Cohen & Steers Inc (CNS) 2017 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Cohen and Steers Third Quarter 2017 Earnings Conference Call. (Operator Instructions). As a reminder, this conference is being recorded Thursday, October 19, 2017.

I would now like to turn the conference over to Adam Johnson, Senior Vice President and Associate General Counsel of Cohen and Steers. Please go ahead, sir.

Thank you, and welcome to the Cohen and Steers Third Quarter 2017 Earnings Conference Call. Joining me are Chief Executive Officer, Bob Steers; our President, Joe Harvey; and our Chief Financial Officer, Matt Stadler.

Before I turn the call over to Matt, I want to point out that during the course of this conference call we may make a number of forward-looking statements. These forward-looking statements are subject to various risks and uncertainties, and there are important factors that could cause actual outcomes to differ materially from those indicated in these statements. We believe that some of these factors are described in the Risk Factors section of our 2016 Form 10-K, which is available on our website at cohenandsteers.com. I want to remind you that the company assumes no duty to update any forward-looking statements.

Also, the presentation we make today contains non-GAAP financial measures, which we believe are meaningful in evaluating the company's performance. For disclosures on these non-GAAP financial measures and their GAAP reconciliations, you should refer to the financial data contained in the earnings release and presentation, which are available on our website.

Finally, this presentation may contain information with respect to the investment performance of certain of our funds and strategies. I want to remind you that past performance is not a guarantee of future performance. This presentation may also contain information about funds that have filed registration statements with the SEC that have not yet become effective. This communication does not constitute an offer to sell or the solicitation of an offer to buy these securities. For more complete information about these funds, including charges, expenses and risks, please visit our website. And with that, I'll turn the call over to Matt.

Thank you, Adam, and good morning, everyone. My remarks will focus on our adjusted result -- as-adjusted results. A reconciliation of GAAP to as-adjusted results can be found on Pages 18 and 19 of the earnings release or on Slides 16 and 17 of the earnings presentation.

Yesterday, we reported record earnings of $0.55 per share compared with $0.51 in the prior year's quarter and $0.50 sequentially.

Revenue was a record $96.5 million for the quarter compared with $94.4 million in the prior year's quarter and $92.9 million sequentially. The increase in revenue from the second quarter was primarily attributable to higher average assets under management and one more day in the quarter.

Average assets under management for the quarter were also a record at $61.2 billion compared with $60.5 billion in the prior year's quarter and $59.7 billion sequentially.

Operating income was $40.4 million for the quarter compared with $37.3 million in the prior year's quarter and $37.4 million sequentially. Our operating margin increased to 41.9% from 40.3% last quarter.

Expenses increased slightly on a sequential basis as higher compensation and benefits were partially offset by lower distribution and service fees. The compensation-to-revenue ratio remained at the 32.75% for the quarter, consistent with the guidance we provided on our last call, and therefore the increase in compensation and benefits expense is in line with the growth in revenue. The decrease in distribution and service fee expense was primarily due to a mix shift into lower-cost share classes.

As a result of a change in the apportionment of revenue, the full year effective tax rate declined to 37.75% from 38%. The third quarter tax rate of 37.3% included the cumulative effect of this rate adjustment.

Page 15 of the earnings presentation displays our cash, cash equivalents and seed investments for the current and trailing 4 quarters, and indicates that portion of our cash and cash equivalents held outside the United States. Our firm liquidity totaled $261 million compared with $242 million last quarter, and stockholders' equity was $309 million compared with $290 million at June 30th. And we remain debt free.

Assets under management totaled $61.5 billion at September 30th, an increase of $1.1 billion or 2% from June 30th. Assets under management in institutional accounts totaled $29.6 billion at September 30th, an increase of $174 million or 1% from last quarter. Open-end funds, which also had record assets under management, totaled $22.5 billion at September 30th, an increase of $903 million or 4% from last quarter. And assets under management in closed-end funds remained steady at $9.4 billion.

We recorded total net inflows of $1.4 billion in the quarter, an annualized organic growth rate of 9%. This marks the 12th consecutive quarter in which we have recorded net inflows.

Institutional accounts had net inflows of $526 million in the third quarter, an annualized organic growth rate of 7%.

Subadvised portfolios in Japan had net outflows of $275 million in the quarter compared with net inflows of $329 million last quarter. Net outflows were primarily from U.S. real estate portfolios. Distributions totaled $731 million, a decrease of $118 million from last quarter, largely as a result of the distribution cut we discussed on our last call. The distribution cut was also a contributing factor to the net outflows that were recorded during the quarter.

Subadvised accounts excluding Japan had net outflows of $221 million, of which $147 million were from large-cap value portfolios and $125 million were from global listed infrastructure portfolios, both of which were the result of rebalancing.

Advised accounts had net inflows of $1 billion during the quarter, primarily from newly awarded mandates in global listed infrastructure, preferred and multi-strategy real assets portfolios. Bob will provide some color on the level of activity in our institutional pipeline in a moment.

Open-end funds had net inflows of $869 million during the quarter, an annualized organic growth rate of 16%. Distributions totaled $177 million during the quarter, of which $129 million were reinvested.

Let me briefly discuss a few items to consider for the fourth quarter. With respect to compensation and benefits, we expect to maintain a 32.75% compensation-to-revenue ratio. We continue to expect G and A to increase between 3% and 4% from 2016. As a reminder, the majority of the year-over-year increase in G and A is attributable to strategic investments we made to our distribution capabilities in the DCIO channel and in Europe, as well as higher mutual fund reimbursement costs and increased costs for administering our collective investment trusts, both of which are generally associated with asset growth. And finally, we project that our effective tax rate will remain at approximately 37.75%.

Now I'd like to turn it over to Bob.

Thank you, Matt. Good morning, everyone.

As you heard from Matt, this was another solid quarter of asset and earnings growth. The $1.4 billion of net inflows, as Matt said, represented our 12th consecutive quarter of positive organic growth. What's more, whereas in the past organic growth was driven mainly by 2 strategies, U.S. real estate and preferred securities, today we're also getting positive flow contributions from global real estate, global listed infrastructure, low-duration preferred securities and multi-strat real assets.

Investment performance in the quarter was good with 5 of 10 strategies beating their benchmarks, and 7 of 10 have outperformed on a year-to-date basis.

Our wealth channel contributed another outstanding quarter of organic growth. Net inflows were $869 million or a 16% annualized growth rate. U.S. REITs, preferred securities and low-duration preferred saw the biggest flows, but global real estate had $55 million of net flows, which was a new quarterly high. During the quarter, we also had several different funds added to 5 recommended lists at important distribution partners, which reflects our continued strong performance.

The institutional advisory channel had an exceptional quarter as well, reflecting both the elevated interest in our strategies and our success rate in competing for these mandates. Net inflows exceeded $1 billion, which was a 41% organic growth rate, and was also derived from a range of strategies including global listed infrastructure, preferred securities, U.S. real estate and multi-strat real assets.

Our pipeline of awarded but unfunded mandates stands at $555 million, down from $903 million at the end of the second quarter. In the quarter, $729 million of the $903 million was funded, and we added $385 million of new but not yet funded mandates. Also during the quarter, we won and funded $228 million from 2 mandates, which, as a result, did not show up in the pipeline statistics. The vast majority of these new assets are investing in our global real estate strategies, adding to the number of different portfolios that our advisory clients are utilizing. We are currently awaiting the outcome of 6 undecided mandates totaling approximately $320 million, and RFP activity remains strong.

Outflows from our subadvisory ex Japan relationships totaled $221 million primarily due to rebalancing out of our large-cap value and global listed infrastructure strategies, which have experienced high absolute returns. As we noted in our last call, following the distribution cut in one of the Japanese U.S. REIT funds that we subadvise, we expected that net inflows we have been recording would shift to net outflows, and in the quarter our Japanese subadvisory business overall did experience total net outflows of $275 million. While we don't break out flows by fund or subadvisory relationship, I can tell you that the outflows from the fund in question, which accounts for approximately 43% of our Japanese U.S. REIT assets under management, are well below our competitors' levels at this stage and are in a declining trend.

Before finishing up, I'd like to share a couple of thoughts. First, I want to reiterate that our organic growth, which for years was powered primarily by U.S. real estate and preferred securities strategies, is now supported by 4 additional strategies, all of which had net inflows in the quarter. Obviously, if these trends continue, this has the potential to improve our future organic growth prospects.

Second, as you saw from our financial results in the quarter, our focus on managing controllable expenses continues to bear fruit. In addition, it appears that concerns regarding the prospect of increasing costs associated with accessing retail distribution have been unfounded. That said, it's very likely in the near future that there will be incremental costs to fully comply with various new regulatory rules such as MiFID II. We have been and continue to work on strategies designed to mitigate the potential financial impact of these and other regulatory changes.

In the end, strong investment performance, select investments in performance and productivity, enhancing opportunities and prudent management of regulatory requirements should enable us to continue to grow profitably for the foreseeable future.

I will stop there and open the floor to questions.

(Operator Instructions). Our first question comes from the line of John Dunn with Evercore ISI.

Just apropos what you were just mentioning, performance against the one-year bucket declined some from last quarter. I'm chalking that up to the CSRSX lagging a little bit. Performance is still great, but can you talk about what you guys are doing to get performance back up and maybe what inning we might be in the REIT investing cycle?

Sure. John, this is Joe Harvey. The decline in our strategies that are outperforming relates to our U.S. REIT strategy, but I think some context is appropriate. And just to correct you, it's not relating to one of our flagship REIT strategies or funds, Cohen and Steers Realty shares.

Within our U.S. REIT strategy, we run a variety of approaches ranging from our core total return strategy to opportunistic strategies to concentrated or focused strategies. We also have strategies that have income objectives.

And so the one strategy in question had some unique considerations including some income objectives. And it's one sub-strategy. Had that strategy outperformed, our percentage of outperforming strategies would be a 90%; so consistent with what it was last quarter.

I'd say we're not concerned with any underlying process or performance issues. Our REIT strategies in general, both U.S. and global, are doing very well. Within our U.S. REIT strategies, we also have different PMs who take leads on strategies. So they will all follow the same process, but in any one quarter or shorter period of time, they can deviate a little bit. But we expect it to converge with the positive trends with our other REIT strategies.

Great. And then so the institutional interest in preferreds is super interesting. Can you kind of talk about the kind of investor profile that you're seeing and then whether and why you think that demand might be sustainable for preferreds in institutional and not just kind of opportunistic activity?

Sure, John. The institutional activity is, first and foremost, being supported by 2 of the largest institutional consultants in the business. And so they have embraced preferred securities. They have us as their top recommendation. And their clients include insurance companies, corporations, pretty much the full range of institutional clients. And we expect more client interest from those consultants, and we would also expect other institutions and institutional consultants to embrace this. And perhaps the driving force is the search for yield and the fact that many, if not most, other income-oriented strategies appear extremely stretched from a valuation standpoint whereas preferreds still offer excellent value.

Our next question comes from the line of Ari Ghosh with Credit Suisse.

Just on the Japan subadvisory business over there. So outflows have been pretty modest and probably even better than we initially anticipated so just wanted to get your thoughts on the remaining assets there. And in the event of a rate cut to the other funds, is there anything different, either from a manager relationship basis or fund strategy, that would cause the reaction to be a little more drastic in the event of a rate cut to the other funds?

That's an excellent question. There's really just 2 funds in question; the one that has already cut, and that fund we would expect to have a higher velocity of flows because it's mainly a broker/dealer distributed fund whereas the other U.S. REIT fund is distributed mainly through regional banks and other institutions where the assets tend to be stickier. So if and when there is an additional cut to the other U.S. REIT fund, if history is any guide, the flows should be more muted than the outflows on the first fund.

Got it. That's really helpful. And then I believe most of the pipeline you spoke about last call was in the advisory-related mandates, and it looks like some of that's funded in 3Q. So just curious as to what the demand trends look like on the advisory side of the business for the next 6 months. And great quarter in 3Q, but I was just wondering if you expect flows here to be either a little more lumpy or are more recurring as you've sort of grown the business management resources to the segment.

Well I would make a couple of comments. There is some seasonality to institutional searches and so we're probably past the peak in terms of the volume of RFPs and searches between now and year-end. That said, the really important trend that I tried to emphasize in my remarks: that demand whether it's in the wealth channel or the advisory channel is becoming much more widely dispersed among our strategies. So as we look at the 6 mandates where we were a finalist and we're awaiting outcomes, the strategies include U.S. real estate, preferred securities, natural resource equities, global real estate and global listed infrastructure. So the key here is that we've gone from really a two-legged stool to a multi-leg stool and that's obviously a much stronger foundation to grow off of.

Our next question comes from the line of Michael Carrier with Bank of America Merrill Lynch.

Hi, It's actually Jeff Ambrosi filling in for Mike. I just wanted to ask about the distribution expense in the quarter. So I guess if you look at that ratio relative to AUM, it seemed like it dropped pretty notably. So I know you mentioned the shift into lower-cost products. So I guess as we look ahead, should we expect, I guess, a similar ratio there with the trend kind of declining in the distribution expense?

Jeff, it's Matt Stadler. I think it's -- each quarter there's a couple of things that influence that, but we've seen a pretty consistent change from A and C shares into iShares. iShares now make up a majority of our overall AUM and so there is a lower cost component.

And in addition, each intermediary has its own cost to do business in, and depending on where the flows are at any particular quarter, there's going to be a differentiation in the overall cost. So whereas it seems like the change to iShares has been pretty steady and most likely will reoccur and be with us for a while, where the flows are coming from and the continuing rationalization of costs versus the DOL is something that I think is still somewhat of a work in progress so it might be hard to handicap that one.

I would just add to that, that we're all closely monitoring the direction of revenue sharing and distribution assistance costs, which are mainly in 2 buckets: the cost for sub-TA and then the cost for networking. And in the post-DOL environment this year, we have seen distributors rethinking their strategies and how they approach this, but the overarching trend we see is standardization of what they charge. And at a minimum, we're not seeing those costs rise, and in fact, in some instances, we're seeing them decline. We're, I think, just in the middle of that process so things are still evolving. But as I said in my comments, intermediate and longer term, we do not see these costs increasing and most likely they will be decreasing.

Our next question comes from the line of Ann Dai with KBW.

My first question is for Bob. I know you touched briefly on the potential incremental costs to comply with regulations like MiFID II. And I guess I'm just hoping you can give us a little color on what you guys have been working on, what's already in place on your side and what's still in the works. And then to take it a little further, how are you thinking about research payments given what we know so far? Are you looking at it from a pass-through versus P and L standpoint? And is there any way to kind of handicap what that impact could be to earnings?

Ann, that's a really excellent question and it's something that is front of mind for us. Joe Harvey is heading that effort up for us so I'm going to ask Joe to answer the question.

Great. So as it relates to MiFID II, there are 2 categories of issues that we're navigating. One is a little more straightforward, but not inconsequential, and that relates to trade reporting, trade execution monitoring, other regulatory monitoring processes. And so we're going through the process of being ready to be compliant at the beginning of the year with that. And I don't -- as it relates to the different regulatory issues we've been dealing with the past several years, it's just part and parcel of that whole program.

The other bucket relates to research costs and who bears those costs: whether they will be paid for by the clients through commissions, which has been the historical framework, or whether asset managers are going to take those on to their own P and L. And just for context, the regulation simply requires that asset managers report on a budget basis what those commission costs will be to MiFID-related clients, Europe-related clients.

But as everybody who's on this call, I'm sure, is well aware, the market is trending in Europe toward asset managers electing to pay for research costs themselves and cease paying for those costs through commissions. So we, not wanting to buck the market trend, are planning for that inevitability. Right now, we can only do that for European clients, and one of the reasons is that the SEC precludes payments from U.S. managers to U.S. broker dealers in cash as opposed to commissions.

So you can get a sense that this is a very complex and it has been a rapidly evolving dynamic. I think the effects are going to be a significant contraction in sell-side research providers. What we are doing is looking at each of our teams. And in preparing for the inevitability of it, asset managers pay for research globally, we're optimizing kind of how we access research externally. We think that, especially for some of our larger teams, it's going to end up being a competitive advantage as the amount of information and amount of sell-side research declines.

In terms of costs, as it relates to what we know now for Europe, it's pretty manageable, and I would say that the direct costs of that is less than $1 million. But in terms of the whole picture, it's still going -- as things change and we understand what all the rules and market trends are and as we develop -- as we evolve our business model, it's too early to know what the total costs will be.

Thanks, Joe. That's incredibly helpful. As a quick follow up, I think just on the European business, do the potential costs change how you think about expanding that business in Europe or impact where you might want to focus your resources especially if there's some aspects that aren't at as much scale? Or is it really so manageable that it's just kind of not an issue at this point?

I'm going to ask Todd Glickson to answer that. But we've made significant investments in Europe from a business development standpoint, both in terms of people, but also new products, registrations and so forth. And so we're more excited than ever, notwithstanding the regulatory environment, about our prospects there. And Todd, why don't you just update everyone on where we stand?

Sure. Thanks, Bob. Just to further the conversation, and to Bob's point, we've spent the last 2 years really sharpening our pencil as it relates to Europe, retrenching, making the decision that it's a strategic place for us to be. So to that end, we've made sure that the products that we have are registered in all the right places, have the right price points, but more importantly, represent the best of Cohen and Steers. So when you look at the products that we have from left to right, you've got global real estate and European real estate products that are 4 or 5 stars and the addition of a global preferred product and, soon to come most likely, multi-asset real assets product, which really in our view, along with the infrastructure product we added a few years ago, gives us a level of completion that's similar to what we have in the U.S. So the thought process is the business that we have there has been tangible for the last decade, is anchored by some very longstanding clients and relationships, and we're very hopeful about what the next 24 to 36 months will bring as it relates to that business.

(Operator Instructions). Our next question comes from the line of Mac Sykes with Gabelli.

Congratulations of the success with the preferreds, but can you talk a little bit about how you're handling deploying the strong inflows? Do you feel constrained at all to execute the strategies just given the strong growth metrics?

This is Joe again. I think -- and we've talked about this in prior calls, but I'll just maybe retrace come of that ground. When you look at our preferred effort, it's not one strategy. We've got multiple strategies and they continue to grow. So our strongest growth has come from our corporate preferred strategy. But, I don't know, 2 years ago, we also launched a low-duration version of that, which takes us to a different universe of securities. And as you see in our flows, we're starting to get accelerated flows in our low-duration version, which is perhaps not surprising considering the low interest rate and the likely rising interest rate environment.

We also have REIT preferred strategies, which have been popular in Japan. We're also seeing interest in real asset debt strategies, which include preferreds. So as the market grows institutionally and continues to grow in the wealth channel, the number of strategies that we're managing, which expands the universe of securities that we have to invest in, is helping to accommodate the flows.

So to answer your question, we have had no challenge in investing the money and delivering the excess returns that our clients expect. But at some point, there could be limits for any one version of these strategies. For example, in REIT preferreds we've closed the strategy to new accounts and we'll do that if and as we deem that to be appropriate.

Okay, great. And then on the DCIO effort, given your inroads this year, could we expect to see some seasonal impact uptick in the first half of next year versus previous years?

That's an excellent question. I would fully expect to see an uptick next year, period. It has been roughly 1.5, 2 years since we've been fully staffed. And not unlike Todd's comments regarding Europe, we had about 18 months of work to do to adjust share classes, adjust fees and to reach out to record keepers and other platform providers. And so it really did require roughly 2 years of sort of backing and filling and developing the infrastructure here. And so that's really been done. And so I would certainly be hopeful both on a seasonal basis, which I think there is some seasonality to this as you indicated, but also thus far we've seen some green shoots, we've won a few accounts of note and lots of smaller ones. But we fully expect 2018 to see a significant uptick in absolute flows.

And just one quick question on that, is there been, in terms of your new engagement with some of these relationships, is there any aspect to, say, starting January 1st in terms of initiating it? Or has it been sort of as you have engaged them you continue to roll in the platforms?

I'd say the latter. It's a long-term relationship-building thing and it's not a sort of turning-the-switch-on type of thing. But without going into details, we're making good progress. We're on recommended lists. We're -- again, the wiring and plumbing is in place now, and perhaps most importantly, our performance in the key strategies are excellent. And so where there aren't current allocations, we should be the winner and, frankly, where there already are, we should be displacing our competitors. Our performance is just way stronger than most anyone else, particularly in the real estate space. So we're very optimistic.

Our next question comes from the line of Ari Ghosh with Credit Suisse.

On G and A real quick, just assuming that -- you've kept the guide intact of like growing it from 3% to 4% year-over-year. I believe that was what you mentioned on the call. That would imply a pretty significant jump just in the 4Q number. So just curious as to if you had any -- what the expenses look like over there in that bucket and if there's anything that might have hit in the beginning half of the year that will filter in through the 4Q quarter.

Yes, Ari, the reality is, is that when we gave the guidance it always was back-loaded. The fourth quarter always had in it a little uptick in conferences and travel that were always scheduled to occur in the fourth quarter. So you're absolutely right. When you look at the guidance year-over-year and where we are on a year-to-date basis nine months over nine months, which is not -- it's a third of the guidance that I've given, that would imply that the fourth quarter is going to have the differential and that's true and that's attributable to a handful of conferences and some international travel that we're doing.

Got it. That's helpful. And then just to circle back on MiFID. I know it's early days and things are still fluid. But you mentioned that $1 million impact from Europe. Now, in the event that you internalize your research costs and the SEC moves towards more of a hard dollar type arrangement, can you extrapolate this $1 million to what the impact could be to the total business? And then even if you just look at from maybe on a G and A growth, if I look at it from 2018, what G and A growth might look like in the event that some of these costs are implemented. What do you think -- what are you pointing to in terms of a band or a range, keeping in mind that some of these costs will probably be absorbed by your investment teams and shouldn't hit the bottom line?

Yes. Hi, Ari. So as Joe had mentioned earlier, although we're starting to rationalize and we're further along on that and have sort of like some estimates, there's still some moving pieces. So I think -- we'll certainly be giving guidance on the next call for how you should be thinking of 2018, but I think it's a little premature right now to really present something on this call.

Mr. Steers, there are no further questions at this time. I will now turn the call back to you.

Great. Well thank you all for calling in this morning and we'll speak to you next quarter. Thank you.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.