Artisan Partners Asset Management Inc (APAM) 2017 Q4 法說會逐字稿

Hello, and thank you for standing by. My name is Chad, and I will be your conference operator today. (Operator Instructions) As a reminder, this conference call is being recorded.

At this time, I will turn the call over to Makela Taphorn, Director of Management Reporting at Artisan Partners. Please go ahead.

Thank you. Welcome to the Artisan Partners Asset Management Business Update and Earnings Call. Today's call will include remarks from Eric Colson, Chairman and CEO; and C.J. Daley, CFO. Following these remarks, we will open the line for questions.

Before Eric begins, I would like to remind you that our earnings release and the related presentation materials are available on the Investor Relations section of our website. Also the comments made on today's call and some of our responses to your questions may deal with forward-looking statements, which are subject to risks and uncertainties. Factors that may cause our actual results to differ from expectations are presented in the earnings release and are detailed in our filings with the SEC. We undertake no obligation to revise these statements following the date of this conference call. In addition, some of our remarks made today will include references to non-GAAP financial measures. You can find reconciliations of those measures to the most comparable GAAP measures in the earnings release.

I will now turn the call over to Eric Colson.

Thank you, Makela, and thank you, everyone, for joining the call. Next month will be the fifth anniversary of our IPO. Our transition to a public company structure was important to the evolution of our business. We retained our independence and culture, while establishing an employee equity structure that allows us to evolve and grow our business.

Over the 5 years since our IPO, we have seen dramatic changes in the investment management industry. The rotation from active to passive has accelerated. Risk-based asset allocations continue to gain popularity at the expense of the style box approach, and the demand for ETFs and other efficient investment vehicles has grown.

In navigating these changes to meet client needs and at the same time evolving our ownership structure, we are proud that we have stayed faithful to who we are. We remain focused on generating high value-added investment returns by creating the best environment for our investment talent. We have also evolved our business in important ways and consistent with who we are we have added more degrees of freedom to our investment strategies, and we have opportunistically sourced talent from new places and backgrounds.

Since 2013, we have added 3 new investment teams and 6 new strategies, including our first 2 credit strategies and our first 2 private funds. We have also expanded our distribution capabilities so that we are now distributing our strategies more broadly than ever before.

Since 2013, our AUM from clients outside of the U.S. has increased from $7.9 billion across 32 relationships to $22.7 billion across 128 relationships.

Slide 2 shows the investment results, net of fees, for Artisan's 13 existing strategies launched prior to 2017. To give you a different view of our business, we have grouped the strategies by U.S., non-U.S.-oriented and outcome-oriented, which doesn't include the Thematic team's strategies or the Credit team's private strategy, all 3 of which were launched in 2017. We have also included style benchmarks where relevant. Any consideration of investment performance must be in reference to a time period. At Artisan, we evaluate performance over full market cycles or long time periods.

Over short time periods, markets can be influenced by extremes. In such periods, the only thing we can really control is the steady application of the investment process. Most of our clients are institutional investors or have institutional-like decision-making process. These clients demand process integrity, which our teams maintain through different market environments while exercising judgment under the particular circumstances.

Over longer periods, you can see that our strategies have produced solid, absolute and relative performance. And all the strategies have track records of more than 10 years. Of those, 9 have outperformed either their broader or style benchmark since inception and after fees.

In the value-added column on the right, you can see that the magnitude of Artisan's outperformance has been greater than the magnitude of underperformance, where it exists. All in all, we are very proud of the investment performance across all of our strategies.

Not shown on this page is the performance of our 4 newest strategies, each launched in 2017. Those strategies have good early performance, which we expect will begin to translate into client demand later this year and into next.

Slide 3 shows how long-term performance can compound well for clients. It also shows the opportunity cost of investing in the passive indexes. This chart shows the growth of a hypothetical Artisan portfolio, consisting of $1 million invested at the inception of each of our 15 existing and historically marketed strategies launched prior to 2017. The hypothetical Artisan portfolio would have grown from a $15 million initial investment to approximately $73.5 million at the end of 2017 after fees. The Artisan portfolio would have generated about $23 million, approximately 50% more wealth than a portfolio consisting of the broad-based passive indexes. When compounded over long time periods, even relatively small amounts of annual or short-term alpha can result in significantly greater wealth for clients.

Active management, as we practice it, has worked for clients. We exist as a firm for the purpose of generating the wealth modeled on this slide and the long-term results shown on the prior slide.

Moving to Slide 4. Over the last 5 years, we have averaged about $1.6 billion in firm-wide net outflows per year. Firm-wide totals, though, conceal more than they explain. First and foremost, we are managing more wealth for clients today than ever before. Between 2013 and the end of 2017, our AUM increased by $41.2 billion from $74.3 billion to $115.5 billion.

Second, our global strategies have attracted assets very nicely over the last 5 years. We began launching the global strategies a decade ago, when we saw our team's global research aligned with the client demand for Global Equity. The investment in the global strategies has worked well for our clients, our investment talent and our firm. Today, our outcome-oriented strategies are similar to the global strategies a decade ago. We have developed these strategies to align well with the evolving asset allocations. The strategies combine broad investment flexibility and focused risk management to create portfolios that are unique sources of alpha, which are difficult to replicate with passive indexes.

So far, we have seen strong early demand. The High Income and Developing World strategies have attracted assets at a faster rate than any strategies in our history. The Credit, Developing World and Thematic teams are laying the foundation in terms of people, process, culture and results for a long-term franchise development and growth. The client demand for our global and outcome-oriented strategies has been offset by net outflows in other areas, primarily U.S. Mid-Cap value and U.S. Mid-Cap growth. We believe that this is the only significant area of our business facing both cyclical performance and secular industry issues.

The outflows from the Mid-Cap strategies are the result of a confluence of factors: One, core relative performance over the last several years; two, client profit-taking due to strong absolute returns; and three, changes in asset allocation and the defined contribution marketplace. Both the U.S. Value team and the Growth team have outstanding long-term track records, and both have worked through periods of underperformance in the past. With improved performance, we believe there will remain demand for these strategies into the future.

Outside of the domestic Mid-Cap space, the flows we have seen over the last 5 years reflect sustainable demand for high value-added active strategies with compelling track records.

Turning to Slide 5. Just like our investment strategy lineup, we are confident in our approach to distribution and how we deliver our investment capabilities to clients. We have always expected to sink or swim on the basis of investment results, not distribution or marketing might. Our approach is to align investment talent with the needs of sophisticated asset allocators. Once we do that, we work to give clients the most transparent and efficient access to our investment capabilities. We try to maintain simple and straightforward investment vehicles, share classes and distribution and marketing relationships.

At the end of 2017, 46% of our AUM was managed in Separate Accounts, the terms of which are individually negotiated with and fully transparent to clients. Another 20% of our AUM was managed in the Institutional Share class of Artisan Partners funds. Unlike some institutional share classes, Artisan's Institutional Shares do not include any payments to intermediaries. To use the recently popular terminology, our Institutional Share class is a clean share class. It has been that way since it was first introduced for Artisan International fund in 1997.

I would also note that we launched the Advisor Shares in 2014 in response to demand from intermediary partners for a share class with lower intermediary payments, and none of the Artisan fund share classes have ever included sales loads or 12b-1 fees. We welcome changes across the financial service industry that make it easier for investors to compare performance and fees. As our investment strategies and client demand continue to evolve, we remain open minded and flexible about investment vehicles. With UCITS, CITs, advisor shares and now private funds, we have demonstrated our willingness and ability to use a variety of vehicles when it makes sense for the investment strategy and the client.

Slide 6 provides some perspective on the overall opportunity set. The precise numbers and percentages are not that important. What's important is that there is a massive demand for investment management around the world. Global AUM is estimated at approximately $76 trillion, representing only about 25% of total worldwide financial assets. The existing $76 trillion marketplace is experiencing an ongoing disruption. We expect investors will continue to shift away from traditional active managers who have hugged benchmarks far too long. Not all of those investors will go passive. Our experience over the last several years supports our belief that many of those investors will select managers who offer differentiated strategies with high degrees of freedom and strong track records. The traditional active opportunity set is and, we expect, will remain massive.

We also expect alternative strategies to continue to attract assets, given their differentiated returns and risk management features. By adding degrees of freedom to our existing and new strategies and launching our first 2 private funds, we have evolved our business into the shaded portion of the asset allocation diagram. By doing so, even as traditional active's market share has declined, we have increased our opportunity set. And importantly, we have evolved in the direction that aligns with our core commitment, the high value-added, talent-driven investing. Artisan's business model has worked across 8 investment teams, with separate and distinct decision-makers, philosophies and process and across multiple asset classes and time periods. We are confident that our investment teams and business model will continue to have success. We are also confident that the client demand for alpha-generating firms will persist and potentially increase when conditions normalize.

I'll now turn it over to C.J. to discuss our recent business and financial outcomes.

Thanks, Eric. Good morning, everyone. Financial results for the quarter and the year are presented on Slide 7 and include both GAAP and adjusted results. I'll focus most of my comments on adjusted results, which we, as management, utilize to evaluate our business operations.

2017 was a strong year for Artisan. The firm added our 8th investment team and launched 4 new investment strategies. Assets under management increased 19% to end the year at $115.5 billion as a result of positive market returns, including strong alpha generation. Revenues for the year rose 10% and adjusted operating income rose 14% as we realized scale from higher AUM levels, ending the year with a higher adjusted operating margin of 37.6%.

Our adjusted results exclude the impacts of tax reform enacted in the fourth quarter of 2017. As a result of tax reform, the company recorded a $62 million noncash GAAP charge in the December quarter from the revaluation of deferred tax assets and liabilities. The net amount of $62 million is comprised of a $352 million noncash tax expense related to lower tax benefits, primarily from our TRA-related deferred tax assets, offset in part by a $290 million noncash benefit from the corresponding reduction in the amounts payable under the tax receivable agreements. We currently estimate that our adjusted effective tax rate will be 23.5% in 2018.

A summary of AUM is on Slide 8. Quarter-end assets of $115.5 billion were up 2% compared to last quarter-end. The increase in the current quarter reflected market appreciation of $4.3 billion, offset in part by $2.5 billion of net client cash outflows. For the year, AUM increased 19% as a result of $24 billion of market appreciation, offset in part by net client cash outflows of $5.4 billion. Net client cash outflows were primarily in Non-U.S. Growth, U.S. Mid-Cap Growth and U.S. Mid-Cap Value strategies due to short-term underperformance and structural headwinds in the traditional long-only and defined contribution markets. Partially offsetting outflows were net client cash inflows in Global Opportunities, Developing World and High Income strategies.

As a reminder, the current quarter's gross client cash outflows included the impact of Artisan funds annual income and capital gains distributions, which were approximately $510 million, net of amounts reinvested in the funds.

Our financial results begin on Page 9. In the current quarter, revenues grew 3% from the previous quarter and 16% from the same quarter last year. Both were generally in line with the increases in average AUM for those periods. For the year, average AUM increased 13% and revenues increased 10%, reflecting a lower average management fee, which declined slightly due to the mix of our AUM as a higher proportion of assets under management were in separate accounts.

Operating expenses are summarized on Page 10. Adjusted operating expense this quarter were up 5% compared to last quarter as a result of higher incentive compensation on increased revenues, technology and travel expenses. The increases are reflective of an increased level of business activity in the fourth quarter. Adjusted operating expenses increased 8% for the year, also as a result of higher revenue-based incentive compensation expense as well as equity-based compensation expense related to the 2017 equity grant to employees and costs associated with the addition of our 8th investment team and the launch of 4 new strategies. These increased expenses were offset in part by lower third-party intermediary distribution expense.

The details of our compensation and benefits expenses are broken out on Slide 11. As a result of the increase in incentive compensation expense in the current quarter, our compensation ratio rose slightly to 48.4% from 48.1% in the previous quarter and was down from 50% in the same quarter last year. Our annual compensation ratio declined slightly to 49% in the current year compared to 49.4% last year. As a reminder, our compensation ratio runs higher in the March quarter of each year due to increased equity-based compensation expense from January equity grants and seasonal compensation costs.

Last week, our Board of Directors approved the grant of approximately 1.5 million restricted shares to our employees, which will add approximately $11 million to noncash equity-based compensation expense in 2018. $2 million of this expense will fall in the March quarter and $3 million each of the other quarters of 2018.

We expect that equity-based compensation expense, which has gradually increased, as we have layered on expense for annual employee equity grants, will reach its peak of $15 million in the June 2018 quarter and then decline to $13 million in the September quarter and $11 million in the December quarter.

The seasonal benefits-related costs, which include employer contributions to health and retirement plans and payroll taxes, typically increase compensation expense by about $3 million the first quarter of each year. Another $1 million of seasonal expenses related to nonemployee director compensation is recorded in G&A.

Moving on to Page 12. Adjusted operating margin in the current quarter was 38.6% and 39.4% last quarter. The decrease is primarily the result of slightly higher expenses in the quarter from increased business activity. For the year, adjusted operating margin improved to 37.6% from 36.4% last year.

Looking forward to 2018, we have identified a number of strategic incremental initiatives, which we consider are reinvestments in our business to support current and future growth. In the area of technology, we expect approximately $1 million of additional run-rate costs in 2018 and an extra $4 million of onetime upfront expenses related to the implementation costs for risk management and regulatory initiatives, mostly to further support expanding degrees of investment freedom. We also plan to implement a new client reporting system, which will enhance the client experience.

In addition, we expect 3 of our investment teams to relocate to new office space this year. As you know, part of our autonomous model is to provide each investment team with its own 4 walls for the team to develop and cultivate its own unique culture. We expect the relocations to increase run-rate occupancy costs by approximately $2 million per year, and we expect to incur approximately $4 million of nonrecurring lease breakage and accelerated depreciation costs related to the moves in 2018.

Finally, as mentioned previously, we expect our adjusted effective tax rate to decline to 23.5% as a result of the passage of the Tax Reform Bill. Based on current estimates, we anticipate the corporate tax rate reduction will generate an additional $0.55 per share of adjusted earnings. The tax savings will provide us with the opportunity to further invest in our business and increase dividends to shareholders. The investment initiatives outlined earlier are consistent with our long-term priorities and will offset only a small portion of the positive impact of corporate tax reform.

Lastly, we announced that our Board of Directors declared a quarterly dividend of $0.60 per share and a special annual dividend of $0.79, both payable in February 28 to shareholders of record on February 14. The quarterly dividend and special dividend do not contemplate the cash benefits we expect to realize from tax reform in 2018. It has been our practice to distribute the majority of the cash we generate in the form of regular and special annual dividends. The $3.19 of quarterly and special annual dividends distributed with respect to 2017 represents 2017 adjusted earnings per share of $2.41 plus noncash expenses and deferred taxes, plus approximately $0.25 of cash retained from prior year earnings and tax savings realized in 2017 after payments under our tax receivable agreements.

As the impacts of tax reform become clear over the course of the year, we plan to reassess our capital management policy, including the levels of our current quarterly and special annual dividend. We also plan to consider transitioning to a variable quarterly cash dividend that would more directly align our quarterly dividend with the earnings we generate each quarter. We believe a variable dividend policy will provide shareholders with a greater appreciation of our quarterly cash generation, allow us to more timely return capital to shareholders and, in general, be a better reflection of who we are and how we operate our business. Of course, we may determine not to make any changes to our quarterly dividend rate or our policies.

Our balance sheet highlights on Page 14 remain strong. Our cash position is healthy and leverage remains modest. As you are aware, our employee partners are generally restricted from selling more than 15% of their pre-IPO equity in any 1-year period. The 1-year period resets in the first quarter of each year. In total, together with shares eligible for sale from retiring employee partners and shares that previously became eligible for sale, approximately 5.5 million shares are eligible for sale from the first quarter. As part of the first quarter liquidity, several senior portfolio managers will have the ability to sell 20% of their remaining pre-IPO equity as opposed to the standard 15% per year. Existing and retired employee partners are not required to sell any shares, and we don't know how many shares they will choose to sell.

Related to partner liquidity, we expect the ownership of our pre-IPO employee partners to fall below 20% before the end of the first quarter, which means that our Class B shares will revert to 1 vote per share from the current 5 votes per share. At that point, all APAM shares will have pro rata voting rights, and our 3-person stockholders committee will go from greater than 50% voting power to approximately 20% voting power. The Class B super vote was designed to ease our transition into the public company structure and minimize disruption to our clients and talent. We intentionally designed the super vote to expire at a future date, when employee-partner ownership fell below 20%. We believed at the time of our IPO and still believe today that transitioning over time so that voting rights are commensurate with economic rights is good corporate governance.

We look forward to your questions, and I will now turn the call back to the operator.

(Operator Instructions) The first question comes from Michael Carrier with Bank of America Merrill Lynch.

Maybe first question, Eric, just when you went through some of the strategies and where you're seeing the outflows versus the growth opportunities, just wanted to get an update on when you look at the mid-cap strategies, I guess, how much of a headwind? We can see the AUM there, but probably on the opposite side, where are you seeing the opportunities for growth? Which strategies are capped or closed to new money? Just trying to get a sense of maybe when that inflection can happen where the growth starts to offset some of the headwinds that you noted.

Yes. Sure, Mike. There's obviously 2 levers there, it's the outflow and the inflow, and we addressed the mid-cap outflow. And just given the combination of the absolute performance that, that asset class has generated over the last few years, I mean, you just look at that 5-year time period of producing 15% in that asset class, and maybe put on top of success of our mid-cap value and mid-cap growth. Any slight change in asset allocation or preference for a proprietary target date has exacerbated the flows there. So we think that in the mid-cap, value has subsided. And with mid-cap growth, we still have a good size of DC assets in there as well as some headwinds. But to offset that, we have been, in the mid-cap growth space, specifically launched the Global Discovery to have a more broader view of the mid-cap space by creating a global version of mid-cap in some degree, and that increases degrees of freedom for that space. Mid-cap is a fairly rigid category that has more limited degrees of freedom than our other strategies. So we like the fact that we launched Global Discovery to help offset the mid-cap growth. And so we think that's one area of an offensive move. I think given the success of Global Opportunities and the Growth team, we think we're well positioned to mitigate some flows in mid-cap. We're also -- we're really at nice inflection point score, the Credit team and the Developing World team, given their 3 and -- close to 3-year track record with Developing World that they're right at those inflection points. And the institutional marketplace likes to see a 3-year track record and process integrity, and we've hit those marks with those strategies. And it's nice to see some volatility enter back into the marketplace. Volatility is the friend of active management. And so we have a good outlet, given where those strategies at and where the market is moving towards.

Okay. And then C.J., you gave a lot of expense guidance. Just on the capital side, when you mentioned in terms of the distribution policy, just given the tax rate potentially reviewing that. Just wanted to get a sense, if you did go to the variable type of distribution, when you think about how much that you're able to pay out versus if you look at the growth opportunities in front of Artisan, just how much maybe seed capital that you would need? Or is that already have enough that's in that can be recycled that the distribution or the payout could be close to 100%.

Yes. So fundamentally, tax reform doesn't really change how we think about how we operate the business and what we're going to invest back into the business. From a cash perspective, you'll notice that our cash levels are down compared to last year, and that's really reflective of our seeding some additional strategies. We launched 4 strategies this year, so we seeded about $40 million. That money will eventually make its way back into cash because seed money is left there for a defined period of time, normally 12 to 24 months. And in addition, we accelerated some bonus payment to take advantage of the higher tax deduction this year. So our cash level was depressed at the end of this year for those two reasons. The variable dividend, the way we think about it is, as a private company, we always paid our quarterly dividends after the end of the quarter, and we typically paid out 100% of the earnings. As you know, we're a low capital-intensive business. So we think that -- in thinking about moving to a variable dividend, it would provide a greater appreciation of our actual cash generation, get -- return capital to shareholders in a more timely fashion. And really, it's a reflection of who we are and how we think about the business. So I don't think our philosophy on returning capital to shareholders has changed at all. It would just be more a timing.

The next question comes from Alex Blostein with Goldman Sachs.

Quick follow-up for you guys on just the expense trajectory. So it sounds like -- and you guys gave a lot of details there on just kind of some of the specifics on the occupancy side. But if you look at the non-comm bucket, I guess, as a whole just kind of excluding distribution expense, what sort of the growth rate do you guys expect to see next year? And again, it sounds like there's a couple of transitory things in there. How much at a total shift as we start to think about 2019 more of a kind of cleaner run rate with the growth there should be again kind of thinking about the whole non-comm bucket?

Yes. I mean, the two areas that I highlighted were occupancy and technology. And I tried to -- I did break out sort of what we thought were sort of the incremental-type costs in 2018, which are quite significant for us. So I think you would -- we would expect the trajectory to be back to normal mid-single digits after you back out those onetime expenses, which I highlighted. They were about $4 million each in occupancy and communications, but then thereafter, sort of back to normal -- to more normal levels.

Got it. But I guess, is the more normal level being 2017 or part of that because '17 you guys also have some incremental build-out needs as you are building the teams?

Yes. I mean, we did a lot in '17 with new team and 4 new strategies. Our first 2 commercial hedge fund products. So yes, there was some elevation in '17 as well. And it all depends if we wind up having another year like '17, I think you would see some elevated expenses as well.

Alex, this is Eric. We've just been experiencing some growth with -- as C.J. mentioned, with the new teams over the past 2 years, and we're really having that growth mindset, given where our performance and our strategies are positioned right now looking forward. There's ample examples in that with regards to the Credit team. And Bryan came to me and said that he really wanted to position his franchise to be extremely durable and ready for growth, given the performance and the foundation he's left. So he requested to move to Denver to get greater access to one, just new investment talent, more talent for his team. He feels it's a good location for that. Secondly, while Kansas City is a good central part -- good central to the country, we're just not getting the exposure and traffic from consultants and prospects and clients, and we think that would pick up. And we also think we will get more meetings for with company management, sell side and research. And really, that was a growth mindset move and we're happy to invest in that. And we felt the same way with Thematic. It's now in a great spot. We're moving it out of temporary location that we were housing it in one of our floors that we had in New York. And we've built their 4 walls in their space that matches who they are and their culture. And these are growth initiatives to our firm, and we're happy to reinvest in that. And as C.J. mentioned, if we continue to have a growth orientation, you'll see that expense spend.

Now that totally makes sense, and certainly the theme we've heard from a lot your peers in the space over the last few weeks here. I guess, my second question to you guys, Eric, kind of dovetails on what you're saying in terms of the build-out. As we think about scaling some of the private funds, what's the process? Do you guys think, it'll be -- and I hate to put a year on this, but is this a 1-, 2-, 3-year process before they start reaching more critical mass just because of the fundraising dynamic in those products? I know it could take a little bit longer? Or do you think it will -- it could extend beyond that to move the needle?

Yes. The private funds don't have the same time frame as traditional strategies, where you tend to need at least a 3-year record for capacity-constrained, liquid-oriented strategies and a certain level of assets so that the consultants and other buyers can tick off their buy list criteria. The private funds tend to be shorter than that, and so we wouldn't expect the full 3 years needed as we would with other strategies. But we do want to be thoughtful on how we move into the space. So we're not looking to take every asset that comes to us. We want to be thoughtful, we're getting the right clients on the right terms that have the right outlook with regards to the time horizon for our strategies. And we think it's critically important to lay that foundation, which I mentioned in my opening remarks about where the Credit team and where the Developing World and the Thematic team are as we think we're really laying that foundation for a real strong franchise as opposed to getting one product per act. So I -- we're going to have a longer view on that so that it's more durable.

Our next question comes from Bill Katz of Citi.

So a couple things. C.J., let's sort of come back to the capital management discussion a little bit. You sort of talked a little bit about not kind of playing the impact of taxes. Is there -- other than the elevated earnings as a result of lower taxes, is there anything else that changes in sort of the add-backs to get to what could be the potential for the quarterly variable dividend? And then separately, how do you think about repurchase now relative to the variable nature of the dividend, given the ongoing drift in the dilution to share count?

Yes. So first off, I think the high-level answer on the dividend is, there is no change in how we think about calculating. We basically look at our adjusted earnings, which will include the impact of the incremental spending that I highlighted. Add-back noncash expenses, primarily equity-based comp and then there's some deferred tax noise, which is somewhat immaterial. And the reason I stated it -- I stated that we didn't contemplate the impacts of tax reform in the dividend that we just announced. Obviously, moving forward, we'll generate more cash as a result of tax reform. And we'll think about running the business and our dividend levels the same as we did last year. There just will be more cash available.

You had mentioned that you used up $0.25 this year as some of that reserve. Where does that reserve stand today?

So we basically flushed out the reserve we had held. If you recall, it was quite probably a year ago where we were getting a lot of questions around our abilities to sustain our quarterly dividend because our earnings were around the same level. Obviously, we had the noncash expenses, which generated cash, which weren't in our adjusted earnings for the quarter. So we had held cash back in '16 and '17 as an insurance policy for that quarterly. And obviously, now we're generating cash flow in excess of that, and that's not a question. So again, same philosophy, just a larger cushion there.

Okay. That's helpful. And then Eric, just a big picture for you. I appreciate all of this. So I see the industry transforming in the evolution of APAM as well. What changes this dynamic then that you sort of got some pressure on the mid-cap side and maybe some on the style box, legacy style box, small but scaling high-yield and in Developing World and Thematic. Is there anything that else you can do to sort of catalyze the growth because when I look at the gross sales of the company, that has come down a fair amount over the last year or so. And so the question of if not now then when, do you start to see a bit of a bump in the net sales overall?

Yes. It's -- where we're seeing the delta is when you really get to large-scale accounts is that we're seeing more competition with regard to fee discounts for those really large accounts. And that's an area we've just held the line on. And so we've held that line on not negotiating steep discounts of, in our minds, capacity constrains strategies in everything we do. I mean, if we're going to deliver alpha over the long run, we have to manage the velocity of assets. We have to manage the mix. We have to manage the absolute AUM in every strategy, and we're unwilling to take those large mandates at today's rate. So the other thing we're doing to offset that is to go deeper into the intermediary space both in the U.S. and abroad. And we're starting to see some progress outside the U.S. to offset the large mandates that, quite frankly, we pass on. You get into a negotiation and you get to a certain rate and at some level, we'd rather take a pass and just be patient. So we think that in the long run, preserving that fee rate, especially if we're delivering the after fee returns that we've delivered and continue to deliver, we'd rather be patient to manage that for the long run. And it takes broadening out the distribution a bit more and having that play through over the next year or 2.

The next question comes from Chris Shutler with William Blair.

First, a couple of quick cleanup questions on the model. So the $4 million of onetime expenses in both tech and occupancy, how should we think about the timing of those expenses hitting the P&L?

So I think the occupancy is probably going to be midyear-ish, and technology typically ramps up through the year. So we -- near the end of the year, the projects typically ramp up. So I think a little heavier in the mid- to end. But admittedly, Chris, we don't budget to the month, so those are just sort of high-level expectations.

Okay. Fair enough. And then let's see. So I want to get your thoughts on the new factor classification system, factor box being marketed by MSCI and BlackRock here recently. Is that something that you think is, at least, the idea, is good for the industry? Do you think of framing investment performance using that factor lens as opposed to style box lens is something that's actually going to gain significant traction in the intermediary channel?

Sure, Chris. I think that the style boxes were a nice way to categorize various managers that compare and contrast. And when style boxes came in and people created style indexes and then the marketplace got quite structured and products then followed suit and created strategies that track these style indexes. So I think style factors take that even further. And in my view, the industry is going the opposite way with regards to the categorization of products for consultants, clients and intermediaries. With that being said, though, the factors are taking hold in the ETF marketplace, and we're seeing those factors cause some volatility even today, especially if you lever these factors. And where I think the factors will come through to us is how we analyze how markets are trading and how some of our teams look at those factors influencing the portfolio, and we'll understand that positioning. Are we on the right side of those factors, given our philosophy and process? But I don't view the end client or consultant micromanaging asset allocation or manager structure to that level.

The next question comes from Surinder Thind of Jeffrey's.

Just following up on discussion around fees and then perhaps some of the larger clients asking for discounts in terms of trying to get in new assets. Has there been any discussion around, perhaps, meeting them partway, in the sense that maybe you go to like a performance fee model or something like that, where maybe you give them the discount, but you say, "hey, if we outperform by X, then we get to recapture X amount or something like that?

Yes. Surinder, this is Eric. We've always been open to performance-based fees, and we are having more of those discussions at that account level. Really, the debate becomes around what's the base rate, what's the fulcrum and what's the symmetry around that fulcrum. And those are always the variables that you talk about. And if I had to look forward and expect that we would see more performance-based fees out of our traditional and new strategies on a go-forward that will be part of the solution.

Understood. And so I guess, just kind of looking at the SMA gross sales activity, obviously, they've been quite low the past 2 quarters, and this quarter is kind of the lowest in quite some time. So is that part of kind of what's going on in the sense that just there's a lot more discussion around fees that's kind of causing clients to hold off at this point? Or how should we think about that? Or is that just kind of the normal ebb and flow for the SMA channel?

I'm not sure if there is any normal ebb and flow for the SMA. It's -- we've always said it's lumpy. It takes a longer time frame to normalize out. And when you actually win an account, get something on an unfunded report and then look out into the future, you never really know when the exact funding is going to come in and how it's going to settle. And it creates that lumpy outcome. So I wouldn't read into a quarter or try to create an SMA pattern. I just haven't seen that over the years in my experience.

Understood. And then maybe touching base on earlier budget comments about kind of the mid-cap products and then maybe if we just focus on the U.S. Value team. They've maybe struggled a little bit more than some of the other teams. And I mean, obviously, everybody goes through periods of underperformance. But your other teams have gone through that as well, but they've tended to bounce back perhaps a lot quicker. Is there any color you can provide on maybe where the delta has been? And then maybe with the addition of a new PM, I think it was the last summer and stuff, if there's any been discussion on the team's investment approach? Or is just literally their investment philosophy's just not quite the right fit for the current environment that we're in at this point?

Clearly, I think the primary discussion of the investment philosophy and process within this 9-year bull market that's very narrow. And it has had a big impact, and it has had a longer and more extended time horizon than past cycles. We always talk about the philosophy a bit or how to navigate, but yet have integrity, and we think of new talent to bring in to bring fresh, new ideas. And that -- both those occurred over this time frame. The individual we brought in, Tom Reynolds, who has, I think, had a nice impact on the team. But it's still early. These things take time. And as the market conditions change and it's not a one-way trade, I think this strategy and this team will do quite well. And the mid-cap value has been around since 1999. It's produced close to 400 basis points in alpha, and they've been with the same leader on that strategy, on the same philosophy and process. So when clients and consultants look at buying, performance is important. But they want to be insured that there's a high-quality team and process integrity at some place so they can evaluate it. And we think all that's in place, and it really won't take a whole lot for performance to start coming back and for us to be in a positive position with this group.

The next question will be from Robert Lee of KBW.

Just curious, maybe Eric, going back to your comments about looking at intermediary channels, both U.S. and outside the U.S., a place where maybe some more emphasis given less fee, better fee structure. Particularly outside the U.S., though the intermediary channels have been a pretty expensive place to access. And while fees tend to be high, there tends to be a lot of distribution expense around it. So could you maybe more narrowly -- in whether specific non-U.S. intermediary channels where you feel like you have a better shot worth of spending as much. So I was just trying to get a feel how -- where your focus outside the U.S. on expanding intermediary and how we should think of that from a kind of an incremental spend beyond what C.J. has mentioned.

Certainly, Rob. I mean, the historical fear of the intermediary market in Europe primarily is the number of vehicles, share classes and expense that goes with distributing in a more fragmented marketplace. Our belief is that that's consolidating. And the regulatory environment is moving to a more clean share class structure, which we see in the U.S. It's happening quite a bit in Europe, and we think that is extremely favorable to our model. And so we're picking and choosing those platforms and partners that fit our institutional mindset. But there will be some additional expense above what we do in the U.S., just given the number of countries you deal with and languages that you have to translate to. So there'll be some, I think, minor expense on top of that. But those are all coming down, and that's one of the real reasons we're getting excited about that space is it's coming down in the expenses.

Okay. And maybe at a high level, you gave some good color around some of the challenges facing mid-cap strategies with rebalancing and whatnot. But I mean, at a high level, could you maybe talk a little bit kind of more broadly speaking kind of RFP activity that you're seeing out there? Are you expecting that global's had a pretty good run for a while. Are you expecting to see more rebalancing there? Or are you seeing more people come back to active or liquid strategies maybe from even some alternative strategies, given -- I was saying the last week or so, there seems probably some optimism about the market outlook for next couple of years or so?

I don't think if we've seen any major change that I can identify that's going to change the flow dynamic that's staring at us today. Obviously, there is volatility creeping into the market, and a lot of material written that active is being positioned better than it was before. And I think that active and passive do have cycles. And so we are optimistic about the near term and to find that over the next 3 years to 5 years. But I don't see any catalyst right in front of us today.

Maybe one last technical question. With the Class B shares, I guess, it seems poised to convert to one vote. Is that at all kind of change in control from a fund contract perspective that's going to require some proxies or anything?

No. We've obviously thought about the design of this outcome to minimize disruption for clients prior to the IPO. We've been very thoughtful about this outcome, and it's not going to create a need to have a proxy vote for validating the change of control. So that won't be in place. And we've just looked at all the areas that going from private to public, we've just tried to smooth everything and create the outcome to be gradual and thoughtful when we think that, that transition for the most part is complete.

Our next question will be from Kenneth Lee of RBC Capital Markets.

I just had one question on the -- a follow-up on the non-U.S. client AUM, which has seen nice growth. Wondering if you could give us a sense of the mix between institutional intermediary retail. I mean, it sounds as if it's skewing towards the intermediary, but just want to get a better sense. And also, relatedly, what particular strategies or products are getting that particular attraction for these non-U.S. clients?

Sure, Ken. The design of going into these non-U.S. distribution marketplace was really through the institutional consultants and our institutional presence. So we have quite a few global consultants that we're well positioned with. And if you look back to the launch of our global strategies and our Emerging Markets, provided for the first time strategies that would be positioned quite well for non-U.S. investors. And so the foundation of our early and continued non-U.S. success is through the institutional marketplace. We have been successful with some intermediaries, but we haven't applied the same resources that we apply in the U.S. to outside the U.S. And we're going to uptick our resources towards the intermediary space in Europe and broaden that out for the future.

Ladies and gentlemen, this concludes our question-and-answer session, and thus concludes today's call. We thank you very much for attending today's presentation. You may now disconnect your lines.