Franklin Resources Q3 2023 Earnings Call Transcript

AlphaStreet
Provided by AlphaStreet
July 28, 2023
Skip to Questions & Answers
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. [Operator Instructions]

I would now like to turn the conference over to your host, Selene Oh, Head of Investor Relations for Franklin Resources. You may begin.

Selene Oh
Head of Investor Relations at Franklin Resources

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 described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including in the Risk Factors and the MD&A sections of Franklin's most recent Form 10-K and 10-Q filings.

Now, I'd like to turn the call over to Jenny Johnson, our President and Chief Executive Officer.

Jennifer M. Johnson
President Chief Executive Officer at Franklin Resources

Thank you, Selene. Hello, everyone, and thank you for joining us today to discuss Franklin Templeton's results for the third fiscal quarter of 2023. As usual, I'm joined by Matt Nicholls, our CFO and COO; and Adam Spector, our Head of Global Distribution.

Over the past several years, we've 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.

This quarter, long-term net flows turned positive, investment performance remained strong and adjusted operating income improved by 8%. Financial markets, in general staged rebounds in the first-half of the calendar year. The S&P 500s indexes concentration in five companies is that it's most extreme level in more than 30 years. A challenge for those seeking to outperformed 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. 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 alternatives and multi-asset strategies, in particular, which both saw positive net flows during the quarter. In addition, we experienced strong flows in ETFs, SMAs and the high-net worth channel, and flow trends continued to improve across all geographies, benefiting from our regional sales model and strategy.

Our EMEA and Asia Pacific regions both reported positive long-term net flows. That's the second 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 and 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 billion in AUM as of April 30, 2023 from Great-West for approximately $925 million, primarily funded with equity. Great-West will make an initial incremental asset allocation of $25 billion to our specialist investment managers within 12 months of closing, with that amount expected to increase over the next several years. Great-West will also become a long-term shareholder in Franklin Resources. And of the equity issued to Great-West, shares representing 4.9% of our common stock are subject to a five-year lock-up. This is a compelling transaction for both firms, and we're looking-forward to actively partnering to develop additional opportunities that would be realized overtime. The agreement aligned with our focus to further grow insurance client assets and expand 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. Specifically, the acquisition of Putnam will increase Franklin Templeton's defined contribution AUM to almost a $100 billion. As a reminder, the acquisition of Putnam is expected to be modestly accretive to run-rate adjusted EPS by the end of the first year after closing, adding approximately $150 million of run-rate adjusted operating income in the first year post-closing inclusive of cost synergies. The acquisition remains on track to close in the fourth 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 $1.43 trillion, primarily due to market appreciation and we shifted into positive long-term net flows of $200 million, 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 billion into alternative strategies. Our three largest alternative managers, Benefit Street Partners, Clarion Partners and Lexington Partners generated a combined total of almost $5 billion in net inflows. This included raising over $1 billion in secondary private-equity in the wealth management channel under the alternatives by Franklin Templeton brand. Today, alternative assets are $257 billion 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 strategies generated another quarter of positive net flows, with $2.3 billion. 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 billion this quarter, including the funding of a previously disclosed $3.2 billion institutional mandate. While active equities continue 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 $3.1 billion. 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, enhanced liquidity and TIPS strategies. 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 region generated positive long-term net flows.

From a vehicle perspective, ETFs generated net inflows of $1.1 billion, representing the third consecutive quarter of net flows of approximately $1 billion, and AUM totaled $16.2 billion at quarter end. In the quarter, we also launched two 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 billion and generated positive net flows. 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 it's AUM has doubled to $4.5 billion since the announcement of the acquisition. This past quarter, Canvas generated net inflows of approximately $300 million 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 clients' 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.

Turning now to investment performance, which we're pleased to stay remains strong, 63%, 53%, 67% and 63% of our strategy composite AUM outperformed their respective benchmarks in the one, three, five and 10-year periods respectively. For mutual fund investment performance, 44%, 58%, 66% and 51% of our AUM outperformed their peers on a one, three, five and 10-year basis. This represents improvement in the three-year and five-year periods from the prior quarter due to strengthened performance in equity and certain fixed-income strategies. The one 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&P 500.

Touching briefly on our financial results. Ending AUM increased by 0.7% to $1.43 trillion as of June 30th from the prior quarter, reflecting market appreciation and positive net flows. Average AUM was flat from the prior quarter at $1.42 trillion. While our effective fee rate remained stable, adjusted operating revenue increased by 3% to $1.56 billion. Adjusted operating income increased by 8.3% to $476.8 million from the prior quarter. Adjusted operating margin was 30.5% compared to 28.9% in the prior quarter. We continue to maintain a strong balance sheet with total cash and investments of $6.9 billion 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. I would like to thank them for their many contributions and for their unwavering client focus.

Now, let's turn to your questions. Operator?

Skip to Participants
Operator

Thank you. [Operator Instructions] First question comes from Alex Blostein at Goldman Sachs. Please go ahead.

Alexander Blostein
Analyst at The Goldman Sachs Group

Hey, good morning. Thanks for -- 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 fundraise here. So how large do you think the size could ultimately of that fund be? 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 six to 12 months?

Jennifer M. Johnson
President Chief Executive Officer at Franklin Resources

So, I think we publicly disclosed that Lexington rate $18.2 billion so far on their latest fund. I think in the quarter it was about -- it's a little over $3 billion, maybe be $3.4 billion. And of that, I think what we're incredibly proud of is the fact that we raised a little over $1 billion in the wealth channel and first time fund. I think the expectation was that if we raised $500 million, that would be pretty good for first time fund. And we've talked on these calls before about how complicated it is to raise alternatives in the wealth channel because it requires not only retraining of your own sales team, but actually training of the financial advisers. And so we put a lot of effort over the last 18 months, we've built out a 40% alts wealth specialist team. We've used our Academy to train our own internal sales folks as well as helping to train the financial advisers. So that was a big part of it. And I think the fund can raise up to $20 billion. And I think it's quite possible that that will happen.

Alexander Blostein
Analyst at The Goldman Sachs Group

Great. And then just as far as the pipeline of other things that are in the hopper as you look out over the next six to 12 months?

Jennifer M. Johnson
President Chief Executive Officer at Franklin Resources

Well, it's specifically in the alt space. I mean, so private credit we still think is just a great opportunity, right? Our view is that banks are going to even lend less and they've been lending. And you know, it is definitely from deploying capital has been slowed down by the fact that M&A slowed down. just read an article yesterday where somebody was talking about, they are seeing M&A pickup. That will make a difference. We're thrilled because having BSP at $78 [Phonetic] billion, we cover both the US and Europe. But in addition to that, what are the things actually really important in these times, is having the knowledge and expertise in special situations where you could work out deals. So, you know, if you have an underlying credit that is struggling because of the -- maybe they can't cover the rate, being able to restructure it is really important and BSP has -- has that expertise internally.

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 have been able to handle this work. And again, we think as M&A activity picks back up, you're going to be -- they are going to be able to deploy more capital. They said, they now are seeing the best deal since they've seen since the global financial crisis.

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 that that's not been a big exposure for them. Their focus has been on industrial space, datacenters 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 underbuilding of multifamily is important. But the issue has been a little bit around the bid and ask on just the sellers been willing to accept lower prices and the buyer is being willing to pay. So, as that -- as we see that smooth out, I think you'll see more -- more movement in the real estate space.

They just -- on the redemption cue. Just a reminder. Their clients are mostly institutional and so they don't have the kind of requirement to do redemptions because the institutions don't want any kind of fire sale. And so they have more flexibility on the redemption cues, which equates to less than,. I think 10% of any the... Adam, it looks like you want to add something there.

Adam B. Spector
Executive Vice President, Head of Global Distribution at Franklin Resources

Sure. I was going to say a couple of things Alex. One, 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 alternative firms in the private markets. I would also say then 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 BSP, our venture funds in the wealth channel. So, feeling good about that. 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.

Matthew Nicholls
Executive Vice President, Chief Financial Officer, and Chief Operating Officer at Franklin Resources

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

Alexander Blostein
Analyst at The Goldman Sachs Group

Got it. Super helpful. Just a quick follow-up, staying on the Alts for a second and it's a little bit of a nuance question. But when we look at the roll-forward in AUM table, it looks like the alts had a negative mark-on and I am a little surprised just given that the mark-to-market dynamics generally have been positive in other places. So is it a lag or is there something idiosyncratic that drove the negative mark-to-market in the alts bucket. Thanks.

Jennifer M. Johnson
President Chief Executive Officer at Franklin Resources

We had positive marks in BSP and Lexington in the slightly negative. It might have been realizations in real estate. So I'm not sure of that. It may have been redemption. So I'm not sure -- I'm not sure what you were referring to out.

Alexander Blostein
Analyst at The Goldman Sachs Group

Okay, we can circle back, it's probably real estate. I appreciate it. Thanks.

Operator

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

Glenn Schorr
Analyst at Evercore ISI

Thanks very much. So wanted to drill a little further in Putnam, its interesting because after Benefit Street and Lexington I think our minds were all focused on the out world. And so I like the partnership we formed with them. I like the $25 billion they are investing with you, the five-year lock-up on the stock. I'm curious on the insurance and the retirement channels. Were they growing there, which strategies? And then more importantly, with your broad diversified offering, what do you expect that you can actually sell into that channel to level that distribution?

Adam B. Spector
Executive Vice President, Head of Global Distribution at Franklin Resources

Sure, it's Adam here. So a couple of things. I would say; one, with Putnam we get tremendous investment performance. I think they are the only firm that had their fund family in the top 10, for like the three to five and 10-year periods. So, good investment performance across-the-board. They bring a few investment capabilities that we did not have before. Target date is a good example where they have $6.5 billion. 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 two other areas where there are quite strong.

They have been very strong in both insurance and the DCIO market, and our plan there is to really integrate those two 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 two teams will be able to serve all of them in a much more effective way.

Jennifer M. Johnson
President Chief Executive Officer at Franklin Resources

And I just will add. I mean, looking at the Morningstar flows, I think it's something like four in the top 10 slowing categories are target date funds, and so having a good performing target date with nearly what Putnam brings is the expertise on selling into the retirement channel that we're really excited. We think that will benefit all the retirement platforms that we do business with. And as Adam mentioned, just having two great products from a stable value maternity will be nice to add to our suite.

Matthew Nicholls
Executive Vice President, Chief Financial Officer, and Chief Operating Officer at Franklin Resources

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 the transaction. Their AUM is up slightly by 2% to 3% based on the market, but 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 of what we expect to get out of the acquisition from both a financial perspective and a 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.

Glenn Schorr
Analyst at Evercore ISI

All right. Thank you for all that.

Matthew Nicholls
Executive Vice President, Chief Financial Officer, and Chief Operating Officer at Franklin Resources

Thank you.

Operator

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

Michael Cyprys
Analyst at Morgan Stanley

Hey, good morning. Thanks for taking the question. Just wanted to ask about capital deployment. The cash balance continues to rise here, cash and investments of $6.9 billion, nearly $7 billion. Just curious how you're thinking about putting that to work from here? It sounds like a little bit of debt paydowns, some buybacks limited to offset share dilution. So it seems like meaningful capital put to work in M&A. So just curious how you're thinking about that opportunity set as you look out from here?

Matthew Nicholls
Executive Vice President, Chief Financial Officer, and Chief Operating Officer at Franklin Resources

Yeah, so I think -- I think our capital management strategy is going to remain consistent with what we communicated in the past year. Number one is maintaining the trajectory of our dividend we've had over many-many years. Number two is organic growth opportunities in the business. Number three, 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 the shares we've repurchased to date. But we will catch up on that this quarter and make sure that we are very much in line with that communication that we've -- that we've been consistent about.

We, obviously have debt that we need to service. We paid down $300 million of debt in July as announced and that was the term loan that we had in place and we paid that off. We're saving about $4.5 million by doing that, but we're retaining the exact same amount of liquidity by replacing that $300 million term loan with a with a larger revolvers, so we've taken out $500 million revolving credit facility and the $300 million term loan which was $800 million in total, paid off the $300 million term loan and replaced it with one single $800 million five-year revolving credit facility. So we've actually enhanced our liquidity and financial flexibility by doing that and saved $45 million in the process.

And then opportunistic share repurchases, on top of that in M&A. I think Jenny has mentioned several times, we're very interested in the infrastructure space around M&A and the alternative asset space in particular. And in terms of the opportunistic share repurchase, the way I would describe that is as a consequence of how we decided to fund the Putnam acquisition with issuing 33.3 million 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 closed the transaction. So, we certainly expect to pick up share repurchase -- consequence of doing that transaction.

Michael Cyprys
Analyst at Morgan Stanley

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 can have on the competitive landscape? And maybe you could talk a little bit about how you're experimenting, to what extent with that today?

Jennifer M. Johnson
President Chief Executive Officer at Franklin Resources

Yeah, so. I mean, first of all 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 four years if you -- you probably have heard lot of goals optimization engine tool that's all built on AI. And we're doing what others are doing around use. We use AI for early warning system. So things like risk management, business intelligence, intelligent automation. So we have a proof-of-concept pilot going on where we have our sort of like a portfolio of research assistant. So its summarizing 10-Ks and Annual Reports for RPM teams.

One of the most important things you have to do is to build a sense 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 for help desk, hoping to respond within 10 seconds if the -- we've got a pilot going on to generate a draft fund commentary, again it's all training the models to be able to generating marketing material. 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 models. So we have -- and the message is we've got quite a bit going on here. We've been -- we're early in it because the go products would have got us in there. And we think it will be both -- I think initially it's more of a expense benefit and efficiency benefits, but you hope that it makes your portfolio managers and your research assistants more efficient, and then things like go -- or revenue-generating tools, so.

Michael Cyprys
Analyst at Morgan Stanley

Great, thank you.

Operator

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

Patrick Davitt
Analyst at Autonomous Research

Hi, good morning, everyone. Sorry if I missed this. But is 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 fourth quarter? Thank you.

Matthew Nicholls
Executive Vice President, Chief Financial Officer, and Chief Operating Officer at Franklin Resources

Yeah, thank you. So, I'll go through what we expect in the fourth quarter 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. Think it might be slightly higher than 39 basis points in the fourth quarter, that's around 39 basis points.

In terms of comp and benefits, again this is all fourth quarter. For modeling purposes I would assume $50 million in performance fees as we've described in the past, that would lead us to approximately $740 million in comp and benefits. IS&T, we took that similar to what we described last quarter at $120 million [Phonetic] very consistent. Occupancy in the mid-to-high 50s, we guided a high 50s last quarter, we came in a little bit lower than that. We expect to be roughly the same again. And then G&A, we expect to be in the mid 140s, inclusive of continued normalization of TNA for the quarter.

In terms of. What that means for the year, Q2 higher assets under management, better performance, increased fundraising related to compensation -- increased raising related compensation and expenses. Our overall guide increases slightly to just over $4 billion. It's very similar to what I described last time, but may be slightly higher than that, certainly on the high-end at $4.8 billion or something like that, $4.09 billion. But again, that's all -- that's assuming the market stays where it is today and assuming those -- that -- excluding performance fees. That is, as I've described.

I mean, then in terms of the margin though, and I think you've asked about this several times in the prior year. It's obviously difficult to guide on the margin because that means we're guiding revenue essentially, but all else remaining equal, we expect our operating margin to be stable in the 30% area in the next quarter.

Patrick Davitt
Analyst at Autonomous Research

Thank you. And any thoughts -- any thoughts on next year or is it still too early?

Matthew Nicholls
Executive Vice President, Chief Financial Officer, and Chief Operating Officer at Franklin Resources

It's too early. The only thing I would say -- it's interesting question obviously because we're going to be in the process of implementing or integrating the Putnam acquisition. I think as we've dug further into this post announcement and as we get into the integration work and execution work, we're quite familiar with by now, I think we can say two things. One, you can expect from us continued meaningful expense discipline going into 2024. And I think you could see from us potentially more -- potential with the acquisition of Putnam as we integrate because we found other areas within Franklin 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&A is we always focused on the growth areas. 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 side to reexamine how we do things and reexamine how we can be better and do things better, and as a result of that I think you'll find 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.

Patrick Davitt
Analyst at Autonomous Research

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

Matthew Nicholls
Executive Vice President, Chief Financial Officer, and Chief Operating Officer at Franklin Resources

Yeah, the way Patrick I would look at that for this quarter is, it essentially is an operating income zero. So in other words, the the revenue associated with the catch-up is practically the same as the expense. In fact, the expenses might have been slightly higher, like $1 million or something like that. That's an operating operating income neutral. But then of course going into [Speech Overlap]

Patrick Davitt
Analyst at Autonomous Research

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

Matthew Nicholls
Executive Vice President, Chief Financial Officer, and Chief Operating Officer at Franklin Resources

It's like $33 million, something like that. In the low-to mid 30s.

Patrick Davitt
Analyst at Autonomous Research

Got it. Thanks a lot.

Matthew Nicholls
Executive Vice President, Chief Financial Officer, and Chief Operating Officer at Franklin Resources

Thank you.

Operator

Thank you. The next question comes from the Craig Siegenthaler from Bank of America. Please go ahead.

Craig Siegenthaler
Analyst at Bank of America

Thanks, good morning. On the Putnam transaction, I know it's going to bring $25 billion of flows in 12 months after closing, but I wanted to come back to what could happen from some of the cost cuts because you're cutting a lot of cost-out of the company. I think $150 million. So maybe you provide some perspective on the potential for merger-related dyssynergies or outflows on Putnam is a $140 billion AUM base.

Matthew Nicholls
Executive Vice President, Chief Financial Officer, and Chief Operating Officer at Franklin Resources

Yeah. So the $150 million guide that we gave as we announced the transaction, that is inclusive of some modest attrition across the company. And that's how we got. I think we 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 strategy is 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 will be be more than offset by other potential operating income and operating expense reductions in the transaction. So again, we stay very firm on the $150 million and we think there's a potential to be higher than that.

Adam B. Spector
Executive Vice President, Head of Global Distribution at Franklin Resources

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

Matthew Nicholls
Executive Vice President, Chief Financial Officer, and Chief Operating Officer at Franklin Resources

But I would just -- I would just also add. Thank you, Adam. I will 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 million 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 first year, but after that first year, all else remaining equal, we certainly see other opportunities to go beyond that.

Craig Siegenthaler
Analyst at Bank of America

Thank you, Matthew and Adam. One follow-up on the SMA business, you've got a great business here and since flowing. I think you highlighted Franklin income is one of the flagship 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 then when you look at sales, what does the mix look like across cross-channel? Is it heavily wire houses and heavily RA? I'm curious to see what of upside?

Adam B. Spector
Executive Vice President, Head of Global Distribution at Franklin Resources

Sure. I think the way to think about that is; One, look at the legacy business and two, look at the projection of the business going forward. So if we look at the legacy of the business, it really was strongest that the [Indecipherable] 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 six broker-dealers at a number of our [Indecipherable] 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 the SMA businesses and munis, where we've seen about a 30% increase in 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 in SMA format and that's what we're building out right now.

Craig Siegenthaler
Analyst at Bank of America

Thank you.

Operator

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

Brennan Hawken
Analyst at UBS Group

Good morning. Thanks for taking my questions. So, just wanted to follow-up there on the catch-up fees in Lexington. Number one, this was -- you're still raising it sounds like. So was this a preliminary close and do you expect there'll be further catch-up fees at the actual formal close? And I was just running the math on the 33 [Phonetic] I'm maybe 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 I it seems as though the catch-up maybe contributed about a basis point this quarter, so I wasn't quite sure about that.

Matthew Nicholls
Executive Vice President, Chief Financial Officer, and Chief Operating Officer at Franklin Resources

Yeah, thanks, Brian. So firstly, I said 33, but I was just using that as a midpoint, that's not the exact number. We're not going to guide on where our catch-up fees are going, but I'll just say couple of things. So the -- in terms of the fundraise, I think Jenny mentioned this at the beginning, where a couple of things were allowed to say around the fund raise. Number one, we're ahead of target. Number two, we're at $18.2 billion right now, that was what was announced and real filed recently. Number three, 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 jut to be clear about this because I think to the question that Patrick was getting at earlier. I think even without the catch-up fee in fourth quarter, our EFR we would expect it to be around 39 basis points. So we're not -- 39 basis points is not reliant upon the catch-up fee per se. That's I think you -- I think that's the question you were trying to get at -- trying to correct.

Brennan Hawken
Analyst at UBS Group

Yeah, yeah, yeah. Thank you. I appreciate that. Just wanted to try to understand some of those mechanics. So thanks for laying that out.

Matthew Nicholls
Executive Vice President, Chief Financial Officer, and Chief Operating Officer at Franklin Resources

And then obviously after the -- 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, then 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 one basis -- 1% area. So, and that's the -- that's the aspect of the fees that I would focus on that helps our EFR on the long-term. That's what helps us remain around that 39 basis points.

Brennan Hawken
Analyst at UBS Group

Oh, for sure. Yeah, yeah, this is sort of noise and what not. I just wanted to understand it for modeling purposes. So thank you for that. You guys flagged in your comment document, I believe, is what it is referred to that there were some improving performance in taxable fixed income strategies, which led to the lift in the investment performance versus benchmarks. 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 dialog, and what drove the reversal? Thank you.

Jennifer M. Johnson
President Chief Executive Officer at Franklin Resources

Yes, so, significantly improved performance at Western in core, core-plus, in macro ops in only [Indecipherable] remember the numbers exactly, but it's first 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 Western, I'm not sure it will be quite, but it feel like they've kind of turned the corner there.

I want to address one other just performance because on the one 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 that. So that's 14% of the mutual fund ETF number. The Franklin Income Fund is in. There is no such category for multi-asset income in the retail channel at Morningstar. 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 fund at 5.75%. The peer average in the retail category yields 1.84% versus 5.75%.

So if there were in income category at Morningstar, then it would be in the top-quartile and that would swing us up to 58 percentile. And because it's so significant, I just feel like it's important to understand there just isn't a category and fortunately the $1.5 billion in flows that we've had -- net flows in Franklin Income Fund improved, 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.

Brennan Hawken
Analyst at UBS Group

Thank you for that color.

Adam B. Spector
Executive Vice President, Head of Global Distribution at Franklin Resources

And to that I just might add, because 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 one but not funded, and that is really because we believe a number of institutions are waiting for the interest rate cycle to settle in or we're going to have one more hike, what will happen to inflation. 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 opportunity.

Brennan Hawken
Analyst at UBS Group

Got it. Thanks very much.

Operator

Thank you. Next question comes from Ken Worthington from J.P. Morgan. Please go ahead.

Kenneth B. Worthington
Analyst at J.P. Morgan

Hi, good morning. When commenting on the improvements in multi-asset product flows, you mentioned solutions as a contributor. To what extent our 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?

Jennifer M. Johnson
President Chief Executive Officer at Franklin Resources

So, you know, I would say that, that depends more on the plans. So for example, FTIS is one mandates 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 have also want insurance mandates that had some competition of alternatives in there. So I think that's more a -- I think that question, it depends more on the channels, the FTIS is -- Franklin Templeton Solutions Investor Solutions Group is serving then how that performs.

Adam B. Spector
Executive Vice President, Head of Global Distribution at Franklin Resources

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 out only solutions as well, where if the 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.

Jennifer M. Johnson
President Chief Executive Officer at Franklin Resources

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 to retirements and building sleeves to go into managed accounts and some models in there. So we think that's a real opportunity.

Kenneth B. Worthington
Analyst at J.P. Morgan

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. Is that right?

Jennifer M. Johnson
President Chief Executive Officer at Franklin Resources

No, because like -- it might be that somebody wants an income solution model portfolio, right, or LDI type, and so they will go away and depending about the client's desired outcome is and they will use multiple of our managers to bring that ultimate solution to the client. If fact, its areal OCIO type situation. They even do -- they have a team that researchers outside managers. But most of their solutions include multiple of our Sims.

Kenneth B. Worthington
Analyst at J.P. Morgan

Right. Got it. Thank you.

Operator

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

Daniel T. Fannon
Analyst at Jefferies Financial Group

Thanks, good morning. I wanted to clarify on performance fees with 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 sits and we think about fourth quarter and even potentially into December, which has some other crystallization, how we should think about maybe where performance sits for that performance eligible AUM?

Matthew Nicholls
Executive Vice President, Chief Financial Officer, and Chief Operating Officer at Franklin Resources

Yeah, 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 five years ago, where a five-year performance threshold has been hit.

We expect going into next quarter performance fees, I think we continue to guide at $50 million because it's so hard to predict this with any form of accuracy, but we'd guide between $50 million and $60 million for the quarter, as you mentioned going into the -- our first fiscal quarter which is the last calendar quarter, the fourth 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.

Daniel T. Fannon
Analyst at Jefferies Financial Group

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 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 to think about the momentum and where you are in that process?

Adam B. Spector
Executive Vice President, Head of Global Distribution at Franklin Resources

Sure. I think let me go back to where the starting point was, which was, that's a central distribution team was responsible for globally all institutional and all wealth management raising and client servicing for legacy Franklin Templeton. On the Legg Mason side, again it was more the teams handled. a large portion of their institutional Asset management, especially in the US. What we've seen over the last two years is a gradual movement towards more coordinated global effort. 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 out of Western that has 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 side, but -- 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 general salespeople are able to make introductions that then the alternative firms can close on their own.

Daniel T. Fannon
Analyst at Jefferies Financial Group

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

Adam B. Spector
Executive Vice President, Head of Global Distribution at Franklin Resources

I can tell you I shy away from that because what we're trying to build is a culture of cooperation, where the 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.

Daniel T. Fannon
Analyst at Jefferies Financial Group

Okay. Thank you.

Operator

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

Brian Bedell
Analyst at Deutsche Bank Aktiengesellschaft

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

Jennifer M. Johnson
President Chief Executive Officer at Franklin Resources

I actually think it's been -- it's been net flows. So as Craig said, there is about $1.5 billion in net flows look. Look, it is the frustration during when interest rates were zero, he was in the 80% equity category because of course he looked for dividend yielding equity because he couldn't get anything and income and then as he was then been able to earn money in fixed-income, he shifted and so now he is in the 50% to 70%. So, yeah, it's honestly it's a discussion I personally had with Morningstar on it and just the problem is there is no real competitors in the wealth channel there, so they can build a big enough peer group. And so we often point to the institutional [Indecipherable] outperformance there.

And so to answer your question. Yeah, I'm sure there are some situations where it get screened out. On the other hand, 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 really pushed to get it on the SMA platform because they can hold it on an SMA platform and they do, they love it. They'll put client in there and fit through quite retirement. 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 on a one year category or any of the categories it can. But he 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&A session. I would now like to hand the call back over to Jenny Johnson, Franklin's President and CEO for final comments.

Jennifer M. Johnson
President Chief Executive Officer at Franklin Resources

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

[Operator Closing Remarks]

Corporate Executives
  • Selene Oh
    Head of Investor Relations
  • Jennifer M. Johnson
    President Chief Executive Officer
  • Adam B. Spector
    Executive Vice President, Head of Global Distribution
  • Matthew Nicholls
    Executive Vice President, Chief Financial Officer, and Chief Operating Officer
Analysts

Alpha Street Logo