Franklin Resources Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
April 29, 2024

There are 11 speakers on the call.

Operator

Welcome to Franklin Resources Earnings Conference Call for the Quarter Ended March 31, 2024. Hello. My name is Sylvie, 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.

Operator

I would now like to turn the conference over to your host, Celine Oh, Chief Communications Officer and Head of Investor Relations for Franklin Resources. 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 2nd fiscal quarter of 2024. I'm joined by Matt Nichols, our CFO and COO and Adam Spector, our Head of Global Distribution. We'll answer your questions in just a few minutes. But first, I'd like to review some highlights from the quarter.

Speaker 2

In terms of public equity markets, 2023 was to some extent a tale of 2 markets, the Magnificent 7 and the S and P 493, with the former contributing the lion's share of returns. So far in 2024, in the public equity markets, we've seen a significant dispersion emerge in performance among the Magnificent Seven, leading to a better environment for fundamental research to capture alpha and when augmented by robust risk management can deliver compelling portfolio results for clients. Given the current backdrop, we believe equity allocation should, in general, tilt towards sectors and regions that are being overlooked due to the heavy concentration in the largest companies. In addition, the theme of artificial intelligence will likely continue to be a significant stock driver both positive and negative for the haves and have nots over time. Meanwhile, on interest rates, consensus estimates currently indicate a notable decrease in the number of expected cuts for 2024 by the Federal Reserve from 6 to now 2.

Speaker 2

Fed Speak increasingly signals openness to delaying rate cuts to later in the second half of this year on the back of improving economic growth and slower disinflation. Against this background, while cash may continue to look attractive in the very near term, fixed income opportunities will likely provide a better total return option over high yielding cash equivalents as the cutting cycle commences. Looking at private markets, secular trends and macro tailwinds continue to create opportunities in alternative credit, secondary private equity and select areas of real estate. In addition, investor demand for private market exposure is increasing given its diversification benefits, potential for higher risk adjusted returns and as a hedge against inflation. Broadly speaking, these signals point to a complex market environment that creates opportunities for active managers.

Speaker 2

This quarter, my executive team and I had the opportunity to travel extensively outside the U. S. To meet with many of our key clients to hear firsthand what is top of mind and how Franklin Templeton can better serve them. As a global active manager with 1.6 $1,000,000,000,000 in assets under management and operating in 35 countries around the world, we believe that Franklin Templeton is positioned to take advantage of the money in motion by assisting our clients with a broad range of investment capabilities across public and private assets in vehicles of choice. We were also pleased to learn that our clients recognize the steps we have taken over the past few years to further diversify and strengthen our presence in important markets and distribution channels outside the U.

Speaker 2

S. We again saw aggregate positive net flows in non U. S. Regions, which now have approximately $490,000,000,000 in assets under management. Furthermore, a number of our clients continue to progress toward working with fewer asset managers and in this regard expect not only a broad range of investment capabilities, but also other services including technology, portfolio construction, customization and thought leadership.

Speaker 2

At Franklin Templeton, we leverage the skills of multiple specialist investment managers to deliver expertise across a wide range of investment styles and asset classes. Our investment teams benefit from Franklin Templeton's scale with centralized investments in content, technology, data and most recently artificial intelligence where we're excited about collaborating with leaders in technology on AI platforms. Moreover, the diversity of our model benefits our corporate shareholders given that no single specialist investment manager at our firm represents more than 12% of adjusted operating revenue and most of our specialist investment managers are diversified within themselves as well. Turning to highlights from

Speaker 3

the quarter.

Speaker 2

Ending AUM increased by 13% to $1,640,000,000,000 from the prior quarter and increased by 16% from the prior year quarter due to the addition of Putnam as well as positive markets and net inflows. Average AUM increased by 13% and 11% to $1,580,000,000,000 from the prior quarter and the prior year quarter respectively. Investment performance continues to be strong and resulted in 62%, 51%, 62% and 69% of our strategy composite AUM outperforming their respective benchmarks on a 1, 3, 5 10 year basis, benefiting from the addition of Putnam. In terms of mutual funds, investment performance resulted in 51%, 60%, 44% 56% of mutual fund AUM outperforming their peers on a 1, 3, 5 10 year basis and performance strengthened versus peers across the 3, 5 10 year time periods quarter over quarter. Our long term net flows were $6,900,000,000 in the quarter, including reinvested distributions of $3,100,000,000 $13,700,000,000 was funded out of the $25,000,000,000 allocation from Great West.

Speaker 2

Long term net inflows were spread across asset classes, investment vehicles and geographies. Fixed income, multi asset and alternative assets led the way from an asset class perspective and we continue to see growth in our separately managed account ETF and Canvas offerings. Each have achieved at least 4 consecutive quarters of net inflows and all are at record high AUM. Long term inflows of $85,000,000,000 increased by 23% from the prior quarter and 37% from the prior year quarter. Excluding reinvested distributions, which are seasonally elevated in the prior quarter and inflows from Great West, long term inflows increased by 17% from the prior quarter and 15% from the prior year quarter.

Speaker 2

In terms of flows by asset class, fixed income net inflows were 8,300,000,000 We saw client interest reflected in positive net flows into core bond, highly customized corporate bond, multi sector, municipal and high yield strategies. Equity net outflows were $5,300,000,000 We saw positive net flows into large cap value and smart beta. Excluding reinvested distributions, which are seasonally elevated in the prior quarter, equity net outflows improved by 29% from the prior quarter. Multi asset net inflows were $2,900,000,000 driven by Franklin Templeton Investment Solutions, the Franklin Income Fund and Canvas, our custom indexing solution platform. Alternative net inflows were $1,000,000,000 driven by growth into private market strategies, which were partially offset by outflows in liquid alternative strategies.

Speaker 2

Benefit Street Partners, Clarion Partners and Lexington Partners each had net inflows in the current quarter with a combined total of $1,400,000,000 As we mentioned last quarter, in January, Lexington Partners closed its latest flagship global secondary fund with $22,700,000,000 of total capital commitments. Fund 10 ranks among the largest funds raised to date and significantly exceeded Lexington's private secondary fund, which closed with $14,000,000,000 in 2020. And we were delighted that approximately 20% of the capital raised in the fund came from the wealth management channel. Also in January, Benefit Street Partners closed its 5th flagship private credit fund with $4,700,000,000 of total capital commitments, reflecting the strong demand for the asset class, BSP exceeded its fundraising target. We believe the current market opportunity and backdrop for U.

Speaker 2

S. Direct lending and alternative credit in general is attractive and BSP has significant underwriting experience, loan structuring expertise and focus on deep due diligence, which provides us with a competitive advantage. In the wealth management channel, alternatives by Franklin Templeton has increased the number of product offerings and expanded platform placements, increasing market share and growing our client base. Our distribution force of more than 3 50 individuals partners with our 50 person group of alternative asset specialists to educate financial advisors and their clients on the potential benefits of private market investing. We expect a busy next 12 months across private markets.

Speaker 2

From an investment vehicle perspective, ETF AUM ended the quarter at $24,000,000,000 and generated net inflows of approximately $1,600,000,000 representing another quarter of net inflows exceeding $1,000,000,000 and the 10th consecutive quarter of positive net flows. SMA AUM ended the quarter at $138,000,000,000 and generated positive net flows of nearly $3,000,000,000 dollars representing the 4th consecutive quarter of net inflows. Canvas generated net inflows of over $750,000,000 with a robust pipeline and AUM increasing by 23% from the prior quarter to over 7,000,000,000 dollars Investment Solutions leverages our capabilities across public and private asset classes to pursue strategic partnerships. This quarter, Investment Solutions generated positive net flows with assets under management of over $75,000,000,000 including the addition of Putnam. This quarter, our institutional pipeline of 1 but unfunded mandates was $20,000,000,000 a significant increase from the prior quarter and does not include the remaining allocation from Great West Lifeco.

Speaker 2

The pipeline is one of the strongest it's been and remains diversified by asset class and across our specialist investment managers. With the close of our acquisition of Putnam on January 1, we are a $1,640,000,000,000 investment manager. We've been pleased with the positive reaction from our clients and in the quarter Putnam contributed positive net flows and its AUM increased by 8% to $160,000,000,000 or 18% since our announcement in May last year. With our expanded capabilities, our AUM in the insurance and retirement channels now exceeds 650,000,000,000 dollars Putnam's investment performance continued to be strong with 89% or higher of mutual fund AUM outperforming peers in the 1, 3, 5 10 year periods and 91% of mutual fund AUM in funds that are rated 4 or 5 star by Morningstar. We were also thrilled to see that Barron's ranked Putnam the number one fund family for 1 5 year performance and number 5 for the 10 year period.

Speaker 2

Since the closing, we're also pleased to see that Putnam's average monthly gross sales has increased by approximately 30%, demonstrating the strength of Franklin Templeton's distribution. Turning briefly to financial results. Adjusted operating income was $419,600,000 an increase of 0.6% from the prior quarter and a decrease of 4.7 percent from the prior year quarter. As always, we continue to focus on disciplined expense management while also continuing to invest in growth and innovation for the benefits of our clients and shareholders. Before I turn the call over to you for your questions, I would like to thank our employees for their many contributions and always staying laser focused on our clients' financial future.

Speaker 2

Now let's open it up to your questions. Operator?

Operator

Thank you.

Speaker 4

Thanks. Good morning, everyone. First, we have a big picture net flow question. Lots of ins and outs in the $7,000,000,000 especially with the $14,000,000,000 in from Great West. So how should we think about the core net flow run rate if we back the $14,000,000,000 dollars out of the $7,000,000,000 of long term net flows?

Speaker 2

So Craig, thanks for the question. Let me answer that question in first kind of how we're positioning ourselves and I will I promise you I will get to those points and Adam could add some additional cover color. So the way we're positioned to firm, I think of it as in 4 key secular trends that has driven our acquisition strategy and what we think will drive flows now and in the future. So the first obviously is our movement to alternatives. We think that it's not going away.

Speaker 2

Private credits here to stay. Banks are going to lend the same way that they've done in the past. Private equity is here to stay. And so if you look at our breadth of capabilities from Lexington, Clarion, BSP, Alcentra, We think we have the broadest alternatives capability of any traditional asset manager. And from a flow standpoint, obviously, well known in the institutional space, what's really important is that the in the wealth channel, there's a desire to go from about a 5% allocation to a 15% allocation.

Speaker 2

And what's significant there, if you just take the 4 biggest wirehouses, a 1% increase in allocation is $130,000,000,000 And what we're excited about is that, as we mentioned in the prior comments, in the opening comments, Lexington's 20% of that fundraise was in the wealth channel. And believe me, that was years of learning, starts and stops and blocking and tackling, learning about education, educating our own team, educating the advisors who are selling to be able to be successful in that. And we think we can take that same strategy with any of our alternatives. The second, I'm going to name 4 of them. The second is just customization.

Speaker 2

You're seeing from technology advances, that clients want either specific vehicles or the portfolios to be customized. And so if you look at this quarter's trends, things like our SMA, which is positive, Legg Mason made us a top 3 SMA provider, you're seeing more and more flows going into SMAs. ETFs, while we were late arguably to the passive ETF space, we were actually early in the active ETF space. And today at our $24,000,000,000 in ETFs, the largest category is actually active ETFs. And we're seeing that in markets like Europe, where the regulatory environment's changed, there's a greater demand now for ETFs.

Speaker 2

And we're having success in our like Green Bond and Paris aligns. So a lot of the ESG ETFs are doing very well in Europe. And then finally, in kind of that customization and vehicle being vehicle agnostic is the direct indexing. And not only we're seeing positive flows consistently with Canvas, but we added 11 new partners to the 88 partners that we have with Canvas. And once you get embedded in from the in the pipes, you continue to see flow.

Speaker 2

So it's just a great opportunity. But I think what gets us most excited about Canvas is the fact that as you're seeing this trend towards greater SMAs, Canvas was built as a technology platform. Some of the direct indexing were more about people who focused on tax optimization. This is truly a technology platform. So we can see taking traditional active portfolios and being able to tax optimize as well as tilting and you have to have the right technology for that.

Speaker 2

The 3rd big trend, I think, is really global distribution. You have a 1,000,000,000 people that are entering the middle class, 87% of those are in Asia. And so we've got that massive global distribution. We were in Taiwan in 1985. We were the 1st foreign manager in India.

Speaker 2

We have local asset management capabilities in emerging markets And so we think we're really uniquely positioned to take advantage of that trend. And as a matter of fact, this quarter, you saw non U. S. Flows were positive outside the U. S.

Speaker 2

And then the 4th and obviously really important is the technology and technological advances. And that's where I would say, I think the players so far, if you play the AI move, you've been playing in the picks and shovels of artificial intelligence. It's going to be the firms that really figure out how to make this work for them to make it a competitive advantage. That's important. You'll hear it about an announcement later this week where we are announcing a strategic partnership on some AI work that we're doing with one of those big players.

Speaker 2

And then the secondary is blockchain and we came out with a tokenized first one to have a 40x shareholder system on the public blockchain. We came out with a tokenized money market fund in 2021, so the first to do that. We are actually a node validator in the space with 11 different nodes. It's an area we know well and we think it's going to be really significant. We announced a partnership with a UAE based firm to leverage.

Speaker 2

They're going to leverage our blockchain technology shareholder servicing systems to launch a stable coin and we'll be managing the portfolio there. So as you bring those together, now to answer your question, it's going to be it's about execution, right? And I can tell you, I think we found it was probably it's a challenge when you take you do 10 different acquisitions and you're trying to choose best athlete for your distribution team and we genuinely believe we put together the best team. But there are headwinds to that where you get a new wholesaler in a region and you've broken relationships maybe with the prior wholesalers' clients. And so it takes time to build those relationships back, but we feel like we're really seeing that pay off this quarter.

Speaker 2

You see it in our pipeline. I mean to go from $13,000,000,000 to $20,000,000,000 and not have that's not any Great West Life. That's just good solid wins in the pipeline growth. Interesting statistic is our core sales and we define core sales as sales less than $100,000,000 So these are the ones that you get on an advisor's platform and they continue to just allocate to you. So excluding Putnam, those are up 14%.

Speaker 2

And again, those are where that wholesalers out there meeting. And so the good success there. And as you look at inflows, excluding reinvested distributions Great West Life, they're up 17%. So we're positive in all those vehicles. We're positive outside the U.

Speaker 2

S. We're we've got good pipeline strength. And then you take a firm like Putnam and this is where we've talked about this and I think you see it with Putnam where the big distribution companies or big distributors are saying they want to consolidate the number of partners. And so you take a Putnam, we've actually grown Putnam sales by 30% since the acquisition. And that's just really in some cases where we were a preferred partner with a distributor and they weren't and now they get the benefit of being part of that preferred partnership.

Speaker 2

It's where our 350 plus client facing wholesalers can be out there telling the phenomenal story of the performance of the Putnam funds. And so to see a 30% increase in really the Q1 of Putnam because of bringing it together, that distribution is really exciting. So long winded answer, Craig, but I think we're we feel like all that we've put together is coming together in distribution now.

Speaker 4

Thanks, Jenny. We're looking forward to seeing your AI announcement later this week. We have a follow-up on alt flows.

Speaker 3

For the

Speaker 4

last 8 quarters, we added it up Franklin had $13,000,000,000 of all inflows. And I know this excludes realizations too. If we add up Lexington 10 and Benefit Street 5, combined they added $27,000,000,000

Speaker 3

So, all flows look to

Speaker 4

have been maybe negative $14,000,000,000 access to flagship fundraisers. So, similar question, but how do we handle the alts business? How should we think about the alt go forward net flow trajectory just given that dynamic?

Speaker 2

So I think it's there's a little bit of noise in the alts numbers. If you just look in calendar year 202220 23, we talked last time about how we raised $40,000,000,000 in the private markets. But the reality in our alternatives business, we raised $55,000,000,000 80 percent of it was private markets. But the net change in AUM, you saw $40,000,000,000 added to the private markets AUM net, net of realizations distributions market everything, but $16,000,000,000 negative in the liquid alts portfolio, which represents about 6% of our alts portfolio now. So that's where you're shifting from much the good news is it's the higher fee private markets that have had solid inflows in that window, but it was a little bit masked by the lower fee liquid alts.

Speaker 2

Now fast forward to this I'll go this fiscal year. So the 1st two quarters, first of all, we said that we would be raising between $10,000,000,000 $15,000,000,000 dollars That's our goal for the year. We're on track for that. We've raised about $7,300,000,000 in the private markets and another just under $2,000,000,000 in the liquid alts. But if you net out distributions, realizations, FX and market And to be honest, market, the only negative market was real estate with Clari and the others were all positive.

Speaker 2

We'd say it nets to flat. So again, kind of a gross number there, but if you take away the distributions, realizations and FX, FX was actually pretty significant. Matt can probably give you more details on this, but we netted flat so far in this fiscal year.

Speaker 5

Yes. Craig, just for perspective, for the last quarter that we're just reporting on, realizations and distributions was $2,600,000,000 for example, and we had negative FX of another $1,000,000,000 dollars But we do we get these questions and I think we're going to try and improve our disclosure on this try and help the question around this. Now we've got the bulk of our alternative assets together. Remembering in previous quarters, we've always said, when we were much smaller, we've always said, look, realizations and distribution are just not they're just not significant enough to report and break down the explanation of AUM, but they're now getting to the point where we're going to start providing that level of detail. But just for information, last quarter, again, the one we're reporting almost €2,600,000,000 of realizations and distributions and 1,000,000,000 dollars negative FX.

Speaker 3

And Craig, the only thing I would add is that the other thing we've been able to do really is to work more closely with our distribution partners on the wealth management side over the last few quarters. And we're able to secure calendar spots further into the future than we ever thought was possible. And I think that speaks well to our future fundraising as well.

Speaker 4

Great. Thanks, everyone.

Operator

Thank you. Next question will be from Glenn Schorr at Evercore. Please go ahead.

Speaker 6

Hi, thank you. So I wanted to talk about fixed income a little bit. So I see pension funded status is much, much better and rates are higher. I like the $8,300,000,000 inflows in the quarter, but I don't know if how much of that came from Great West or something else. So maybe you could talk about that.

Speaker 6

And then bigger picture, is this do you feel this is the beginning of a broader trend, the long awaited fixed income flows? Maybe you can give us a little bit of insight from whether it be RFPs, client combos or the consultants on if we're at the precipice of some larger flows into fixed income? Thanks.

Speaker 2

Yes. Thanks, Glenn. So interestingly, let's face it, as long as people believe rates have peaked and potential come down, they're going to go longer duration, right? So, the only thing is you're now starting to hear the noise for the first time where actually people think rates may be longer higher for longer and somebody was even talking about a potential rate increases. So that could slow things.

Speaker 2

But let me give you that what we're seeing. So we obviously had positive flows, but just looking at the pipeline and the pipeline doesn't include any Great West Life. If you add well, about 70 plus percent of the growth in the pipeline is fixed income and that crosses Western, Franklin and Brandywine. And if you actually add BSP, because I always think private credit really should be thought of in the fixed income, because the decisions around that are often how you're thinking about your fixed income portfolio. The growth in the pipeline, 97% of it comes from fixed income.

Speaker 2

6 of our top 10 gross selling funds in the last this past quarter were in fixed income, corporate bond, core bond, multi sector munis, highly customized core plus. So definitely demand in the last quarter, but if you actually look at the pipeline going forward, the institutional pipeline, you see very strong demand for fixed income.

Speaker 3

And I would say that it's also pretty broad based. If you take a look at that funding pipeline, it's really across all 4 of the fixed income firms we have, which all have very significant pipelines right now. And if you take a look at the products we're offering, we're positive in core and high yield and munis was our best selling segment. So really broad based fixed income appeal, not just one product.

Speaker 5

Yes. And they're also last year I said that is they're also positioned differently in terms of their view on where rates are going. So that means where we've had performance weaknesses, it's being offset not always fully, but being partially offset by strengths in other parts of the franchise.

Speaker 3

And while the institutional business that you asked about is strong, we're also positive in ETFs and SMAs, muni ladders, so lots of different fixed income vehicles doing well for us.

Speaker 6

Just a tiny follow-up on that same topic is, have allocations changed a lot? In other words, I hear you on the flows. That's a very bullish commentary for the forward look. But if you took a snapshot of a year ago and 2 year ago allocations to where we are now and maybe 2 years forward, do you think we'll see a major equity fixed income shift? Or I know it's a lot broader than that, but like will fixed income allocations be a lot higher 2 years out?

Speaker 2

Again, I think it depends on your view on rates. And as I think Adam or Matt mentioned, Arctic's income teams are all kind of spread out as far as their view on where rates go. The Franklin guys probably think a little bit higher for longer. Western is probably more aggressively positioned for rate cuts. So I think it really depends on your views.

Speaker 2

I do think if rates stay higher for longer, it has impacts on returns on equity markets as far as expectations, private markets as well. So Glenn, I think again, I think it's going to depend on where people where do they think they should position their portfolio. I don't know, Adam, do you want to add anything?

Speaker 3

Yes. I think it depends on the client, right? You mentioned more fully funded pension plans, right? If we get a wave of more immunization going on, we're going to see that drive fixed income flows. At the same time, really in every channel around the world, what do we see is move towards alternative.

Speaker 3

That money is coming out of all of the other traditional buckets. So I think both of those are kind of competing with each other and pushing fixed income allocations in the opposite direction.

Speaker 6

Thank you for all that. Appreciate it.

Operator

Thank you. Next question will be from Dan Fannon at Jefferies. Please go ahead.

Speaker 7

Good morning. Thanks for taking my question. I guess, Matt, maybe we could start with some expense questions. So curious about what the delta was in comp versus your guidance? And then as we think about the seasonal impacts of some of this quarter, how much do you expect to roll off as we go into 2Q?

Speaker 7

And then maybe update us on kind of the full year outlook for expenses?

Speaker 5

Yes. Thank you. Thank you, Dan. So a couple of things on expenses around the Q2. I'll get to the comp and benefits in a second.

Speaker 5

I'd just like to say that notwithstanding the higher resets around compensation, calendar resets around compensation that I'll talk about in a minute and meaningfully higher markets. If you exclude Putnam, which was the main addition we had in the quarter, our expenses would have been flat. So notwithstanding higher performance fees than we expected, higher calendar resets than we expected and higher markets than we expected, our expenses for the quarter would have been flat when you exclude Putnam. So hopefully that demonstrates some discipline there. In terms of your specific question around comp and benefits for the Q2, The difference is, I'd say it's around almost half of it's the performance fee, a little bit less than half is performance fee increase relative to where we thought it would be.

Speaker 5

And then there's these high I would sort of we were expecting Canada resets in compensation, but they're just higher than we thought they'd be. So things like the 401 mutual fund units in compensation, deferred compensation plans, vacation accruals, They were all when you add all those things up, plus the performance fee delta, it adds up to about $30,000,000 So when you add the $30,000,000 to, I think I $815,000,000 on the call that gets you to pretty much where the $844,000,000 is where we ended up. So that explains that part of your question. In terms of the annual guide, last quarter we guided to $4,600,000,000 and that's excluding performance fees, but including the double rent that we talked about around our New York City consolidation exercise. And I would increase that just slightly to probably $4,640,000,000 to $4,650,000,000 a very narrow range.

Speaker 5

So less than 1% higher and that's really driven by the higher markets that we've experienced. If markets come back down again, as we've been experiencing very recently in the 1st part of this quarter, it wouldn't surprise me if our annual guide remains flat. But right now, all else remaining equal is expected to be just slightly higher for the annual guide.

Speaker 7

Great. That's helpful. And then maybe just a follow-up on that with regards to the effective fee rate. I think you had talked about it coming into the mid-thirty 8s as the year progressed. So I guess given where mix is, AUM levels, all the dynamics that go into that, how do you see that trending?

Speaker 5

Yes. Thank you for the question. So the EFR for the quarter dropped to 38.5%, and I believe that's exactly how we guided for the quarter. And we're able to do that because you had a pretty good feel for the mix that were coming in, in terms of flows. And I think I also pointed out that we were a basis point higher than usual, let's call it, or the effective fee rate for the last quarter was inflated by a basis point based on Lexington catch up fees.

Speaker 5

Going forward on an annual basis, I would say that our EFR should remain in the 38s, probably in the mid 38s. It will be slightly higher than that, driven by episodic alternative asset fees as we've experienced over the last 12 months and highlighted those clearly I think in our results. And it can and the other thing that will help it be higher is a larger percentage of alternative assets and a higher percentage of equities. With the public markets going up as much as they did in the Q1, obviously as a percentage overall, our alternative assets came down a bit. So that brought the EFR pressure down slightly.

Speaker 5

And then we had quite a few successes, as Jenny mentioned in her remarks, in ETF, Canvas, separately managed accounts. And all these things are lower fee rate businesses. It's less about fee erosion per se, I'd say. It's just more about the business mix. So for the next quarter specifically, we expect EFR to probably be even in the high 37s.

Speaker 5

So let's say high 37s to 38, percent. But this is because of the success that we didn't anticipate as much success with Putnam because the overall Putnam business is a low effective fee rate. They're kind of in the mid-thirty five percent s. Faster inflows from Great West Life at the lower fee end, as we communicated, hopefully, clearly enough that those the $25,000,000,000 of AUM that we expect to come in from Great West Life that will ultimately when we get it all in that will be in the mid teens. But the initial amount that we've got in are all in the lower fee categories, things like investment grade credit, for example, for general account.

Speaker 5

But then on top of that, we expect continued growth in our ETFs, Canvas and separately managed accounts, all of which are lower fee rates. Now the reason why we keep the guide for the year in the 38% is because we have a view again as Jenny mentioned of our alternative asset fundraising capabilities and expectations for the next 12 months, let's call it. So on an annual basis, we expect the mix of business around alternative assets, equities, fixed income and then these other areas of growth that I just mentioned to offset the fee reductions that at times in various quarters could go into the high 37s. But that's just based on that 1 quarter on the mix of that 1 quarter. But for the year, we expect to remain fairly stable in the 30 8% area.

Speaker 7

Great. Thank you.

Speaker 3

Thank you.

Operator

Next question will be from Ken Worthington at JPMorgan. Please go ahead.

Speaker 8

Hi. Good morning and thanks for

Speaker 5

taking the

Speaker 8

question. On the institutional pipeline, when you win an institutional fixed income mandate, are you getting a bunch of cash? Or are you getting a portfolio of securities that you transition and then remanage? And do you get a sense of where the assets are coming from? If it's going into fixed income, is it investors going from rates to credit?

Speaker 8

Are they going from equities to performance? So any view on what you've seen in this pipeline that's driving the fixed income success you're having?

Speaker 3

You might not like the answer, but the answer is yes. I think we're seeing all of those things, right? So often people will switch managers because of performance. We see people beginning to extend duration out. Those are usually funded by cash.

Speaker 3

We see some of the plus sectors being added to those are funded in a mix of different ways. And then, of course, on the retail side, it's typically a sale of a fund. So you really don't know, where that's coming from. In terms of how folks fund things, I would say that's a mix. We see 3 different ways.

Speaker 3

We see being funded in cash. We see people using a transition manager. And then sometimes we'll see folks fund us with securities and ask us to get to the new point by a certain time. The other interesting thing we see in terms of how accounts are funded is actually outside of fixed income on the Canvas side where we see significant use cases for Canvas as a tool to aid in the funding of accounts for taxable accounts, we're able to do that in a much more tax efficient way.

Speaker 8

Okay, great. Thank you. Just on ETFs, how are you thinking about ETFs outside the U. S? You're having nice success in your franchise within the states.

Speaker 8

How are you thinking about leveraging the brand or are you thinking about leveraging the brand you have and the ETF franchise that you've already built?

Speaker 3

Yes. ETFs outside of the S have grown in 2 important ways. 1, I don't think this was the point of your question, but our single country ETFs, so ETFs that focus on a country, even if they're sold in the U. S, that's been a huge success for us. We're able to price those very competitively.

Speaker 3

But also in terms of ETFs that we're selling outside of the U. S. Regardless of investment mandate, we've seen real growth, there in Canada and in EMEA in particular. Some of that is the single country flow. As Jenny mentioned in her remarks, we've seen some of the more sustainably oriented products go quite well.

Speaker 3

Green bonds, Paris align, S and P 500 would be 2 that are examples of that. Outside of the U. S, we continue to see a mix of active, passive and smart data. Passive is still the most significant portion of the market, but active has by far the highest growth rate. And just to put things into context, I believe that if you look at our flow for this quarter, about half of it or so was from outside of the U.

Speaker 3

S. In terms of our ETF business. So really trying to expand that to the best we can and seeing very good results.

Speaker 8

Great. Thank

Speaker 6

you.

Operator

Thank you. Next question will be from Alex Blostein at Goldman Sachs. Please go ahead.

Speaker 9

Hey, good morning. Thanks for the question as well. Jenny, I was hoping to dig into your comments from the prepared remarks when you talked about being quite busy over the next 12 months with respect to private markets. Could you, I guess, expand on that a little bit? And I'm assuming wealth is going to be part of the answer.

Speaker 9

So when you think about the opportunity set in the wealth channel and lots of other folks coming in with offerings already and it seems like that part of the market is getting a little bit busier, What are you guys doing to make sure you don't miss the window and opportunity there? Thanks.

Speaker 2

Yes. So I mean we're in the market with a few different things. And as Adam mentioned, we are getting on calendars. This stuff is laid out. I could probably surprise early on to learn this.

Speaker 2

I mean, sometimes up to 2 years in advance. So the areas that we're talking, Lexington obviously has capabilities beyond their traditional Fund 10 where they've got middle market and co invest offerings. In the case of real estate, Clarion's top 3 biggest funds are all perpetual. So they're always fundraising, although we definitely see kind of muted demand for real estate. They've got terrific performance.

Speaker 2

And so I think when things shift back, Clarion should do very well there because they have very little exposure to office. In the case of the private credit, real estate debt is really interesting and we're talking to several clients about that. Obviously, CLOs, structured credit, special situations. And then actually, we've been successful. I never know how much I can talk about, but in our Inventure, our Franklin Venture Group is in the wealth channel right now raising money and 1st fundraise there and it's going very well.

Speaker 2

So you just had 2 between BSP and Lexington close their flagship funds. So then you're in that they're digesting and investing in those cycles. They're doing more of their niche type strategies, but they're in markets with those. And they'll as soon as those are deployed, I think Lexington's probably deployed 60% of their, Lex 10. They'll come back into the market for another flagship.

Speaker 2

But in the meantime, they've got their middle market and co invest. And I cannot emphasize enough the in the wealth channel, it's 50% the right product and 50% whether you got the heft on the distribution side. And I think that is often underestimated. Our 3.50 plus client facing, specialists included can sell to an advisor's entire book. If you don't have the breadth of capability that we have, that's incredibly expensive because let's say you're just an alternatives manager, you're only selling to 5% to 10% of that advisors book.

Speaker 2

And so it gets really expensive to build the breadth of capability that we have. And the years of investment that we've done in the academy, again, our academy is global, where we've now been able to bring alternatives by Feet, which is a website that has tons of training on how advisors should think about alternatives in their portfolios to supplement just that wholesale being out there in the field, I think has been really important. So very much focused on the wealth channel, really excited about it. I think we have a great suite of products to be able to meet the needs in that market and the distribution capability and expertise to be successful there.

Speaker 9

I got you. Okay. All makes sense. And then clarification for you guys on the pipeline. It sounds like there's a bunch of things in the institutional pipeline as you discussed earlier.

Speaker 9

Is it could you guys help us just size the fee rate of the institutional pipeline excluding Grey West as you described it? And then I guess is it fair to assume that the remaining piece of Grey West that's going to come in will be coming in at a much higher fee rate, so kind of north of that teenish basis points just given that the back end or what's come through came at a pretty low fee rate?

Speaker 2

The pipeline is the fee rate is slightly up from last quarter. But look, any time you 1, it's institutional, so that's lower fee than your traditional EFRs. And then number 2, it's heavily weighted in the fixed income. Well, the new stuff is heavily weighted in fixed income, but probably overall pipeline, I don't know, Adam, 60 plus percent probably fixed income. Correct.

Speaker 2

So I don't I never know if we give guidance on the actual numbers in the pipeline, but it's stable. Matt, have we given guidance there?

Speaker 3

I would say it's consistent with our institutional fee rate. Got it. Okay.

Speaker 5

Yes. It's in the mid to high 20s, Alex. And then but it can be it's gone from anything from the mid to high 20s to our overall effective fee rate, depending on the quarter and depending on the type of the nature of the pipeline at a particular time? And then the to answer your second question, yes, the additional flows we expect to come in will be higher on average on the rest of the Great West Life flow. And that's expected over the next 12 months.

Speaker 5

As we've said, we'll of course put that detail into our monthly flow so you can see that and then we'll provide detail on the effective fee rate when we have these calls and provide updated information.

Speaker 3

Great. Okay, perfect. That's what I

Speaker 9

was looking for. Appreciate it.

Speaker 5

Thanks, Alex.

Operator

Next question will be from Bill Katz at TD Cowen. Please go ahead.

Speaker 10

Okay. Thank you very much. I apologize on the weather. So in terms of if I start with your reported net flows of 6.7% and I back out the 3.1% of dividends reinvested, which the industry doesn't include, I get down about $3,500,000,000 If I back out the initial capital from Great West, that's nice $10,000,000,000 If I then back out the $1,400,000,000 from the 3 alt managers you highlighted, I get to about $11,000,000 And then if I back out the Canvas ETF and the SMA, I think I get to about minus $18,000,000,000 for what I would consider to be a long only business. A, is that math correct?

Speaker 10

And B, if it is, what's the go to plan here to sort of stabilize that part of the business?

Speaker 3

So I am not Matt Nichols. I can't do the math that quickly. He probably could. So I couldn't quite follow all of that. But I will tell you that the growth areas were some of the things you wanted to pull out alternatives, ETFs, Canvas.

Speaker 3

I think we've said consistently that those are

Speaker 6

our growth focuses and that they're

Speaker 3

growing a little faster. More traditional business and you look at our outflow rate, I think at the more traditional business and you look at our outflow rate, our decay rate, it's really been stable to improving. So I think over the last few years, we've been able to do a very good job at protecting ourselves on the downside. And as we said earlier, I think Jenny pointed to a notion that we talk about in terms of core sales, which is our smaller sales, which are up pretty consistently at about 14% on average. So stable outflows, increasing core sales, we're feeling pretty good about the traditional part of the business.

Speaker 2

And I'll just add, look, we've been very open and honest that we've been underrepresented in the retirement channel. As I mentioned on the last quarter's call, we were ranked 14th on Empower's platform and it's similar in some of the others. And with this acquisition of Putnam and the relationship and the absorption of their retirement team, as well as their target date products, a third of retirement flows go to the qualified investment plans and they've got phenomenal performance of their target date products as well as stable value. We think we are poised to and again, if we just take our market share, it's a massive increase. And the retirement channel is still a very traditional asset oriented channel, traditional mutual funds, equities and fixed income.

Speaker 2

And we just think with our distribution capability, not just to benefit from Empower, but taking that to all the different retirement platforms and gain more market share there.

Speaker 5

And then the last thing I'd just add Bill is that this area you're trying to get to, which we actually have a little bit, it's not really 18, but we think of it as I think it's more like 10 that we got to. But when you get to those numbers, it's very concentrated in areas where performance is even more important than usual, let's call it. So and in those areas, performance has begun to improve certainly on the equity side in particular quite significantly. So we've seen quite a slowdown in those outflows. On the fixed income side in a couple of areas, we've had some weaknesses there as you know, but we see some improvement there too.

Speaker 5

So it's fairly it's a fairly concentrated situation that you're referring to and one that as performance improves, you see a correlation of slowdown in outflows.

Speaker 3

And finally, Bill, I would add that it's sometimes difficult to separate investment product from the vehicle itself. We have a number of instances where the investment team is positive, but it's they're positive because their SMA, their usage, their ETFs are all positive and the mutual fund might be negative. So is that the core business or not, right? It's a traditional asset class. They're gaining flow, but they're gaining it because of the vehicle choice, not necessarily because the mutual fund is positive.

Speaker 10

That makes tons of sense. And just a follow-up on all of that, Matt, maybe for yourself. Just your base fee rate, it just seems like it's bouncing around a little more than I would envision just given the sheer sizing of the platform today. So can you help me understand if you're going to be sort of in that 37% range plus for the next quarter and then you sort of bounce back into the 4th? Is that impute to a very high level of flow in the alts managers?

Speaker 10

And if that's the case, is that just vehicles that are just turning on from capital raise? Or is that from new money coming in the door? And if so, where might that be? Thank you.

Speaker 5

Well, remember, the annual guide I gave included the first quarter or so where we had an elevated EFR for the reason that I explained around the catch up fees and so on. I think we were pretty close to 40 basis points at one point. We've been trying to be quite clear about that. So when you normalize that out, you get into the 38%. And then the only thing that's driving it down periodically from quarter to quarter is the areas of growth.

Speaker 5

And when you add those areas of growth up and you just did a second ago, Bill, when you went through your analysis on the traditional side of the business versus other areas of growth, when you start adding up ETFs, Canvas, SMAs and then the flows from Putnam, the overall Putnam remembering that it's not just the flows coming from Great West Life on Putnam, it's the $160,000,000,000 which is 17% higher than when we announced transaction of AUM that's at a multiple basis multiple points lower than the EFR of Franklin. So the fact that we've been more successful in that it has that's what's driven the EFR down a little bit. But what we would expect is that going into at least fiscal 2025, what we experienced at the beginning of fiscal 2024, depending on what products we have and everything that changes went through or not, there's a possibility that it could step back up again into the higher 38 based on the episodic alternative asset fees. But that's just an explanation around why it could go up a little bit more and down a little bit more than usual. It's those offsetting factors.

Speaker 5

It's basically a form of business mix plus the episodic activity out of alternatives.

Speaker 10

Thank you for taking all the questions.

Speaker 5

Bill, I'll also answer because I think you had the question on a little bit more of a breakdown of our Q3. I've already gone into some detail on EFR. In terms of comp and benefits for the Q3, we expect that to be around $820,000,000 That assumes performance fees of $40,000,000 That's lower than the previous quarters, driven by lower performance fees out of our real estate business for the reason that Jenny mentioned. It's important to note that the relative performance of Clarion is very strong, but the absolute valuation of real estate has come down, that's impacted the extent to performance fees. That's why we're guiding that down to 40,000,000 dollars from 50.

Speaker 5

IS and T, we expect it to remain at 150,000,000 occupancy, dollars 80,000,000 As you all know, that's going to come down later on in fiscal 2025 based on the double rent going away. But for next quarter, we expect that to remain at $80,000,000 And then G and A, we expect to be probably around €175,000,000 It could be as high as €180,000,000 Because we're planning on spending more in advertising, but it won't go it shouldn't go beyond that. So let's say, 175 to 180 in G and A. But I already provided the annual guidance earlier on based on Dan Fannon's question.

Operator

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

Speaker 2

Great. Well, everybody, thank you for participating in today's call. And once again, we would like to thank our employees for their hard work and dedication delivering this quarter. And we look forward to speaking to all of you again next quarter and everybody stay healthy.

Operator

Thank you. Ladies and gentlemen, this does indeed conclude today's conference call. You may now disconnect your

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Earnings Conference Call
Franklin Resources Q2 2024
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