Franklin Resources Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 28, 2023

There are 13 speakers on the call.

Operator

Welcome to Franklin Resources Earnings Conference Call for the Quarter Ended June 30, 2023. Hello, my name is Joanna, and I will be your call operator today. As a reminder, this conference is being recorded. And at this time, all participants are in a listen only mode. I would now like to turn the conference over to your host, Celine Oh, Head of Investor Relations for Franklin Resources.

Operator

You may begin.

Speaker 1

Good morning, and thank you for joining us today to discuss our quarterly results. Statements made on this conference call regarding Franklin Resources, Inc, which are not historical facts, are forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward looking statements involve a number of known and unknown risks, uncertainties and other important factors That could cause actual results to differ materially from any future results expressed or implied by such forward looking statements. These and other risks, uncertainties and other important factors are just described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including in the Risk Factors and the MD and A sections of Franklin's most recent Form 10 ks and 10 Q filings. Now I'd like to turn the call over to Jenny Johnson, our President and Chief Executive Officer.

Speaker 2

Thank you, Celine. Hello, everyone, And thank you for joining us today to discuss Franklin Templeton's results for the 3rd fiscal quarter of 2023. As usual, I'm joined by Matt Nichols, our CFO and COO and Adam Spector, our Head of Global Distribution. Over the past several years, we have been intentional in building a diversified company that offers a broad range of investment expertise And capabilities across asset classes, investment vehicles and geographies to benefit a broad range of clients through various Market conditions and cycles. We believe our corporate model of preserving the investment autonomy Of each of our specialist investment managers, combined with the resources of a global firm, Meets the demands of our diverse client base and produces strong long term results.

Speaker 2

This quarter, long term net flows turned positive. Investment performance remains strong And adjusted operating income improved by 8%. Financial markets in general stage rebounds in the first half of the calendar year. The S and P 500's Index's concentration in 5 companies is at its most extreme level in more than 30 years. A challenge for those seeking to outperform the index while managing for concentration risk in their equity portfolios, But also an opportunity for skilled and disciplined active managers with a long term horizon.

Speaker 2

Client focus Has always been a hallmark of Franklin Templeton, and we've been actively engaging with our clients to assist them in navigating this complex environment. As our industry and client preferences continue to evolve, there is strong demand for asset managers to have a full range of investment options that span geographical regions, both in public and private market strategies. We generated interest in our alternative and multi asset strategies in particular, which both saw positive net flows during the quarter. In addition, we experienced strong flows in ETF, SMAs and the high net worth channel. And flow trends continued to improve across all geographies benefiting from our regional sales model and strategy.

Speaker 2

Our EMEA and Asia Pacific regions both reported positive long term net flows. That's the 2nd consecutive quarter of net inflows For Asia Pacific, while we're always focused on organic priorities, we have previously stated our interest in distribution led Strategic transactions that would further diversify our business and accelerate growth in key markets. With the vision of offering more choice to more clients In important sectors, we were pleased to announce the establishment of a long term partnership with the Power Corporation of Canada and Great West Lifeco this quarter. As part of the relationship, we will acquire Putnam Investments, which managed $136,000,000,000 in AUM As of April 30, 2023, from Great West for approximately 9.25 $1,000,000 primarily funded with equity. Great West will make an initial incremental asset allocation of $25,000,000,000 To our specialist investment managers within 12 months of closing, with that amount expected to increase over the next several years.

Speaker 2

Great West will also become a long term shareholder in Franklin Resources. And of the equity issued to Great West, Shares representing 4.9 percent of our common stock are subject to a 5 year lockup. This is a compelling transaction for both firms and we're looking forward to actively partnering to develop additional opportunities That will be realized over time. The agreement aligns with our focus to further grow insurance client assets And expands the existing relationship between Franklin Templeton and the Power Group of Companies in the key areas of retirement, Asset Management and Wealth Management. The transaction will also enable us to further increase our investment in retirement and insurance To better serve each and every client in these important segments, our clients will benefit From expanded and complementary investment capabilities across key asset classes with strong long term track records.

Speaker 2

Specifically, the acquisition of Putnam will increase Franklin Templeton's defined contribution AUM To almost $100,000,000,000 As a reminder, the acquisition of Putnam is expected to be modestly accretive to run rate Adjusted EPS by the end of the 1st year after closing, adding approximately 150 $1,000,000 of run rate adjusted operating income in the 1st year post closing inclusive The acquisition remains on track to close in the 4th calendar quarter of 2023 subject to customary closing conditions. Turning now to our specific numbers for the quarter, Starting first with assets under management and flows. Ending AUM increased to $1,430,000,000,000 Primarily due to market appreciation and we shifted into positive long term net flows of 200,000,000 Inclusive of reinvested distributions, our long term net flows continue to benefit from a diversified mix of assets in the quarter led by record net inflows of $4,000,000,000 into alternative strategies. Our 3 largest alternative managers, Benefit Street Partners, Clarion Partners and Lexington Partners Generated a combined total of almost $5,000,000,000 in net inflows. This included raising over $1,000,000,000 in secondary Private Equity in the Wealth Management channel under the alternatives by Franklin Templeton brand.

Speaker 2

Today, alternative assets are $257,000,000,000 or 18% of our total AUM And contribute more significantly to our financial results. In terms of other areas of activity in the quarter, Our multi asset strategy generated another quarter of positive net flows with $2,300,000,000 Our solutions team Has been gaining success with large institutions building customized solutions across our broad array of investment strategies. Equity net outflows improved to $3,000,000,000 this quarter, including the funding of a previously disclosed $3,200,000,000 institutional mandate. While active equities continued to be impacted by the risk off environment, We saw positive net flows into international, large cap core, emerging markets, all cap value And Small Mid Cap Equity Strategies. Fixed income net outflows were $3,100,000,000 Despite market uncertainty, We experienced increasing demand for fixed income, and we benefited from having a broad range of strategies With non correlated investment philosophies, client interest continued with net inflows into multi sector, core bond, Enhance liquidity and tip strategies.

Speaker 2

Our regionally focused sales model and strategy Resulted in improving flow trends across all of our geographies compared to the prior quarter. As mentioned earlier, the EMEA and Asia Pacific regions generated positive long term net flows. From a vehicle perspective, ETFs generated net inflows of $1,100,000,000 Representing the 3rd consecutive quarter of net flows of approximately $1,000,000,000 and AUM totaled $16,200,000,000 at quarter end. In the quarter, we also launched 2 thematic ETFs In Europe, in both future of food and health and wellness, two areas where we expect to see strong client interest. Separately managed account, AUM, ended the quarter at $116,000,000,000 and generated positive net flows.

Speaker 2

We continue to expand our SMA offerings in important growth categories and new market segments to provide clients choice And how they access our investment expertise across the breadth of our products. This quarter, We had important launches focused on customization such as tax managed overlay and SMA key flagship strategies, Including the Franklin Income Fund. Canvas, our custom indexing solution platform, continued its trend of net inflows In each quarter since the platform launched in September 2019 and its AUM Has doubled to $4,500,000,000 since the announcement of the acquisition. This past quarter, Canvas generated net inflows of approximately $300,000,000 and continues to have a robust pipeline. Canvas allows financial advisors to build and manage custom indexes in SMAs that are individually tailored To the client specific needs, preferences and objectives, we believe custom indexing represents the next progression of direct indexing and ETFs and is a significant long term growth opportunity.

Speaker 2

Turning now to investment performance, Which we're pleased to say remain strong. 63%, 53%, 67% 63% of our strategy composite AUM outperformed their respective benchmarks in the 1, 3, 5 10 year periods, respectively. For mutual fund investment performance, 44%, 58%, 66% and 51% of our AUM outperformed their peers on a 1, 3, 5 10 year basis. This represents improvement in the 3 year And 5 year periods from the prior quarter due to strengthened performance in equity and certain fixed income strategies. The 1 year decline was primarily due to one of the largest funds managed for income, which was overweight utilities and financials, Which generate higher yield and underweight technology compared to the S and P 500.

Speaker 2

Touching briefly on our financial results, Ending AUM increased by 0.7 percent to $1,430,000,000,000 as of June 30 From the prior quarter reflecting market appreciation and positive net flows. Average AUM was flat from the prior quarter at 1.4 $2,000,000,000,000 While our effective fee rate remains stable, adjusted operating revenue increased by 3% To $1,560,000,000 Adjusted operating income increased by 8.3% To $476,800,000 from the prior quarter. Adjusted operating margin was 30.5% Compared to 28.9 percent in the prior quarter. We continue to maintain a strong balance sheet With total cash and investments of $6,900,000,000 as of June 30, 2023. To wrap up, we have worked through another quarter of complicated markets and our progress and success Would not be possible if it weren't for our dedicated employees around the world.

Speaker 2

I would like to thank them for their many contributions And for their unwavering client focus. Now let's turn to your questions. Operator?

Operator

The confirmation tone will indicate your line is in the question We request that you limit to one initial question and one follow-up. First question comes from Alex Blostein at Goldman Sachs. Please go ahead.

Speaker 3

Hi, good morning. Thanks for the question. Maybe we could start with some of the trends you're seeing in the alternative asset management space. First, I was hoping we could get a little bit more color on how much capital Lexington raised in the second quarter In their flagship fund and as you highlighted in the deck, continuing to fund raise here. So how large do you think the size could ultimately of that fund be?

Speaker 3

And then when you expand a little bit broader into private alts generally, what else is in the pipeline that you expect to come in over the next 6 to 12 months?

Speaker 2

So I think we publicly disclosed that Lexington's raised $18,200,000,000 so far On our latest fund, I think in

Speaker 4

the quarter it was about it was a

Speaker 2

little over $3,000,000,000 maybe $3,400,000,000 And of that, I think what we're incredibly proud of is the fact that we raised a little over $1,000,000,000 in the wealth Channel is first time fund. I think the expectation was that if we raised $500,000,000 that would be pretty good for a first time fund. And we've talked on these calls before about how complicated it is to raise alternatives in the Well channel because it requires not only retraining of your own sales team, but actually training of the financial advisors. And so we put a lot of effort over the last 18 months. We've built out a 40 person, Alt's wealth specialist team.

Speaker 2

We've used our academy to train our own internal sales folks, as well as helping to train the financial advisors. So that was a big part of it. And I think the fund can raise up to $20,000,000,000 and I think it's quite possible that, that will happen.

Speaker 3

Great. And then just as far as the pipeline of other things there in Hopper as you look out over the next 6 to 12 months?

Speaker 2

Well, specifically in the off space, I mean, so private credit, we still think is just a great opportunity. Our view is that banks are going to even lend less than they've been lending. And it is definitely from Point capital has been slowed down by the fact that M and A has slowed down. Just read an article yesterday where somebody was talking about they are seeing M and A pickup. That will make a difference.

Speaker 2

We're thrilled because having BSP at $78,000,000,000 we cover both the U. S. And Europe. But in addition to that, one of the things that's actually really important in these times is having the knowledge and expertise In special situations where you could work out deals. So if you have an underlying credit that is struggling because of Maybe they can't cover their rates, being able to restructure it is really important and BSP has that expertise internally.

Speaker 2

So, the biggest issue there has been around deploying, but they're seeing continue to see very good deals. They're seeing their underlying companies be very strong. And where there are some stresses, they've been able to handle those workouts. And again, we think as M and A activity picks back up, You're going to be they're going to be able to deploy more capital. They've said they're seeing the best deals since they've seen since the global financial crisis.

Speaker 2

And then in the case of real estate with Clarion, probably the biggest issue Is this price discovery? Now I think everybody knows the office story. Unfortunately, Clarion has just about 10% exposure to office, so that's not been a big exposure for them. Their focus has been on industrial space, data centers and things like that, which with AI, frankly, will only get bigger and more demand, But also on multifamily, and I think the story about the underbuilding of multifamily is important. But the issue has been a little bit around the bid and ask on just the sellers being willing to accept lower prices and the buyers being willing So as that as we see that smooth out, I think you'll see more movement in the real estate space.

Speaker 2

They just on the redemption queue, just a reminder, their clients are mostly And so they don't have the kind of requirement to do redemptions, because the institutions don't want any kind of fire And so they have more flexibility on their redemption queues, which equates to less than, I think, 2% of NAV. Adam, it looks like you want to add something there?

Speaker 4

Sure. I was going to say a couple of things, Alex. One, I I think we see strong fundraising in the traditional markets that they've been in, but with stronger public markets, the denominator effect is less of an issue. So We're feeling really good about the raise for all of our alternatives firms in the private markets. I would also say that in the wealth channel, it's not just The Lexington flagship we're offering, we have Clarion products in there like CP Reef and Opportunity Zone that are going well, launching, BDCs and interval funds For VSP, our venture funds and the wealth channel, so feeling good about that.

Speaker 4

And then the Alcentra acquisition has been very positive for us and having the ability to launch European managed product in Europe through our distribution force there, we think will be a very positive add as well.

Speaker 5

And then one other data point, Alex. In terms of dry powder, BSP has in excess of $4,000,000,000 And over the next 12 months, they expect to raise several $1,000,000,000 more.

Speaker 3

Got it. Super helpful. Just a quick follow-up, staying on the alts for a second, and it's a little bit of nuance question. But when we look at the roll forward in the AUM T ball, It looks like the alts had a negative mark. I'm a little surprised just given that the mark to market dynamics generally have been positive in other places.

Speaker 3

Is it a lag or is there something idiosyncratic that drove the negative mark to market in the alt bucket? Thanks.

Speaker 2

I think we had positive marks in BSP and Lexington and it was slightly negative. It might have been realizations in real estate. So I'm not sure that it may have been redemptions or something. I'm not sure what you were referring to, Alex.

Speaker 3

Okay. We can circle back. All right. It's probably real estate. All right.

Speaker 3

I appreciate it. Thanks.

Operator

Thank you. Next question comes from Glenn Schorr of Evercore. Please go ahead.

Speaker 6

Thanks very much. So I wanted to drill a little further in Putnam. It's interesting because after Benefit Street in Lexington, I Our minds were all focused on the old world. And so I like the partnership you formed with them. I like the $25,000,000,000 they're investing with you, the 5 year lockup on

Speaker 5

the stock.

Speaker 6

I'm curious on the insurance and the retirement channels, were they growing there? Which Strategies and then more importantly with your broad diversified offerings, what do you expect that you can actually sell into that channel to like lever that distribution?

Speaker 4

Sure. It's Adam here. So a couple of things. I would say, 1, with Putnam, we get tremendous investment performance. I think They're the only firm that had their fund family in the top 10 for like the 3 to 5 in the 10 year period.

Speaker 4

So good investment performance They bring a few investment capabilities that we did not have before. Target dates is a good example where they have $6,500,000,000 And given that about a third of the assets in DC Go into things like that, we're feeling that that gives us a real leg up. Stable value and ultra short are 2 other areas where they're quite strong. They have been very strong in both insurance and the DCIO market, and our plan there is to really integrate those 2 distribution teams So that we will be stronger in each and every client that we partner with. We have a broad range of clients in the insurance and DCIO space, And we think together the 2 teams will be able to serve all of them in a much more effective way.

Speaker 2

And I just add, I mean, I'm looking at the Morningstar flows. I think it's something like 4 of the top 10 Slowing categories are target gate funds. And so having a good performing target gate with really what Putnam brings is the expertise You know, selling into the retirement channel that we're really excited. We think that that will benefit all the retirement platforms that we do business with. And then as Adam mentioned, just having 2 great products with a stable value and the target date will be nice to add to our suite.

Speaker 5

And then, Glenn, the only thing I'd add on Putnam is just to make the point that obviously it's been a month ago, actually over a month now since we announced Transaction, their AUM is up slightly by 2% to 3% based on the market Flows have been stable, the performance is still as strong as Adam just outlined. We've got team agreements in place with all the key Investors and our planning process around the acquisition and what we expect to get out of the acquisition from both the financial And the strategic perspective as Adam and Jenny just mentioned, we feel like we're very much on track as we communicated at the time of the acquisition announcement.

Speaker 6

All right. Thank you for all that.

Speaker 4

Thank you.

Operator

Thank you. The next question comes from Michael Cyprys at Morgan Stanley. Please go ahead.

Speaker 7

Hey, good morning. Thanks for taking the question. Just wanted to ask about capital deployment. The cash balance continues to rise here. Cash investment is $6,900,000,000 nearly 7,000,000,000 Just curious how you're thinking about putting that to work from here.

Speaker 7

It sounds like a little bit of debt pay downs, buybacks, limited to offset share dilution. It seems like meaningful capital put to work at M and A. So just curious how you're thinking about that opportunity set as you look out from

Speaker 2

here? Yes.

Speaker 5

So I think our capital management strategy is going to remain consistent with what we communicated in the past. Number 1 is maintaining The trajectory of our dividend that we've had over many, many years. Number 2 is organic growth opportunities in the business. Number 3, as you alluded to, it's hedging our employee grants. It might look like we're a little bit behind on that front in the context of Shares we've repurchased to date, but we will catch up on that this quarter and make sure that we Very much in line with that communication that we've been consistent about.

Speaker 5

We obviously have debt that we need to service. We paid down $300,000,000 of debt in July as announced, and that was the term loan We had in place and we paid that off. We're saving about $4,500,000 by doing that, but we're retaining the exact same amount of liquidity by replacing Yes, dollars 300,000,000 term loan with a larger revolver. So we've taken out 500,000,000 Dollar revolving credit facility and the $300,000,000 term loan, which was $800,000,000 in total, paid off the $300,000,000 term loan And replaced it with 1 single $800,000,000 5 year revolving credit. So we've actually enhanced Our liquidity and financial flexibility by doing that and saved $4,000,000 to $5,000,000 in the process.

Speaker 5

And then opportunistic share repurchase On top of that, in M and A, I think Jenny has mentioned several times, we're very interested in the infrastructure space around M and A And the alternative asset space in particular. And in terms of the opportunistic share repurchase, the way I would Describe that as a consequence of how we decided to fund a Partnam acquisition, we're issuing 33.3 1,000,000 shares when the closing date occurs and we expect to start repurchasing those shares In a methodical manner, all else being equal in fiscal 2024, obviously after the date that we've Close the transaction. So we certainly expect to pick up share repurchase as a consequence of doing that transaction.

Speaker 7

Great. Thanks. Just a quick follow-up question, more broadly AI, generative AI getting a lot more attention these days. So just curious how you're thinking about The potential and opportunity from AI, is this a revenue or an expense benefit? What sort of impact do you think this could have on the competitive landscape?

Speaker 7

Maybe you could talk a little bit about how you're experimenting to what extent with that today?

Speaker 2

Yes. So I mean, fortunately, I think this is probably one of the benefits of being headquartered in Silicon Valley, we've been actually doing some work in AI for the last 4 years. If you probably have heard about our gold optimization engine tool that's So all built on AI. And we're doing what others are doing around you use AI Early warning systems, so things like risk management, business intelligence, intelligent automation. So We have a proof of concept or a pilot going on where we have our sort of like a portfolio research assistant.

Speaker 2

So it's summarizing 10ks and annual reports For our PM teams, one of the most important things you have to do is to build a fence around your data so that you're not Training the world on your own data. And so we've had that undergoing. We're working on things like conversational AI to for our help desk, I'm hoping to respond within 10 seconds. The we've got a pilot going on to generate A draft fun commentary. Again, it's all training the models to be able to see how good generating marketing material.

Speaker 2

So we're and we're Using both Azure and Amazon because we're not quite sure what's the best for us from the language model. So The message is we've got quite a bit going on here. We've been early in it because the Go product sort of got us in there. And we think it will be both I think initially it's more of an expense benefit An efficiency benefit, but you hope that it makes your portfolio managers and your research assistants more efficient. And then things like Go are revenue generating tools.

Speaker 4

Great. Thank you.

Operator

Thank you. The next question comes from Patrick Davitt at Autonomous Research. Please go ahead.

Speaker 8

Hi, good morning everyone.

Speaker 9

Sorry if I missed this, but is

Speaker 8

there any change to your expectations for expenses this year? And do you have any early thoughts on how to think about the path into fiscal 2024 as we enter the Q4? Thank you.

Speaker 5

Yes, thank you. So I'll go through what we expect in the Q4 in terms of the guide and then that will Lead to what the full year guide is essentially. So Firstly, in terms of our EFR rate, we expect it to remain around 39 basis points. I I think it might be slightly higher than 39 basis points in the 4th quarter, but let's call it around 39 basis points. In terms of comp and benefits, again, this is all 4th quarter.

Speaker 5

For modeling purposes, I would assume $50,000,000 in performance fees As we've described in the past, that would lead us to approximately $740,000,000 in comp and benefits. IS and T, we put that similar to what we described last quarter at 120, very consistent. Occupancy in the mid to high 50s, we guided high 50s. Last quarter, we came in a little bit lower than that. We expect to be roughly the same again.

Speaker 5

And then G and A, we expect to be in the mid-140s inclusive of Continued normalization of T and E for the quarter. In terms of what that means for the year, Yes. Due to higher assets under management, better performance, increased fundraising related to Increased fundraising related compensation and expenses, our overall Guide increases slightly to just over €4,000,000,000 It's very similar to what I described last time, but maybe slightly Higher than that, certainly on the high end of €4,080,000,000 or something like that €4,090,000,000 But again, that's all That's assuming the market stays where it is today and it's assuming those that excluding performance fees that is as I described. And then in terms of the margin though, and I think you've asked about this several times in the past here, it's obviously difficult to guide On the margin, because that means we're guiding our revenue essentially, but all else remaining equal, we'd expect our operating margin to be stable In the 30% area in the next quarter.

Speaker 8

Thank you. Any thoughts on next year or is it still too early?

Speaker 5

It's too early. The only thing I'd say, it's an interesting question obviously because we're going to be in the process of implementing Or integrating the Partnam acquisition. I think as we've dug further into this post announcement and as we get into the Integration work and execution work that we're quite familiar with by now, I think we can say 2 things. 1, You can expect from us continued meaningful expense discipline going into 2024. And I think you can see from us Potentially more potential with the acquisition of Parthen as we integrate because we found other areas within Frank and Templeton that we can be more efficient And as a consequence of the transaction, we've highlighted in the past that one of the benefits of M and A is we always focus on the growth areas.

Speaker 5

That's what drives our acquisitions, but the second sort of derivative of the transactions that we've chosen to pursue, it has helped us on the expense and efficiency So to re examine how we do things and re examine how we can be better and do things better. And as a result of that, I think you'll find that Our expense discipline in 2024 will be will continue and perhaps outperform what we've communicated in terms of what we get out of the Putnam acquisition.

Speaker 8

And one quick housekeeping. Could you give us the exact amount of the catch up fees and then how much offsetting placement fee was in expenses? Thank you.

Speaker 5

Yes. The way, Patrick, I would look at that for this quarter is that essentially an operating income 0. So in other words, the revenue associated with the catch up is Keep the same as the expense. In fact, the expense might have been slightly higher like $1,000,000 or something like that. So it's an operating income neutral.

Speaker 5

And then of course going into the

Speaker 8

So we can kind of get to the run rate of management fees?

Speaker 5

That's $33,000,000 something like that. Okay. Thank you. In the low to mid-30s.

Speaker 8

Got it. Thanks a lot.

Speaker 5

Thank you.

Operator

Thank you. The next question comes from Craig Siegenthaler from BofA. Please go ahead.

Speaker 10

Thanks. Good morning. On the Putnam transaction, I know it's going to bring $25,000,000,000 of flows in 12 months after closing, But I want to come back to what could happen from some of the cost cuts because you're cutting a lot of costs out of the company, I think 150,000,000 So maybe I'll provide some perspective on the potential for merger related dis synergies or outflows on Putnam's $140,000,000,000 AUM base.

Speaker 5

Yes. So the $150,000,000 guide that we gave as we announced the transaction, that is inclusive of Some modest attrition across the company. And so that's how we've got it. I think We again have a history. We don't want to jinx ourselves with this of course, but we're extremely focused on asset retention As well as the potential growth, the overlap is relatively modest in this transaction given The complementary investment strategies that Adam outlined at the beginning and therefore we expect Modest attrition from this transaction across the board, which and frankly, We think that any attrition that we get above what we had expected would be more than offset by Other potential operating income and operating expense reductions in the transaction.

Speaker 5

So again, we stay very firm on the $150,000,000 and we think there's potential to be higher than that.

Speaker 2

Craig, the other thing I

Speaker 4

would add is that given the number of transaction we've done and the continuity of portfolio management team Post transaction, we're getting very good reactions from clients that they feel that their investment teams will be stable and they don't make I intend to make any shift, which is very positive.

Speaker 5

I would just also add thank you, Adam. I would just also add that I would never understate ever the complexity of integration and implementation and working across The firm involving a new acquisition, but the $150,000,000 is 30% margin. So it's not a hugely aggressive margin objective from that business. We should be able to get to that And exceed it over time. But our guide remember is on the 1st year, but after that 1st year all else remaining equal, you certainly see Are there opportunities to go beyond that?

Speaker 10

Thank you, Matthew and Adam. One Follow-up on the SMA business. You got a great business here, it's inflowing. I think you highlighted that Franklin Income is one of the flagships that's driving this And also direct indexing, but what are some of the other funds that are driving flows into the SMA business? And And when you think when you look at sales, what does the mix look like across channel?

Speaker 10

Is it heavily wirehouse? Is it heavily RAA? I'm curious to

Speaker 2

see what it looks like.

Speaker 4

Sure. I think the way to think about that is, 1, look at the legacy business and 2, look at the projection of the business going forward. So if we look at the legacy of the business, it really was strongest at the Old Legg Mason, which means that A significant portion of the assets are with Western and ClearBridge, and those firms tended to be stronger in the wires. If you look at the trajectory of the business, it's really adding new products like our income fund to the SMA platform. We're already now since recently launching it on 6 broker dealers and a number of RIAs there.

Speaker 4

So that's where really where a lot of the momentum is. The other place I would say that we have huge opportunity is in our in the SMA businesses in munis, where we've seen about a 30% Increasing our AUM there year over year and I think that's a place where we can really grow as well. So again, the strategy is to make sure that we give our clients vehicles of choice. So for all of our key strategies, we'd like to be able to offer them In both the fund format and an SMA format and that's what we're building out right now.

Speaker 11

Thank you.

Operator

Thank you. Next question comes from Brennan Hawken at UBS. Please go ahead.

Speaker 11

Good morning. Thanks for taking my questions. So just wanted to follow-up There on the catch up fees in Lexington. Number 1, this was you're still raising it sounds like. So was this a preliminary close?

Speaker 11

And do you expect there'll be further catch up fees at the actual formal close? And I I was just running the math on the 33 and that made me a little confused about your prior comment on Fees being expected to be flat quarter over quarter, do you think there'll be more catch up fees in the coming quarter? Because It seems as though the catch up maybe contributed about a basis point this quarter. So I wasn't quite sure about that.

Speaker 5

You could clarify the color. Yes. Thanks, Brian. So firstly, I said 33, but I was just using that as a midpoint. That's not the exact number.

Speaker 5

We're not going to guide You know where our catch up fees are going, but I'll just say a couple of things. So the In terms of the fundraise, I think Jenny mentioned this at the beginning, where a couple of things we're allowed to say around the fundraise. Number 1, we're ahead of target. Number 2, we're at $18,200,000,000 right now. That was what was announced filed recently.

Speaker 5

Number 3, we're still fundraising, which means to answer your question, we may have another Closing in the next quarter. We don't know exactly, but I think it's likely we have some form of Closing in that quarter and that could have a positive impact on our effective fee rate, but even without, so to speak clear about this, I think this is Question that Patrick was getting at earlier. I think even without the catch up fee in the 4th quarter, Our EFR, we would expect it to be around 39 basis points. So we're not our 39 basis points is not reliant upon the catch up That's I think your I think that's the question you were trying to get at, right?

Speaker 11

Yes, yes, yes. Thank you. Appreciate that. Just want to try to understand some of those mechanics. So thanks for laying that out for me.

Speaker 5

And then obviously, after the When we have this moment in time when we do a closing and we have a catch up fee and then we have expenses associated With raising the funds and after that of course, we don't have those one off expenses, but we do have the normalized Alternative asset higher fee rate against the assets that we're raising On the entire AUM, which is, as you know, around the 1 basis of 1% area. So and that's the Aspect of the fees that I would focus on that helps out EFR on the Yes, long term. That's what helps us remain around that 39 basis points.

Speaker 11

Oh, for sure. Yes, yes, yes. This is Sort of noise and whatnot. I just wanted to understand it for modeling purposes. So thank you for that.

Speaker 11

You guys flagged in your A comment document, I believe is what it's referred to, that there was some improving performance In taxable fixed income strategies, which led to the lift in the investment performance versus benchmark. So just wanted to confirm that's Western and whether or not you're seeing any impact From this improving performance on either RFP activity or client dialogue and what drove the reversal? Thank you.

Speaker 2

Yes. So significantly improved performance at Western in core, core plus and macro ops. I mean, I'm trying to run with the numbers exactly, but it's 1st quartile year to date. And what we've seen is Significantly improved net flows to the point where I thought we might be positive this month at I'm not sure it will be quite, but it's it feels like they've kind of turned the corner there. I want to address One other just performance because on the 1 year mutual fund ETF performance at 44%, I think it's really important To understand how significant the Franklin Income Fund can be in swinging this.

Speaker 2

So that's 14% of the mutual fund ETF Number. The Franklin Income Fund is in there's no such category for multi asset income in the retail There is an institutional category and if you were to compare it to the institutional category, they would be in the 11th percentile. The peer average yield in that category is about 4.25 versus the income at 5.75%. The pure average in the retail category yields 1.84% versus 5.75%. So if there were an income category at Morningstar, it would be in the top quartile and that would swing us up to 58% And because it's so significant, I just feel like it's important to understand there just isn't a category.

Speaker 2

Unfortunately, the $1,500,000,000 in flows that we've had, Net flows in the Franklin income proves that the income strategy is as relevant today as when my grandfather started it 70 plus years ago, Despite the fact that there are no true peers in that space.

Speaker 11

Thank you for that color.

Speaker 4

And to that, I just might add since your question was about RFPs and pipeline and such. What we're really seeing is if you think about a sales pipeline, a Significant buildup in late stage opportunities, but what we're not seeing is the conversion to that as quickly as we would expect to 1 but not funded. And that is really because we believe a number of institutions are waiting for the interest rate cycle to settle in. Are we going to have one more hike? What will happen to inflation?

Speaker 4

So that last stage of deployment and final contracting is a little slower, but we do see a bit of a bulge building up in those late stage opportunities.

Speaker 11

Got it. Thanks very much.

Operator

Thank you. Next question comes from Ken Worthington from JPMorgan. Please go ahead.

Speaker 4

Hi, good morning. When commenting on the improvements in multi asset product flows, you mentioned solutions as a contributor. To what extent are alternative investment capabilities important to growing Franklin Solutions AUM And to what extent are your existing alternative products already integrated with your public market capabilities within the solutions ecosystem?

Speaker 2

So I would say that that depends more on the client. So for example, FCIS has won mandate in model portfolios in retail channel, and very few of those have so far included Alternatives in those model portfolios. On the other hand, they've also won insurance mandates that have some combination of alternatives in there. So I think that's more a I think that question, it depends more on the channel that the FTIS Franklin Templeton and Solutions, Investor Solutions Group is serving then how that group performs.

Speaker 4

The other thing, Jenny, that I would add to that is that we can really build traditional only A mix or what we're starting to do now is to build alts only solutions as well, where if a client wants to have a single source for private equity, Venture, private debt, real estate, I think we're one of the few firms that can build those for clients.

Speaker 2

And actually one thing is we also have been working with some retirement platforms who are interested in trying to figure out how to bring alternatives Retirement and building sleeves to go into the same managed accounts and some models in there. So we think that's a real opportunity.

Speaker 4

Okay. So solutions really isn't about combining these different capabilities together and providing a solution That results from the combination, it's really just solutions in single silos marketed out.

Speaker 2

No, I don't so they can be no, because they it might be that somebody wants an income solution model portfolio, Right. Or LDI type in. So they will go in depending on what the client desired outcome is, And they will use multiple of our managers to bring that ultimate solution to the client. Okay. Thank you.

Speaker 2

It's like in Stargate, it's a real OCIO type situation. They even do they have a team that researches outside managers. But most of their solutions include multiple of our SIEMs.

Speaker 4

Got it. Thank you.

Operator

Thank you. Next question comes from Dan Fannon of Jefferies. Please go ahead.

Speaker 9

Thanks. Good morning. I wanted to clarify on Performance fees, what the funds or affiliates that were the contributors and I know I hear the guidance and you've been consistent with that, but you've also Consistently been above that in terms of the results. So as you think about where high watermarks sit and we think about 4th quarter And even potentially into December, which has some other crystallizations, how we should think about maybe where performance sits for that performance eligible AUM?

Speaker 5

Yes. So this quarter, it was and it has been for the last few. I mean, even though we received performance fees from Several of our specialist investment managers in particular on the alternative side, there has been a meaningful portion of it Driven by Clarion, Specialist Investment Manager on the Real Estate side. And 80% of the performance fees is driven by multi year performance thresholds being hit by clients that invested 5 years ago, Where a 5 year performance threshold has been hit. We expect going into next Quarter performance fees, I think we continue to guide at 50 because it's so hard to predict this with any form of accuracy.

Speaker 5

But we've guided between $50,000,000 $60,000,000 for the quarter. As you mentioned going into For our 1st fiscal quarter, which is the last Calendar quarter, the 4th calendar quarter, that's sort of a little bit more widespread across the specialist investment managers And we may experience a little bit more performance fees then, but we'll provide more guidance on that next quarter when we get to that point.

Speaker 9

Okay. Thanks. That's helpful. And then, Adam, just a broader question on distribution. Given all of the acquisitions over the last several years, I I was hoping you could update us on how much of the AUM is actually utilizing the centralized distribution at this point and where you are in terms of onboarding, Whether it's some of the specialist managers or acquisitions that are more recent in terms of closing, in terms of fully onto that platform I'm thinking about the momentum and where you are in that process.

Speaker 4

Sure. I think, let me go back to where the starting point was, which was that the central distribution team Legacy Franklin Templeton. On the Legg Mason side, again, it was more the Sims handled a large portion of their institutional Asset Management, especially in the U. S. What we've seen over the last 2 years is a gradual movement towards More coordinated global efforts.

Speaker 4

I would say that movement is quicker at a smaller firm like a Martin Currie, Where the benefits of centralized resources are much more significant. If you look at the other end of the spectrum at a Western that has a A massively well built out global distribution capability of their own. It's really more episodic where the central distribution team Is raising assets for them. So it does depend on the size, but the movement Has been to find more places to cooperate, and we're also seeing a lot of benefits in the alternative space Where the generalist salespeople are able to make introductions, that then the alternative firms can close on their own.

Speaker 9

Is there any way to put numbers around that in terms of like what still is held at the affiliate manager level versus

Speaker 4

I couldn't tell you I shy away from that because what we're trying to build is a culture of cooperation where these teams work together And numbers imply that one team did it or the other team did it and what we're really trying to move towards is where it's a collaborative effort.

Speaker 3

Okay. Thank you.

Operator

Thank you. The next question comes from Brian Bedell at Deutsche Bank. Please go ahead.

Speaker 12

Great. Thanks. Good morning, everyone. I just want to hop back on the Franklin Income Fund for one second. I think that's in that Moderate allocation Morningstar category, but and I agree with what you're saying about the performance and the sort of mischaracterization of it.

Speaker 12

But Do financial intermediaries use that Morningstar or have you seen them use that Morningstar Categorization in terms of, I guess, just recommending the fund, because I do see it still in outflows despite the improved performance.

Speaker 2

Well, I actually think it's been net flows. So that's why I said there was about $1,500,000,000 in net flows. Look, it is a frustration during when interest rates were 0, he was in the 80% equity category because, of course, he Look for dividend being yielding equity because you couldn't get anything in income. And then as he's as you've been able You don't earn money in fixed income, he shifted, so now he's in the 50% to 70%. So yes, honestly, it's a discussion I Personally, I have with Morningstar on it, and they're just the problem is there's no real competitors in the Well channel that so they can't build a big enough peer group.

Speaker 2

And so we often point to the institutional one and his outperformance there. And so to answer your question, yes, I'm sure there are some situations where he gets screened out. On the other hand, he has a tremendous he the team has tremendous Following and loyalty. And one of the challenges has been as the world went to fee based, It's harder for some financial advisers to buy and hold the income fund for 10 years like they used to do. And that's why we've really pushed to get it on the SMA platform Because they can hold it in on an SMA platform, and they do.

Speaker 2

They love it. They'll put a client in there and sit through the So it's a message that we continue to try to get the story out. And I just think that because it's 14%, it was important that people understand how much it will swing our 1 year category or any of the categories it can. But he's going to manage it. The team is going to manage it for yield, which is what the clients expect.

Operator

Thank you. This concludes today's Q and A session. I would now like to hand the call back over to Trinity Johnson, Franklin's President and CEO, for final comments.

Speaker 2

Great. Well, I just want to thank everybody for participating in today's call. And again, we'd like to thank our employees for their hard work and dedication. And we look forward to speaking to you all again next quarter. So thank you.

Operator

Thank you. This concludes today's conference call. You may now disconnect.

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Earnings Conference Call
Franklin Resources Q3 2023
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