富蘭克林資源 (BEN) 2021 Q2 法說會逐字稿

Welcome to Franklin Resources earnings conference call for the quarter ended March 31, 2021. Hello. My name is Denise, and I will be your call operator today. As a reminder, this conference is being recorded. (Operator Instructions)

I would now like to turn the conference over to your host, Selene, Head of Investor Relations of Franklin Resources. You may begin.

Good morning, and thank you for joining us today to discuss our quarterly results.

Statements made on this conference call regarding Franklin Resources, Inc., which are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a number of known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from any future results expressed or implied by such forward-looking statements. These and other risks, uncertainties and other important factors are described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including in the risk factors and the MD&A sections of Franklin's most recent Form 10-K and 10-Q filings.

Now I'd like to turn the call over to Jenny Johnson, our President and Chief Executive Officer.

Thank you, Selene. Hello, everyone, and thank you for joining us today to discuss Franklin Templeton's second quarter results. Greg Johnson, our Executive Chairman; Matt Nicholls, our CFO; and Adam Spector, our Head of Global Distribution, are also on the call with me today. We hope that everyone is well.

We continue to operate our business effectively with over 95% of our employees working from home. Broadly speaking, we are planning for a return to office in September, though our approach will be flexible and shaped by local requirements and the status of the pandemic in the countries where we do business. We are encouraged by the number of vaccines that are now being distributed worldwide. Though the rollout rates obviously vary by country, the progress is very promising. Having said that, we have been deeply concerned by the suffering that has resulted from a surge in cases in India and other parts of the world. Our thoughts go out to our employees and clients who have been personally impacted by this terrible disease.

Turning now to our second fiscal quarter. Today, we are pleased to report financial results that reflect our continued progress with revenue growth and margin expansion resulting in a 6% increase in adjusted operating income to $581 million. Our financial flexibility remained strong with cash and investments of $6.2 billion at March 31, net of $250 million of debt paid down in the quarter.

After only 2 quarters as a combined company, we're experiencing organic growth in a number of key areas. We're now a more robust and diversified active management business, and we're encouraged and excited by our collective potential. Our merger has created a differentiated global firm, which balances scale and specialization and which we believe offers expanded opportunities for our stockholders, clients and employees as well as the financial professionals with whom we partner.

Turning to performance. We're seeing an improvement in performance across a broad base of investment strategies from the prior quarter. More than 2/3 of our strategy composites outperformed their respective benchmarks for the 4 key time periods. The number of our mutual funds rated 4 or 5 stars by Morningstar increased to over 140 funds this quarter.

Turning next to distribution highlights. We're encouraged by the positive results of our new sales initiatives and efforts to deepen relationships. More clients purchased both legacy Franklin Templeton and legacy Legg Mason strategies as demonstrated by our larger wins during this quarter. Our expanded distribution efforts drove an increase in gross sales of 32% from the prior quarter across a broad array of funds, vehicles and asset classes, led by U.S. retail. Long-term inflows increased by $15.9 billion or 19% quarter-over-quarter to $99.4 billion, excluding reinvested distributions. Second quarter long-term net outflows improved to $4.2 billion compared to $4.5 billion in the prior quarter. Importantly, if you exclude reinvesting distributions, net outflows improved by over $10 billion.

Our sales momentum continued with positive net flows into Benefit Street Partners, Clarion Partners, ClearBridge, Fiduciary Trust International, Franklin Equity Group, Franklin Templeton Fixed Income, Martin Currie, Royce and Western Asset.

As we said on previous calls, the firm has been focused on expanding our alternatives platform, and this quarter we did. Alternative strategies grew by $4 billion to $131 billion in assets under management with contributions from real estate, private credit and retail alternatives.

Clarion Partners and Benefit Street Partners both reached record AUM levels, and K2 alternative strategies also contributed to positive net flows. Fixed income inflows increased by 27% to $53.5 billion from the prior quarter due to positive contributions from a diverse group of fixed income strategies, including core bond, core plus and corporate. We are pleased that Western Asset experienced net inflows of almost $10 billion in the quarter, its highest level in over a decade. Equity inflows were $32.4 billion, consistent with the prior quarter, excluding reinvestment distributions. We continue to see strong interest in our thematic equity strategies. And while it's still early days, we're seeing progress and increased interest in our value strategies.

As of this quarter's end, our institutional pipeline has increased with a combined total of won but unfunded mandates of $13 billion and is diversified across all asset classes.

Aside from our specific results for the quarter, we are also pleased to release our Corporate Social Responsibility Report in April. We established clear goals and priorities for fiscal year 2021. ESG investing is key among them, and we continue to make important strides to keep our diversity inclusion efforts at the forefront.

Before we open it up to questions, I'd like to thank our outstanding teams around the globe for continuing their extraordinary work every day on behalf of our clients and firm, and they've done so this past year under challenging circumstances. I am grateful for everything they do.

Now your questions. Operator?

(Operator Instructions) Your first question comes from Dan Fannon of Jefferies.

My question is on flows and just kind of the momentum. If you look at the backlog, which continues to grow, can you talk about the difference in the backlog this quarter versus last? And then also, on the strength in alternatives, if you could talk about the fundraising, if it's evergreen or ongoing or if there was some kind of specific closes that maybe drove the strength in this past quarter.

Sure. I'll take it. It's Adam here. Thanks for the question. If you think about what's happening now and how flows are changing, the good news is that they're becoming far more diversified, which is actually what we've been planning to do. So we're seeing good flows, equity, fixed, alternatives as well as in our solutions business and geographically diverse as well. The U.S. remains, by far, the largest driver of flows, but we're seeing very good flows in Europe and the Americas as well.

In terms of alternatives, I'd say 2 things happened there. At the top end of the market, we saw really healthy subscriptions into Clarion, K2 and others from the institutional market, but we are also really trying to address the democratization of alternatives and had some very healthy raises for BSP and others in the wires. And that's something that I think will continue throughout this year as we have other retail launches for other alternative products throughout our system.

Your next question comes from Brennan Hawken with UBS.

This is Adam Beatty in for Brennan. Just want to ask about some of the exchanges from equity into multi asset. Seemed like that had bit of an effect in the quarter. And just the trend you were seeing throughout the quarter, maybe the trajectory, do you expect a little bit more of that given where the markets have been? And is there anything in terms of maybe a poll on the multi-asset side that, either through marketing or distribution, where you're kind of accelerating that movement in some way?

Sure. Let me address that in 2 parts. First of all, in terms of the exchange, that is more of a onetime thing where we have essentially reclassified and tweaked how we manage an existing fund. So that caused a reclassification. So that's an accurate change for this quarter but not something that you should see happening quarter-over-quarter.

In terms of solutions, in general, though, that has become a focus. What we see at our largest distribution partners is that there is a focus on having their advisers focus more on asset gathering and less on portfolio management, which means that the management teams at our biggest partners are really looking to firms like Franklin that are full-service, offer active sleeves across the entire suite to provide models and solutions. And that's where we're seeing a significant pickup in our solutions business and would imagine that would continue throughout the year.

Your next question comes from Robert Lee with KBW.

This is Jeff Drezner on for Rob. A quick question in regards to gross sales for fixed income. There's a large step-up there, but then there was a bit of a sharper drop in equity gross sales. And wondering if you can provide any color. I know some of your peers have been showing some more demand on the equity side.

Yes. We're seeing good demand in fixed income and in equity. In fixed income, Western just had an absolutely fabulous quarter, and I think that's what drove a lot of the top line on fixed income. From an equity standpoint, the great news is that, with value coming back in the marketplace from a return perspective, we feel that we are quite well balanced in terms of our exposure to value and growth. The majority of our inflows in equities continue to be on the growth side, in things like DynaTech. ClearBridge is a large-cap growth. But we have very strong product on the value side, and we're starting to see a pickup there as well.

Also, if you exclude reinvested distributions from the chart, the sales were about flat. And in fact, the net flows improved into equities when you exclude reinvested distributions.

Great. And if I could just quickly follow up with one more. Just in terms of capital management, maybe your thoughts on acquiring additional high net worth businesses, and maybe just a general outlook on the acquisition.

Yes. I'll take that.

I mean -- okay, Jenny. Go ahead.

We've stated that we want to continue to grow fiduciary trust. And as we're looking at those potential acquisitions, we're usually looking not only for assets and expanding our distribution there but geographic benefit, maybe in a location that we're not located, as well as capabilities. So as you know, the last 2 with Athena, we got really a top ESG manager and can trust with the special needs trust. So it is still an area of focus for us, and we will continue to look to acquire there.

Your next question comes from Ken Worthington with JPMorgan.

The Biden administration has proposed higher dividend and capital gains taxes for the high net worth. If these proposals go through, do you think they could or would have an influence on your business, either the types of products that are sold or the distribution channels through which they're sold?

So we look at ourselves as a firm. Our expertise is our investment management capability. We want to be flexible in delivering that expertise in whatever vehicle our clients would like to receive it in. So that can be a mutual fund. That can be an ETF, a CIT, a separately managed account. So there's no question that there's a lot of discussion out there, that the mutual fund has some tax inefficiencies that an ETF doesn't have and that there is the potential to see a shift there. However, you were probably already seeing a bit of that shift as many fee-based advisers prefer the ETF vehicle.

So we want to -- if that happens, you're likely to continue to see an acceleration in that shift. What we have been hearing for the last couple of years from our distributors is you need to be able to package all of your products in any of these vehicles and be agnostic to it so that you can meet the demands of our varying distribution groups.

And what I would add to that, Jenny, is that we believe we'll see increased demand for our muni capabilities, where we have a really strong capability at both Franklin Templeton Fixed Income as well as at Western. And in general, as taxes take a larger bite of the apple, active management becomes more and more important, which we think is in our favor as well.

And Jenny, you mentioned the ETF wrapper. Since you guys control Precidian, is that something that you're seeing benefit them in terms of either leads or new business inquiries? Any flavor there?

So I think it's -- the jury is still out a little bit on whether people want a true kind of blind trust for their active management capabilities. I think there's a view that many of the products, it's okay to have some transparency, even on the active side. We do certainly, and certainly in fixed income. But I think there are -- you take a small-cap strategy, you're going to need to have that in some kind of blind trust in the ETFs. So I think that Precidian has the opportunity to benefit, but I don't think this will be at the level maybe when it was launched, where people thought it would -- that all active ETFs would be in that kind of packaging for an ETF.

Your next question comes from Michael Carrier with Bank of America Merrill Lynch.

This is actually Shaun Calnan on for Mike. Can you guys update us on your distribution efforts for placing legacy Legg Mason products into retail products? And did that have a major impact on the improved gross flows in the quarter?

Sure. One of the -- 2 things that I think we need to be successful is cross-selling. The other is getting our general specialist model, right. So from a cross-selling perspective, if you take a look at the 2 organizations premerger, Franklin had much more of a strength in the regional broker-dealer channel. Legg was a little stronger in the wires. There were some geographic differences as well. One of our major, major efforts is to make sure that we take advantage of that complementary nature of the 2 businesses. So if you take a look at what's happened so far year-to-date, we've cross-sold to about 5,000 new advisers, advisers who either owned only legacy Franklin and bought legacy Legg product or vice versa. And that cross-selling is having a pretty significant impact. Another way to look at that geographically is to think about the presence that, say, Franklin had in Canada or the Americas where Legg was a little lighter. We're now at about 25% ahead of last year's sales in those regions from legacy Legg Mason. So yes, kind of that cross-selling has had a significant impact.

Your next question comes from Alex Blostein with Goldman Sachs.

This is Sheriq filling in for Alex. My question is on the expense guide. In the commentary, you had mentioned as to subject to market conditions. So just wanted to get a sense as to what are the market assumptions and flows estimates that you have taken into consideration for the rest of the year.

So in terms of the market, we're assuming at a flat market, we don't make any additional market overlay assumptions in our guidance. In terms of the flow trajectory, we're assuming something similar to what we've been experiencing and the improvements that we've been experiencing over the last 2 quarters. So that's why our guidance remains consistent with what we described last quarter.

The -- what's pushed it up slightly in terms of the -- we mentioned $3.75 billion to $3.8 billion for adjusted expenses. What pushed that up slightly is the -- obviously, the continued momentum in the market but also our performance has improved. Our flows have improved, and our results have improved. So by definition, that does have an upward pressure on compensation in particular, but we have other offsets in our cost structure on -- in that regard.

Understood. Yes. Just a follow-up on that. So assuming that this flow trajectory and the markets continue to grind higher, what's the sensitivity of this guide to kind of go up for the rest of the year?

I think we -- for the third quarter, we feel good about the continued $3.75 billion to $3.8 billion. We'll provide further guidance for the fourth quarter and 2022 when we reach that point.

Your next question comes from Brian Bedell with Deutsche Bank.

Great. Just wanted to talk about the fixed income business broadly. Obviously, when we get -- and we tend to have a backup in yields or a rising long-term yield environment. On retail bond funds, that tends to cause at least a temporary downdraft or a spike up in redemption sometimes as the NAVs get hit on that. But can you talk about -- for the institutional side, it could be a different dynamic. So can you talk about what clients are saying about that? Or what are their concerns about that or what you perceive as client demand? If we do have a spike up in yields for Western, would you see a temporary sort of elevated redemptions on that? Or do you think that's actually positive for long-term flows?

I mean particularly on the institutional side, I mean let's face it, pensions, insurance companies, they need fixed income as part of their portfolio, both from a cash flow perspective as well as to potentially dampen volatility. So we have about 43% of our AUM in fixed income, and there are multiple fixed income franchises within Franklin Templeton. And they all manage differently. So we go anywhere from treasuries, obviously, to private credit with the BSP. And so they all manage differently.

With a rising rate environment, obviously, you're going to have an impact on the duration component of the fixed income portfolio. But if you take Western, for example, only 4% of their AUM is actually in government bonds. So the rest of it, they're doing -- they're managing across sectors, bank loan, high yield, emerging markets. And if you have a rising rate environment, chances are that's a better economy -- economic environment, and chances are those -- the credit component and the sector component outperform.

So when you look at -- we actually did a study at Western and looked back to 2000, and there were 30x where you had a significant short term -- or significant period of rate increase, which defined by greater than 15 basis points in a month and was extended. And in that, Western tended to underperform in the short term but then significantly outperform in 6, 9 and 12 months because what ended up -- and that's versus obviously benchmark and peers. And that's because the credit sector component kicked in on the performance. So institutional clients understand that and are willing to kind of work through, at least that's been our experience.

And the other thing I would add is that as raise rights rise -- as rates rise, we would expect to see some money coming out of lower fee cash and very ultra-short products into more core products, which will have a positive impact for us.

Yes. No. That's great. If I can sneak in another one on the Schwab, the AdvisorEngine platform integration with Schwab, the AdvisorEngine that you mentioned. Any view on how that might impact the sales trend through the Schwab Advisor Network going forward from where it's been?

Our strategy is to -- as the world has moved on the retail side to more of a fee-based environment, with somewhere between 75% -- about 75% flows kind of go in that direction, it has pushed -- because there's obviously transparencies on what the client is paying the adviser, pushed the adviser to be more of a wealth manager. So our goal is to provide additional tools beyond just investment capabilities to help that adviser be a wealth manager, deepens the relationships with that.

So in the case of AdvisorEngine, there are tools within AdvisorEngine, and it may be a simple -- the CRM system, Juncture, that an adviser that's sitting on the Schwab platform and custody-ing on the Schwab platform may want to use some of those tools for some of the clients or all of their clients. And they won't use it unless you have integrated to the custody level. So it remains to be seen how that plays out, but that's essentially -- our goal is to just make it as easy for a financial adviser to do business with us and to provide those additional types of services that, for example, like [Go], which ends up providing goals-based investment models so that you deepen the relationships and hopefully have stickier assets with the advisers.

Your next question comes from Patrick Davitt with Autonomous Research.

The last few answered all my questions. I'm good.

Your next question comes from Craig Siegenthaler with Credit Suisse.

This is actually Kareem Afifi filling in for Craig. My first question is on flows. I was wondering if you could expand on the reason behind the $6 billion fixed income institutional redemption. Was it performance related? Or did the client want to move the money in-house? And also, does this particular client have other mandates with Franklin Templeton?

Why clients make particular moves, I think you never quite know. I would say, in general, with some large sovereign institutions, we do see a trend to in-source some places. I think this was just not the right mandate for them at the right time. That client still does have significant assets with us as an institution, and we feel solid with the overall relationship. We just happen to lose one piece of the overall relationship there, a lot of money but only a portion of our overall relationship.

Got it. And if I could sneak one more. Can you maybe comment on the sustainability of retail flows given the large government stimulus and strong equity market which may be making current activity levels unsustainable?

Look, I can only tell you what we're doing, not what the government is going to do from a stimulus policy. And I'm feeling really confident about what we're doing in sales. We, post merger, really brought the best of the 2 firms together. We feel really confident in the field force we have out there. We've got folks in new territories now for 6 months. We're seeing the results of that interaction. We've put a specialist generalist model in place. And I see no abatement in terms of the activity we're having, the level of engagement we're having and feel really, really good about where we are from flows. If you look at U.S. retail, it's, by far, the largest segment of our overall business. It's the place we put the most attention post merger to make sure we get the integration right, and we're seeing huge benefits from it. So I'm feeling pretty good about the future.

Your next question comes from Michael Cyprys with Morgan Stanley.

This is Stephanie filling in for Mike. My question is around the fee rate. Given the improvement in performance fees this quarter, do you think the outlook for generating performance fees has improved into the rest of the year? And then just any help on how we should think about the fee rate exiting the quarter and trending from here.

Yes. I mean, look, the fee rate this quarter was supported by a couple of quite large low-fee redemptions. We had growth in alternatives. We had good support in equities, so it solidified where the current rate is. We feel quite good for the year to say that the high end of our guidance at 38 basis points, potentially 38 to 39 basis points is the right way to model it for the entire year.

Great. And then just one quick one on cryptocurrencies. Do you see a commercial opportunity in crypto? If so, how are you approaching the opportunity from types of products or investments that you might be considering?

So I'm not a huge fan of things like Bitcoin because I think, over time, if crypto got so big, governments would want to step in and regulate because they like to control their currency. So I'll put that sort of out there first. That is not to be confused with tokenization both of assets because I think that, that will unlock illiquid assets that become interesting and also tokenized coins that help facilitate business models. And that's different. There's nothing backing a Bitcoin, but there is something backing a coin that actually has a functional capability.

So I think there's a lot of education that's kind of happen out there around tokenization, and I do think that blockchain will completely change sort of how this -- how our industry, how the financial services industry operates their back office. I think it has, as I said, has the real capability of democratizing illiquid assets that some would argue might even take some of the premium out of alternative space over a long period of time. But that would be my answer to that question.

I just would add one other thing on the wealth side. having the capability to field, let's call it, digital assets in general is going to probably be important for the future. So we are focused on the capability front in that regard.

Yes.

(Operator Instructions) Your next question comes from Brian Bedell with Deutsche Bank.

Great. It's on ESG. I mean you have some detail in the commentary on that. Just wanted to see if you're able to assess what the flows were into ESG-dedicated products or what you call a specific focus for the quarter? And then the $175 billion that you mentioned with specific focus. I just wanted to fill in on that a little bit. I think Legg Mason, but if I'm not mistaken, is the bigger part of that. Not sure if you can go into some color on some of the bigger parts of that $175 billion that you're including in that? Does it include any exclusionary product, for example?

So let me give you my little spiel on ESG, while Adam looks a little more detail on the actual flows in some of those. So first of all, we would -- 93% of our AUM has ESG factors. I mean we think it's here to stay. We don't think anybody could be an active manager without ESG. And all of our investment teams incorporate ESG factors into their investment process.

And we think that one of the reasons we're so far along in that is, one, as an active manager, we think that the data out there is not particularly good, and it requires engagement by investment teams with companies to actually gather the data; and number two, having as a large -- having a large presence in both Europe and Australia, where really these trends kind of started, we had to develop these products way before they became really important in the U.S. And we think that, again, despite the industry coalescing around things like SASB and TCFD, right now, it really requires engagement of an active manager to do true ESG kind of screening.

When you look at Europe, they have something called Article 6, Article 8 and Article 9. Article 6 is you do the screen, so our 93% of our AUM would qualify in that. In Article 8, we have 25 products there. And Article 8 is I have a tilt towards ESG factors. And Article 9 is really impact, and we have 8 funds there. We are seeing good flows into our 2 Paris-aligned climate ETFs. Our European Total Return and our Templeton Global Climate are both reaching $1 billion, good flows into our infrastructure fund. I know ClearBridge U.S. Equity Sustainability Fund has been in net sales for the last 12 months. So to answer a little bit of your question, we're seeing flows in a broad set of products.

And what's interesting I think you're seeing is the supply side of ESG is really increasing. As you hear like Europe, 1/3 of their COVID relief fund will go into green bonds, which is doubling the size of the market. Obviously, with the Biden infrastructure, if that gets passed, you're going to see increase there. And so there'll be a lot more supply, which will continue to drive this.

And Adam, I don't know if you want to add any additional details to that.

I think, Jenny, you hit on all the high points. I would just say that the great thing about our ESG capabilities is that, yes, we have it in the traditional asset classes, equities, fixed income but also in solutions and alternatives. And it's in alternatives in places like K2, Clarion, et cetera, where we're also seeing significant flows. And I think that combination of ESG and alts is going to be a real winner for us.

That's super helpful. In fact, if I just back out the onetime redemption of the $6 billion on the India fund, we would have about $3 billion of positive flows for the quarter. Is it fair to say ESG funds would have driven, on a net basis, a significant portion of that positive $3 billion?

I don't think we know the answer to that, but you're right on $3.4 billion, though. Yes.

That ends our today Q&A session. I would like to hand the call back over to Jenny Johnson, Franklin's President and CEO, for final comments.

Okay. Well, thank you, everybody, for participating in today's call.

Through the work that we've done over the past year, we've built a really truly differentiated investment firm. And our progress highlights why we are more confident than ever about our future.

Once again, I'd like to thank all our employees for their significant efforts, dedication and client focus. And we look forward to speaking with all of you again next quarter. So thank you, everybody.

This concludes today's conference call. You may now disconnect.