot of point in doing that kind of a transaction.

Great. Thanks. Good morning, folks. Maybe just Tom, you made some good comments earlier in the presentation on the portfolio implementation in custom beta on the equity side and the covered call writing outflows. Maybe you could just give a little perspective on your outlook for flows within the portfolio and Parametric portfolio implementation products and the sales environment moving into 2019 and whether you see any competition that is emerging that might mute that or do you view this as continuing to be an exceptional growth at that growth category in the industry?

Yes. Within the portfolio implementation segment that we report, this primarily consists of the Parametric business. A smaller portion of this is known as centralized portfolio management, which has lower fees and modest flow expectations. However, the larger opportunity lies in what is referred to as custom core. This involves customized index-based strategies available in various markets, particularly targeting the U.S. retail high net worth and multi-family office markets, as well as institutional versions. This represents a significant business for Parametric, where we currently hold a strong market position. We have noticed announcements from competitors introducing new products or expanding their offerings in this sector, which we find unsurprising. We estimate that the total assets in this area may be between $100 billion to $200 billion across the industry, though it’s difficult to pinpoint an exact amount. When we assess the opportunity against several trillions of dollars in indexing, reflected in index mutual funds and ETFs, we see a substantial potential for custom indexing to expand compared to bulk indexing. Custom indexing provides clear tax benefits, as owning the same stocks in a separate account allows for tax loss harvesting and recognizing losses immediately, which isn’t possible in a fund structure. Additionally, funds typically do not allow for in-kind funding of positions, deferring the recognition of gains when starting a position. In a separate account format, you can tailor holdings to align with clients' responsible investing criteria or manage oversight of positions the investor may have elsewhere in their portfolio. These options are unavailable in bulk index funds or ETFs. We firmly believe that custom indexing is set for rapid growth, and we are committed to maintaining our leadership in this market. While we anticipate increased competition, we also expect significant growth in this sector and welcome new entrants, as they can help demonstrate that custom indexing is a superior investment approach compared to traditional methods. Thus, we see ample growth potential for Parametric in this market, even alongside rising competition.

This is a pretty durable positive net flowing segment of your business even with that and obviously if we do get into tougher market environment in '19, you have a lot of confidence in this still being a positive net flow contributor.

Certainly based on everything we can say.

Well, just addressing the first question related to fund expenses, I would think that I would not anticipate that our fund expenses in the first quarter are going to go down for all the reasons we highlighted on the call as well as in our text. There are couple of products that have been performing well, where we do have sub-advisory expenses and we’ve also got some funds subsidies associated with those. I don't anticipate given the growth in those franchises that we are going to see a decrease there. So I would not anticipate seeing that go down. In terms of our other expense categories, there are a few significant drivers both for the quarter and for the fiscal year that I would highlight. Facilities, I think we talked a little bit about some increased depreciation expense we took earlier in the year, but looking forward, Parametric is in the process of moving their corporate offices and we will have some incremental headwinds there in terms of our rent expense and other facilities expenses associated with that move. And I would think if you are thinking about your sort of the first quarter of fiscal '19, I would think a mid single-digit expense increase there would be appropriate something in the neighborhood of 5%. In terms of technology, as we’ve noted, we’ve been making some significant investments in terms of our trading platforms and also making investments in Calvert's research platform. I would anticipate, we will continue to make investments in 2019 and also in that sort of investment technology category you got market data that is just going up as a function of doing business in this industry. So I would also anticipate in those areas you are going to see some probably mid single-digit percentage increases just given the level of investment. Maybe just as we think about trying to prognosticate what margins might look like in the first quarter and I’m not going to give a percentage, but if you think about our overall cost structure, about 45% of our costs are variable and about 55% are fixed. The fixed we kind of covered as we talked about the expenses related to facilities into software and market data etcetera, but in terms of our overall comp structure within that, 40% of our comp is variable, around 60% is fixed. And if you look at what we did in fiscal '18, our revenue was up 11%, our operating income was up 15%, our variable compensation was only up 8%. So we are very, very mindful of the rates at which we pay out on our variable compensation and manage that carefully. In terms of the fixed portion of our comp structure, which is again about 60%, you are largely looking at headcount driven expense and our ending headcount was up 8%. Our average is about 7% for the year. Our fixed compensation was up about 9%. Again, we are very, very careful, we are mindful of that headcount adds because we recognize that adding to our fixed cost base that we are not necessarily going to be able to pull levers on immediately in the event of a downturn. So, I think that going into the first quarter, if you kind of keep those metrics in mind, I think the one thing you’ve to also keep in mind is we’ve got seasonal pressures every year in compensation, we highlighted a couple of them in my comments. I would anticipate that sort of the benefit in payroll tax clock reset a headwind that we're going to be facing is roughly in the neighborhood of about $3.5 million to $4 million. We see that every first quarter. We are also going to have the impact of base increases and you will probably have some increase in stock compensation associated not only with retirements in our fourth fiscal quarter, which generally will recognize in terms of the accelerated stock-based compensation expense in the first, but also just increased new grants, the impact of those grants on stock-based compensation in the first quarter. So, some seasonal headwinds that you will see going into the new fiscal year, but we are very, very mindful of how our cost structure works. Very mindful of the triggers that we can pull as we are trying to control the margin. And as we noted on the call, we are just going to be very, very mindful of how we think about expenditures going into fiscal '19 recognizing that we are coming out of a pretty volatile market environment.

Do we have any other questions left in the queue. I think we’ve time for maybe one more.

Okay. Good afternoon. Thanks so much for squeezing me in. I really appreciate it. So just maybe a two-part question. Tom, you mentioned that doubling your AUM for sort of marginal growth or earnings power is probably not likely. So you step back and think about your franchise. You think about the five initiatives you laid out. Where, if any, do you see some product gaps or geographic opportunity maybe to potentially expand the platform?

We have a significant geographic gap in nearly all aspects of our operations. While our coverage in the U.S. is strong, our presence outside the country is quite limited. Currently, about 95% of our assets and revenues are generated from the U.S. Therefore, identifying the right partner and opportunities for growth internationally is something we are definitely considering for potential acquisitions. However, I feel like I've been repeating myself, as we've been exploring this for a while without success in finding a suitable partner. Frankly, we're not sure if there is a partner that would effectively help accelerate our business growth outside the U.S. We have been experiencing organic growth internationally, expanding our office in Tokyo, adding a new facility in Frankfurt earlier this year, and opening an office in Dublin. Although we are making incremental progress, we are eager to find an opportunity to enhance our international expansion through acquisitions, but so far, we haven’t found one. In terms of product offerings, we have good coverage across various categories, including public equities, fixed income, floating rate income, and multi-asset strategies. We have also explored potential investments in private assets, such as private real estate or private debt, which could complement our public market securities business. While we've looked into a few possibilities there, we haven't taken any decisive actions yet, but we are definitely interested and continue to explore various acquisition opportunities.

Okay. And just one last one. Thanks for that answer. Just as I think about your distribution margin and maybe we are not capturing all these ins and outs between what’s going through the management fee line versus what goes through the distribution expense line. How do you sort of see that ratio evolving over the next several years given your focus of where you are growing other products or by distribution segment?

So just to clarify, what do you mean by distribution margin, Bill?

When I analyze the revenues compared to the expenses, it seems to me that the distribution expenses relative to revenues have been unbalanced over the past few quarters. I'm trying to determine if there is a consistent trend.

I think the only thing I would say is obviously there's significant pass-throughs in terms of distribution, service fee income and distribution expense and one other component that's in the distribution expense obviously is other marketing expenses associated with for example, our marketing support payments to our third-party intermediaries, which is never an expense line item that’s going down, given that it's largely driven by asset growth. So we haven't noticed anything structurally in terms of a significant change there. So I’m not sure what is driving your question, but hopefully recognizing that there are other distribution line items including promotion and marketing that are going into the distribution expense line item that might actually be factoring into what you're seeing.

I think, we may have lost the line. Okay. Very good. Well, operator I think this concludes our call for today.

Thank you.