Artisan Partners Asset Management Q2 2024 Earnings Call Transcript

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Provided by Quartr
July 24, 2024

There are 7 speakers on the call.

Operator

Good afternoon, and welcome to the Artisan Partners Second Quarter 20 24 Earnings Call. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Artisan Partners Asset Management. Please go ahead.

Speaker 1

Welcome to the Artisan Partners Asset Management Business Update and Second Quarter 2024 Earnings Call. Today's call will include remarks from Eric Colson, CEO Jason Gottlieb, President and C. J. Daley, CFO. Following these remarks, we will open the line for questions.

Speaker 1

Our latest results and investor presentation are available on the Relations section of our website. Before we begin today, I would like to remind you that comments made during today's call, including responses to questions, may include forward looking statements. These are subject to known and unknown risks and uncertainties, including, but not limited to, the factors set forth in our earnings release and detailed in our SEC filings. These risks and uncertainties may cause actual results to differ materially from those discussed in the statements, and we assume no obligation to update or revise any of these statements following the presentation. In addition, some of our remarks today will include references to non GAAP financial measures.

Speaker 1

You can find reconciliation of those measures to the most comparable GAAP measures in the earnings release and the supplemental materials, which can be found on our Investor Relations website. Also, please note that nothing on this call constitutes an offer or solicitation to purchase or sell an interest in any Artisan Investment Products or a recommendation for any investment service. I will now turn it over to Eric Polson.

Speaker 2

Thank you, Eileen, and thank you everyone for joining the call or reading the transcript. Artisan Partners is a high value added investment firm designed for talent to thrive in a thoughtful growth environment. Since our founding in 1994, we have focused on areas with a combination of investment talent, attractive absolute returns, long term demand from sophisticated clients and market inefficiencies that allow talented investors to generate alpha over extended periods of time. This kind of high value added investing transcends any single asset class, investment style, geography, sector or market cycle. A business built on high value added investing is durable.

Speaker 2

Excess returns are rare. Allocators will pay a premium for them and demand will endure. Artisan Partners aligns talented investors with long term allocators. We are not a distribution shop. We do not engineer product to meet short term demand.

Speaker 2

Over our history, we have remained committed to high value added investing, while methodically expanding our capabilities by adding breadth to existing investment franchises and onboarding exceptional talent in new areas. Our approach is guided by a core set of characteristics. We seek exceptional investment talent. We focus on asset classes where talent can compound capital at attractive absolute rates of return and where market inefficiencies and degrees of freedom allow for differentiation and alpha over benchmarks. We invest behind long term demand from institutional allocators.

Speaker 2

We prefer fragmented markets where competition is based on net of fee returns, not fee rates or distribution scale. Lastly, we arbitrage time. We operate in areas where we believe our patients and our long term approach are competitive advantages. Applying these characteristics, we have historically entered new areas with specialty strategies. We started nearly 30 years ago in small, midcap and international equities.

Speaker 2

We then grew into less capacity constrained, larger cap and global strategies. In 2014, we entered fixed income in the high yield market and more recently we launched emerging market debt. As high value added investing has evolved towards alternatives and private assets, we have added degrees of freedom to our existing strategies and launched an array of new strategies with existing and new talent in less liquid and more alternative spaces. Throughout, we have established ourselves in smaller, but robust specialist markets where talent matters. Differentiation is possible and investors are willing to pay a premium for a premium outcome.

Speaker 2

As we show on Slide 2, successfully establishing ourselves in specialty areas has provided the foundation for evolving into larger opportunity sets and growing larger and more diversified businesses. From the foundation created by these five strategies, we now manage 19 strategies and over $149,000,000,000 in AUM. Slide 3 is our most recent example, the M sites Capital Group. We identified, recruited and onboarded exceptional and proven investment talent in Mike Sarami, Sarah Orban and Mike O'Brien. Emerging market debt has historically generated attractive absolute returns and it has been a fertile hunting ground for exceptional investment talent given the poor quality of indices, the larger number of issuers and currencies and a multitude of ways to take and manage risk.

Speaker 2

The potential returns and diversification benefits have made emerging markets debt a logical target for institutional allocators seeking both yield and uncorrelated returns. Lastly, the competitive landscape is highly fragmented with the top 10 funds accounting for just 25% of category AUM as of March 31, 2024. Over the last two years, with the M sites Capital Group, we have seen these characteristics play out. Since inception opportunities strategy has generated an average annual return of 11.71 percent beating its index by an average of 724 basis points annually. The emerging markets local opportunity strategy has generated an average annual return of 8.01% since inception in August 2022 and after fees beating its index by 202 basis points.

Speaker 2

When we established the M sites Capital Group, we were not trying to time the market or satisfy near term demand in a hot dot product. In fact, we launched into unprecedented outflows for the asset class. We were executing our playbook, getting talent and performance right in the area where long term demand exists and exceptional investment talent can differentiate. Notwithstanding the difficult business environment, as of July 15, we have raised a cumulative $2,200,000,000 across M sites Capital Group's 3 strategies. This includes high quality institutional anchors in each strategy.

Speaker 2

I will now turn it over to Jason to discuss how we are executing this process and approach in alternatives.

Speaker 3

Thank you, Eric. We have shown the data on Slide 4 many times. AUM revenue in traditional active strategies is plateauing with net outflows offsetting investment returns. Net new asset growth is occurring on either end of the barbell, passive and alternatives. And the lion's share of the allocator management fee budgets are being spent on alternative strategies.

Speaker 3

Traditional active management remains a very large market with money constantly in motion and tremendous long term opportunity. We will continue to compete and have success in that market long into the future. But our incremental investments are focused on alternative investments. Alternatives are very natural fit for us. They are talent driven.

Speaker 3

They have generated attractive absolute returns and many alternative strategies operate in highly inefficient areas where talented investors can generate consistent and meaningful excess returns. There is demand for alternatives from sophisticated allocators, both institutions and within the wealth channel. And the landscape is highly fragmented with competition centering around investment quality, differentiation and net of fee returns, not scale or fees. This is a very natural evolution and growth area for us, reminiscent of how we have expanded our business in the past. Today, we classify 6 of our investment strategies as alternative or liquid alternatives Antero Peak, Antero Peak Hedge, Credit Opportunities, China Post Venture and Global Unconstrained.

Speaker 3

In addition to these open ended strategies, we have the closed end credit dislocation fund, which has successfully closed on $160,000,000 of commitments. We have methodically developed these strategies over the last 7 years. They are led by proven leaders who are passionate about their asset classes, their philosophies and their processes and generating exceptional absolute and relative returns for clients. To implement these strategies, we have expanded our operational platform to support more instruments, markets, counterparties, vehicles, data and other resources. And we have remained patient knowing that it takes time to develop the track records necessary for long term business success.

Speaker 3

All 5 open ended alternative strategies have performed well. 4 of the 5 have generated compelling absolute returns. 4 of the 5 have generated more than 300 basis points of annual outperformance net of fees since inception. And the credit opportunities and global unconstrained strategies have provided the diversification and low correlation benefits sought by clients. As we have broadened out our alternatives lineup and established investment track records, we have begun to invest more in dedicated alternative distribution, increasing expertise, improving marketing and growing our network.

Speaker 3

In addition, these early outcomes have created more opportunities to add additional alternative capabilities with existing and external talent. We have demonstrated our ability to successfully execute in alternative spaces. Continuing to expand our alternatives capabilities and sharpen our alternatives distribution remains high priorities for our entire management team. We are highly confident that our business model and philosophy are ideal for alternatives talent and strategies. Our early success confirms our thinking and we fully expect to do more.

Speaker 3

Thank you, Jason. Before turning it

Speaker 2

over to CJ, I want to provide an update on emerging markets. In the Q3 update last year, we included the data on Slide 6. As we said then, an extended period of underperformance relative to developed markets has resulted in emerging markets allocations being under target and in allocators rethinking emerging markets allocation altogether. We continue to believe that for many sophisticated allocators, emerging markets equity and debt will remain meaningful long term allocations. We have an impressive and diverse lineup of emerging markets equity and fixed income strategies built over time and focused on the same characteristics we have been discussing.

Speaker 2

In June, we onboarded an $800,000,000 institutional mandate in our sustainable emerging market strategy. Maria Negrete De Grusin and her team are now managing just shy of $2,000,000,000 with a healthy pipeline of institutional interest. The recent win is a testament to Maria and her team's dedication and Artisan's long term approach. We continue to believe that there is significant opportunity for the sustainable emerging markets team to grow. And in the first half of July, the M sites Capital Group onboarded an $860,000,000 institutional account in the emerging markets debt opportunity strategy, another recognition of the quality and potential of our emerging markets lineup.

Speaker 2

Across the strategies highlighted on this page, we manage approximately $8,000,000,000 in AUM. We have considerable additional capacity and are poised to benefit as allocators come back to emerging markets or reallocate to emerging market managers who can add value over what have been lackluster index returns. As with all of our strategies, the characteristics are consistent: talent, absolute and relative returns, long term allocations, fragmented markets and time. We will continue to execute and remain patient. Over time, we expect outcomes consistent with the value we have historically added for clients and generated for shareholders.

Speaker 2

I will now turn it over to CJ to discuss our recent financial outcomes.

Speaker 4

Thank you, Eric. An overview of financial results begins on Slide 8. Assets under management ended the June quarter at $159,000,000,000 down slightly from last quarter and up 11% from the June 2023 quarter. Net client cash outflows during the quarter were 1,600,000,000 dollars Net outflows in our growth and value strategies were partially offset by net inflows in our sustainable emerging markets and fixed income strategies. 2nd quarter outflows were lumpy and included 2 redemptions from non U.

Speaker 4

S. Clients totaling $1,100,000,000 As Eric mentioned, the 2nd quarter included a roughly $800,000,000 inflow in our sustainable emerging market strategy, nearly doubling the assets in that strategy. And in early July, we onboarded 860,000,000 dollars into our emerging markets debt opportunity strategy. Average AUM for the quarter was up 3% sequentially and up 14% compared to the June 2023 quarter. Our complete GAAP and adjusted results are presented in our earnings release.

Speaker 4

Revenues for the quarter increased in line with average AUM, up 2% when compared to the March 2024 quarter. Compared to the June 2023 quarter, revenues were up 11% on higher average AUM. Our average recurring fee rate for the quarter was 69 basis points consistent with last quarter. The fee rate is down 1 basis point from the June 2023 quarter largely due to strategy mix with the addition of lower fee fixed income inflows. Adjusted operating expenses for the quarter were up slightly over the Q1 of 2024, primarily from travel associated with our annual investment forum held in the Q2.

Speaker 4

The increase in short term incentive compensation from higher revenue was offset by seasonal decline in certain compensation related expenses that we typically see in the Q2 of each year. In comparison to the same quarter last year, adjusted operating expenses are up $18,000,000 or 11% primarily from higher revenue based incentive compensation. Adjusted operating income increased 7% sequentially and 13% compared to last year's June quarter. Adjusted net income per adjusted share improved 8% compared to last quarter and 15% compared to the June 2023 quarter. Year to date revenues were up 12% compared to the same period in 23 on a higher average AUM.

Speaker 4

Adjusted operating expenses increased 11% from the 2023 6 month year to date period, primarily from higher incentive compensation on elevated revenues. Also contributing to the increase in compensation and benefits are higher fixed comp expenses from a 4% increase in the number of full time associates and annual merit increases. Amortization of long term incentive compensation increased primarily from the $4,000,000 impact of the acceleration clause included in the 2024 annual grant discussed last quarter. We expect the long term amortization to be $16,000,000 in each of the 3rd 4th quarters of this year, excluding the mark to market impact. Higher revenues year to date led to a 15% improvement in adjusted operating income and a 16% improvement in adjusted net income per adjusted share over the comparable prior year period.

Speaker 4

In calculating our non GAAP measures, non operating income includes only interest expense and interest income. Although the income generated on our seed investments adds to shareholder economics, we fully exclude these investment gains from our adjusted results to provide transparency into our core business operations. Our balance sheet remains strong. We currently have $150,000,000 of seed capital in our investment products with significant amounts of realizable capacity. As those products begin to scale, we will redeem the seed capital to deploy into new products, otherwise reinvest in the business or return it to shareholders.

Speaker 4

In addition, our $100,000,000 revolving credit facility remains unused. We continue to return capital to shareholders on a consistent and predictable basis through quarterly cash dividend payments and a year end special dividend. Consistent with our dividend policy, our Board of Directors declared a quarterly dividend of $0.71 per share with respect to the June 2024 quarter, which represents approximately 80% the cash generated in the quarter. That concludes my prepared remarks, and I will now turn the call back to the operator.

Operator

We will now begin the question and answer session. The first question comes from Alex Blostein with Goldman Sachs. Please go ahead.

Speaker 5

Hey, good afternoon. Thanks for taking the question. I was hoping we could start with the old discussion that you started at the beginning of the presentation. So maybe spend a couple of minutes on just walking through strategies that you expect to be most active in their fundraising goals over the next kind of 12 to 18 months within the alts kind of distribution and the footprint that you established there. And as you build out this part of the business, can you talk a little bit about the fee rate within the alts bucket and how that's likely to evolve based on where you expect the growth to come from?

Speaker 3

Sure. Hey, it's Jason. I think we've got pretty high expectations that all of the strategies in the alts bucket will be active over the next several months, if not 12 to 18 months. I'd highlight a few. If you look at global unconstrained, as you well know, the milestone of a 3 year track record is a pretty meaningful milestone and we're about 6 or 7 months away from that.

Speaker 3

That strategy has continued to compound wealth at a meaningful absolute rate of return, provided diversification benefits, low correlation, low volatility, produced really nice alpha for clients. We've put a strong campaign around that to get that out in light of the fact that the M sites team has been managing the strategy going back well past a decade prior to joining Artisan. And so we feel like we've really got good momentum for that strategy. And when the time comes, when the 3 year record hits, we think we'll be in a really good spot. When you think about credit opportunities, something that we've been talking about for a while, we're now well into our 7th year of performance.

Speaker 3

The 5 year number is generating a mid teens net return to clients. It's delivering on pretty much every expectation that we can think of that clients are looking for. Allocations within alts and fixed income are picking up and we're seeing that activity and that volume pick up well. The pipeline feels really strong there. This isn't going to surprise you, China post venture and just the overhang from the macro makes it a little bit more of a challenge.

Speaker 3

So while there is that macro overhang, we are still actually still having clients engaging. They don't want to miss the bump when if and when China does re rate. And the fact that Tiffany and her team have just continued to deliver this year alone, I might get the number exactly precisely wrong, but I'm close here. But they're producing over 1,000 basis points of excess return year to date and that compounds on top of long term alpha that they've already been able to produce. And so that to us is more of a timing issue.

Speaker 3

And then when you think about Antero, you've seen a really nice uptick in their performance more recently. That might take a little bit more time in light of the fact that they did have a difficult alpha history over the last 1 to 2 years. But we're thrilled that Chris has been able to right the ship and put up some really good numbers. When you think about the fee rates, all of our strategies have fee rates commensurate with the alpha that we expect them to deliver on. Global unconstrained, the expense ratio and management fees are somewhere around 100 basis points and we would expect that to be maintained.

Speaker 3

Some of the new things that we're looking at on the horizon would continue to deliver in that sort of 100 basis point category in that 100 basis point range. So we don't see any reason to believe that trend won't continue.

Speaker 2

Got you. Yes.

Speaker 5

No, I was thinking that the fear rate might actually start to kind of creep up a little bit, right, in that bucket more meaningfully if some of these wins come online. Great.

Speaker 3

Yes.

Speaker 2

I think you're right. Cool.

Speaker 5

All right. Well, speaking of FURATE, can you maybe give a little bit of color on the $800,000,000 win you highlighted in emerging market debt? It sounds like it funded in July and whether or not that's going to have any impact on the fee rate for fixed income as we look forward?

Speaker 2

Yes, Alex, it's Eric. The fee rate was highly competitive for a large mandate. I think the positive we're starting to see in the marketplace as people rebalance and restructure is we don't see the trend towards just taking the lowest fee rate bid, which we were always hesitant to bid over the last few years when large mandates were just completely a scale and fee game. In more recent competition, we see a shift towards finding focused, high quality active managers and competing at a fee rate. It is competitive for large allocations, but I think that the positive trend and takeaway for us is we're starting to really compete there across the board.

Speaker 2

When we look at our pipeline across the firm, we're seeing a lot of larger mandates, where that's the case and it's across many of our investment franchises as we look out next couple of quarters.

Speaker 5

Okay, great. Thanks. I'll hop back in the queue.

Operator

The next question comes from Bill Katz with T. B. Cowen. Please go ahead.

Speaker 6

Okay. Thank you very much for all the color. So just in terms of the opportunity set you mentioned trying to get bigger and alternatives both in the manufacturing and the distribution side. Could you talk a little bit about how you're thinking about incremental teams now and how that sort of played through on sort of a de novo versus maybe an inorganic opportunity? And then how you're facing off in the distribution?

Speaker 6

There's a lot of the alternative managers who have built pretty sizable sales forces and speak to the import of that sort of gain traction with the traditional financial advisor community to increase those allocations. So just trying to get a sense on where else to look for incremental investment by the team to grow Alts and then how to leverage that through the retail distribution channel notwithstanding your notion that you don't want to become like a distribution led platform? Thank you.

Speaker 3

Hey Bill, it's Jason. I'll take the first part of your question. We're certainly spending incremental time with both our existing franchises where we think that there's some broad opportunities to expand degrees of freedom and move incrementally across the board into alternatives. So that's taking up a fair bit of our time and we're excited to partner with our existing teams. That's going to be the highest and best use of our time.

Speaker 3

But when we look across the landscape, we are extremely busy evaluating external opportunities as well. And as you can imagine, it ranges across a number of different asset classes. We're seeing everything from private equity, private credit, private real estate, GP stakes, investment opportunities, you name it. And the I would just highlight something that I think we talked about last quarter or the quarter before, but our investment strategy group, which is a very deep and experienced team that partners with our existing franchises and certainly is out there in the market talking with new opportunities is well equipped to handle the volume. But we have seen a pretty meaningful uptick in the volume of opportunities that's coming across our desk.

Speaker 3

And they are coming in many different forms. There's clearly the lift out approach, which we've incorporated into our business for the last 30 years and certainly acquisition opportunities across all those asset classes. And we're not saying no to anything. We want to look and be objective and evaluate each one on the merits. But it's as you've heard us say numerous times, it's always going to come down to the talent.

Speaker 3

If we find the right talent and the right asset class that diversifies the platform, then that's what excites us. And if we can make it work, we will certainly do it.

Speaker 2

And Bill, it's Eric. With regards to the question on the distribution, we've certainly seen quite a few alternative shops filled out distribution to mainly capture the wealth channel is what we're seeing and hearing. And we have added a couple of individuals to focus on alternative strategy sales. The feedback we received from those individuals as we are hiring them is that we were extremely attractive organization to join because of our current footprint in the intermediary channel. We have 80 plus ratings across the broker dealer space.

Speaker 2

We have an enormous breadth in the large financial advisor or RIA market and we have an established network in the bank trust world. It really is just connecting the relationship to the alternative side of the house, which gives us a leg up versus starting from 0.

Speaker 6

That's helpful. And then just coming back to your commentary around the opportunity here for emerging markets to pick up both in terms of the seizing of your platform as well as potential allocations. Maybe 2 part, where might those allocations be coming from and what are the implications for the rest of your business, the growth in the value side of the equation? And then you mentioned the big win in July. I wonder if you can give us a broader update of what you're seeing and so some of the other parts of the business to net up against that?

Speaker 6

Thank you.

Speaker 2

Primarily in the emerging markets, we a lot of discussion around the institutional channel. You've seen an array of discussions go on over the last year. Some people have excluded emerging markets altogether. Some people are talking about separating out China and many are looking at their targets and wondering should they be rebalancing up or restructuring managers to address with the lower returns. Net net, we think any discussion around emerging market allocations and any rebalancing back to target or restructuring benefits us enormously.

Speaker 2

Given the mix of strategies we have, especially on the emerging market equities and more recently on the emerging market debt, as our emerging market debt seasons and gets to that 3 year record. And as we increase the AUM in those strategies, we're going to be able to compete at the institutional level, where typically a 3 year and asset minimum is required. So we have a positive outlook on our emerging markets, opportunity set and see it primarily occurring in the institutional, both U. S. And non U.

Speaker 2

S, maybe a little bit more emerging market that outside the U. S. And equities in the U. S, but that would be a slight difference. And with regards to the other large mandates, it's across the platform, that we see this tilt as people may have brought down their active waiting versus passive.

Speaker 2

They've also rebalanced and structured towards higher quality active managers that has benefited us. And they've stepped back away from just going after the lowest fee possible as they rebalanced the managers. So we've seen multiple at least 5 plus franchises compete on large mandates on a go forward basis.

Speaker 6

Thank you.

Operator

This concludes our question and answer session and the Artisan Partners Asset Management Business Update and 2024 Earnings Call. Thank you. You may now disconnect.

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