Cohen & Steers Inc (CNS) 2018 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Cohen & Steers Third Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded Thursday, October 18, 2018.

I would now like to turn the conference over to Brian Heller, Senior Vice President and Corporate Counsel of Cohen & Steers. Please go ahead, sir.

Thank you, and welcome to the Cohen & Steers Third Quarter 2018 Earnings Conference Call. Joining me are our Chief Executive Officer, Bob Steers; our President, Joe Harvey; and our Chief Financial Officer, Matt Stadler. I want to remind you that some of our comments and answers to your questions may include forward-looking statements. We believe these statements are reasonable based on information currently available to us. But actual outcomes could differ materially due to a number of factors including those described in our most recent annual report on Form 10-K and other SEC filings.

We assume no duty to update any forward-looking statement. Also, our presentation contains non-GAAP financial measures that we believe are meaningful in evaluating our performance. These non-GAAP financial measures should be read in conjunction with our GAAP results. A reconciliation of these non-GAAP financial measures is included in the earnings release and presentation. The earnings release and presentation as well as links to our SEC filings are available in the Investor Relations section of our website at www.cohenandsteers.com.

With that, I'll turn the call over to Matt.

Thank you, Brian. Good morning, everyone. My remarks this morning will focus on our 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 Slide 16 and 17 of the earnings presentation.

Yesterday, we reported earnings of $0.64 per share compared with $0.55 in the prior year's quarter and $0.59 sequentially. Revenue was $98.2 million for the third quarter compared with $96.7 million in the prior year's quarter, and $94.2 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 were $60.4 billion compared with $61.2 billion in the prior year's quarter, and $58.7 billion sequentially.

Operating income was $39.4 million in the quarter compared with $40.4 million in the prior year's quarter, and $36.4 million sequentially.

Our operating margin increased to 40.2% from 38.7% last quarter, primarily due to lower G&A and compensation and benefits when compared to revenue. Please recall that the second quarter of 2018 included accumulative adjustment to increase the year-to-date compensation to revenue ratio to 33.75%. Expenses increased 1.7% on a sequential basis as higher distribution and service fees and compensation and benefits were partially offset by lower G&A.

On our last call, we mentioned that one of our intermediaries deferred the imposition of revenue sharing and sub-TA fees on retirement accounts into the second half of the year. The increase in distribution and service fee expense this quarter was primarily due to the recognition of these deferred fees as well as increased expenses associated with higher average assets under management in U.S. open-end funds. The increase in compensation and benefits was primarily due to higher salaries and incentive compensation attributable to new hires during the quarter, as well as the full impact from new hires made in the second quarter.

The decrease in G&A was primarily due to fewer sponsored and hosted conferences. Our effective tax rate for the quarter remained at 25.25% consistent with the guidance provided on the last call.

Page 15 of the earnings presentation displays our cash, corporate investment in U.S. Treasuries and seed investments for the current and trailing 4 quarters. Our firm liquidity totaled $291 million compared with $263 million last quarter, and stockholder's equity was $324 million compared with $303 million at June 30. We continue to be debt-free. Assets under management totaled $60.1 billion at September 30, slightly less than the $60.2 billion at June 30. Net outflows in the quarter were $76 million.

As many of you know in mid-August, our largest Japanese distribution partner cut the distribution rate on the 2 largest funds that we sub-advised. As a result, outflows accelerated representing the majority of the $314 million of net outflows from sub-advised portfolios in Japan. Distributions for the quarter, which included only half of the impact of the August distribution cuts totaled $433 million compared with $566 million last quarter.

Sub-advised accounts, excluding Japan, had net outflows of $335 million, primarily from the termination of a commodities account and redemption from a large cap value account.

Advised accounts had net inflows of $148 million during the quarter, primarily from a preferred mandate in our first multi-strategy real assets separate account. Bob Steers will provide an update on our institutional pipeline.

Open-end funds had net inflows of $425 million during the quarter. Distributions totaled $241 million, $191 million of which 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 33.75% compensation to revenue ratio. We expect G&A to increase approximately 2% from the amount recorded in the third quarter of 2018. And finally, we expect that our effective tax rate will remain at approximately 25.25%. Now I'd like to turn it over to Joe Harvey, who'll provide commentary on our investment performance.

Thanks, Matt, and good morning, everyone. In the third quarter, our asset classes were not in favor compared with the S&P 500, which returned 7.7%. Importantly, however, we delivered strong relative performance with 9 of our 10 strategies outperforming their benchmarks. For the latest 12 months, 8 out of 10 strategies outperformed.

Looking at AUM, 98% of our portfolios are outperforming on both the 1-year and 3-year timeframe. Macro trends influencing our strategies include a strong economy that is broadening and maturing, fueled by tax reform, deregulation, fiscal stimulus and an increasingly vibrant consumer. With unemployment at 49-year lows, workers are confident enough in the job market and in wage growth that consumption strengthened. Market factors influencing our strategies included rising short-term interest rates and bond yields and strong energy markets. The 10-year treasury yield grows 20 basis points to 3.06% during the third quarter, and subsequently, yields gapped out in October.

While rising bond yields restrained returns on some of our strategies, our portfolios performed better than it did earlier this year, reflecting that interest rate sensitivity has been partially priced in. Our strategies are not direct beneficiaries of the resurgence and consumer spending, and China's trade war has dampened commodity and resource equity returns. As a result, real asset returns lagged equities. In spite of rising bond yields, our preferred securities returned 1.1% on the back of spread compression of 35 basis points in the quarter. Low-duration preferreds returned 1.4%.

We outperformed in our core strategy and underperformed in our low-duration strategy. Over the past 12 months, however, we outperformed in both. We continue to see expanding investor interest in preferred securities with asset consultants [embracing] them, more institutions evaluating them as alternative sources of income and wealth firms placing them in asset allocation models. The appeal of preferred securities is yield. Comparing our open-end mutual funds, our core open-end fund with the symbol CPX yields 5.6% with duration of 4.6. While our low duration open-end fund yields 4.5% with duration of 2.1. Midstream energy and MLPs was our best-performing asset class with a 6.6% return. We underperformed our benchmark in the quarter, yet, have had strong outperformance for the last 12 months and longer term.

We recently received an upgrade to 5 stars by Morningstar for our open-end midstream energy fund. We had expected this, frankly, based on our strong peer performance, and the upgrade is meaningful considering the high business priority we have placed on midstream due to [our bullish] investment thesis. We have added analysts to our midstream team, which now totals 5.

Midstream performed well because oil prices and production are strong. There was some softening of a negative energy commission proposal made in March and more importantly, midstream companies have announced positive corporate actions and restructurings.

Private equity continues to be active in midstream energy, particularly in the U.S. In the second quarter, we [seeded] a focus or concentrated version of our midstream portfolio consistent with our strategy of having focused track records in all relevant strategies. The infrastructure asset class returned [to] 0.5% for the quarter. We outperformed in both our core and focused portfolios for the quarter and for the latest 12 months. Interest in infrastructure continues to expand institutionally, including most recently in the Middle East. Part of this interest is connected to the abundance of capital, totaling $170 billion earmarked to acquire private infrastructure assets. The public market is benefiting from the spillover of that capital in 2 ways: first, allocations are being made to active listed infrastructure strategies; and second, private equity funds are buying assets from public companies or are buying public companies outright. Further driving allocations are the diversification benefits where infrastructure shows low correlations to equities of about 0.6% and favorable downside capture of about 50%.

Turning to U.S. real estate securities, they returned 0.8% in the quarter, and global real estate returned negative 0.3% in U.S. dollar terms. We outperformed in the quarter and for the latest 12 months in virtually every sub-strategy we manage. This applies to each regional real estate strategy, U.S., Europe and Asia, and across our range of portfolio of risk profiles from our focused portfolios along the spectrum to core and income strategies.

With respect to real estate, and in the spirit of educating on our asset classes, I'd like to address the topic we have faced our entire existence as a firm and is becoming even more relevant today. While we receive our fair share of allocations compared with private real estate, we believe listed should get more. This dynamic for private versus listed allocations may be shaped by the performance in private equity where investors have consistently earned a return premium for forgoing liquidity. Yet in core real estate, investors consistently over the long term have not earned a return premium for giving up liquidity. In fact, the public market has returned 2.5% to 5% more per year over various 10- to 25-year timeframes. Lately, however, the private market has outperformed listed, perhaps, in part, because the public market is discounting interest rate increases and expectations for lower real estate returns in the future. That, private is outperforming public is surprising, considering the public market continues to evolve with new property types, many new economy property types, such as data centers or cell towers, while the private market is more heavily represented in core property types, including retail. Because real estate is cheaper in the public market than in the private market and there is $280 billion in dry powder awaiting deployment from private funds, we are starting to see REITs taken private. A trend not seen since 2007. Sooner or later, the gap between what the public market foreshadows and what the private market is doing must converge. While we see the desire for private most prevalent in the institutional market, particularly, in the endowment and foundation market, it is increasing in the wealth channel with nontraded REITs.

Vintage years are always a key when investing, and considering how this cycle has run, we do not see an adequate return premium in the private market for real estate, especially, through nontraded REITs, which have fees that can consume 15% to 20% more of investor returns over their life cycles relative to active listed real estate strategies.

On the topic of comparing private and public real estate, 30 years ago, we were a lone voice. Yet today, the data are statistically significant and have been analyzed, not just by us, but by organizations, such as Cambridge, Green Street and [Stangearn] company. We will continue to educate and advocate for listed real estate to garner a greater share of investor real estate allocations as the public market offers a compelling proposition, which includes a greater choice of property types with expert management and franchises at a lower cost and with liquidity. With that, investment overview, I'll turn the discussion over to Bob Steers.

Thank you, Joe, and good morning. As a reminder, and as we addressed extensively in our annual report, our overarching strategy on our strategic focus is to deliver more for less. To that end, as you already know, we have made significant investments in growing our investment teams and productivity-enhancing technology, aimed at delivering more alpha while also maintaining profitability. As you heard from Joe, but it bears repeating, the performance of all of our core real asset and alterative income strategies remain strong in all relevant time periods. Today over the last 1- and 3-year periods between 98% and 100% of our total AUM is in strategies, which are outperforming their benchmarks, and 86% of our open-end fund assets are rated 4 or 5 stars by Morningstar.

The combination of industry-leading performance and competitive fees for our real estate infrastructure and preferred security strategies has translated into sustained, positive organic growth and meaningful market share gains versus our active peers. We intend to sustain these trends by staying focused and specialized and going deeper into the real asset space. For example, we are currently highlighting our 5-star and top decile performing midstream energy fund, which also offers a total cost that is among the lowest in the industry. This is what we mean by delivering more for less and what will hopefully sustain our market share gains across all of our core strategies. As you know from our reported results, overall flows in the quarter were mix with continued strength and net inflows in our open-end fund and advisory segments, but with net outflows from our Japan and Japan ex sub-advisory businesses. However, looking ahead with the exception of Japan sub-advisory, which will take time to return to equilibrium, we believe the outlook for open-end funds, advisory and even sub-advisory ex-Japan is positive.

U.S. open-end funds enjoyed $421 million of net inflows in the quarter, which benefited from substantially lower redemption rates compared to the first and second quarters. Our low-duration preferred and income fund generated $263 million of net inflows, which more than offset the outflows from our longer duration preferred securities fund. We also continue to see net inflows into our U.S. and global real estate funds. As I said earlier, we are seeing meaningful market share gains across each of our real estate, preferred and infrastructure funds. Our non-U. S. open-end funds saw modest net inflows of $4 million in the quarter, but we expect to see increasing flows in the coming quarters as the benefits of our expanded fund share classes, new registrations and additional selling agreements gain traction.

Net inflows in the advisory channel were $148 million, driven by fundings of preferred securities and multi-strat real asset strategies. More importantly, [our awarded but unfunded] pipeline grew to $1.2 billion in the quarter, which is the second highest on record. This increase from $535 million in the second quarter was driven by rising real asset allocations, the recognition of strong investment performance and additional market share gains manifested by an increasing number of takeaways from competitors. U.S. and global real estate strategies contributed the bulk of the pipeline increase in the quarter. While the net outflows of $335 million in sub-advisory

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is down to approximately $375 million. The factors that will influence when we will return to equilibrium flows versus distributions include both the passage of time and the absolute returns from U.S. REITs.

To sum up, virtually, 100% of our firm-light AUM is now comprised of core real asset and alternative income strategies, which are beating their benchmarks and garnering additional market share in each of the wealth, advisory and sub-advisory channels.

Looking ahead, following several years of 8% annualized headcount growth, we believe that we are rightsized for our global opportunity set, without the need for meaningful additional personnel additions in the near future. In the meantime, allocations to real estate, infrastructure, natural resource equities and alternative income strategies are increasing and thanks to our consistently strong performance, we are gaining market share across the board.

With that, I'd like the operator to open the floor to questions.

(Operator Instructions) And our first question comes from the line of Ari Ghosh with Crédit Suisse.

Sorry, if I missed this in the prepared remarks, but just on the Japan's sub-advised business, it looks like industry-wide sales have slowed a little as distributors are sort of rethinking the way they sell U.S. REIT funds and our increasing education around products over there. So should we expect inflection point here anytime soon? Or is that kind of more of the same in the near term as the kind of the sales trends slow a little bit?

That's a great question. I think that inflection points will vary depending on the manager. I think the overarching headwind is going to be not so much the distribution cuts, which are largely or completely behind us. It's the absolute returns from U.S. REIT. So this year U.S. REITs are -- have generated negative returns and so at least up until this month technology funds and high yield funds got most of the market attention in Japan. Going forward, I think that both with the passage of time and how U.S. REITs perform, absolutely, will determine the level of interest on the part of investors. Secondly, most managers have different distribution arrangements. And so, whereas, I think those managers who distribute exclusively through brokerage or wirehouse channels, I think, will continue to face headwinds, whereas those that have more diverse, including regional banks and other non-brokerage distributors, I think, will do better.

Got it. And then just a quick follow-up. Given the rate backdrop right now, which products are you more [constructive]on as net flow generators over the next 12 months. And then may be, give us a quick update on some of the newer launches, including global logistics and your multi-strategy offerings as well? And then, just if I can squeeze another one in there as well, kind of talked about it this morning, but on the M&A front, you have been involved in some of the late stage due diligence recently, so curious how the search for potential targets may be has evolved over the last 12 months? And then on the other side of it, I think, you've also typically seen some ongoing interest there yourself as potential targets. So curious if there has been any uptick and chatter there? Or what that looks like?

Is that all? I'll handle the first part of that question and I'll ask Joe Harvey to talk about our product pipeline. So looking forward, there are a number of our strategies that we think are well-positioned to garner significant flows. That would include low-duration preferreds, as we have seen. As Joe mentioned, it generates significant yield with roughly 2-year duration. That's, frankly, been a strong interest on the part of retail and, candidly, I think it competes well with long-shore funds for institutional. Secondly, as both Joe, and I talked about, our fundamental outlook for midstream energy is extremely positive. It's one of the few segments of the market that is well below its prior highs and looks statistically cheap. And it's not an accident that coincident with us getting our 5 stars we've recently reduced our expense cap on the fund to among if not the lowest in the industry. And so we're putting a very aggressive push on all of our midstream energy strategies and our mutual fund. Thirdly, we do expect REITs, particularly U.S. REITs, to perform well. They've been flat for several years. They've underperformed private as Joe mentioned. And they are statistically cheap. There are many companies selling below asset value. And as we've seen in prior cycles when private equity has record levels of dry powder that tends to provide an NAV floor on the valuations of REITs. And so we like REIT fundamentals, we love their valuations. And so we think the outlook there is great. And then as Joe will speak about, we have similar phenomenon in infrastructure, lots of dry powder, great universal public companies, and we think a lot of dry powder will find its way into the public markets. And so, again, we see the fundamentals there are strong, we see the technicals strong. And like midstream energy, we are planning to launch number of new initiatives. And so I'll ask Joe to maybe expand on some of those.

Sure. So in terms of strategy and product development, there is several dimensions to it. Maybe I'll just talk about some of the investor needs that we see out there and, I mentioned in my comments, but the first is a need for more active share and we achieved that through creating these very concentrated portfolios, which is the antithesis of an index-oriented strategy. And for the talented managers that can deliver that alpha that's where we think that active managers can get paid fairly in the future. So for all of our strategies where we think that a focused portfolio is relevant, we have either have them seeded and are managing them or managing them for clients or we're evaluating whether to package those strategies in LP structures for certain market segments. Another area that we're seeing is interest in multi-strategy portfolios. So this could range across a spectrum from investing across the capital stack in real estate with real estate equity or preferreds or REIT debt to our multi-strategy real asset portfolios. And we've got sort of 3 different versions of that, which are cross the risk and return spectrum. Then in terms of new markets, we've talked about developing strategies for multifamily office, endowment of foundation, and outsource CIO markets where we see the greatest growth in AUM. And these are markets that have very particular needs. They want customized portfolios that are high alpha, that are differentiated, they may be thematic or more focused across a thinner slice of a particular asset class. So we have a range of strategies that either, we're managing now. We have several focused versions of our real estate strategies, which are ideal for those markets. But we're also developing other strategies such as ESG real estate, a hedge version of real estate. Then turning to infrastructure, where it's a very dynamic market based on the capital needs and the activities that's taking place. We have seeded global logistics and digital infrastructure strategies. We're currently working on others, such as a small cap infrastructure strategy. And as I mentioned, the focused version of our midstream portfolio, which could include some private elements to it. So we've been very busy in strategy development area. And this gets us back to a theme that Bob has been talking about. We've written in our annual report, which is getting more focused. And it starts with being creative and innovative in terms of our investment strategies. I am energized along with our investment teams to develop these new strategies, and we think we have a lot of opportunity.

Just the answer to your M&A question, there are no current -- no conversations going on either side of that question.

Our next question comes from the line of John Dunn with Evercore ISI.

A little more on the advisory pipeline. You talked about the big take away from a competitor. But can you talk about over the past couple of years how the profile has changed, stuff like, if there's been a change in the average [mandate] size? Or whether it's new clients or existing clients adding to what they already have and maybe any regional changes?

Sure, John. Well, I think, it's changed in a number of ways. One is, some of our larger existing clients have asked us to go deeper and be sort of their total solution in real estate or real assets. So there is a concentration of managers going on institutionally. Second, in the sub-advisory space, I think, there is very substantial increasing pressure on large intermediaries, be they insurance companies or CIOs, consultants, others, manufacturers of retirement products. There is tremendous pressure to replace managers who are not performing and/or who have higher fees and even in some cases where there is a conflict or with the parent perhaps. So our performance has put a lot of space between us and most of the rest of the industry, and so the combination of our performance -- but also being current with the market on fees and cost it is allowing us to go after some significant takeaways in the some sub-advisory space. More globally, we're seeing demand for listed, everything in areas, in regions that where it didn't previously exist. And that's why, we have made investments in our business development efforts both in Europe and the Middle East. And so and interestingly, most of that interest is coming from very large institutions that already have very significant exposure to real estate [and] infrastructure through private managers, and now they are very interested in adding to the other side of that, which is listed. Whether that's because they subscribe to our thesis that a significant amount of the dry powder in both areas is going to be deployed in the public markets or simply acknowledging that having investments and knowledge of both the public and private side of real assets just makes them better investors. So we'll definitely see a broadening out of institutional demand.

Got you. And you guys have been investing for a few years -- heavily for a few years now, and I think you have another real asset [institute] in the fourth quarter. I think you've kind of put in place -- you've done that through just such an opportunity in the MLP fund. Can you talk about some of the specific things you've done and invested in that is going to make it sell -- easier to sell this fund? Because it looks really teed up.

Well, we've -- as you've suggested, we've continued to grow headcount both in our wealth channel, which includes not just salespeople but national accounts people, but also we've grown headcount in our institutional and consultant relations teams. And so as you touched on, it's a top decile -- mutual fund is a top decile performer with the lowest cost. I mean it's the best performer with the lowest cost. The story is phenomenal. And so we've never had more opportunities and voices to help disseminate that story both in wealth and institutionally. So we feel we're in pretty good shape. As Joe mentioned, some of the more recent headcount we've added is in the team that is focusing on foundation, endowment, OCIO, multifamily office, where I think their interest in energy infrastructure is high, and where our ability to create bespoke solutions in midstream, I think, will be greatly appreciated. So we do have new people focused on discussing strategies like this with those newer markets.

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

Could we dig into the retirement space a little bit more? What are you seeing in terms of the acceptance of real assets from the retirement platforms in general versus your own distribution progress?

Another good question. Retirement has been a space that, as you know, we made commitment to 3 years or 4 years ago. And candidly, our penetration of that market, while it is improving, it's been slower than we would have expected, particularly in the target [data] space, where we're just seeing -- I believe until you see serious inflation and some catalysts that tells those product manufacturers that it's time to include real assets or an inflation hedge in those portfolios there's been relatively less interest there. Secondly, with DOL having disappeared, I think, the move to open architecture and target dates has diminished significantly. Conversely, we are seeing adoption of real assets in larger not-manufactured product areas, so we do see large retirement funds adopting real asset and in particular, listed. And so that's where we're making progress less so in the target [date] space.

Great. And with respect to capital allocation, can I assume the special dividend or the potential special dividend could be higher this year just given your strong cash generation and also the repatriation benefits that you mentioned earlier in the year?

I'm going to have to give you the same answer we give every at this time is that we're evaluating all of our potential uses of capital, which we've talked about in the past both investing internally and seeding funds, et cetera. And the board will be taking this up in the next meeting and following that you'll know.

And there are no further questions. At this time, I'll turn the call back to Mr. Bob Steers, Chief Executive Officer, for the closing remarks.

All right. Well, thank you all for dialing in this morning, and we look forward to speaking to you again about the fourth 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 lines.