Artisan Partners Asset Management Inc

NYSE:APAM

Earnings Call Transcript 2023-Q1

[Operator]

Hello, and thank you for standing by. My name is Roger and I will be your conference operator today. At this time all participants are in a listen-only mode. After the prepared remarks, management will come back the question-and-answer session and conference participants will be given instructions at that time. As a reminder, this conference is being recorded.

At this time, I will turn the call over to Artisan Partners Asset Management. Please go ahead.

[Makela Taphorn, IR]

Welcome to the Artisan Partners Asset Management Business Update and Earnings Call. Today's call will include remarks from Eric Colson, CEO, and C.J. Daley, CFO. Following these remarks, we'll open the line for questions. Our latest results in investor presentation are available on the Investor Relations section of our website.

Before we begin, I would like to remind you that comments made on today's call, including responses to questions may include forward-looking statement. These are subject to risks and uncertainties and are presented in the earnings release and detailed in our SEC filings. We are not required to update or revise any of these statements following the call.

In addition, some of our remarks today will include references to non-GAAP financial measures. You can find reconciliation of those measures to the most comparable GAAP measures in the earning release.

I will now turn the call over to our CEO, Eric Colson.

[Eric Colson, CEO]

Thank you all 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. Our added investing has been core to who we are since our firm was founded in 1994. We have always managed investment strategies designed to be differentiated with the potential to outperform indexes and peers.

As asset allocations and capital markets have evolved, we have expanded the high value added investing we do at Artisan Partners. Our financial and business outcomes are downstream of the high value added outcomes we generate for clients.

If we generate differentiated value added outcomes for clients, as we have historically, we believe successful financial and business outcomes will follow. Compounding assets under management, growing revenues and profits, attractive margins, successful careers for our people, and compelling returns for our shareholders. These outcomes take time. And we are patient.

We recently marked the 10th anniversary of our March 2013 IPO becoming a public company did not change our business philosophy, operating model or investment activities. We have stayed true to who we are. The long-term outcomes have validated our approach to running a business, centered on high value added investing.

Slide 2 outlines what high value added investing means to us. We identified and recruit exceptional investment talent. We give that talent the autonomy, degrees of freedom and resources needed to execute a unique and differentiated investment program. We minimize distractions and maximize time spent investing. We create economic alignment between our investment talent, client outcomes and business growth. And we give great investors the time it takes to execute their process through market cycles and differentiate from others.

The combination of these inputs plus time yields high value added results. That a fee return over extended periods to meet client goals. Alpha over passive indexes, outperformance relative to peers, portfolios and returns that are differentiated and difficult to replicate with exposure products.

We have been bringing together these elements and generating high value added results for over 25 years. We originally focused on style box and non-U.S. strategies attractive to institutional allocators and intermediaries in the United States. We then launched a series of global strategies beginning in 2006 that were attractive outside of the U.S. Beginning almost 10 years ago, we expanded into fixed income and emphasized greater degrees of investment freedom across the existing and new strategies.

As we have evolved, expanded and diversified our business, we have demonstrated that our philosophy and approach to high value added investing works across generations and asset classes. This gives us leverage to continue to thoughtfully grow our business overtime.

High value added investing can have a tremendous impact on client portfolios and wealth. On Slide 3, we show the outcome of a hypothetical portfolio consisting of $1 million invested at the inception of each of the 28 strategies we have launched over our history. The $28 million original investment would have grown to approximately $117 million at March 31, 2023, after fees. That is approximately $44 million, or 59.5%, more than a portfolio consisting of the same amount invested on the same dates, and each of the strategies corresponding benchmarks.

On Slide 4, we show the performance since inception of our 10 strategies with track records of more than 10 years. Nine of those strategies have outperformed their benchmark index since inception after fees. The average annual alpha of those nine strategies is 274 basis points after fees. We estimate that since inception, these strategies have generated approximately $26 billion of excess returns for clients. That is $26 billion of additional resources that our clients have to fulfill their missions and achieve their goals.

High value added outcomes for our clients drive our long-term business and financial outcomes. We constantly repeat that we are focused on long term results for our clients, our people and our shareholders. As I mentioned earlier, this quarter marked the 10th anniversary of our initial public offering. It decade is a sensible time period over which to assess our business philosophy and our execution of it.

Over the last 10 years, we have generated approximately $16.7 billion in excess returns for clients grown AUM from $83 billion to $138 billion, grown quarterly revenue from $148 million to $235 million, maintained average annual adjusted operating margins of 39.2%, distributed nearly $3 billion to our owners resulting in total dividends per share of $32.37, more than our IPO price of $30 per share. Generated a total annualized shareholder return of 9.81 with dividends reinvested, relative to 10.23% for the S&P 500, 6.79% for the Russell 2000 and 5.49% for the Dow Jones Asset Managers index.

While generating those financial outcomes, we have evolved our firm to align with secular shifts and asset allocations, capital markets, and sources of demand for high value added investments. Since 2013, we have grown from five investment teams to 10, from 12 investment strategies to 25 and from a single asset class to multiple asset classes, including high yield credit, long short equity, long short credit, emerging market debt, public-private, hybrid, and global macro. We have gone from no fixed income to two credit oriented teams and six credit oriented strategies.

We have significantly expanded our international emerging markets and China oriented investment activities, launching the Developing World, Global Discovery, non-US Small mid growth, international explorer and China post-venture strategies. Across our entire platform, we have expanded the opportunity set for our investment teams from primarily global public equities to include private equity, corporate credit, sovereign credit, loans, and a host of derivative instruments.

Today, we have more embedded growth potential than ever before. We have 15 investment strategies in their foundational growth phase with track records of less than 10 years. The total addressable market for high value added investing affords tremendous opportunity. We have the ability to extend our success and duration in public equities. And we expect to have similar success across fixed income alternatives, and other regions of the world such as China.

It will take time, but over appropriate time horizons, our approach has consistently generated successful client outcomes, business growth, high margins, and attractive total returns.

I will now turn it to CJ to discuss our more recent financial results.

[C.J. Daley, CFO]

Thanks, Eric. Our first quarter results reflect strong market returns and investment outperformance which drove our AUM up by 8% to $138.5 billion and March 31. While revenues improved nicely this quarter compared to the December 2022 quarter, our profitability remained flat as seasonal expenses increased in the first quarter.

I'll overview of our results begins on Slide 7. Global Equity markets rose during the quarter and gross of fees, our strategies in the aggregate generated returns of approximately 240 basis points above their respective benchmarks. As a result, our AUM increased $238.5 billion at quarter end of 8% compared to the last quarter, but down 13% from the March 2022 quarter.

Investment returns contributed $11.9 billion to the increase, which partially was offset by $1.2 billion of net client cash outflows.

Average AUM was $135.4 billion for the quarter, up 6% sequentially, and down 17% compared to the prior year March quarter. There were no material changes in the weighted average management fee or AUM mix by vehicles.

Slide 8 presents our AUM by asset class, which is new this quarter, and replaces the AUM by generation slide we have provided in the past. We believe this presentation provides a better view into our AUM mix, as our fixed income and alternative products become a larger portion of our business as we execute on our long-term growth strategy.

Financial results presented on Slide 9. Our complete GAAP and adjusted results are presented in our earnings release. Revenues in the quarter increased 4% compared to the previous quarter, on higher average AUM partially offset by two fewer days in the quarter. Compared to the first quarter of 2022, revenues were down 17% or lower average AUM. Performance fee revenues were negligible for all periods.

Just operating expenses for the quarter increased 6% sequentially due to an increase in certain compensation related costs, including those that are impacted by seasonality. Though, seasonal expenses are always highest in the first quarter of each year. In the march 2023 quarter, expenses impacted by seasonality were $6.7 million higher than last quarter. Adjusted compensation expense also increased in line with higher revenues.

During the quarter, we continue to invest in our talent through annual grants of franchise capital and restricted stock awards. Over 85% of the awards were granted to investment professionals to align our key talent with clients and shareholders. On an adjusted basis, which eliminates the mark to market when franchised capital awards, long term incentive compensation expense was $14.3 million in the March 2023 quarter. Adjusted operating income declined 1% sequentially and 34% compared to last year's first quarter. Likewise, adjusted net income or adjusted share declined 2% compared to last quarter, and declined 35% compared to the first quarter of 2022.

Full year expense projections remained consistent with the guidance I provided on last quarter's earnings call.

Our balance sheet remains strong and continues to support our capital management needs and cash dividend payout policy. Our $100 million revolving credit facility remains unused.

Slide 11 highlights our seed investment portfolio. With the addition of our newest investment team EMsights Capital, the use of our cash to see future growth and new strategies has increased substantially. Our seed investment book is now $130 million, which includes $18 million of gains on amounts initially invested

Using cash to see new products is an important component of our growth strategy. We are disciplined in our approach to seed investments, particularly respect to the amount of and duration of seed capital invested in each product. We are patient and allow products to grow thoughtfully before recycling cash into new investment strategies and vehicles. And our seed capital needs may continue to grow as we invest in future growth.

We're investing in growth not only by increasing our seed capital in new products, but also by using our P&L to make further investments in talent and operational infrastructure. While these investments in the short term drag on margins, we remain committed to our dividend policy, which returns 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 $0.50 per share with respect to the March 2023 quarter, which represents approximately 80% of the cash generated in the quarter.

As Eric emphasized in his prepared remarks, we believe we have more embedded growth potential today than ever before. We will continue to strategically invest in our business support further growth, or remain committed to returning a substantial portion of our cash generated to shareholders in the form of cash dividends.

That concludes my prepared remarks. And I will turn the call back to the operator.

[Operator]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Mike Brown with KBW. Please go ahead.

[Mike Brown, KBW]

Hey, great, thank you for taking my questions. Eric and CJ, I was hoping to maybe get a little bit more color on the trends that you're seeing on a separate account side of the business where the outflows continue to persist. How have the conversations evolved with clients here? And how does the sales pipeline looks?

[Eric Colson, CEO]

Yeah, hi, Mike. It's Eric. Yeah, this quarter, we thought was another noisy quarter, making it really difficult to extrapolate the future. As you saw in the update, we had a negative $1.2 billion of NetFlow for the quarter.

We also had -- when we when we broke this down, we had eight clients with about $1.2 billion that hired us and then terminated us with less than a three-year performance record across seven different investment strategies.

Now, I think market volatility provides us a great opportunity as an active manager to differentiate over some reasonable time periods. The more uncertainty that we've experienced in the inflation with the Russia-Ukraine war, to the policies in China, coupled with everybody's short term orientation lately, it's kind of caused havoc on allocators decision making process and providing those reasonable timeframe. So looking at that the most recent quarter that we just continue to think that noises it's hard to predict going forward.

With regards to activity on a look forward, we know are coming off a 2022 year that saw outflows across most equity and fixed income and even the 60-40 portfolios and clearly emerging market debt and high yield categories on the debt side saw elevated outflows. And we're starting to see interest back in the fixed income for our client base primarily institutional that process is anywhere from six to 12 months. And we're have very strong dialogue in the institutional marketplace and some of the gatekeepers intermediary in the credit space. So we're optimistic there.

[Mike Brown, KBW]

Okay, great, thanks for color there. And just from my follow up, first congrats on 10 years as a public company. It's a great achievement. And it's pose kind of a high level question to here. When you guys look back at your last 10 years, what do you think is kind of most impactful changes you've implemented at a time? And then as you look forward for the next 10 years, how could the evolution of the company differ from the past? And where are you kind of most excited about what you're going to keep as you look at that longer term horizon?

[C.J. Daley, CFO]

Yeah, Mike. I guess I would say take it the other way, I think the area that I look at that we're the most proud of is the ability to go from a private to a public company and stay true to who we are. Because, honestly, that's what got us the first 15 plus years to be successful, and to be able to replicate that as a public company. And to continue to attract world class talent, and be able to resource them and position that with the most sophisticated clients that conduct hours and hours of due diligence to make those decisions. We're extremely proud of that consistency. And that consistency creates enormous predictability for our shareholders to continue forward.

And I think that's an enormous achievement going from private to public and maintaining that, that stability and consistency for our employees, our clients, and for our shareholders will look forward and say, Artisan's a highly predictable organization, and can these 10 years be replicated? I believe the answer is yes.

[Mike Brown, KBW]

Okay, well said. Thank you for taking my question.

[Operator]

Thank you. And our next question today comes from John Dunn with Evercore ISI. Please go ahead.

[John Dunn, Evercore ISI]

Thank you, the international value strategy flipped to a quite positive quarter of it. Well, can you talk about what spurred that and where maybe the flows were sourced from?

[C.J. Daley, CFO]

Yeah, certainly, the international value strategy, we've had some exchange of ticks over the last few years of growth and value. We saw quite a few of our existing clients and international value want to reallocate to the value category. So the bulk of those flows were existing clients, increasing allocations, as well as some consultants that have known us for quite some time and in this strategy, rebalancing, and putting that into international values.

So the rebalancing, coupled with the extremely favorable performance results in the strategy relative to the index and peers created that the flow number for really last year and continuing into the first quarter.

[John Dunn, Evercore ISI]

Gotcha. And then, just more broadly on the fun side got a lot better quarter over quarter. Can you talk a little bit about the shift that happened between the two quarters? And then looking forward? What kind of the funds intermediary side mindset is going -- as we go into the second quarter?

[C.J. Daley, CFO]

Yeah, certainly, I think when you break down the separate account, and the mutual fund breakdown, and I think you're probably highlighting this that category, and more specifically in the broker dealer had positive flow versus the other categories. I think we have a strong allocation of clients in the broker dealer of high value and high income. And those two strategy and asset base saw the flows and that's reflective of their client base.

[John Dunn, Evercore ISI]

And do you think that might can continue demand for those strategies?

[C.J. Daley, CFO]

I think quarter-over-quarter, it tends to be fairly consistent. And it's hard to predict the future but using changes and looking through quarter-over-quarter changes, they don't happen overnight. So I would say that that would probably have a positive lean both on those strategies as well as that category. But you're coming off of the first quarter where there is some asset allocation shifts, and that might dampen it, going into second quarter and third quarter.

[John Dunn, Evercore ISI]

Makes sense. Thank you very much.

[Operator]

Thank you. And our next question today comes from Bill Katz at Credit Suisse. Please go ahead.

[Bill Katz, Credit Suisse]

Excellent, thank you very much, and Happy anniversary indeed. I feel old all of a sudden. So just on Slide 8, and thank you for recasting it this way. It's one of the ways we track it as well. When you think about growing the fixing company, all its buckets, they're both small. So I think they both offer pretty good organic growth potential, just growth potential. Do you need to amplify the opportunity through maybe a more acquisitive approach or faster ramp up teams or product? Because the other side, we speak to some of the pureplay alternative managers, they do speak to the fact that LPs want to generally consolidate, with fewer larger GPs. And just wondering how you sort of reached the opportunity here, just given the size versus the team. Thank you.

[C.J. Daley, CFO]

Yeah, thanks, Bill for question. We do believe in the team that you just highlighted. And again, as you know, in our history, we don't believe you can short circuit success by identifying the category and hoping that something's available at that moment in time and marry the TAM with whatever's available and think it's going to fit in to organization. We do believe that the TAM will be there for quite some time.

And if you look at our seed book, which I think has generated extraordinary returns both on an absolute and relative basis. We've always looked at that as a driver of growth. And we protect we resource and nurture these early strategies so that we compete on the three and five year record, which is what most allocators use, whether you're building it or acquiring it, there's that time of settlement.

We like the idea of taking that three year approach versus trying to acquire and convince people that it fit in over the one and two year and by the time you get to three. You have growth potential. But if you just look at our current seed book, the bulk of the dollars they're in was on Page 11 $66 million is in fixed income strategies, the bulk of that say $50 million is in our EMsights [Indiscernible] strategies. We've turned $50 million into 55 after one year returns of 11.8, and 10.7. They're very strong results. And I think we're getting the activity that we want. And by the time we get to that three and four year number, we're going to be able to capture that TAM.

Likewise, on the alt space, we have $44 million and the bulk of that money is in credit ops, as well as global unconstrained. And again, they have strong performance of roughly 8% and 10%, and 700 and 800 bps of alpha over their indexes.

I think we're, we're well positioned and the timeframe we look at, we're going to be able to backup that breakdown of assets by equity fixed income and alternatives. And the fact that we're willing to do that, I think, is a very strong signal of our confidence in our ability to grow.

[Bill Katz, Credit Suisse]

Okay, one more big picture for you. Only because you put the slide in the presentation, but just to play devil's advocate for a moment on the stock return a total return slide. Your relative performance to the S&P is there's a push. And so I think they've been sort of two areas of headwinds from our conversation with clients. One is just the sustainability grow organically or desire to grow organically. And secondly, is the capital policy, capital return policy? As you think about the next 10 years, is there any thought here of letting organic growth run a little bit more broadly? Is that an opportunity, and then any alteration to the capital return policy? Thank you.

[Eric Colson, CEO]

I think the organic growth is always going to be a fallout of the capacity of our strategies and the alpha -- the ability to generate alpha. As you've known over the years, we would in the exchange of kicks, we'd rather drive growth of the firm through alpha than just pure flows. So that'll naturally ebb and flow based off of the strategies and teams that we bring in. And there's no set target just to create flows for the sake of flows.

With regards to the capital policy, I do believe that as we get into credit and into alternatives, there'll be a higher demand on reinvesting in these opportunities, whether it's in the strategies themselves, or even co-investing, and idiosyncratic are unique opportunities that are made available through our existing teams. So go forward, I think the capital policy will require more seed and more investment. But that would build over time we don't see a dramatic change in that year-over-year. It's going to be a natural evolution as we evolve into credit and into alternatives?

CJ, you want to add?

[C.J. Daley, CFO]

I think, obviously you can see our seed book has increased significantly over the past 18 months, as we've gone into these areas, which is I think just a proof point of, of what Eric has said. But, we're committed to our capital policy, we would expect our payout ratio to remain very high. It's been 90% to 95%, the past two years. Previously, it was 100%. So, we've demonstrated our willingness to use the balance sheet for future growth.

[Bill Katz, Credit Suisse]

Thank you.

[Operator]

Thank you. And our next question today comes from Alex Blostein with Goldman Sachs. Please go ahead.

[Unidentified Analyst]

Hey, guys, this is Luke on behalf of Alex. Appreciate the time for the question. So real quick performance has been strong start the year both absolute and on a relative basis. Have you noticed this influencing conversations to start the year? And are there particularly particular strategies where performance has been a bigger driver than others? Or is everything more of a macro driver right now?

[Eric Colson, CEO]

Yeah, Luke, it's Eric I think we're still in the macro drivers, as we've talked about, flows around the noise. And the short term nature of people trying to find their footing, really waiting for the macro drivers to settle a bit. Clients and allocators they get their footing. And the strong results are just an embedded growth option for us once clients get to the spot of allocating.

We see quite a bit of due diligence work and interest looking forward, but nothing tangible to stay stayed on this call.

[Unidentified Analyst]

That makes sense. Thanks. And, appreciate the additional disclosures you guys have given? Based on some of the changes you've made to the slides this quarter, it seems like there's a little bit more of a focus on presenting fixed income and alternatives separately. I guess, big picture. Are there any longer term plans you guys have for building out these two segments? And how are you thinking about them longer term? Thanks.

[Eric Colson, CEO]

I think the main two points here is one that the fact that the firm has now, two fixed income teams and six strategies. And the trend of investment degrees of freedom running through the organization. That depth and breadth has given us the confidence to break out the assets in this manner.

And then secondly, as we see the industry trends, we look at the early stage performance in our strategies and these categories. And our history of being able to deliver. We're confident we can back up growth in these categories on a go forward basis. But we're not signaling any activity that we're going to short circuit with an acquisition. We're going to do it in the manner that's made us successful in the past, which requires time, and we're happy to operate under that time horizon.

[Unidentified Analyst]

Make sense. Thank you.

[Operator]

Thank you. And our next question today comes from [Indiscernible] at RBC Capital Markets. Please go ahead.

[Unidentified Analyst]

Hi, thanks for taking my question. Just a follow up on the seed capital. And the remarks upon the growth there, wondering to stuff further expand upon any outlook in terms of further growth within seed capital. And is the expectation that there could be more meaningful growth within the fixed income and alternative sides. And, could you just talk about how would you quantify any potential seed capital needs over the near term next? Thanks.

[Eric Colson, CEO]

And currently, we feel very comfortable with the amount of seed capital we have and how its deployed. We think the allocation of seed the early stage results are both promising for our future growth. At this current stage, we don't need any additional seed assets. We have probably 10 to 12 strategies in the seed book. And the emerging market debt is created a lot of reinvestment in the operations and in our distribution. And the things that you have to do to continue to bring in investment talent is be successful with the current seed book.

The more we can demonstrate that we can grow, fixed income strategies, as well as alternative strategies, are going to get greater and greater interest of talented fixed income and alternative managers that are outside the firm. So our approach right now is to stay committed to this seed book, see through on delivering growth across these strategies, and remain patient for new talent that joined the firm with a directional interest in credit and alternatives as well as potential regional investment teams in Asia.

[Unidentified Analyst]

Got you. Very helpful there. And just one quick one. Regarding the ongoing efforts to expand the fixed income and the alternatives, I think a while back. You had made some investments in terms of the investment platform that the analytics. Just wondering, at this point, is there a pretty good base at this point? Or could there be potentially further needs for investments on the technology side with the platform side to accommodate for a new strategy overtime? Thanks.

[C.J. Daley, CFO]

Yeah, Ken I'll take that one. That process is sort of evergreen ongoing, will continue to reinvest back into the business. I think you're likely answering you're asking that question from an expense outlook. And we're so committed to the guidance we gave last quarter on expense levels for 2023. So there's no change in the expense outlook, but -- and are all the plans that we have to reinvest in the infrastructure this year are baked into what we've guided.

[Unidentified Analyst]

Got you. Very helpful there. Thanks again.

[Operator]

Thank you. And ladies and gentlemen, this concludes today's question-and-answer session and today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.