Artisan Partners Asset Management Inc

NYSE:APAM

Earnings Call Transcript 2023-Q2

[Operator]

Hello and thank you for standing by. My name is Jason and I will be your conference operator today. [Operator Instructions] As a reminder, this conference call is being recorded. At this time, I will turn the call over to Artisan Partners Asset Management.

[Unidentified Company Representative]

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 and 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 statements. These are subject to risks and uncertainties and are presented in the earnings release and detailed in our SEC filings. We’re 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 reconciliations of those measures to the most comparable GAAP measures in the earnings release.

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

[Eric Colson, Chief Executive Officer]

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. Since our founding in 1994, we have methodically delivered quality outcomes for clients, quality business growth and quality returns for our shareholders. The power of compounding underlies each of these outcomes, compounding client capital in excess of benchmarks and peers extend client duration and grows our AUM. Compounding business outcomes with each successful investment team, strategy and asset class increases our future opportunity set as well as the quality and probability of those opportunities.

Success begets success. As we compound client capital and business outcomes, our shareholders are the residual beneficiaries. Compounding requires time, and time requires trust. Trust is established by communicating who we are and what we plan to do. Trust is maintained by staying true to our word and by sticking to our philosophy and process. We strive to do this day in and day out, over and over again. The development of our fixed income capabilities shows how we compound our business.

The performance of our six credit-oriented strategies as shown on Slide 2. This performance is net of fees. We launched the Credit team 10 years ago in 2013 on the basis of our foundational success in equities. We partnered with Portfolio Manager, Brian Crow, to methodically build a premier credit franchise. In turn, the Credit team has methodically generated high value-added returns for clients. Over 9-plus years, the Artisan high income strategy has generated average annual alpha of 186 basis points after fees. That is, on average, a return of 50% more per year than the strategy benchmark index.

The high income strategy has also outpaced peers. Since inception, the Artisan High Income Fund is ranked #5 out of 330 funds in the Lipper high-yield category. On the foundation of our Credit team success, we recruited Mike Cirami, Sarah Orvin and Mike O Brien to Artisan Partners in 2021 and established the EMsights Capital Group. With EMsights, we launched our second credit-oriented team and further expanded our investment platform into sovereign credit, FX and greater use of derivatives. Each of the 3 EMsights strategies have passed its first anniversary. The team’s early performance and reputation in the marketplace are translating into a healthy level of early interest. On July 1, they received their first large institutional mandate a $425 million investment in the Artisan Emerging Markets Local Opportunity strategy. We are making significant progress towards similar foundational investments in the team’s Endo and global unconstrained strategies.

Slide 3 shows the year-to-date AUM; growth of our credit-oriented strategies. As of July 15, between the Credit team and EMsights Capital Group, we have raised a net $1 billion from clients and investors. The pipeline for both the Credit team and EMsights Capital Group is strong, and we expect strong business development throughout the remainder of 2023 and beyond for both teams. It’s also worth noting that these investment teams are winning business as differentiated alpha generators. Not as providers of benchmark hugging exposure in hot dot asset classes. Based on mutual fund data year-to-date, high-yield bonds, bank loans, emerging market debt and nontraditional bond funds are all in net outflow. That’s in contrast to the headline-generating flows into money market and investment-grade bond funds. This is consistent with who we are. We are investing with great talent in spaces where they can differentiate and compound capital to deliver absolute return over extended periods of time. We believe that demographic change and expanding credit opportunity sets bode very well for both the credit and EMsights teams. In short, we believe we are in the early innings with both these investment teams with considerable opportunity in front of us.

One year ago, we showed the information on Slide 4 during our second quarter earnings call. Since our founding in 1994, there have been 12 calendar quarters in which the indexes to which our strategies are compared, have declined by more than 10%. On average, a 10% quarterly drawdown occurs about every 2 years, though not evenly distributed over time. On the way down, assets tend to sell off across the board. Things become highly correlated making it more difficult to generate differentiated outcomes in the short term. Higher correlation on the way down, though, creates opportunity for asset managers with extended time horizons. Historically, our investment teams have taken advantage of that dynamic. A year ago, we observed that our firm-wide asset-weighted performance had exceeded benchmark performance in 8 of 11 12-month periods following a greater than 10% quarterly drawdown. We can now update that to 9 of 12. Markets have rebounded from a year ago, and in the aggregate, we have outperformed.

Looking at 3-year periods following a greater than 10% quarterly drawdown, we have outperformed in 8 of 10 periods with the outperformance averaging 308 basis points. The important point is that Artisan Partners is built for the uncertainty and volatility of financial markets. In the midst of last year’s drawdown, we continue to methodically invest in our investment platform, in particular, the build-out of the EMsights Capital Group. We were patient in playing the long game. We have come out the other side with a healthy, diversified business and multiple vectors for future growth.

Slide 5 shows the since the inception performance of our 10 strategies with more than 10 years of performance. As you go from 1 year to 3 years to 10 years and beyond, our record of investment success becomes stronger and stronger. This is not a surprise. High value-added investment results require talent plus degrees of freedom plus time. We attract and retain exceptional investment talent by designing and operating our firm as an ideal long-term home for investment talent. We provide talented investors with a broad and growing opportunity set of asset classes, markets and instruments, increasing the available levers for generating return and managing risk for clients. And we extend duration by clearly and repeatedly articulating our long-term horizon to all of our stakeholders. And by putting our money where our mouth is, supporting investment teams through market cycles.

This slide is a good summary of the quality of our investment business. It shows the breadth of performance across teams, categories and time and the repeatability of our business philosophy and process. What gets us particularly excited is that we are applying the same business philosophy and process to the 15 Artisan strategies not shown on this slide, strategies that have yet to reach the 10-year mark. We expect our newer teams, asset classes and strategies to compound client capital with similar success. And we expect high-quality client outcome will continue to translate into high-quality outcomes for our business and our shareholders.

I will now turn it over to C.J. to discuss our recent financial results.

[C.J. Daley, Chief Financial Officer]

Thanks, Eric. Our results in the first half of the year have been strong, driven by higher assets under management, which ended the quarter at $143 billion, up 12% from the beginning of 2023. These results reflect the quality of our client and investment-centric business model. So far this year, our investment teams have generated over $3 billion of excess returns for clients, about 250 basis points above the weighted average benchmark returns, compounded client assets as markets rose adding over $14 billion of wealth to our clients’ portfolios and returned $2.3 billion of capital back to investors.

During the second quarter of 2023, global equity and debt markets increased, contributing $5.7 billion to our AUM compared to last quarter. These investment returns were partially offset by $1.1 billion of net client cash outflows, primarily reflecting outflows in separate account global mandates. Average AUM was $139.3 billion for the quarter, up 3% compared to last quarter and down 3% compared to the prior year June quarter. Year-to-date average AUM was $137.4 billion, down 10% from last year.

As indicated on Slide 8, there were no material changes in our weighted average management fee or AUM mix by asset class or a vehicle. Financial results are presented on Slide 9 and 10. Our complete GAAP and adjusted results are presented in our earnings release. Revenues in the quarter increased 4% compared to last quarter on higher average AUM and 1 more day in the quarter. Compared to the second quarter of 2022, revenues were down 3% on lower average AUM. Performance fee revenues were negligible for all periods. Adjusted operating expense for the quarter increased 1% sequentially due to an increase in incentive compensation expense in line with higher revenues, partially offset by a decrease in certain compensation-related costs that are seasonal in nature. Seasonal expenses are always highest in the first quarter of each year. Adjusted operating income and adjusted net income per adjusted share both increased 11% in comparison to the previous quarter and declined 10% compared to last year’s second quarter. Year-to-date, revenues were down 10% compared to 2022 on lower average AUM. Adjusted operating expenses decreased 3% from the 2022 6-month year-to-date period due to a decrease in incentive compensation expenses on lower revenues, partially offset by an increase in fixed compensation costs related to a 6% increase in our number of employees compared to June 2022. The increase in employees has been in line with our strategic growth plans.

Travel expenses continued to increase during the quarter, driven by client activity and the hosting of our annual investment forum, which attracted approximately 300 clients to interact with our investment teams and discuss investment perspectives. As a result of lower revenues, year-to-date adjusted operating income and adjusted net income per adjusted share were down 23% compared to the 2022 year-to-date period. Full year expense projections remain consistent with the guidance I provided on the February earnings call.

We remain committed to our dividend policy, which returns capital to shareholders on a consistent and predictable basis through quarterly cash variable dividend payments and a year-end special dividend. Consistent with our dividend policy, our Board of Directors declared a quarterly dividend of $0.61 per share with respect to the June 2023 quarter which represents approximately 80% of the cash generated in the quarter. During the quarter, S&P announced the addition of Artisan Partners to the S&P Small Cap 600 Index effective June 19. The announcement, in addition to the index, drove a noticeable increase in the trading volume of our stock and along with strong equity markets in June, contributed to the 23% share price return experienced in the quarter.

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

[Operator]

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

[Alex Blostein, Goldman Sachs]

Hi, good afternoon. Thanks for taking the question. First, I was wondering if you could comment a little bit more around the institutional pipeline that you guys are seeing, especially across some of the new strategies, kind of third-generation products that you launched over the last couple of years? And then specifically, CJ to the mandate that you guys won the $475 million or so. Any way to frame the fee rate around that. Thanks.

[Eric Colson, Chief Executive Officer]

Great, Alex. This is Eric. We’ve been having a little bit of technical issues. Can you hear us?

[Alex Blostein, Goldman Sachs]

Yes, I hear you guys, great.

[Eric Colson, Chief Executive Officer]

Perfect. Thank you. Yes. The across the board on the newer strategies, primarily the EMsights, given the credit orientation in the current outlook on credit, I think we’ve all seen the news around the credit cycle. Our discussions with clients and consultants around capital market forecast to asset allocation decisions to manage our structure have all been positive. So we’ve been pleased with the dialogue and activity, especially around the EMsights team and as well as the Credit team with Bryan Krug. As we stated, the EMsights we’re coming off of a pretty good outflow into the Emerging Market debt category last year. I think it was the largest outflow in the history of Emerging Market debt allocations, and we’re starting to see that creep back in, which is a nice timing for us. And we announced a $425 million allocation. We have a few other fundings that we believe are on track that will help launch the Emerging Markets local only as well as the global unconstrained strategies. And we continue to have a very active dialogue around our credit opportunities with continued flow into the high income strategy.

Beyond the EMsights, the earlier strategies hasn’t been as uniform and homogenous as you see in the credit. So it’s been a lot of gives and takes, and we see lumpy results around that primarily with some of the regulatory changes out there, some of the customization, and it seems that the performance or the rate or the tenure of that client doesn’t matter as much as some of the non-investment related. We think those are early short-term issues. Structurally, if you get the investment right, you get the long-term compounding correct. So we’re pleased about where we’re at on a performance, especially after rebound of the draw down a year ago. And we think across the board, the newer strategies are well on track. I think we all of the $425 million funding, it was a good funding for the MLO strategy. So I think we hit both your questions there.

[Alex Blostein, Goldman Sachs]

I got it. I’m sorry I missed, but the fee rate on that one, and I don’t know if any comments around like the fee rate being relatively consistent with the institutional business, kind of higher, lower or on the 425 one.

[Eric Colson, Chief Executive Officer]

Yes. It’s a large separate account mandate. So the fee rate is lower than our expectation on an average fee rate given the size and the initial funding. It doesn’t change our outlook on how we’re modeling it and looking at forward. Sometimes you fund strategies that come through the intermediary strategy and come through a pooled vehicle and sometimes you launch with a large separate account. So there’s a large separate account and it is below what we would expect.

[Alex Blostein, Goldman Sachs]

I got it. Great. Thank you, guys.

[Operator]

The next question comes from John Dunn from Evercore. Please go ahead.

[John Dunn, Evercore]

Thank you. Maybe just a little more on the institutional channel. Can you talk a little bit more about particularly outside of credit, just kind of the temperature of consultants and temperature of clients and where they might be looking outside of credit and kind of willingness to commit to strategies?

[Eric Colson, Chief Executive Officer]

Yes, the institutional channel, we’ve seen this year-to-date, a bit more of an outflow, a little bit more on the separate accounts, especially some large separate accounts in Australia, where we’ve seen a bit more regulation around the superannuations. We’ve seen some outflow in Europe around some customization and the importance of ESG. And in some cases, some asset allocation away from active equity, but I think that’s been muted a bit. So, outside of the pure performance, the institutional separate account is balancing regulatory environment, customization, ESG. We think in the exchange it sets that more on the short-term side and at the end of the day, if you deliver quality performance. And what we mean by quality is an investment team with stable leadership, a process with integrity that leverages investment degrees of freedom to create a differentiated portfolio. You have a very secure position in the overall asset allocation long-term. But the current short-term is still battling non-investment inputs on the institutional side.

[John Dunn, Evercore]

Got it. And then maybe could you update us on capacity? Has there been any changes more or less over the different strategy?

[Eric Colson, Chief Executive Officer]

No. We haven’t had a lot of change on any capacity discussions from the last quarter or year-to-date.

[John Dunn, Evercore]

Great. Thank you.

[Operator]

The next question comes from Kenneth Lee from RBC Capital Markets. Please go ahead.

[Kenneth Lee, RBC Capital Markets]

Hi. Good afternoon and thanks for taking my question. Just wondering if you could provide any updated outlook in terms of seed capital needs over the near-term? What’s sort of like the outlook for any sorts of new product developments down the pipeline? Thanks.

[Eric Colson, Chief Executive Officer]

With regards to new product development and the demand for seed capital, we have over the last few years, probably launched more strategies than we have done in past years. We highlighted that we have 15 strategies below the 10-year mark. And if you look at strategies with less than 3 years, we are putting quite a bit of emphasis on the current strategies, aligning resources. We have done a bit of hiring on the current investment teams. If you look at the uptick in headcount, it’s primarily been on our existing investment teams as opposed to going out and finding new teams. We think there is quite a bit of opportunities out in the marketplace, but the bar is quite high right now with our mindset on delivering on what we have created. So, I don’t see any real short-term movement around new teams or seed capital for new teams. However, there are some interesting investment opportunities that are falling out of the current teams we have today and the strategy that we have launched, and we need some funding around some investment opportunities over the next year based on ideas generated out of our new – our current teams.

[C.J. Daley, Chief Financial Officer]

And Ken, from a balance sheet perspective, we have capacity to do more from the existing balance sheet. We have always said the special dividend is a year-end decision. Last year, we held back $20 million from the special to increase our capacity to seed new products. And we likely will do similar amounts. And if capacity or need for seed exceeds that, we have quite a bit of room left in the special to invest for future growth, which excites us about the ability to put more of our balance sheet to use to grow the business in the future.

[Kenneth Lee, RBC Capital Markets]

Got it. Very helpful there. And just one follow-up if I may, just on entire OP [ph]. Were there any particular drivers for the net outflows that you saw over the last, call it, two quarters or so, or is it just related to the sentiment end market? Thanks.

[Eric Colson, Chief Executive Officer]

Yes. I would give those things specific on the team as much as the concentration in the U.S. equity markets over the last quarter. I think even been coined a name with the Magnificent Seven. So, when you coin a name and there is concentration in an index, I think just the competitive landscape over the last quarter is probably the main driver there.

[Kenneth Lee, RBC Capital Markets]

Got it. Very helpful. Thanks again.

[Operator]

The next question comes from Michael Brown from KBW. Please go ahead.

[Michael Brown, KBW]

Hey. Great. Thanks for taking my questions. Maybe just a question on the margins here, I guess first, is there any other major investment required around the EMsights team, or is that mostly done at this point? And then a longer term question there, how do you think about the ability to improve the margin from the current levels over time? And when you look forward, can that margin get back to that mid to high-30% over time?

[C.J. Daley, Chief Financial Officer]

Mike, I will take that one. Yes, certainly, we have invested in future growth across the EMsights team as well as new strategies. We have seen our margin decline during that period. There is absolutely the ability to grow the margin given the amount of capacity that exists in the system. And largely from an investment perspective side, we have done the heavy lifting on the investment. We have got more spend on the distribution side. I don’t think that will – I don’t think you will see a huge noticeable chunk of spend that will stand out, but we will continue to invest in distribution. And we saw what can happen to our margin when our assets spiked during the COVID and we went from mid-30s up to 44% just from the market action. And that certainly could happen again. But given the fair amount of capacity that’s left in the system, if we are able to capitalize on that capacity, we could – we definitely should see the margins back in the high-30s.

[Michael Brown, KBW]

Great. Thank you. I guess AI is of course one of the hot topics in the financials landscape these days and it certainly sounds like asset managers have been trying to figure out how to kind of use the generative AI more in the process. How do you guys think about your data, data management and the potential for AI in your processes? And how the teams may want to use it? Is that something that has already been implemented and/or is it something that could be a potential opportunity for you guys?

[Eric Colson, Chief Executive Officer]

I think there is opportunity in how we run the business, how we run distribution. And certainly, with regards to some of the investment teams, as you know, with the ten autonomous investment teams and how they incorporate data, quantitative tools and eventually more AI will really be based on each investment team’s leadership and their process and their value they see from leveraging AI with regards to the business and distribution. We are clearly – there is pockets from development within programming. There is pockets in writing. There is pockets in leveraging more data into the distribution. And I think there is great efficiency that’s going to be brought across the business. And as you get back to the margin, I don’t think you will see a big savings on like headcount in the near-term, but the ability of individuals to do more given the data and tools available, will be highly productive for the organization. And then teams – investment teams that really want to leverage and move into higher use of data in incorporating AI, we will through our investment services group in the middle, bring those services to bear to optimize the investment teams. So, it’s a hot topic. It’s in the early innings, and we are looking at it in probably three different ways.

[Michael Brown, KBW]

Okay. Very interesting. Thank you.

[Operator]

This concludes our question-and-answer session. The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.