Virtus Investment Partners Inc (VRTS) 2014 Q4 法說會逐字稿

Good morning my name is Tony, 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 the Virtus website, www.virtus.com. This call is also being recorded, and will be available for replay on the Virtus website. At this time all participants are in a listen-only mode. After the speakers' remarks there will be a question and answer period, and instructions will follow at that time. I will now turn the conference over to your host, Jeanne Hess.

Thank you, 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 fourth quarter and full year of 2014.

Before we begin I direct your attention to the important disclosures on page two 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 and uncertainties and other factors that may cause actual results to differ materially from those discussed in the statements. These statements may be identified by such words as expect, anticipate, believe, outlook, may, and similar terms. For a discussion of these risks and uncertainties please see the Risk Factors in Management Discussion and Analysis section of our periodic reports that are filed with the Securities and Exchange Commission, as well as our other recent filings which are available in the Investor Relations of our website www.virtus.com.

In addition to results presented on a GAAP basis, Vertis uses certain non-GAAP measures to evaluate its financial results. Our non-GAAP finance 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 press 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 Virtus.com. Today we will begin with remarks from President and Chief Executive Officer, George Aylward, who will review our operating results and accomplishments for the quarter and the full year. 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 position. 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, Jeanne. Good morning everyone. We appreciate having you on our call with us today to review our fourth quarter and full year 2014 financial and operating results. By financial measures both the quarter and the full year were strong. However, we were disappointed to report overall net outflows due to elevated mutual redemptions in the fourth quarter, that led to our first quarter of mutual fund net outflows since the first quarter of 2009. So let me start by reviewing assets under management, sales and flows. Assets under management ended the year at $56.7 billion, an increase of 1% over the prior year, excluding money market assets, which were liquidated in October of 2014. Total sales of $3.4 billion in the fourth quarter were consistent with third quarter sales of $3.5 billion, and the sales rate was relatively unchanged from the third quarter at 22%. Fourth quarter mutual fund sales were $2.8 billion, representing a sales rate of 28%. Total sales for the full year were $15.2 billion, of which $12.7 billion were attributable to open-end mutual fund sales. Open-end fund sales were once again diversified by asset class. International equity at 35%, Fixed income at 29%, and domestic equity at 27%. Our full year sales rate was at 34.8%, which is above industry averages.

Net outflows were $2.2 billion in the quarter, and were primarily attributable to $2 billion in net outflows in our domestic equity and alternatives strategies. While this is generally consistent with net outflows in the industry, the outflows in our funds were elevated in the quarter. To provide more detail, starting with the domestic equity, net flows were a negative $1.4 billion in the quarter. Our two largest domestic equity funds are the AlphaSector Rotation and the Premium AlphaSector funds. While AlphaSector Rotation had modestly positive net flows for the quarter, Premium AlphaSector experienced net outflows of $1.3 billion, due primarily to elevated redemptions. Several factors contributed to the outflows including reactions to a large capital gain distribution communicated on November 13th, the absolute performance of this downside protection product in the up market, and developments at the fund sub advisory and the related announcements and the resulting media coverage. These factors individually and collectively impacted redemptions. In terms of the capital gains distribution we saw a noticeable uptick in redemptions following the November 13th communication, and November was the weakest month for flows. Frequently financial advisors will make changes in their fund holding space on the implications of capital gain distributions for tax planning purposes. Regarding performance we believe the appropriate way to evaluate downside protection products is on a risk-adjusted basis over a full market cycle. The Premium AlphaSector Fund continues to have compelling risk-adjusted statistics, however in the quarter and for the year the funds absolute performance did not compare well to a strong market return of 13.7 for the S&P 500. Also given this fund's downside protection orientation, it may be less attractive in continued rising markets that we were experiencing.

In contrast the AlphaSector Rotation fund which had both increased sales and modestly positive net flows for the quarter had absolute performance for 2014 which compared much more favorably to the return of the S&P 500. In the alternative category, we saw net outflows of $0.6 billion almost entirely related to our long short dynamic AlphaSector. We believe the reasons for the flows are similar to those that I just mentioned for premium funds. And further from an industry perspective, the alternatives category did post a double-digit organic decay rate, as many hedge strategies including our fund produced less attractive absolute returns, compared to broader market indices. The impact of absolute performance on these funds is illustrated by the difference in flows, as the one with the strongest upside capture was modestly positive in the quarter, while the other two were in outflows.

Our fourth quarter flows in international equity and fixed income were more inline with industry trends. Our International equity mutual funds contributed 9% organic growth, and our funds in this asset class primarily the emerging markets opportunity and foreign opportunity funds, have posted strong investment performance on a consistent basis. Our net outflows and fixed income were consistent with industry trends in the asset class. In Institutional we were pleased with the increase in both sales and net flows, sales in the category increased to $0.3 billion from $2.2 billion in the prior-year quarter, and $0.1 billion in the sequential quarter. The increase was primarily attributable to a new fixed income sub-advisory mandate of our Newfleet affiliate. The mandate funded in October, and continued to receive flows throughout the quarter. While flows in premium are dynamic have remained negative in January, it's important to look at the rest of our fund offerings. We believe that a benefit of our business model is having broad product offerings that are responsive to investor needs. We have 13 4 and 5-star funds as of December 31st. These funds span all of the major asset classes. Specifically some of our key opportunities in 2015 depending upon investor preferences, include international equity, where our emerging markets opportunities and our foreign opportunity funds, some advised by Vontobel have strong short and long-term performance. The foreign opportunities fund is ranked in the top decile on a one and five year basis as of December 31st in the international large cap growth category.

In Fixed income, our flagship product the multi-sector short-term bond fund is a 5-star fund with a long track record of strong performance. In addition, Newfleet also offers other multi-sector offerings in an intermediate duration, as well as on a more unconstrained basis. Newfleet also manages sector-specific offerings in loans, high yield and emerging market debt. In Alternatives, we continue to believe that our multi-strategy funds sub-advised by Cliffwater Investments, provides us an opportunity to us, as financial advisors seek to employ alternative products in their clients' portfolios.

We have anticipated having these funds available for access at the larger distribution firms by the end of the year. While that did not occur, we are pleased to note that one of our major wirehouse distribution partners is in the process of making our total solutions funds available this week. Also in alternatives our three real estate strategies managed by Duff & Phelps as well as their global dividend equity strategy, all have strong long-term performance performed well in 2014. Our global REIT fund is ranked five stars by Morningstar, and has top decile returns on a one and five-year basis. I would also note that we believe that the Herzfeld Fund, which is a differentiated strategy of investing in closed-end funds is very attractive.

Turning over to financial results. We reported strong growth in operating income as adjusted over prior year periods as the Company generated higher revenue on increasing average assets, and continued to benefit from the leveragability of the business. Operating income as adjusted increased 11% over the prior-year quarter, and 24% over the full year of 2013. The related margin remains strong and increased to 50% in the quarter from 48% in the fourth quarter of 2013. For the full year operating margin as adjusted increased to 48% from 45%. Earnings per diluted share were $2.05 in the quarter, after adjusting for non-operating items, which Mike will address in some specificity later on, earnings were share were $2.72, an increase from $2.36 in the fourth quarter of 2013. Before turning it over to Mike for more detail on our financial results, let me review capital activities and some of the other items included in our earnings release. At December 31st, we remain debt-free and all of our key capital metrics were strong as a result of capital activities during 2014. During the period our Capital Management continued to balance protecting the business, investing in growth, and returning capital to shareholders. We have a strong level of working capital as compared to our annual spend ratio, which provides us with operating flexibility. Our seed capital portfolio was at its highest level to date after we introduced three multi-strategy alternative funds advised by Cliffwater, and the strategic income fund managed by Newfleet. In addition we utilized $10.1 million of capital earlier this year to launch the Duff and Phelps closed-end fund that now has $600 million in assets under management. For the year we returned our highest level of capital shareholders, reflecting the initiation of the dividend, the highest level of share repurchases, both in terms of total dollars and number of shares, and the net sale of restricted stock units. We are pleased with the strong levels of capital, and continue to believe that it's appropriate to balance maintaining our operating flexibility with returning capital to shareholders. Turning now to the other announcements included in the earnings release, we have continued to add to our investment capabilities from product offerings. We announced an agreement to provide Aviva's investors strategies on an exclusive basis in US open and mutual funds. Aviva investors which manages approximately $400 billion in assets, will employ distinctive multi-strategy and outcome oriented investment approach as sub-advisor on the funds. The first part we expect to introduce is the Virtus multi-strategy target return fund. This global tactical asset allocation fund will be our first offering in this popular category. We are optimistic about the future opportunity in this category, as it has been increasingly attractive to financial advisors and investors.

We also announced an agreement to acquire a majority interest in ETF Issuer Solutions, or ETFis. A company that offers a platform for listing operating and distributing exchange traded funds. ETFis' approach of offering investment capabilities from boutique managers in ETF is similar to our approach for open-end mutual funds. The transaction will provide us with actively managed ETF capabilities, and we have filed for an offering managed by our Newfleet affiliate, utilizing the ETFis platform. The fund will leverage the Newfleet team's broad experience in multi-sector fixed income, investing in a strategy that will have the flexibility to capitalize on opportunities across all sectors of the bond markets, including evolving specialized and out-of-favor sectors.

We filed for the differentiated Virtus Essential resources fund, which will be managed by KBII. The fund strategy will focus on identifying companies providing solutions to the supply demand and balances for vital resources, including water, food and energy. In addition, we filed for a new long short equity fund managed by Sirios, which will seek to invest in very liquid securities with mid-to-large capitalization and short stocks with deteriorating fundamentals. The fund intends to employ leverage derivatives, and will be able to invest opportunistically in fixed income. This represents a new long short offering in addition to the dynamic AlphaSector that I discussed earlier. Finally, we entered a share class intended to expand our presence in the defined contribution segment of the retirement market. These activities illustrate the strength of our multi-manager model, which offers access to a broad array of differentiated investment strategies that can appeal to investors in the changing market cycles. 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. Let's started today on slide eight, assets under management. We ended the quarter with assets of $56.7 billion, which represented an increase of 1% from the prior year, excluding money market assets, and a 5% decline from the prior quarter. As we discussed last quarter we liquidated our three money market funds, which represented a non-core component of our business. From an earnings perspective the liquidation had no impact on run-rate investment management fees. The $0.6 billion year-over-year increase in assets under management is attributable to $2.8 billion of market appreciation, offset by $1.2 billion of net outflows, and a total of $1 billion from dividends distributed net of reinvestments and changes in leverage. On a sequential basis the $2.8 billion decrease in assets again excluding money markets, reflects a 9% decline in open-end mutual end assets, which as George discussed, experienced elevated net outflows. Changes in leverage also had an impact on AUM, specifically the long short equity product dynamic AlphaSector employs leverage as part of its strategy. The maximum level of leverage occurs when the strategy is at its least defensive, and it moves to zero when it is positioned most defensively. During the quarter the fund took a defensive position, and reduced leverage by approximately $0.8 billion, contributing 21% of the sequential decline in open-end fund mutual assets under management. We earn management fees on total managed assets, so the reduction in leverage does impact our investment management fees. From a reporting standpoint we report changes in leverage, as well as mutual fund distributions net of reinvestments in the other ROE, in the asset roll-forward included in the earnings release. Closed-end fund assets ended the quarter at $7.6 billion, an increase of $1.1 billion, or 17% over the prior year, primarily due to the Duff & Phelps closed-end fund that was launched in June, as well as market appreciation. Closed-end fund assets were 13.4% of ending assets, compared to 11.4% in the prior year, and were 17.4% of run-rate investment management fees at December 31st. Up from 14.3% in the prior year.

Turning to slide nine, asset flows, in the fourth quarter we had total net outflows of $2.2 billion, as a result of the elevated redemptions in our long-term open-end funds. Earlier George provided additional detail into the main factors causing the elevated level of redemptions. It's important to reiterate that both total sales and open-end fund sales levels were generally in line with the prior quarter. Indicating that net outflows for the quarter are primarily related to the elevated level of open-end fund redemptions.

Let me provide some insight into flows by asset class. International equity fund net flows were positive $0.2 billion, representing an organic growth rate of 9%. Positive net flows were driven by continued strong demand for our emerging markets and foreign opportunities funds, sub-advised by Vontobel. In terms of fund performance, both of these funds generated top decile relative returns in 2014, and have very strong long-term investment performance statistics. Fixed income net outflows were $0.4 billion, consistent with industry trends as some investors shifted away from fixed income in the quarter. The outflows in the quarter were primarily attributable to net outflows of $0.3 million in our Multi-sector Short-term Bond Fund. Domestic equity net outflows were $1.4 billion, compared with $0.1 billion of positive net flows in the prior quarter. As George discussed, net outflows are primarily due to net outflows in one of our two defensive equity funds, the Premium AlphaSector Fund. Sales in our other defensive equity fund, AlphaSector Rotation increased on a sequential quarter basis. Alternative strategies had net outflows of $0.6 billion, primarily related to outflows on our long short equity strategy.

As noted earlier this experience is consistent with the industry data with reviewed for long short equity, and the alternatives category overall, that face double-digit organic decay, as funds in the category generally underperformed broad US market indices. Excluding the impact of the defensive equity premium AlphaSector product and the long short dynamic AlphaSector product, the long-term open-end fund organic decay rate for the quarter was 4.9%, which we believe was generally consistent with industry trends. Institutional had net inflows of $178 million in the quarter as positive inflows in our fixed income strategies reflected a new sub advisory mandate that funded in October. Sales in the quarter were comprised of initial takeover of $101 million, in addition to $73 million of ongoing sales.

Slide 10 shows the trend of operating income as adjusted and the related margin. In the fourth quarter we generated operating income as adjusted of $42.7 million, an increase of $4.4 million, or 11% on a comparative basis to the prior year. The increase over the prior year primarily reflects the 6% increase in the average assets excluding money markets, combined with the benefit of a leveragable business and our variable expense structure. Operating income as adjusted decreased $2.1 million, or 5% on a sequential quarter basis. This change reflects lower revenues as adjusted, which decreased by $3.4 million, related to a 3% decline in average assets. The operating margin as adjusted for the fourth quarter was 50%, an increase of 220 basis points from the fourth quarter of 2013. Our total year capture ratio or incremental margin of 70%, primarily reflects the variable structure of our incentive plans, and our abilities to leverage the operating infrastructure. We would anticipate if revenues declined, there would be a similar incremental margin impact to lower revenues, absent a significant change to our cost structure.

As a reminder, we will have incremental payroll taxes compared to the fourth quarter, due to our annual incentive compensation payments that we make in the first quarter of each year. To provide context in the first quarter of 2014 incremental payroll taxes were $2.5 million, compared to the fourth quarter of 2013. Concerning GAAP results, net income attributable to common stock holders was $18.9 million, or $2.05 per diluted common share. The quarter included $0.91 per share of unrealized mark-to-market adjustments reflecting the volatility in the quarter, and $0.24 per share of realized gains. Excluding these two items earnings per share would have been $2.72 in the fourth quarter, down slightly from earnings per share of $2.75 in the third quarter, when adjusting for the $1.67 net tax benefit, and $0.40 for the impact of the seed capital portfolio. Compared to the prior year earnings per share of $2.72 increased $0.36, or 15% over the prior year when adjusting for the impact of the seed portfolio.

For the total year reported earnings per share were $10.51, up 18% over 2013 earnings of $8.92 per share. The 2014 earnings included the third quarter net tax benefit of $1.67, $0.67 of closed-end fund launch costs, and a $0.43 per share impact from the seed capital portfolio. Excluding these items earnings per share would have been $9.94, up 15% compared with 2013 when adjusting 2013 for these items. Finally, our effective tax rate for the quarter was 44.4%. This included a $2.4 million valuation allowance related to the mark-to-market adjustments on our marketable securities. To the extent our marketable securities changed unrealized gain positions in future periods, this valuation allowance will be released. For the full year excluding discrete items, our effective rate was 38.1%, which is consistent with our stated expectations.

Turning to investment management fees on slide 11, investment management fees of $75.4 million increased 6% from the fourth quarter of last year, and decreased 5% on a sequential quarter basis. The components of the change in investment management fees are average assets and fee rates. Average long-term assets under management of $58.3 billion increased 6% from the prior year quarter. The increase was primarily related to higher open-end and closed-end fund average assets. Average assets decreased 3% from the sequential quarter as open-end average assets were 5% lower.

The average fee rate was 51.5 basis points, an increase of 1.5 basis points from the prior year primarily related to the liquidation of money market funds, and an increase in closed-end funds that was offset by a decrease in the open-end fund fee rates, specifically the 3.3 basis point increase in the closed-end fund fee rate is primarily attributable to the closed-end fund launch during the year, and the 1.1 basis point decrease in open-end funds fee rate is primarily attributable to one fund with a performance related fee that was negative in the fourth quarter. The average fee rate increased by 0.9 basis points sequentially, which was again primarily related to the liquidation of the money market funds in October. Turning to employment expenses, total employment expenses for the quarter were $34.1 million, an increase of $0.6 million from the prior year, and a decrease of $1.1 million sequentially. The increase over the prior year primarily reflects costs associated with personnel additions to support the growth of the business. The decrease compared to the third quarter is primarily due to lower variable incentive compensation that is tied to both profit and sales. The key metric to consider is employment expenses as a percent of revenues as adjusted, which stayed flat with the third quarter at 40%, despite the $3.4 million of lower revenues as adjusted. As a reminder our compensation structure is variable with a range of 50% to 60% of employment expenses being variable, based on earnings or sales.

As I mentioned earlier, the first quarter will include payroll taxes related to the payment of annual incentive compensation. In the first quarter of 2014 higher payroll taxes resulted in an incremental $2.5 million of employment expenses compared to the fourth quarter of 2013. The trend in other operating expenses reflects the timing of product distribution and operational activities. Other operating expenses of $11.6 million in the fourth quarter were up $1.1 million from the prior year, and increased $0.3 million on a sequential quarter basis. The increase over the prior year at sequential quarter relates to higher portfolio management and marketing activities, as well as system transition costs. Regarding system transition costs, the current quarter expenses were $0.4 million, compared to $0.2 million in the prior quarter. This increase relates to costs associated with the transition from multiple trading systems to a single trading system platform. As a reminder these costs are either transitional or duplicative to existing costs, and will be a non-GAAP adjustment until the completion of the projects. The ratio of other operating expenses to revenues as adjusted was 13.6% for the quarter. This ratio increased 90 basis points compared to the third quarter, primarily due to lower revenues as adjusted. Moving to Slide 14, we ended the fourth quarter with strong cash and investments and working capital position. And we remain debt-free. At December 31, 2014 our cash and investments were $470 million, or $52 on a per share basis, an increase from $49 per share that we reported in the sequential quarter. We ended the quarter with working capital of $190 million, an increase of $16 million, or 10% from the third quarter. The increase is attributable to the financial results, partially offset by $18 million of return of capital to shareholders. Our working capital to annual spend ratio ended the quarter at 63%, within our targeted level of 50% to 75% of annual spend. Our seed capital investments totalled $238 million at the end of the fourth quarter, flat with the third quarter. The fourth quarter change reflects the net activity of our seed program consisting of $6.1 million of new investments, and $5 million of reinvested dividends, partially offset by $3.3 million of withdrawals, and $9.3 million of unrealized mark-to-market adjustments.

In terms of return of capital during the fourth quarter, we returned $18 million to shareholders consistent with the third quarter. The amount consisted of $14 million of share repurchases, and $4 million of dividends. The fourth quarter also marked our highest level of repurchases in terms of shares, with 88,567 shares repurchased in the quarter. As a result of repurchases at this level, our shares outstanding declined by 130,000, or 1.4% from the prior year, as our repurchases over the past fourth quarters more than offset new shares issued.

On a full year basis which also includes the declaration of our fourth quarter $0.45 per share dividend, we have returned $61.7 million to shareholders through share repurchases, including net settlement of vested RSUs and dividends, which represents 66% of economic earnings, which we calculate as operating income as adjusted plus non-operating income excluding any impact from our marketable securities. That amount has been tax effected at our expected effective tax rate. Total year return of capital to shareholders reflects a 127% increase, compared to $27.2 million in 2013. The primary goal of our Capital Management strategy is to balance investments in the business, with returning a meaningful level of capital to shareholders. We believe the growth and the level of capital returned in 2014 compared to 2013 demonstrate that commitment.

In closing there's one final item I would like to note. In past quarters we have talked about a new non-GAAP measure in terms of how we evaluate our level of return of capital. We believe this measure will provide the most transparency into our ongoing operating results, and is consistent with how we look at the business. Our expectation is to provide additional details prior to our first quarter 2015 earnings call, including the specific definition, the key differences from GAAP net income and our current non-GAAP metric operating income as adjusted, and historical results on the new basis. With that, let me turn the call back over to George.

Thank you, Mike. That concludes our prepared remarks, so now let's take some questions. Tony, can you open up the lines, please.

(Operator Instructions). Your first question comes from the line of Mr. Tom Whitehead of Morgan Stanley, please proceed.

Hey, guys. Good morning. Thanks for taking my questions. I just wanted to touch on the partnerships and the acquisitions you have announced. So on Aviva, can you elaborate on any plans you may have beyond the Multi-Strat targeted return product, and sort of how their capabilities mesh well with holes you may have? And then on ETFis, they are known as a white label ETF issuer, so are there any other strategies beyond the Multi-sector bond strategy that you think you can replicate in the ETF wrapper?

Yes. No, great question, so I will start with Aviva, and we are very excited about the opportunity to work with Aviva Investors. We have all been just incredibly impressed with just the sheer breadth and depth of the capabilities that they have, and in particular as we sort of look at the types of capabilities that we could bring to market, we would argue they are one of a very small number of firms that have that much capability, particularly in a multi-strategy global asset allocation type of offering. So we're excited to be working with them, and the arrangement we have is that we will work collaboratively together to develop several new products, the first of which is in filing so I can't speak directly about that, but generally it will be employing, their outcome oriented multi-strat, multi asset class, driven by their views in terms of opportunities in the market. So we're excited to work with them. We think that they have incredible capabilities and a breadth that few others we would be able to partner with would have.

We also think this is great to have an offering in this category. We have not traditionally had something that would fill that need that sometimes financials have, for what they consider a very highly tactical strategy that could move in and out of a lot of different asset classes. So this is really as I indicated in the prepared remarks, the first time that we're going to have an offering of that, and the people at Aviva, and we referenced Euan Munro and his long history, and in at least our personal view, he is really a pioneer in this space, and has a very long track record of successfully dealing with these types of strategies. So we're really excited about the opportunity, and they are great people to work with.

Turning over to ETFis, which again is a provider to offer the ability to offer ETFs, including actively managed ETFs, so their approach in some ways is not dissimilar from ours, right where they want to have the capabilities, and then provide a platform to which to make them available in ETFs, and again actively managed ETFs. So it's a great strategic fit, and the way we look at approaching this part of the market, and again, we're not the only ones working on the best ways to have access to ETFs, so I will start with why does that make sense. ETFs increasingly are finding their ways to be utilized by financial advisors in portfolios, so we want to be able to have that type of a project structure for those financial advisors or firms that want to utilize those, and being able to do that in an actively managed sense, because obviously we're big believers in active management, as opposed to passive management. So we are very happy to have that ability.

Our approach with ETFis is, it is a great group of individuals, who I think are very focused on building out a great platform, and to be very competitive, so partnering with them was sort of a good fit for us. And even the way we're approaching our alignment with the principals at ETFis, our investments are literally going to be the capital used to grow the business. So we're really working hand-in-hand and alongside with a group of talented individuals to build out this platform, and we do think that that's a great approach, and a good alignment of interests between us, because we will be the majority shareholder, with the ability to increase over time.

Everyone is highly motivated to work together and very happy to offer our first affiliate managed offering that we discussed. We have actually, Newfleet also actually does sub advise another actively managed ETF, so we have some experience in that space. So we view both of them as good positive developments, again building our opportunities for growth in different sectors of the market, and we have always said that our opportunities for growth will come from leveraging the capabilities that we have, and it can come from offering things in new product structures, which ETFis would meet, or by using our ability to partner to bring more capabilities, and I think Aviva is a great example of that.

Okay. That's great. Thanks for the color on both of those, George. That was very helpful. And then my follow-up question is just a little bit, switching gears a little bit looking at capital returns. So Mike talked about how you guys have sort of stepped up year-over-year, and now are returning sort of two-thirds of your economic earnings to shareholders, and you have done a ton on the growth on the seed capital side. But if I just look where the stock is today, it seems awfully attractive just in terms of historical evaluation and valuation versus peers. So how should I think about the buy back going forward, and how tactical do you guys plan to get in terms of executing on that buy back when the stock has a little bit of stress, as it does now?

I can't. No. Question great question and we're fully aware of the stock price and I can't give any specific indications of what we may or may not do in terms of share repurchases. A couple of things I would point to. As you may have noted, we had announced the increase in the authorization of the repurchase program by an additional 500,000 shares, so that is something that we announced. As Mike sort of alluded to earlier, we have actually sort of discussed on earlier calls, we do look at targeting a meaningful percentage of our net economic income to return it to shareholders, and Mike gave some of the stats, and sort of where that is. So we look at total return of shareholders, and in general we have been below industry averages on that, and as we were a smaller, growing company that was more appropriate. I think it was just sort of indicating moving closer to industry averages would be a logical development.

So we look at that total percentage of economic and net income, which again currently is slightly below averages, and then we look at the two vehicles that we currently have, which is the dividend which we initiated just last year, as well as the repurchases. And while our repurchase program generally seeks to offset the dilution that is caused by the issuance of equity, obviously we have the ability and the flexibility to opportunistically utilize that, when we obviously think it is in the best interest of the Company to do that. I think as Mike pointed out, our fourth quarter was our highest level of stock repurchases in both numbers of shares or dollars, so I was just, put all of those things together and determine your thoughts from there.

Yes. I would just add some. Ratios that I mentioned, Tom, this is Mike. We look at that over a sort of an annual basis, so you might see in any given quarter, be above or below that depending on some of the factors George indicated. So we look at many factors going into how we think about return of capital, and I think we're trying to provide that transparency into how we think about it from an economic earnings perspective, which is somewhat consistent with how we're starting to move to this new non-GAAP metric that I had indicated in the prepared remarks. And it will be forthcoming later in the year. So we will continue to provide that transparency, and we think about it over a given year, but hopefully that provides color to help you with how we think about it.

It absolutely does. Thanks for taking my questions, guys.

Your next question comes from the line of Mr. Steven Schwartz of Raymond James & Associates. Please proceed.

Hey. Good morning everybody.

Morning

Good morning.

I want to touch on F-Squared AlphaSector funds, and basically what is going, maybe you can update us on what is going on there? There's something obviously with the SEC, and Mr. President resigned. But what are you doing, what is F-Squared doing, with regards to getting that back on shelves and getting sales going again?

Yes. And we're not going to answer any questions related to the sub advisor or any regulator matter, so talking about the funds and the strategies so we alluded to a few things in the prepared we marks. So basically what we saw in the fourth quarter was obviously elevated redemptions, and I did attribute it to those categories of items that I did mention, and individually and collectively, because really there was sort of all three of the things that contributed to that. What is interesting sort of is that the impact obviously was most pronounced, primarily seen on the outflow side. Actually on the growth sales side, it was impacted, but significantly less, so I think for example premium I think sales quarter-over-quarter were down about 13%. So while the outflows were definitely elevated in the premium fund, that was not as much of a decline in the gross sales. I think as Mike alluded for the AlphaSector Rotation fund, sales actually increased quarter-over-quarter, and it was slightly positive.

So we always look at obviously things that are driving flows, look at the investment strategy and the performance, and constantly just sort of evaluate, are there things that need to be done to address that. I mean the performance of these types of products in up markets is always going to be look less attractive than it should, so we do look at these things over a longer time horizon, but clearly we are very mindful, and we are very focused on the strategy and the fund, and the implications, and the thoughts of our distribution partners, and consider them very closely at that.

Okay. Sure a little bit of a bear market would probably not be a bad thing for them

It would be a good thing. It would be a very good thing.

Just one other thing on that one of the things that you noted was the capital gain distribution and reaction to that. Could you get a little deeper into that, George, and what happens in that kind of instance with the FAs?

Yes. Well, sometimes what you see, you now, when capital gains distributions have an impact to people from a tax perspective. So over the years we frequently have seen where if there is a very large capital gains distribution, and with some of these funds they were unusually large, but it was the result of literally accumulating a lot of capital gains, which is generally considered a good, but then having a capital gains distribution and a strategy where you would normally just reinvest, for tax planning purposes one of the many services that good financial advisors provide, in addition to managing their portfolio allocation, is trying to do it in a tax efficient way. So there are frequent instances where a financial advisor may choose not to stay in a fund that may report a large capital gains distribution, which would then have a tax implication, and sometimes they'll re-allocate, so from what we have seen over the years, we have seen this before. These were very large capital gains distributions as a percentage of the fund, and they were definitely we received a lot of calls, and a lot of discussions related to that. So it's one of the factors that I cited.

Okay so selling in front of this is I guess is what you're explaining?

Yes. In other words, people may choose, because you want to give people an indication that you're going to have a capital gains impact, and they may choose not to be in the fund on the X date.

I got it.

But that will happen basically in mid-November. Starting in mid-November.

Okay. Thank you, guys.

Thanks, Steve.

Thank you.

Your next question comes from the line of Mr. Michael Kim of Sandler O'Neill. Please proceed.

Hey, guys. This is actually Andrew Disdier sitting in for Michael. And I apologize if some of my questions are redundant, but we have had some phone issues here, so bear with me. But I know it's still early, and just coming be back to the discussion on your liquid alt funds, how would you characterize the uptake for those strategies, in light of where you stand really as it relates to distribution and asset growth?

Yes. So on the alt funds, meaning those that are managed by Cliffwater, right, specifically?

Yes.

Again, we strongly believe that retail portfolios really need to utilize more non-traditional, non-correlated types of approaches, of which these would fit into that category. And while people may struggle with doing that because there are again, also more of a risk managed type of approach, so as markets go up and up, people may not see the need for it, but actually we would argue as more volatility and more uncertainty comes in, this is when they should be making those decisions. So we still think fundamentally those types of strategies have a really important place in portfolios, and I think most of if not all of the firms that we partner with for distribution, strongly want their clients to do more of that. We think the way we're approaching it is differentiated, and we like the way we're doing it by partnering with an institutional consultant, who then is using their experience and expertise to make both the portfolio allocation decisions and the manager selection, so we think we have a very differentiated approach.

That being said, there's a lot of entrants coming into this market, all of the firms have to do a lot of work to get comfortable with these firms, which we fully agree with that they should do a lot of work, and there's also a lot of education that needs to be done with financial advisors, because just like with any product, you never want somebody to utilize the strategy for the wrong reason, or without understanding when they will outperform and when they will, more importantly when they will underperform.

So I think there's been a lot of that process going on and we acknowledged earlier that while we had hoped that our funds would be able at some of the majors by the end of the year that did not occur, and literally just this week, one of the funds our Total Solutions fund is becoming available. So I think the opportunity is there, because they should have a meaningful part in a portfolio. I do believe though, it will generally for us be driven more about what's going on in the market and dynamic.

So again, I think the strategies are important, I think our differentiated approach should be very compelling, so back to an earlier comment if the market just keeps going up and up and up, there will probably be less demand than otherwise, but if people start realizing that it can't deep doing that, and they start worrying about how heavily tied they are to traditional indices, I think you could see a lot of demand, and hopefully in our product, as well as some of the other competitors that have come out.

Great. And then more broadly you remain pretty active on the product development side, so I was just wondering the outlook going forward, and then any updates on potentially coming to market with other closed-end funds?

Yes. Again, a fundamental, we believe a fundamental benefit of our business model, the multi-manager and more importantly having a flexible approach, again I went to the products that we mentioned, some of them are sub advisors, some of them are minority interest, like KBII, some of them our affiliates, by having that flexibility and access to that many types of firms, gives us the ability to be very prolific on introducing new product, which I think we have been very prolific, and a lot of these things take time to build-up track records. Sometimes you have early successes, sometimes you don't. So we think that is a good opportunity, and we're pleased when firms with the caliber of Aviva, choose us to partner with. So I think we continue to have probably more opportunities than we can take advantage of, in terms of bringing offerings to market, so we do try to stay very focused and very disciplined, but as you see we have done quite a bit just in the last few months that we've recently announced. In terms of closed-end funds, we're strong believers in the closed-end fund structure, we think the closed-end fund structure allows for the execution of investment strategies, where it doesn't have to worry about the sensitivity of outflows, right, which just lets managers and strategies operate differently than an open-end fund. Mike gave you the stats. I mean our percentage of revenue that's coming from closed-end funds, which again don't have traditional redemptions is about 17%, which is actually a relatively high percent other than a couple of other our peer companies. We love close end funds. We continue to look for opportunities, it's a very competitive market, and it tends to be very cyclical, so you have even seen it with us. I think the three we have done over the last few years. As we have the ability to either do it when the credit strategies are in favor, or when the equity strategies are in favor. Our most recent one was an MLP, so we continue to have a pipeline of ideas that we think are compelling, and continue to talk to potential underwriters for those strategies, and I think we have demonstrated to the underwriters our ability to raise assets. I mean we've had a very respectable and decent raises in all of our funds, so we would love and we look forward to continue to do more closed-end funds, but it's really driven a lot by the cyclicality, and what underwriters are looking for.

Great. Thanks. I appreciate you taking the questions.

Okay. Thank you.

(Operator Instructions). Your next question comes from the line of Mr. Michael Carrier of Bank of America Merrill Lynch. Please proceed.

Thank you, and good morning. This is Adam Beatty in for Mike. Just turning to revenues and margins. You mentioned earlier that continued revenue headwinds would probably have a similar effect on margins, absent any change in the comp structure. I just wanted to ask about what levers there might be, should you be so inclined to kind of reduce costs and maybe protect the margin a little bit, you talked about the variability of incentive compensation. Maybe that's the primary one, and also you're willingness to use those in the upcoming quarters or years, should revenue headwinds continue given your needs for growth investment and spending? Thanks.

Yes. No. As we sort of built the structure of the Company, one of the main tenements was we wanted to make sure that we had a very flexible and variable cost structure, and a lot of what we do is variable, a lot of it is outsourced, so there is a high level of variability in all aspects of our expense structure, both employment, as well as maybe to a lesser extent on the other operating side where, maybe it's not fully variable, but it's contractual. So I think Mike actually gave you a statistic on the employment expense earlier, where he basically indicated of employment expense within the range of about 50% to 60% of it is variable. And then the variable is really based upon either profits or sales, which sometimes don't move in the same direction. So there is a big percentage of those expenses that are variable, and then on the pure other operating expenses which includes more things like trading systems and research, that's a little less flexible, but another real large area of expenditures is distribution meetings, activities, T&E, due diligences, where we have a lot more flexibility in terms of making decisions. We're very focused on generating a high level of profitability, we are currently at 50% in the non-GAAP margin which we think is very strong, and we will very carefully work with the preexisting levers, which are just the pure variability of the business, and then obviously make any of the decisions we need to make, just because we feel that we have a commitment to try to maintain the highest levels of profitability that's reasonable, given whatever the time period is, if there were to be any decline in revenue. Mike, I will ask you to give some more.

Yes. I think George articulated very well, and I pointed to some the statistics of our historical incremental margin, and our 2014 incremental margin of about 70%, and depending on how some of those revenue headwinds unfold, will determine the impact on our margin, but we will carefully manage it, clearly some of the assets under management of sub-advised business are at a higher level of incremental margin that we have talked about over the years, so we will carefully focus on that. But at this stage, I don't think there's any pending change in the cost structure for sure, and we continue as George has outlined here, to focus on growth areas for the Company.

Thank you. That's very helpful. And then just a question on the blended fee rate which had some lift in the quarter. It looks like mainly from institutional and separate accounts. Were there money market assets in there that affected that? It looks like it has been trending somewhat higher, so what were the drivers and what is the outlook there, do you expect a little bit of lift to continue? Thanks.

Yes. I think I pointed out a couple of the drivers in the fee rate in the prepared remarks, and the most significant is the loss of the money market assets, and closed-end fund assets increased a bit without a launch of our closed-end fund, so I think those are the primary drivers of the fee rate.

Sounds good. Thanks for take my questions.

Thank you.

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

Thank you everyone, and I appreciate you joining us today. We certainly encourage any of you, and if we didn't get to everyone's questions, just to give us a call, and we look forward to speaking with you in the future. Thanks. Have a great day. Thank you.

That concludes today's teleconference. Thank you for participating. You may now disconnect.