Allison Dukes
Senior Managing Director and Chief Financial Officer at Invesco
Thank you, Andrew, and I also want to convey my appreciation to Marty for his leadership.
Good morning to everybody joining us today. I'm going to begin on Slide 4. Overall, investment performance improved in the second quarter, with 66% of actively managed funds in the top half of peers or beating benchmark on both a three-year and a five-year basis. This is an improvement from 64% for both timeframes in the first quarter, with excellent performance in fixed-income across nearly all capabilities and time horizons. Performance lacked benchmark in certain US Core and Growth Equity Funds. Performance in global and emerging markets equities has been a headwind, but we're encouraged to see steady and meaningful improvement emerging in this asset class.
Turning to Slide 5. AUM was $1.54 trillion at the end-of-the second quarter, which was $55 billion higher than last quarter. Technology stocks surged in the second-quarter and as a result QQQ AUM reached $200 billion, an increase of $27 billion as compared to the end-of-the first-quarter. Market increases and additional products, foreign-exchange movements and reinvested dividends combined to increase assets under management by a further $15 billion. That ends well in the money market products for $15 billion and net long-term outflows were $2 billion. Despite the net long-term outflows for the quarter, we exited the quarter with strong momentum after more than $2 billion of net inflows for the month of June. We expect that we outperformed most peers on a net flow basis, another data point, demonstrating the value of our breadth of capabilities and a difficult environment for organic asset growth.
Client demand for passive capabilities was strong and as a result, we garnered $6.4 billion of net long-term inflows in the second-quarter. Offsetting the growth in passive was $8.4 billion of net outflows in active strategies. Through growth in our key capability areas, we are recapturing client demand as it moves to favored capabilities flat this quarter by growth in ETFs and our business in Greater China. Our global ETF franchise delivered a strong quarter, growing at a 9% annualized organic growth rate with $5.7 billion of net inflows. Our top-selling ETFs included the S&P 500 Equal Weight and the QQQM, which grew to over $13 billion in AUM after posting $3.3 billion net inflows. Innovation remains a key strength in this area. At QQQM, which was launched less than three years ago, now representing the fifth largest ETF in our lineup.
Currency and commodity ETF, part of our alternative asset class experienced net outflows of $1.1 billion during the quarter. We delivered net inflows of $200 billion from retail clients in the second-quarter, an improvement from $3.7 billion in net outflows in the prior quarter. A rebound in Asia-Pacific net flows is the primary driver of growth. More specifically, we experienced strong growth in Japan for several quarters now, and in the second quarter with $54 billion of AUM. Our Henley global equity and income fund garnered $1.6 billion of net inflows from Japanese clients, making it the top-selling retail fund in Japan on both the quarterly and year-to-date basis.
Moving forward, we are well-positioned in this important market and Japanese markets are experiencing some of the most constructive conditions for risk-on assets in many years. Offsetting growth in the retail channel was $2.2 billion of net long-term outflows in the institutional channel, primarily in the Americas. The channel remains a net inflows year-to-date after $6.6 billion of net inflows in the first-quarter. Further, we have a robust and diversified Won Not Funded pipeline.
Moving to Slide 6, net long-term inflows resumed in Asia-Pacific with $1.5 billion in the second quarter due to the growth I just discussed in Japan, and a rebound in net inflows in our China joint-venture. Net outflows were modestly negative in the Americas and in EMEA. Looking at flows by asset class, fixed-income capabilities experienced net inflows -- 18th straight quarter with $1 billion. Drivers of growth this quarter included China, where we launched an institutional fixed-income product and our tax managed SMA capability, partially offset by net outflows in EMEA ETFs.
Net outflows in global and emerging market equities continue to be a headwind in the second quarter, with $3 billion of net outflows, including $1.2 billion from our emerging market funds. Encouragingly, this is similar to the net outflows experienced last quarter from emerging market, and below the redemption rates we experienced last year. We're optimistic that headwinds appear to be further diminishing in emerging markets. Alternative net outflows were $3.4 billion in the second-quarter. Public alternatives accounted for $1.9 billion, with $1.1 billion concentrated on commodity and currency ETFs, as commodities have been out-of-favor across the industry in recent quarters. Private markets net outflows were $1.5 billion, inclusive of $1 billion of net outflows in direct real-estate strategies.
As we move to Slide 7, I'd like to take a few minutes to highlight our global alternatives platform, which had $182 billion in assets under management as of June 30th. Although market conditions have made it a challenging year for organic growth in the asset class, we have high-conviction that alternatives will be one of the key pillars of our long-term success. Within alternatives, we have a diverse range of capabilities, including $72 billion of public alternatives, spanning commodity strategies, listed real-estate and hedged and macro strategy. Real-estate is the largest component of our private alternatives platform with $72 billion in direct real-estate AUM at the end of second quarter. Invesco competes throughout the capital stack investing in direct real-estate and originating real-estate debt.
Our direct real-estate business offers a range of investment styles, including Core and Core-Plus strategies, as well as funds with higher-return strategies. Our private credit platform is the second component of our private alternatives business with $38 billion in assets under management, anchored by our bank loan capability that holds US and European Securities. We have over 30 years of experiencing -- experience managing senior corporate loans, relationships with over 2,000 unique companies and more than 200 private-equity firms. More recently, we began to offer direct lending to middle-market companies as well as opportunistic investments, in special situations and distressed credit.
On Slide 8, we want to provide a deeper look at our direct real-estate portfolio, where we have 40 years of experience investing on behalf of our clients worldwide. Our direct real-estate holdings are well-diversified by product -- property type. Commercial office properties comprise about 35% of our AUM. Apartments and other residential properties account for approximately 23%. And the AUM share of industrial properties about 22% at the end of the second quarter. The final 20% of our AUM is invested in retail and specialty sectors including mixed-use developments, self-storage and medical.
Focusing on office properties specifically, since the beginning of the COVID-19 pandemic, we've been deliberately managing our exposure down, particularly in the Americas and EMEA as market dynamics have shifted with attitudes towards remote work. In the first quarter of 2020, 42% of our institutional open-end AUM and Core and Core-Plus strategies was comprised of traditional office properties. At the end of the second quarter, it was 27%, and our exposure in the Americas was reduced by about one-third. Several of our direct real estate funds use leverage but were measured in our approach and the average loan-to-value across our direct real estate funds was approximately 35% as of March 31, 2023. These figures may fluctuate over time and vary across specific funds.
We serve our clients through a range of vehicle types and manage liquidity in accordance with the established bylaws of each fund. Approximately, half of our AUM is in institutional separate accounts or closed-end funds with a predetermined life. The remainder in open-end vehicles that manage redemptions on a best effort basis. In our open-end funds, redemption requests go into a queue and are mainly met by net investors into the fund. Investors in our open-end strategies are highly sophisticated institutional investors that understand it may take several quarters to work down a redemption queue while preserving the fund performance for all investors.
For our full business cycle, we would expect funds to average a redemption queue of 5% to 6% of NAV. This can fluctuate higher in times of market volatility like we've been experiencing recently. As of the end of the second quarter, all of our open-end funds were operating according to normal redemption protocols and our real estate teams have successfully navigated market cycles for four decades. Real estate activity has been slower during the first half of 2023, and we would expect activity to be muted in the near term until market conditions improve. In the long run, we expect that investor demand for private market capabilities will grow significantly, and we're well positioned to capitalize on that growth.
Let's all move to Slide 9. Our institutional pipeline was $22 billion at quarter end, consistent with last quarter. Although we experienced net outflows in the second quarter, our institutional business remains in net inflows for the year-to-date, and we continue to win new mandates. Our pipelines have been running in the mid-$20 billion to mid-$30 billion range, dating back to late 2019.So this is on the lower end of that range. We view our pipeline as strong given the market volatility we've been experiencing and the $6.6 billion in net inflows that occurred in the first quarter. As we've noted previously, some mandates are taking longer to fund in this environment, we would estimate the funding cycle of our pipeline is running in the three to four quarter range versus two to three quarters prior to the market downturn.
Our solutions capability enabled 35% of the global institutional pipeline in second quarter and we're pleased to see this share increase from 14% last quarter. We embed solutions into our client interactions, and we have ongoing engagements about new opportunities. The pipeline reflects a diverse business mix with alternative and active equity accounting for 40% of the total associated assets.
Now turning to Slide 10. Net revenue of $1.09 billion in the second quarter was $83 million lower than the second quarter of 2022, and $15 million or 1% higher than the first quarter. The decline from the second quarter of last year was due largely to lower investment management fees, driven by asset mix favoring lower-yielding strategies. The sequential quarter increase was primarily due to higher performance fees earned on private real estate mandates. A $4 million decline in other revenues partially offset the increase in performance fees.
A shift in asset mix has had a meaningful impact on our revenue due to the uneven performance across key market indices as well as investor preferences for passive and risk-off strategies, including demand for money market products. Total average AUM for the second quarter of $1.49 trillion, were $32 billion or 2% higher than the first quarter. However, $25 billion of the increase was in QQQ average AUMs for which we do not earn management fees. A further $4 billion of the increase was in money market AUM. Meanwhile, average passive AUM ex-QQQ was up $3 billion and average active AUM was flat to last quarter. As compared to the second quarter of 2022, total average AUM increased by $38 billion or 3%. The primary driver was a $58 billion increase in average money market AUM given the risk-off investor sentiment of the past 12 months. Average assets in the QQQ were $12 billion higher than the second quarter of 2022.
Average passive AUM, excluding the queues, increased by $9 billion while average active AUM declined by 5%. We believe that a meaningful portion of the asset mix shift that has occurred is a product of market movements and risk-off sentiment, and those pressures should abate as preference for risk assets returns and conditions improve. That said, growth in investor preference for passive exposure and solutions capabilities is a long-term secular trend, and we continue to reposition our cost base to align with changes in our business mix as we build greater scale in key capability areas.
Total adjusted operating expenses in the second quarter were $789 million, $27 million higher than the second quarter of 2022, and an increase of $40 million from the prior quarter. Included in our second quarter operating expenses were $27 million of compensation expenses related to executive retirements and organizational changes. In the second quarter of 2022, expenses of this nature were not included in our non-GAAP results as they were included in transaction, integration and restructuring expenses. We recognized $13 million of such expenses in the first quarter of 2023. Also impacting second quarter compensation expense were higher incentive pay on $22 million of performance fees partially offset by a seasonal decline in payroll taxes.
As Andrew noted, we are simplifying the organization to position the firm for greater scale and profitability as we grow our revenue base. The majority of the $27 million of compensation expense I mentioned was related to executive retirements and the balance was a result of other organizational actions taken in the quarter. We will action further adjustments to our operating model over the remainder of 2023, and would expect to recognize approximately $20 million of additional costs associated with these decisions in the third quarter. The full benefits from our simplification efforts will be seen over time as we generate revenue growth and margin recovery. To this point, we have identified $50 million of annual run rate expense savings that will be realized by the beginning of 2024. Work is ongoing to quantify and action additional opportunities, and we will keep you informed on our progress.
As we've discussed, we managed variable compensation to a full-year outcome in line with company performance and competitive industry practices. Historically, our compensation to net revenue ratio has been in the 38% to 42% range, trending towards the upper end of that range and periods of revenue decline. At current AUM levels, we would expect the ratio to continue to be at or slightly above the high end of the range for 2023, when excluding the cost pertaining to executive retirements and other organizational changes.
Marketing expenses of $32 million, were $4 million higher than the prior quarter, indicative of the seasonally higher activity we typically see in second quarter. Marketing expenses were $4 million lower than the second quarter of last year as we are tightly managing discretionary spend in this revenue environment. Property, office and technology expenses were $2 million higher than the first quarter, primarily due to higher software costs, partially offset by the end of overlapping rent now that we have completed the move to our new Atlanta headquarters.
G&A expenses of $114 million increased $19 million from the prior quarter. Second quarter expenses included approximately $7 million in spending on our Alpha NextGen program, which was previously included in transaction, integration and restructuring expenses. Going forward, these costs will be reflected in our non-GAAP results. We would expect quarterly average spending on Alpha NextGen to remain at the same level for the next few quarters.
As we mentioned on our last call, we benefited from indirect tax credits in the first quarter. A reduction in credits received drove a $3 million increase in expenses quarter-over-quarter. The remaining increase in G&A expenses related to higher project spending for ongoing technology improvement initiatives as well as normal fluctuation that we can see in G&A period to period after relatively lower spending in Q1. Looking ahead, we expect G&A expenses in the third quarter to be flat to modestly lower than the second quarter.
We're balancing continued investment in our key growth areas and technology programs while diligently managing discretionary spend, and we are limiting hiring to key growth areas and critical positions. We've also been increasing our use of lower cost locations where it makes sense to do so. As an executive leadership team, we are committed to driving profitable growth in the coming quarters.
Moving to Slide 11. Adjusted operating income was $302 million in the second quarter, which included the costs related to executive retirements and other organizational changes. Adjusted operating margin was 27.7% for the second quarter. Excluding the costs related to retirement and other org changes, second quarter operating margin would have been 250 basis points higher.
Earnings per share was $0.31 in the second quarter. Excluding those same expenses related to executive retirement and organizational changes, second quarter earnings per share would have been $0.05 higher. The effective tax rate was 24.7% in the second quarter. We estimate our non-GAAP effective tax rate to be between 23% and 25% for the third quarter of 2023. The actual effective rate may vary from this estimate due to the impact of nonrecurring items on pretax income and discrete tax items.
I'll finish on Slide 12. Building balance sheet strength has been an unwavering priority, and I'm pleased to note that our cash balance increased in the second quarter to $1.01 billion, and that with $1.5 billion of outstanding debt this lowered our net debt to less than $500 million. We were able to achieve this reduction in net debt while also repurchasing $150 million of common stock in the quarter, or 9.6 million shares, equivalent to 2% of the total common shares outstanding. The share buybacks occurred at an average price of $15.65, which we viewed as a very attractive opportunity. The improvements we have made on the balance sheet in the past several years facilitated our ability to take advantage of this opportunity. Our leverage ratio, as defined under our credit facility agreement was 0.7x at the end of the second quarter modestly lower than last quarter.
We are committed to building an even stronger balance sheet, and our goal is to bring net debt excluding the preferred shares down to 0 in 2024. We have an opportunity to further address outstanding debt with the maturity of the $600 million in senior notes at the end of January. We ended the second quarter with nothing drawn on our revolving credit facility.
To conclude the resiliency of our firm's net flows performance in a difficult market for organic growth is evident again this quarter, and I'm pleased with the progress we're making to simplify the organization and build a stronger balance sheet while continuing to invest in key capability areas. As a firm, we're committed to driving profitable growth and a high level of financial performance, and we're confident that we have the right talent, mindset and strategic positioning to do so.
And with that, I'll ask the operator to open up the line to Q&A.
