Virtus Investment Partners Inc (VRTS) 2014 Q1 法說會逐字稿

Good morning. My name is Lisa and I will be your conference operator today. I would like to welcome everyone to the Virtus Investment Partners quarterly conference call. The slide presentation for this call is available in the investor relations section of Virtus's website, www.Virtus.com. This call is also being recorded and will be available for replay on the Virtus website. (Operator Instructions).

I would now like to turn the conference over to your host, Mr. Fazzino. Please go ahead. Thank you.

Thank you, Lisa, and good morning, everyone. On behalf of Virtus Investment Partners, I would like to welcome you to the discussion of our operating and financial results for the first quarter of 2014.

Before we begin, I direct your attention to the important disclosures on page 2 of the slide presentation that accompanies this webcast.

Certain matters discussed on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not statements of facts or guarantees of future performance and are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those discussed in these statements.

These statements may be identified by such words as expect, anticipate, believe, outlook, may and similar terms. For a discussion of these risk and uncertainties, please see the risk factors in management discussion and analysis sections of our periodic reports that are filed with the SEC as well as our other recent filings which are available in the investor relations section of our website, www.Virtus.com.

In addition to results presented on a GAAP basis, Virtus uses certain non-GAAP measures to evaluate its financial results. Our non-GAAP financial measures are not substitutes for GAAP Financial results and should be read in conjunction with GAAP results. Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in our earnings release which is available on our website.

For this call, we have a presentation including an appendix that is accessible with the webcast through the investor relations section of our website.

This morning we will begin with remarks from President and Chief Executive Officer, George Aylward, who will review our accomplishments and operating results for the quarter. Mike Angerthal, Executive Vice President and Chief Financial Officer, will then discuss our financial results in further detail and will also review the balance sheet and capital items. We will conclude by opening the call to your questions.

Now I would like to turn the call over to George Aylward. George?

Thank you, Joe, and good morning everyone. We appreciate having you on the call with us today and Mike and I are pleased to have the opportunity to talk about our financial and operating results as well as the other developments that we have recently announced.

I will review some of the items that contributed to the strong results and discuss sales and flows, where we saw the impact of the market environment, general industry trends and investor preferences.

The cumulative asset growth from the strength and diversity of our product offerings resulted in higher revenue and increased operating earnings and margin compared with the first quarter of last year. Total and mutual fund sales and net flows were lower on both a year-over-year and sequential basis and that is the result of several factors.

Total sales were $4.2 billion, a decrease of 32% from the first quarter of last year and 8% from the fourth quarter of 2013. The decrease in the prior year is reflective of the very high level of fund sales we achieved in the first quarter of 2013 related to our sales of the emerging market opportunity fund as a result of the asset class being in favor, our fund having strong performance and the announcement of the soft close of that fund.

The sequential decrease in total sales reflects lower mutual fund sales which offset a 24% increase in separately managed accounts sales.

We did have total net outflows during the first quarter but they were primarily the result of two items. The first was the redemption of a single option overlay account with a net management fee after all related costs of about 8 basis points. The second was a distribution partner's move to a recommended zero weighting for emerging market strategies that drove redemptions in the fund at that firm.

Despite the total net outflows this quarter, assets under management were up 13% from last March primarily on the strength of the 22% increase in mutual fund assets over the past year to $37.3 billion at March 31 from $30.5 billion a year earlier.

Mutual fund sales were $3.6 billion in the first quarter, that is an annualized sales rate of 41% which was higher than the industry average during the quarter. We maintained above average level of sales in the major asset classes, domestic and international equity, fixed income and alternatives. We had positive net mutual fund flows for our 20th consecutive quarter demonstrating that our diverse set of investment strategies provides the ability to maintain sales throughout market cycles.

Positive net flows in domestic equity, fixed income and alternative strategies offset net outflows in international equity that included a meaningful reduction redemptions at the distribution partner that moved to the zero weighting for emerging market strategies.

Would also note the monthly trends with March achieving the highest net flows of the quarter and the trend continuing into April with our fund flows for the month that look to be about the same as the total for the entire first quarter.

Operating earnings in the related margin were up over the prior year as a result of higher revenues from our cumulative topline growth and generally stable fixed costs.

Operating income as an adjusted was $36.6 million for the quarter, an increase of 46% from $25.1 million in the first quarter of last year. This reflects the 25% increase in revenue over the past year as a result of our growing AUM particularly in open end funds.

Sequential change in operating income as adjusted from the fourth quarter is primarily attributable to $2.5 million of additional payroll taxes related to the payment of annual incentive compensation.

The profitability of the business is reflected in the related operating margin which was 46% in the first quarter, an increase from 39% a year ago.

As with operating earnings, the increase in the related margin reflects the benefit of higher revenue on our growing asset base. Earnings per diluted share were $2.34, up 35% from the $1.73 per share in the first quarter of 2013.

Regarding our new alternative mutual funds, we have said that our approach is to provide a broad offering of distinctive strategies that can be changing markets and investor preferences and last week we expanded our alternative product offerings with the introduction of three new multi-strategy funds. Each fund addresses a different particular investor need and all of them are intended to give individual investors the opportunity to reduce portfolio volatility and generate more consistent returns through market cycles.

The funds are managed by Cliffwater Investments, the affiliate we established last year in a joint venture with Cliffwater LLC, and we believe that their approach to portfolio construction and manager selection will distinguish our products in the market.

Cliffwater employs a top-down asset allocation process to select and weight the multiple alternative strategies that are incorporated in the funds' portfolios and uses an open architecture approach to source leading alternative managers based upon proprietary research. This approach gives individual investors access to the same caliber of alternative strategies and managers that are available to many large institutional investors.

We introduced these funds at a time when there was a clear demand in the market. More and more financial advisors recognize that a meaningful allocation to alternatives can help their clients achieve their long-term investment goals. Institutional investors have a long history of incorporating alternative strategies to manage their risk profile and deliver consistent lower correlated returns and financial advisors are beginning to understand the potential advantages of adding Alts to an investor's portfolio.

We also believe the launch of these alternative funds plays to several of our competitive strengths, particularly our strong retail distribution, our value proposition as one point of access to distinct boutique firms, and our consultative approach to partnering with advisors and explaining sophisticated investment strategies.

We are working closely with our distribution partners to help educate advisors on liquid alternatives and how they can be expected to perform in an investor's portfolio.

The new funds add to our existing portfolio of alternative products which has been our fastest-growing asset category over about the last year which is led by our long/short offering. So we are excited about the launch of these funds and believe we are well-positioned to continue to have compelling investment solutions for investors in current and future markets.

Let me mention one other item that we referenced in the news release which is the decision to engage SS&C to provide middle and back office services for our affiliated managers. Our business model is based on providing quality operational support to our affiliates and this new relationship will give our affiliates access to best-in-class technology services that are tailored to each of the affiliates' specific needs.

Our affiliates collectively selected the SS&C platform and will choose the specific services they will need for their operation. This new relationship will enhance our current investment management activities and more importantly, support our long-term growth needs.

With that, let me turn the call over to Mike to provide more detail on the financial results and then we will open up the call for questions. Mike?

Thank you, George. Good morning, everyone. This morning I'm going to review our quarterly results starting with assets under management, sales and flows and then I will review our key income statement line items and discuss our balance sheet and capital position.

Starting on slide eight, assets under management. We ended the quarter with total assets of $58 billion, an increase of 13% from the prior year and unchanged from the prior quarter. The $6.8 billion year-over-year increase is primarily attributable to $3.9 million of net flows or 57% of the increase and the remaining increase primarily attributable to market appreciation. On a sequential basis, the asset change reflects market appreciation of $1 billion in net outflows of $0.5 billion.

As it relates to mutual fund assets which represent 64% of total AUM, consistently positive flows and generally positive market returns are the primary drivers of a 22% increase from the prior year and 3% increase over the prior quarter.

Turning to slide nine, asset flows. Total flows were net negative $0.5 billion primarily as a result of the redemption of a single low fee options overlay account and redemptions at one distribution partner related to a recommendation to reduce exposure to emerging market strategies.

Total sales for the quarter were $4.2 billion, a decrease of 8% from $4.6 billion in the sequential quarter. Mutual fund sales were $3.6 billion in the first quarter, a decrease from 36% from the first quarter of 2013. The very high level of mutual fund sales in the first quarter of 2013 were due to strong market demand for emerging market equities and fixed income strategies particularly our Emerging Market Opportunities and Multi-Sector Short-Term bond funds.

By comparison, the current quarter reflected lower demand for both of these asset classes in the financial intermediary channel. Mutual fund net flows were positive by $0.3 billion even after $335 million of emerging market equity redemptions at the distribution partner that went to a recommended zero weighting.

To provide additional transparency into the mutual fund flows, here are some general highlights by category specifically domestic equity net flows were positive $0.4 billion consistent with the prior quarter as our defensive equity strategies continued to provide investors an opportunity to increase their equity exposure while managing downside risk.

Alternative strategies net flows were positive $0.2 billion, primarily attributable to our long/short product offering. Fixed income net flows were positive $0.1 billion primarily related to our multi-sector short-term bond fund and international equity fund net flows were negative $0.5 billion affected by continued lower demand due to market trends. Most distributors currently have emerging markets equities at an underweight rating and we are confident that as market sentiment changes in this category, we are well-positioned to gather assets with our strong performing equity markets opportunities fund.

As a reminder, we include additional disclosure about mutual fund flows by asset class in the supplemental appendix in our earnings deck.

We are highest level of separately managed accounts sales with $472 million, a 29% increase from the first quarter of last year with growth in our small cap and international equity strategies. Net outflows of $556 million were the result of a $558 million redemption of a single options overlay account. This is a long-standing overlay on a single position in a concentrated stock and the client made a decision based on his long-term view of the stock.

The run rate financial impact of the redemption is insignificant as the account had a net fee rate of 8 basis points after taking into account variable distribution and other costs.

Slide 10 illustrates the quarterly trend in operating income as adjusted and the associated margin. In the first quarter, operating income as adjusted was $36.6 million, an increase of $11.5 million or 46% on a comparative basis to the prior year. The substantial increase primarily reflects revenue growth from the cumulative impact of $4.8 billion of positive long-term open-end fund flows and $3.6 billion from market appreciation over the past four quarters along with the benefit of a highly leveragable business and our variable expense structure.

The sequential decrease of $1.8 million or 5% in operating income as adjusted primarily reflects $2.5 million of incremental payroll taxes related to annual incentive payments that occur in the first quarter of each year.

The operating margin as adjusted for the first quarter was 46%, an increase of 680 basis points from the first quarter of 2013 and a decrease of 220 basis points on a sequential quarter basis. As noted earlier, the quarter included the payroll taxes related to annual incentive compensation that had a 310 basis point impact on the margin.

Concerning GAAP results, net income attributable to common stockholders was $21.9 million or $2.34 per diluted common share representing a $0.61 per share or 35% increase compared to the prior year quarter. The average number of fully diluted shares outstanding was 9.4 million in the first quarter of 2014, a 16% increase from the first quarter of 2013 as a result of our equity offering last September.

On a sequential basis, earnings per share were down $0.31 or 12% per share and the change is primarily attributable to two items. There was a $0.16 per share after-tax expense related to the payroll tax item noted above and a $0.15 per share decrease in unrealized mark to market adjustments on our seed capital portfolio.

Finally, our effective tax rate for the quarter was 39% which excludes the impact of minority interest and consolidated sponsored investment products. This quarter had a discrete item that had a $0.03 per share impact on earnings. We expect a normalize rate to be closer to 38.5%.

Turning to investment management fees on slide 11. Investment management fees increased to $71.8 million, up 24% from the first quarter last year and 1% on a sequential quarter basis. The two elements of investment management fee changes are average long-term assets and fee rates. Average long-term assets under management of $55.7 billion increased 18% from the prior year quarter and 1% from the sequential quarter due to positive mutual fund net flows and market appreciation.

The average fee rate was 50.9 basis points, an increase of 2.4 basis points from the prior year and 0.9 basis points sequentially. The increase from the prior year and sequential periods primarily reflects an increase in assets in our higher fee mutual funds. Over the past four quarters, over 85% of our fund flows have been into higher fee equity and alternative strategies. Specifically during the first quarter, the fee rate for mutual fund sales was 52.7 basis points which is up 0.8 basis points from the prior year.

Total employment expenses for the quarter were $35 million, up 8% or $2.6 million from the prior year quarter. The increase over the prior year reflects personnel additions related to the growth of the business and higher variable incentive compensation. On a sequential basis, employment expenses increased 5% or $1.6 million (sic - see Accompanying Slide 12, "$1.5 million.") driven by payroll taxes related to the annual incentive payments that occur in the first quarter of each year resulting in higher expenses of approximately $2.5 million compared to the fourth quarter. And partially offsetting this item was lower variable incentive-based compensation.

The key metric to consider is the ratio of employment expenses to revenues as adjusted which increased 190 basis points on a sequential quarter basis to 43.7%. Excluding the impact of the higher payroll taxes, the ratio would have been 40.6% or 120 basis point decrease from the prior quarter.

The trend in other operating expenses demonstrates the leveragability of the business as these expenses continue to represent the relatively low percentage of revenues that are adjusted. Other operating expenses of $10.5 million in the first quarter were up $1.5 million from the prior year quarter and in line with the fourth quarter of 2013.

Quarterly expenses will vary based on the timing and extent of certain business activities and the increase from the prior year was related to an increase in investment research costs related to several of our newer strategies, an increase in sales conferences and sponsorships related to retail distribution activities, and higher professional fees related to various business activities.

The ratio of operating expenses to revenue as adjusted was 13.1%, an improvement of 80 basis points over the prior year. The trend of this ratio reflects our ability to leverage our cost structure and expand profitability.

In regard to our agreement with SS&C Technologies, they will provide middle and back office services for approximately $20 billion of separately managed institutional and open and closed end funds assets that are managed by our affiliates. Consistent with our approach to disclosure, we will provide detail on this multiyear project to identify costs associated with the transition.

Moving to slide 14, you see that we ended the first quarter with a very strong cash and investments and working capital position. We ended the quarter with working capital of $271 million, up 12% from year end. The increase is attributable to continued strong operating results partially offset by return of capital to shareholders.

At March 31, 2014, our cash and liquid investments were $388 million or $42 on a per share basis, an increase of $29 per share from $13 per share in the prior year quarter.

Our seed capital investments which include our portion of the net assets of consolidated sponsored investment products, totaled $124.1 million at the end of the first quarter, an increase of $72.3 million over the prior year reflecting investments in new strategies.

In the third quarter of last year, we deployed $40 million of additional seed into the Wealth Masters Fund to assist in gaining full distribution access at our major distribution partners. As a result of the fund's strong performance track record and increased distribution access, Wealth Masters now has more than $100 million of third-party assets which has led us to begin the process of recycling the $40 million of seed capital out of the Wealth Masters Funds and into other strategies.

Earlier this month we launched the three new alternative funds and deployed a total of $130 million to seed those funds. The three funds have multiple distinctive strategies from a total of 11 different managers so the seeding at this level allows the multiple managers in each fund to effectively execute their strategies and we will facilitate distribution access at our major distribution partners.

With the launch of the three alternative funds as well as other changes in our seed investments, we expect our seed capital program to be in the range of $200 million to $250 million at the end of the second quarter.

During the quarter we returned capital to shareholders of approximately $7.4 million through the net settlement of 42,000 restricted stock units which represents an effective payout ratio of 21% of free cash flow.

With that, let me turn the call back over to George.

Thank you, Mike. We are excited about our many opportunities and I'm confident we have the right products, the right strategies and the right team in place to continue delivering long-term value to shareholders.

With that, we will take some questions. Lisa, can you open up the lines please?

(Operator Instructions). Michael Carrier, Bank of America Merrill Lynch.

First question just on the alternative side with Cliffwater, given your history of launching new products obviously in a different strategy but from a time of gaining kind of traction and scale in those products and then also maybe new distribution opportunities because you have that strategy in place, I just wanted to get some color on like the potential opportunity and the timing that we are looking at.

Sure. Generally as we look at any new strategies introduced specifically in open and fund, our base assumption is that it may take up to three years to generate a low enough track record to be attractive. But we will alter that is how differentiated and interesting is the product and what is the current level of demand related to that. So over the years we have introduced a lot of funds. Right now we have 49 open end funds some of which have taken a long time to incubate a track record and sell and some where we have had very early and quick success in terms of raising assets.

So as I look at the alts, a couple of things. We do think our approach is a very interesting approach and that the partnership with an institutional consultant driven with their top-down approach and really having a view of what is the right portfolio construction given a certain market and then their access to multiple underlying managers because of their work as an institutional consultant, we think that that will be attractive.

As I have said earlier today and on many other calls, we really see an incredible demand out there for these types of strategies. Most of the firms that we distribute through will recommend somewhere in the range of 15% to 20% allocation for the retail clients but on average they may only have 3% to 6% of their clients' assets in these funds.

And while there are a couple of very good offerings out in the market, there are certainly not enough compelling choices for investors.

So all those things together, we do think that these types of funds have generally a greater opportunity than a more traditional fund in a category that already has a lot of competition. We are not going to give any specific guidance in terms of our expectations but we do think and the sense that we are getting is people are very interested in looking at these funds and we are working very closely with our distribution partners because we also think we have an opportunity to help them educate their clients on what these products do and more importantly what they don't do. Because a lot of times we think there is some misunderstandings of how people should think about alts, what is the difference between alts and liquid alts and how they work in a portfolio.

So a lot of our preparation has been working on educational material that can help the firms that we sell through hopefully do a good job with their clients in positioning these types of products.

And in terms of new distribution opportunities, the last piece of your question, we basically have selling agreements with everyone so I don't think there will be a new quote unquote selling agreement that will come out of having these products but I do think the uniqueness and attractiveness of these products may make some of the firms that we technically can sell through maybe focus a little bit more because of these products.

Okay, thanks. And then on the emerging markets side, you mentioned in terms of the outflow, in terms of taking the allocation, one [platform] allocation to zero, I guess on the flipside because we have kind of been in an environment where emerging markets have been under some pressure for some time, so when you look at when allocations are either at underperform or at zero and you start to get that shift across platforms to a higher percent or an overweight, like how long does that typically take, like that process and how significant can the bounce back in flows be?

That is a great question and each of the firms are usually a little different in terms of the timing of when they make certain of these decisions. So over the last few quarters, we have had a couple of firms where we sort of had these redemptions that were related to people going overweight generally to equal weight or to then going to underweight. This is the only one that we have discussed that actually went to a zero weight.

In all of those instances our fund and our manager is still very attractive so it was really the result of the view of the asset class. In some ways you saw the flipside of this over the last -- three years ago and two years ago when the firms went from under weights of (inaudible) to equal weights and over weights is when you saw a lot of our high levels of flows. Those were -- while we didn't necessarily spike those out, that was really what was happening, the fund was performing very well and emerging markets as an asset class was on the reverse side of being upticked.

So we feel very good about our fund, it is a great fund of (inaudible) long-term track record. It is very, very strong. People like the way they manage money. Again, it is a high quality orientation which is a little different than other managers. So again, we are very hopeful that as some of these firms maybe in the next few quarters make different decisions about how they feel about the emerging markets sector, our funds are still on those platforms and are still in some of those models that yes, we lost assets when they went to equal and underweight. Our hope would be that you would see the opposite. But again, we can't predict when the firms will make their choices to change their recommended allocations.

Okay. Thanks for the color, guys.

Marc Irizarry, Goldman Sachs.

Great. Thanks. George, can you just share with us on the liquid alternative side and your alternative offerings, the funds you are raising. It looks like you have been seeing a favorable shift in your fee rate. How should we think about the fees on those products overall?

And also I guess just the economics and the sort of margin associated with selling some of the alternative products, should we expect sort of an investment, an uptick in maybe some of the expense line items associated with that rollout if you will?

On the fee side, the -- our new funds as well as the other competitive funds in those categories generally have higher fees than many of the traditional funds. One thing though I will make sure it is clear because these funds will employ underlying managers, there will be underlying fees. You can't look at the gross management fee and assume that that is going to directly correlate to how much we retain. So there will be underlying managers that will be paid out of those numbers.

But generally these will be higher fee products and so in the range of the higher fees or higher than the more recent high fee products that we have been selling quite a bit of.

In terms of on the cost side, we generally don't think you will see any meaningful change in our cost structure per se as a result of these funds. Obviously there will be the normal variable expenses associated with these but since they are sub advised to actual alternative managers, hedge fund managers and other alternative managers, we won't have that operating costs associated. We will have the oversight and performance measurement and all of that. But, Mike, I don't think there will (multiple speakers)

On a net basis, as George is describing, I think that is absolutely right from our P&L perspective. Just from a line item basis, there will be some costs that flow through other operating expenses that go to Cliffwater and their role for oversight and for a license fee to them. And then we have the effect of having a minority interest in the majority owned joint venture. But on a net P&L basis, it will be consistent economics with our existing sub advised approach to product.

We will give more clarity once those numbers start showing up. We will give that clarity that Mike is pointing to in terms of where things are in the line items for those products.

Okay. Then can you just share with us kind of a little bit of the recent maybe it's April -- I think you might have commented a little bit on flow trends and maybe having some of the redemptions. But what about on the gross sales side and some of the products like AlphaSector, you starting to see an uptick on the gross sales side as well in April?

We will talk about the quarter in general because the quarter did have a trend in it itself where for us February was the weakest quarter and the two elements that we look at is really what are the sales rates looking like and then what are the redemption rates looking like. Because both sides and they will show up in the net. For us, we definitely saw the weakness going into February and that did include the period where the zero weighting recommendation at one of our distribution partners increased the redemptions and then that got better in March. And then as I indicated earlier in the call, April so far year to date is pretty much close to the total net flow of the first quarter in its entirety.

I think generally we have seen pretty good sales across the board and some of the weakness that we saw were periods what I would view as periods of uncertainty in the market where maybe you saw upticks in redemptions other than just the EM redemption. Mike, are there any other specific --?

No, I think that is right. Redemptions have moderated more in line with some of our prior historical averages and we are seeing it broadly across the domestic equity, the alternatives and certainly the international category has been positive for us in April so a pretty balanced month thus far.

Okay, great. Thanks.

(Operator Instructions). Steven Schwartz, Raymond James & Associates

Good morning, guys. Just a couple -- a couple have already been gone over that I had.

Mike, what is the accounting on the investment looking at the balance sheet, the investments in seed capital and net assets consolidated sponsored investment products. I notice the amounts are basically the same but the categories have shifted. Is there something there?

The amount you are alluding to are from the table in our press release, is that the one you are pointing to? The 64.7?

64.7 and 29.2 is 124 million. It was -- the two for the fourth quarter were 124 million as well but as you can see (multiple speakers).

Seed capital investments and we spike out our portion of the consolidated sponsor investment products in our table to eliminate the third-party assets under management because as you know on a GAAP basis for those mutual fund products where we own greater than a 50% interest, we consolidate the entire fund's results and then eliminate through the minority interest a portion of that fund which we don't own that is representative of the third-party assets.

So the seed capital that I alluded to of $124 million is the two elements, the $64.7 million and the $59.4 million in our table which combines to the $124 million and they are really the same type of investment. However, the $64.7 million, we own less than 50% of the fund. So it shows up in a direct investment of the Company and the $59.4 million shows up in the consolidated sponsored line item inclusive of third-party assets and the amount that we show is just our portion.

The increase from $25.2 million to $64.7 million, there is no real change economically. What you are telling me is say Wealth Masters because so much new money has gone into Wealth Masters from an affiliate, that changes the allocation?

That is exactly right, Steven. It was consolidated in the prior quarter and as we have gained third-party assets, that fund was deconsolidated this quarter so you see the investment line increase and the consolidated sponsored line decrease. And we have tried to be very transparent about what goes into each of those categories in the appendix and the deck that we go through where you can look through and see the detail of every investment that makes up those rows.

Another thing to focus in on, I think looking at the total cash and investments is really helpful because there will be some movement between those lines as we consolidate and deconsolidate. And in the deck that went along with our presentation, we have sort of very carefully shown what the total is of that because that really is a way to look at the big picture of how much cash and investments which again are all liquid and can be utilized and that number is $388 million which is really a quite sizable numbers.

So you are going to see a lot of movement in some of the lines, but that might be another metric for you to think about.

I think a good follow-up on that is we talked about the seeding of the liquid alts occurring after the quarter so when we think about -- we have talked about our balance sheet in terms of seed capital and working capital and return of capital and our seed capital program is going to be in the range of between $200 million and $250 million as we have talked about after we have deployed the capital for these three alternatives.

And then the pro forma working capital after we deploy that exclusive of the seed gets into a range between that 50% to 75% level of our annual spend which is really what we have been targeting in that range, the industry average. So we feel like the balance sheet in terms of having an appropriately sized seed capital program and moving our working capital to an appropriate range has positioned our balance sheet very effectively moving forward.

On the topic -- and maybe I can figure this out from what you just said -- but the monies that are in the seed capital, the $40 million in Wealth Masters, will that be recycled into the $200 million to $250 million that will go to Cliffwater?

Not necessarily directly into those strategies. Our goal is not to hold investments in our seed capital once we have gotten to a certain level of third-party assets under management and that fund has begun -- has over $100 million of third-party assets and consistent with our approach to seed capital, we will begin to and we did begin in the first quarter to withdraw that capital, recycling some of it and then we will continue to evaluate and launch additional products to the extent that we have that need given our investment capabilities.

Just to add to that and to clarify, so the total size of the program for all seeded strategies, we are sort of indicating will be in the 220 to 250 range. Cliffwater just to be clear is I think you used a different number, Cliffwater will be 130 so when you think about all of our seed regardless of which funds they will be in, will be about that total approximate number and as money comes out of one, it will go into other opportunities.

So think of that as the total portion of the program for lack of a better word that we are setting aside. And for all of these things that we have just been discussing, I think our relative size of our cash and our investments and our seed capital for a Company our size I would encourage you to look. Because I think it is quite large and I'm not sure if we give the appropriate credit in terms of looking at our valuation as people look at the amount of cash and investments that we currently have on the balance sheet.

Okay. Just a couple more if I may. An update on the deferred tax position, Mike?

We continue to report certainly our tax position, the effective tax rate from a GAAP perspective and utilize our deferred tax assets including our uncertain tax positions and we will continue to record our uncertain tax positions throughout 2014. And as we go through those, the good news is the higher earnings levels have enabled us to utilize our tax attributes and the outcome of that is in the next 12 to 18 months we could become a federal cash tax payer. So you will see the uncertain tax position liability on the balance sheet but we will continue to disclose that as we use it.

Okay. Then one more if I may. George, I don't know how much you look at it, but the emerging markets opportunities fund, not good performance last year, phenomenal performance in the first quarter. Is this really all about India?

It really is. Just to be clear, the emerging markets fund which is I believe in the 9th percentile for the three-year numbers was on a 7 percentile for the quarter and there were two quarters last year where it did underperform given some of its weightings, given its strategy and its call on Japan and India.

But now with the first quarter, those calls have ended up positioning it quite well so again, this is kind of a strategy where you could have what you did have which was two quarters of performance that looked weak but then because of that positioning, they had a first quarter in about the 7 percentile.

So the three-year number being in the top decile is very strong. So it is a great manager, they do a great job. They have a great long-term track record. The financial advisors who use the fund and the firms that we sell through think very highly of the strategy in the fund.

Okay, great. Thanks, guys.

Michael Kim, Sandler O'Neill.

First, just to follow-up on the mutual fund business just looking at your flow trends more recently, and Mike, I think you touched on this earlier but it does look like the breadth of flows seems to be broadening out a bit. So is it fair to say maybe that the sustainability or the consistency of your flow profile is evolving since you are maybe less dependent on one or two flagship funds?

I will answer that. Yes, that is our basic approach and what we tried to do with our product offerings and we have seen other areas of flows that we don't even talk a lot about in our SMAs, part of the increase was on an international ADR strategy which has a great track record.

So we are seeing, so I think I would actually think about it a little differently. I think in the past, some of the concentrated success of one or two funds was so phenomenal that I think the diversity of the overall strength -- we tried to point out over the years that if you look at the organic growth of not just our top two or three funds but our top 20 funds, they were always very, very strong.

So I think when the tide comes out you can actually see things and I think you are not seeing the individual strength of an EM, I think you are sort of seeing that underneath that there is a few other strategies. So between our REITs and now with the Wealth Masters, the Perennial, my perennial favorite fund which is the multisector short-term bond fund, there is a whole set of offerings.

And again, it will all be about what people are interested in at given points in the market cycles and I think we have now added to that the whole alternatives.

And just one last thing I will say, I always want people to understand when we talk about the alternatives and we think it is a great opportunity but the important thing for us is not just to sell alternative products, it is again for us to have all the building blocks of a well-diversified portfolio. So that whether a financial advisor is looking for fixed income or equity or now alts, we become more of a go to player.

We have done incredibly well without being one of those go-to players so we think this will help us become one of those more consistently used names for all the different choices of investment classes.

But again, we think we have a lot of multiple engines for growth. That is why we think we have had good flows. Last year you saw like the EM and fixed income being very popular. Then after May 22, you saw a shift in that and we were able to sell downside equity as well as long/short. That is really our entire focus of our product and our distribution strategy is to have us be able to navigate those differences.

Okay, that is helpful. And then in terms of margins, I think I ask a form of this question every quarter but just wondering if you could possibly frame the potential upside from here just given what seemed to be ongoing tailwinds around rising AUM and revenues, maybe slowing sales rates as well as high incremental margins?

I think you have asked the same question each quarter and I think we give you the same answer every quarter. So we will try and talk about the incremental margins and our capture ratio and we have historically been in the 50% to 60% range. We still think given our fixed cost structure that that still is a good range to consider and we have seen our margin this quarter exclusive of the payroll tax item really move to about 49%. So I think you are seeing us move the margin up right to the bottom of that range. I still think that is a good way to think about incremental revenues as we move forward.

Maybe just a follow-up on that answer and put a different spin on it. You mentioned you are getting starting to bump up right against that incremental margin range of 50% at the low end. Assuming the margin continues to trend higher, at some point would you maybe think about starting to ramp up some spending just to maybe make use of that excess if you will?

This is George. We wouldn't think in those terms. Again, we have a very variable business model and as we are giving the range, we are cognizant of what the various components of those variable pieces would lead to. And again, we haven't held back on the costs that we need to run the business the way we think we should in the past so if you are saying if the margin started getting frothy, would we use that as an opportunity to sort of maybe invest in things that we wouldn't otherwise invest in? The answer to that is, no. I think we have a very vocal approach to as we grow our businesses with sales, we grew our sales at incredible levels and then invested in the wholesalers as opposed to the other way around. So we will continue that philosophy.

Okay, fair enough. Thanks for taking my questions.

Surinder Thind, Jefferies.

Good morning, guys. So my question is actually kind of around the dynamics of near-term investment performance versus the longer term. We are beginning to see I think perhaps you guys have had in the past year a little more volatility than you probably would have liked in your short performance. But your long-term performance has always been very strong. Now we are beginning to see that near-term performance improve.

And so I'm trying to gauge how much of an impact that has in your client conversations? When you guys are in that sales process, you are talking about it how much of an impact does it make or how often does it come up I guess in that --?

It is a great question. It is a great question because obviously there is a relationship between performance and sales and flows. I do sometimes think that there is a misunderstanding of how causal and how directly related they are and then the timing associated with that. And also performance -- increasingly -- and this is not just about our product set, there are a lot of products that don't really -- aren't thought about in terms of how they are doing against the benchmark. They are thought more about how they fit into the diversified portfolio.

So sometimes I can see people looking at headline performance numbers and they assume if this performance number went up, there will be more flows when sometimes the performance number is not the right way to look at it and people aren't looking at short-term numbers.

So a couple of things. Even though we have had incredible performance, we are very careful not to sell hot performance. We sell managers, we sell what their strategies are and how they will perform over the long term. So we don't highlight or pump good short-term performance. We really focus on the long-term numbers.

So in most of our conversations I will use EM as the perfect example. There were two quarters last year where those absolute performance numbers looked very, very weak. But having spent five to seven years -- I can't even remember when we started with Vontobel -- telling their story, telling their strategy and telling them about how Rajiv looks at the world, the people we do business with understood that and I think were very, very understanding where they wouldn't have been had they just screened the product and bought it when it was a Morningstar, when it received an award as being one of the best funds.

So I think the shorter-term numbers, I don't have as much impact if you sold it thoughtfully and you sold the manager versus the strategy. Though that being said, if a fund does have two quarters, people may take their foot off the pedal for a little bit but at this point, I think all of those products -- I mean we had a very good quarter in terms of the performance and now with the cycle changing in terms of high-quality versus low-quality, we feel really good about the first-quarter for all the Vontobel products was very, very strong.

AlphaSector, people always look at it I think the wrong way. You should really look at it -- I would recommend looking at it in terms of where it is in the percentiles of Standard Deviation and Sharpe ratio because that is what it is really being sold for is how much volatility you are taking on the return.

So that is a fund where sometimes I will get a question people think it is underperforming when actually if you look at its percentile rankings again under Standard Deviation or Sharpe, you are going to see that it is doing incredibly well.

But we also, what I will leave you with is we also set expectations of when our strategies will underperform and we think that has helped us not have some of the same levels of redemptions that you sometimes see in strong performing products that hit a rough patch. You can generally see a very big uptick in performance related redemptions. Even with EM, I would argue I don't believe we have seen any performance related redemptions. They have primarily been asset class redemptions and I think that is a testament to the manager and I think that helps you understand how we sell the products.

But again, having a strong first quarter in most of those products will certainly be a positive as we move through the rest of the year.

Okay, that is very helpful. And then on a follow-up question here, I mean in general you guys sell solutions but are there periods where you go through where you perhaps incentivize a certain product to be sold or something like -- let's say for example, your liquid alts have a great track record six months from now. Would you at some point maybe incentivize those funds to be sold or is there any kind of scheme like that within sales?

One of the benefits of having the diversity of products that we have is our wholesalers will always have -- have always had something in their bag that is attractive. So we don't like necessarily pushing any individual specific products. Our preference is to be able to go into a financial advisor and try to find out whether they are looking for yield, for non-correlation, are they looking for non-US exposure, are they looking for principal protection and help them solve the client need that they are currently focused in on?

We think that is a better way to retain assets over time than selling our current Hot Five Star Fund. I think that is one of the reasons we have been successful in the retail channel and I believe most of our distribution partners would say that that is a differentiator for us.

In terms of our compensation, our compensation, it is variable compensation. It relates to the profitability of the fund, the size of the fund but we may have campaigns which is a logical thing to do when you are introducing funds, but we don't turn all of the pay on and off for funds or only pay for people to push certain funds which I know other firms do. We do not do that. We want them to sell long-term and we want them to have the flexibility to sell any of our products.

So even if it is a product no one is thinking about, international small-cap,. they are highly incented to sell that product in case it comes up. I think that also helps with our diversity of sales because it you hike the compensation on one or two funds, you are only going to sell one or two funds. But if you keep a very appropriate comp structure in place for 49 funds, you have a chance of selling more than two or three funds.

And then hopefully a really, really quick question. I apologize if I missed this but for example in the Wealth Masters Fund, you guys are beginning to withdraw the seed capital. What is the timeframe over which you would do that? Would you try and do that within the quarter or is it spread out a little bit more or is it done as you are getting ready to maybe seed other strategies?

For each of those funds, we would look at it and what the level of third-party assets are and we would thoughtfully withdraw it so we would do it in a way that made sense for the management of the fund, the asset levels in the fund. So we would look at it.

So I think, Mike, you started Wealth Masters in the third quarter.

In the first quarter.

I'm sorry, in the first quarter and we will continue thoughtfully. And one thing to sort of look at is as long as the fund is over $100 million, there is probably an opportunity for us to move that money so that is a good benchmark for you to think about as you look at recycling of seed.

Okay. Thank you. That is it for me.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Aylward for any closing remarks.

Okay. I just want to thank everyone for joining us and we certainly encourage you to give us a call if you have any further questions and thank you. Have a great day.

Thank you. That concludes today's conference call. You may now disconnect. Thank you for your participation.