Artisan Partners Asset Management Inc

NYSE:APAM

Earnings Call Transcript 2021-Q4

[Operator]

Hello, and thank you for standing by. My name is Tom, 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 conduct a question-and-answer session, and conference participants will be given instructions at that time. As a reminder, this conference call is being recorded.

At this time, I will now turn the call over to Makela Taphorn, Director, Investor Relations for Artisan Partners Asset Management. Please go ahead.

[Makela Taphorn, Director, Investor Relations]

Thank you. 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. Our latest results and investor presentation are available on the Investor Relations section of our website. Following these remarks, we will open the line for questions.

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

In addition, some of our remarks made 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 Eric Colson.

[Eric Colson, Chief Executive Officer]

Thank you, Makela, and thank you, everyone, for joining the call or reading the transcript. We manage our business based on the philosophy and principles on Slide 1. We aligned the firm with long-term industry evolution to manage thoughtful growth. We take incremental steps to create stability and duration in our business. And we believe this is authentically managing for the long-term.

Turning to Slide 2. In the early years of Artisan Partners, we captured a powerful trend of talent-free agency and a categorization of active management. Within categories, talent had the opportunity to shine and was well aligned with end clients. Like any powerful trend, the categorized approach eventually became overmanaged, overstructured and oversupplied, while the universe of U.S. public equities shrunk in half.

Today, the industry has deemphasized individual and creative talent, instead packaging passive strategies and individual talent into investment solution products. Emphasis has been on scale, packaging, fee rate and distribution. Great investment talent has been diluted, underappreciated, and poorly aligned with end client outcomes.

We believe that we are at an inflection point at the beginning of a new phase of active management, in which talent is reemerging out of rigid structured strategies, seeking autonomy and the freedom to be innovative and creative. The old categories of active management are increasingly breaking down and blurring. With increasing demand for active managers who can invest broadly to generate return and manage risk.

We see long-term demand for high value-added active management that includes the use of concentration, multiple security types, varied time horizons, and the full capital structure. We also see an industry trending towards two broad categories, passive and exposure on one end and active and alternatives on the other.

Within the ladder, we highlight private equity and venture capital extending duration into public securities. Hedge funds converging into long bias strategies managed relative to an index and hedge funds and other active converging into hybrid or crossover funds, including public and private companies. In short, high-value active management has evolved to incorporate a full array of investment and security types across an array of time horizons. This industry evolution presents Artisan Partners with tremendous opportunity.

We believe it’s a reaffirmation of active management. It embraces degrees of freedom, broader opportunity sets, and more tools to be different. It values creative talent and differentiation and it more directly aligns talent with end clients.

As we look forward, we expect to add more investment capabilities and more degrees of freedom. We will continue to empower unique talent within active management operating autonomously. We see active opportunity sets continuing to grow and overlap, evolving away from narrowly defined boxes.

As we have in the past, we will provide end clients with undiluted access to unique investors operating within large or inefficient spaces. This evolution places a premium on investment talent and the operational capability to invest broadly. It will allow our existing teams to further grow their opportunity sets, capabilities and businesses. And it will help us to continue to attract and add external talent operating in different spaces and across spaces that were traditionally bifurcated.

We see a great supply of talent in the marketplace. And we have a proven formula and process for matching talent, opportunity sets and long-term demand to support sustainable investment franchises.

I want to say a few words about the supply of talent on Slide 3. Over the years, the number and types of homes for talent have grown. That creates competition, but it also creates supply. We believe our combination of autonomy, resources, economic alignment, patients, and proven success remains unique and attractive in the marketplace. Because of the investments we have made in our operational platform, we can support a wide array of investment talent and strategies across the high value-added spectrum.

The convergence of asset classes and investing styles and the importance to talent of broad opportunity sets creates opportunities for us to attract talent from sources that even a few years ago would have been unlikely. At the large integrated firms, industry consolidation and the focus on scale and solutions increases our relative attractiveness to active talent, talent that is underappreciated and poorly aligned. We also believe that the multi-strategy platforms may become a fertile source of new talent.

Given the number of investors that these platforms have attracted and developed over the last decade or so, we expect to see more talent emerge from this source. Across the board, we are excited about the supply of talent in the marketplace today. We’re meeting with compelling talent. Our proven success at franchise development creates a positive feedback loop, increasing both the quantity and quality of opportunities and we have the capacity and bandwidth to do more.

Along with talent, the other two components of our growth formula are the right investment opportunity set and long-term demands. We focus on inefficient spaces and large and growing opportunity sets either from an increasing number of issuers, or by redefining a traditional opportunity set, sometimes both. In all cases, we are identifying opportunities to differentiate and add value for clients, where we expect there will be long-term demand from sophisticated allocators who value what truly active managers do.

Recently, you’ve seen us bring together these growth components in a number of areas. Our credit team enhances the high yield opportunity set by including floating rate loans, roughly doubling their investable universe. Our China Post Venture Group accesses growth in China through both publicly listed and private companies. China’s on and offshore listed markets are already larger than those in the U.S. in terms of the number of issuers, they are growing and they are less efficient.

The CPV team increases the opportunity step further with late-stage private investments, giving the team greater access to growth, a world in which many growing companies are staying private longer. In all three of these areas: differentiated credit, China and private markets, we see large growing less efficient opportunity sets and long-term demand from allocators looking for active investment management.

These aren’t the only areas where we will add capabilities and develop businesses. But they are three areas that we are particularly focused on, where we have toeholds for future growth and where we can add value for talent and clients.

Our newest team, emerging markets debt, brings all these themes together: outstanding talent disrupted by industry consolidation; a large growing inefficient, often difficult to access opportunity set, with plenty of opportunity to differentiate and add value; and long-term demand from investors seeking yield, total return and diversification.

Since the founding members joined Artisan in September, we have built a team of 10-plus investment professionals. We’re standing up a next generation set of tools and systems, which will further increase our operating capacity and breath. And we are in the process of establishing three investment strategies: blended currency emerging market debt opportunities, local currency emerging market local opportunities, and the highest degree of freedom strategy global unconstrained. We currently expect to launch these strategies in the first half of this year.

Slide 6 shows the long-term outcome for our stakeholders. We aligned talent, the right investment opportunity sets and long-term demand. We also aligned economic interests and time horizons across stakeholders, our people, our management team, our Board, our clients, our shareholders. The result is a highly productive firm, a firm that adds value for all its stakeholders, absolute returns and alpha for clients, a stable rewarding long-term home for our people, and a predictable source of financial return for our shareholders. Creating sustainable value takes time. Outcomes are lumpy over short time periods. But over the long-term, there is a steady predictable growth outcome.

In 2021, we generated record annual revenues of $1.23 billion and adjusted EPS of $5.03 per share. When we pay our dividend in February, we will have distributed $29.55 per share since our IPO in 2013, representing nearly 100% of our IPO share price. We have returned nearly 100% of investor capital since the IPO, while at the same time, growing and diversifying the firm from five investment teams and $74 billion in AUM to 10 teams and $175 billion in AUM.

Consistent with who we are and the themes I’ve discussed on this call, we expect to accelerate the evolution of our firm and continue to generate value-added outcomes for all of our stakeholders, clients, associates and shareholders.

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

[C.J. Daley]

Thanks, Eric. As a reminder, our financial model principles are highlighted on Page 7. Our complete GAAP and adjusted results are presented in our earnings release. My comments will focus on our adjusted results.

In 2021, we achieved record revenue and earnings. Revenues rose 36%, adjusted operating income rose 51%, and we declared dividends related to 2021 earnings of $4.70 per share. These record results reflect our continued commitment to our talent-focused business model, which is designed and executed for the purpose of generating and compounding wealth for clients over the long-term.

Assets under management were $174.8 billion at December 31, 2021, up 1% from the September 2021 quarter and up 11% from the prior year-end. In the fourth quarter, investment returns contributed $4.1 billion to the increase in AUM. This was partially offset by $2.2 billion of annual Artisan fund distributions that were not reinvested and slight negative net client outflows.

Average AUM for the quarter was down 1% sequentially. For the full year, investment returns contributed $17.6 billion to the increase in AUM and net client cash inflows contributed $1.7 billion. Average AUM for the year was up 38% year-over-year.

Our AUM grew across all three generations in 2021. Growth in our first and second generation strategies was driven by investment returns, and growth in our third generation strategies was primarily driven by net client cash inflows. Third generation strategies now represent close to 20% of our total AUM.

Key financial metrics for the quarter and year are presented on Pages 10 and 11. Revenues in the current quarter were $315 million, down slightly from the September quarter, reflecting lower average AUM. Our recurring average fee rate remained at 71 basis points. Expenses rose 2%, primarily due to higher incentive compensation, travel and administrative expenses.

Our fourth quarter adjusted operating margin was 43.8% and adjusted net income per adjusted share was $1.29. Average – for the year, average AUM was up 38% and we generated revenues of $1.23 billion, up 36% from 2020. Our variable operating expenses, principally incentive compensation expense, adjusted with higher revenues. Fixed expenses also rose in 2021, reflecting additional headcount, including our newest investment team, increased long-term incentive expense, and continued investment in technology to support our investment teams and operations platform.

Our 2021 adjusted operating margin was 44.1% and adjusted net income per adjusted share was $5.03, up 51% from 2020. Our balance sheet remained strong. Our cash balance of December 31, 2021 reflects the significant earnings growth we experienced throughout the year. A portion of this will be used to pay the dividends most recently declared.

In the fourth quarter, we executed a note purchase agreement to refinance the $90 million tranche of senior notes that mature in August 2022. The transaction will close in mid-August, subject to certain closing conditions. The new notes will mature in August 2032, and have a coupon of 3.1%. Covenants will remain unchanged.

Our Board of Directors declared a quarterly and special cash dividend to shareholders of record on February 14 of $1.75 per share. In aggregate cash dividends declared with respect to 2021 were $4.70, which represents the majority of the cash generated in 2021. The dividends declared with respect to 2021 represent a trailing 12-month dividend yield of approximately 10% based on our share price at the end of 2021.

In 2022, we will continue to invest in our business, reflecting purposeful pace of growth. As we deepen our investment and operational capabilities in fixed income and differentiated strategies, we expect increased spend in 2022 that will be primarily focused on investment talent and technology to support our newest investment team, as well as new strategy launches in existing teams.

In addition, we will continue to invest in expanding our distribution reach with investments in talent, marketing, digital capabilities and data. More specifically, during the first quarter, we will grant approximately $87 million of long-term incentive awards. The majority of these grants will be made to our investment talent. These long-term incentive awards are comprised of $49 million of franchise capital awards and approximately $38 million of restricted stock awards. Generally, 50% of the awards vest pro rata over five years, and the remaining 50% vest in connection with a qualified retirement.

As a result of this year’s grant, we estimate the long-term incentive amortization expense in 2022 will be approximately $56 million. Given our priorities in 2022, we expect to increase headcount by as much as 10% over the next year across investments, distribution and marketing and back office. We expect a fixed component of our hiring plans will add approximately $15 million to our compensation and benefits costs.

Occupancy and technology costs will also uptick, and we expect the annual expense in each of those two categories to be up $5 million to $7 million next year. In addition, we expect travel expense at some point will revert to pre-pandemic levels, but as of now it hasn’t. As a reminder, our compensation and benefits expenses are generally higher in the first quarter of each year due to seasonal expenses. We expect the seasonal expenses were approximately $5 million in expense during the first quarter of 2022.

In conclusion, as Eric so accurately stated in his prepared remarks and earnings release, we see opportunity all around us and we are investing more resources back into our business. We will manage this investment in our growth with our proven business model and history of success. However, results will be lumpy, successful outcomes will take time, and we remain confident in the long-term outcomes we can achieve for our clients, associate and our shareholders.

I’ll now turn it back to the operator.

[Operator]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question comes from Bill Katz with Citigroup. Please go ahead.

[Bill Katz, Citigroup]

Okay. Thank you very much. Good afternoon. Appreciate you guys taking the questions. So my first question, C.J. may pick it up from commentary from both you and Eric, just in terms of investing that certainly resonated with a press release and your comments today. The guidance you provided, just to be clear, is that year-on-year growth or sequential change, overall? And then any kind of flexibility against that if markets continue to sort of stay where they are, or even weakened from, here’s my first question.

[C.J. Daley]

Yeah. No that – Phil, thanks for the question. That’s year-over-year growth, sorry for not clarifying that. And our spend is focusing on growth. We have complete control over our spend. It’s – the spend is focused on growth for the long-term. We look out five to seven years and we’re building over that timeframe.

So there isn’t any sort of dependence on near-term growth with that spend. But it’s basically focused on building out the emerging markets debt team, which obviously, we need to do to realize growth there. But the rest of the spend is really expanding our capabilities – operational capabilities to enable us to continue to onboard differentiated strategies and align our distribution marketing and data organization around these opportunities, which, I think Eric has laid out quite nicely in the remarks.

[Phil Gresh]

Okay, that’s helpful. And then, Eric, may one for you, just sort of stepping back a little bit. So it seems like there’s a lot of long-term opportunity here. So I agree with some of the themes you’ve talked about. Could you sort of help us sort of maybe ring fence, where you might be on the legacy book in terms of portfolios of funds that are sort of partially closed or capacity constrained versus the timeline you think you could materially tap into some of these mega trends that you’ve identified?

[Eric Colson, Chief Executive Officer]

We’ve always been fairly patient on letting those play out. They’re very hard to force in the short run over a one or two-year period, where you can force demand or try to short circuit the foundation, building of a new strategy or franchise. So you can look out over the next three to five years and look at solid growth in our mind because of the supply demand that we’ve laid out of product and the long-term demand. Trying to play that in the short run is very difficult. I think we’ve always said, flows are lumpy, and how to time that it’s going to be difficult.

With regards to the emerging market debt team that we brought on, I would play that out somewhere that we’ve looked at our other credit team and how that team grew. They have very similar features with regards to onboarding and potential opportunity.

[Phil Gresh]

Okay, thank you.

[Operator]

[Operator Instructions] The next question comes from the Kenneth Lee with RBC Capital Markets. Please go ahead.

[Kenneth Lee, RBC Capital Markets]

Hi, good afternoon. Thanks for taking my question. You mentioned in the prepared remarks, you could potentially enter some new investment areas that’s possible down the line. And wondering if you could just further expand upon that, what particular areas are you looking at right now? Thanks.

[Eric Colson, Chief Executive Officer]

As we’ve done in years past, we’re fairly open minded on the number of teams or the type of strategies that we look at. If you look back, we’ve been talking about emerging market debts for years. And we finally had a great opportunity to bring on Mike Cirami and team.

And so that team is very indicative of the opportunities that the disruption hits the market with regards to some type of M&A or consolidation. It makes a team that we weren’t thinking about available to us. We look at the team and find out beyond emerging markets debt. There’s an array of strategies that come with the team and –strategies that come with the team and we opted with a global unconstrained strategy.

And you look at the universe there, we’ll see a handful of new strategies coming out of this emerging markets debt team that yields into more alternative-oriented strategies. Today, we’re seeing more teams that maybe constrained in the overall opportunity that are maybe embedded in a multi-strat that we look at and say, there’s good parallels to launching a small cap growth strategy back in 1994, you would have thought it would been a billion dollars, and yet it spawned a growth franchise at large.

So we’re looking at more alternative-oriented strategies on the credit and the equity side. That may be thought of as more narrowly defined today, but have the opportunity to expand. Those are the type of opportunities that we’re looking at to get – that we get excited about and it’s going back to that growth formula. Is there a supply of issuers and opportunities that allow active management to differentiate? Is there a growing supply of demand that’s going to be directly allocating to that category? And those are the characteristics as opposed to these specific categories.

[Kenneth Lee, RBC Capital Markets]

Great, very helpful. And just one follow-up, if I may. You mentioned that some of the alternative-oriented strategies have recently passed some milestones, including a five-year and one-year track records. One of you just talk a little bit more in terms of your expectations, would you expect to see potential widening in terms of client demand and perhaps some pickup in inorganic growth? Thanks.

[Eric Colson, Chief Executive Officer]

With specifically to the Antero Peak Group hitting a milestone as well as our credit opportunities hitting a milestone, say, China Post Venture still in the early phase. But the more alternative-oriented strategies hitting those milestones and certain asset levels provides us a broader opportunity for greater organic growth in those strategies. And we’re also stacking more distribution efforts to align with that growth over the next year or two.

[Kenneth Lee, RBC Capital Markets]

Great, very helpful. Thanks again.

[Operator]

The next question comes from Robert Lee with KBW. Please go ahead.

[Robert Lee, KBW]

Great. Good afternoon, or good morning as the case may be, and thanks for taking my questions. And C.J., just wanted to clarify a couple of your comments on expense guidance for next year. So was the $5 million to $7 million in 2022 for tech and occupancy separately or combined? I just want to make sure I have the right numbers.

[C.J. Daley]

Separately.

[Robert Lee, KBW]

Okay. And…

[C.J. Daley]

$5 million to $7 million.

[Robert Lee, KBW]

Okay, great. That’s helpful. And then you talked about the $15 million from the expected headcount increase, I mean, should I think of that as being kind of, in addition to you have kind of your normal salary increases that kick in, and unfortunately increased costs of existing benefits. So, is that kind of, on top of that, or should we think of that as inclusive of kind of the normal increases you’d see in comp and benefits?

[C.J. Daley]

Yes. No, that that’s inclusive. It represents the merit increases we gave for 2022. It also includes the fully loaded in costs of employee new hires that were hired in 2021 that just had partial compensation as well as headcount additions for 2022.

[Robert Lee, KBW]

Okay, great. That’s super helpful. And then maybe one last question, broader question. As you think about the opportunity set to expand the platform, and obviously, you’ve started to launch some private funds or different fund structures. I mean, how is this – how did you expect your capital management to continue to evolve, obviously still going to be distribution oriented?

So – but is it reasonable to think that going forward that – reasonable to think that going forward, greater and greater proportions of cash flow will be used, at least, for the next several years to fund or seed some of these new strategies over and above what you’ve had to do historically or have done recently?

[Eric Colson, Chief Executive Officer]

Yeah. No, that’s a good question, Rob. And our policy will, as you indicate, the highly skewed towards cash dividends. We do manage our seed capital book on a fairly tight basis. Some of the strategies that we’ve recently launched and do plan to launch will require more seed capital. And from time to time, we have taken from the special or our current year earnings and utilized more seed. So it’ll be evolving, but it wouldn’t be unrealistic to think that we would eat into the special, as we have done on several occasions to see products.

[Robert Lee, KBW]

Okay, great. Those are my questions. Thanks so much for taking them.

[Operator]

The next question comes from Ryan Bailey with Goldman Sachs. Please go ahead.

[Ryan Bailey, Goldman Sachs]

Good afternoon or good morning. So maybe a quick question for C.J. Initially, the pace of investments for this year, is this a one-year build that you’re thinking about to get you where you need to be? Or should we be thinking, this is kind of the start of more investment needs for the firm?

[C.J. Daley]

Well, Ryan, as you know, certain costs seem to only go up with inflation and more usage, and I’m speaking technology and data. And as our business grows, our talent focus will remain. So I would say that we have a, as I said before, control over our spend. We’re leaning into it this year. Some subcategories like tech and occupancy had been a little bit suppressed over the last couple of years with COVID. We had a great last year, so we’re leaning into the spend.

So I don’t want to say you should expect the same type of growth year-over-year. And as we get into the year and into the end of next year, we’ll provide further guidance on where that goes. But our efforts will, will span over several years. And beyond that, because we’ll continually reinvest in the business.

[Ryan Bailey, Goldman Sachs]

Okay, that’s fair. And then maybe for Eric, you had said that you were excited about the supply of talent in the market today. And I know I sort of asked this question in the past, but it can – and it can be difficult to forecast when you bring new teams in. So maybe I’ll ask it a different way. Based on what you’re seeing in the market today, is there any reason why we shouldn’t see more in your hiring, and new teams coming into APAM over the next few years than we’ve seen in the past? And the reason I’m asking is this could potentially [Technical Difficulty]…

[Eric Colson, Chief Executive Officer]

You broke up there at the end, Ryan, just on the last part of it.

[Ryan Bailey, Goldman Sachs]

Sure, sorry. I was just saying, if you do have more teams coming in more steadily, that could improve the diversification of the firm and see a more steady sort of pace of growth.

[Eric Colson, Chief Executive Officer]

Yes. I do think that we are looking at a greater supply of talent for the broad comments that I made on the earnings call. As I stated, I do think these strategies tend to be a bit more capacity constrained as you look at the alternative space. But how teams have evolved inside of the Artisan framework coming in with a strategy and skill set, how you capitalize on that skill set over time and how the market evolves is unknown.

So our first priority is always bank on talent and differentiated and great performance, and let the market evolve the franchise. And as we look at the number of potentially strategies that are available to our platform today, as C.J. has mentioned, we’ve invested in the broader platform, I would expect more teams coming in at a more diverse array of strategies over the next five years.

[C.J. Daley]

And then Ryan, just to clarify my earlier comment on your question, I do think the spend will provide us leverage for the future to bring on more teams, as Eric has stated. And so, while spent and reimbursable will continue, we should gain efficiencies from some of the things we’re doing this year.

[Ryan Bailey, Goldman Sachs]

Got it. Okay. And thank you for the color, Eric and C.J. for the clarification.

[Operator]

The next question comes from Dan Fannon with Jefferies. Please go ahead.

[Dan Fannon, Jefferies]

Thanks. Just looking at the AUM mix of the generations – the third generation – the three generation of funds. And as you look at the third generation and its makeup by client location and vehicle and even distribution channel, I guess, how do you see that evolving comparing versus the first two generations? And do you see that kind of more of a growth in non-U.S. from here or SMAs, are some of the kind of thinking about the maturation of that segment or that generation of products?

[Eric Colson, Chief Executive Officer]

Yes, it’s been a debate we have within the firm of exactly how certain strategies fall into the various generations. And I clearly think with the new emerging market, that team in one side, the global unconstrained really fits in nicely into that third generation, just the amount of degrees of freedom and the differentiated performance results. And on top of it, the fee that goes with that type of strategy.

But I also look at the emerging market blend and local is going to attract quite a bit of non-U.S. client base, and it’s going to help that global generation, too. So you can look at that team and say that the emerging market debt is a strategy that lends itself very well to asset allocation around the world. Arguably, you might lean towards a non-U.S. and even European mindset, given the comfort with currency and emerging market debt. And clearly, looking at the the rates across Europe, this is a very attractive asset class.

So this team may fall into the globalization as well as the degrees of freedom. So two and three. And then on the flip side, when we look at what’s going on with the credit team, we again have a credit opportunities. It’s clearly a generation three, but the floating rate strategy is a category killer, the number of securities in that segment of the market has now caught up or even surpassed what you see in the corporate credit in high yield. So you have a burgeoning supply of securities to differentiate within a category.

So we’re not against categorization. We think it’s going to be – it’s here to stay. And in some cases, the number of issuers are going to bring that back into vogue, or the redefinition of the category that allows greater flexibility will bring it back in. So we think growth could occur across all three generations. And just looking at the two credit teams that we – that I highlighted, that – it gives you a lens into how it fits across the various categories and opportunities.

[Dan Fannon, Jefferies]

Great, thank you. And then as a follow-up, C.J., just the 10% headcount, is that mostly, I think you said distribution, as well as the building out of the recent team hires? But I assume that doesn’t include any forecast of additional teams. So maybe thinking about where – what the starting point, I guess, even numerically what – how many people that might be, and then where the breakdown of that headcount is going?

[Eric Colson, Chief Executive Officer]

Yeah, I mean, we were probably talking around 50 to 60 additions. And it’s really spread across primarily investments and distribution. No, not forecasting any new teams. A new team could prop that up a bit more. And then on the administrative side some smattering of individuals across a number of different areas as we look ahead and think about existing growth and future opportunities.

[Dan Fannon, Jefferies]

Got it. Thank you.

[Eric Colson, Chief Executive Officer]

Do we have any other questions?

[Operator]

No, we have no further questions. So this concludes our question-and-answer session, which also concludes today’s conference call. Thank you for attending today’s presentation. You may now disconnect.

[Eric Colson, Chief Executive Officer]

Thank you.

[C.J. Daley]

Thank you.