Cohen & Steers Inc
NYSE:CNS
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Cohen & Steers Inc
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Ladies and gentlemen, thank you for standing by. Welcome to the Cohen & Steers Third Quarter 2018 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded Thursday, October 18, 2018.
I would now like to turn the conference over to Brian Heller, Senior Vice President and Corporate Counsel of Cohen & Steers. Please go ahead, sir.
Thank you and welcome to the Cohen & Steers third quarter 2018 earnings conference call. Joining me are Chief Executive Officer, Bob Steers; our President, Joe Harvey; and our Chief Financial Officer, Matt Stadler.
I want to remind you that some of our comments and answers to your questions may include forward-looking statements. We believe these statements are reasonable based on information currently available to us. But actual outcomes could differ materially due to a number of factors including those described in our most recent annual report on Form 10-K and other SEC filings. We assume no duty to update any forward-looking statements.
Also, our presentation contains non-GAAP financial measures that we believe are meaningful and evaluating our performance. These non-GAAP financial measures should be read in conjunction with our GAAP results. A reconciliation of these non-GAAP financial measures is included in the earnings release and presentation.
The earnings release and presentation as well as linked to our SEC filings are available in the Investor Relations section of our website at www.cohenandsteers.com.
With that, I'll turn the call over to Matt.
Thank you, Brian, good morning, everyone.
Our remarks this morning will focus on our as adjusted results. A reconciliation of GAAP to as adjusted results can be found on Pages 18 and 19 of the earnings release or on Slide 16 and 17 of the earnings presentation.
Yesterday, we reported earnings of $0.64 per share compared with $0.55 in the prior year's quarter and $0.59 sequentially. Revenue was $98.2 million for the third quarter compared with $96.7 million in the prior year's quarter and $94.2 million sequentially.
The increase in revenue from the second quarter was primarily attributable to higher average assets under management and one more day in the quarter. Average assets under management were $60.4 billion compared with $61.2 billion in the prior year's quarter and $58.7 billion sequentially.
Operating income was $39.4 million in the quarter compared with $40.4 million in the prior year's quarter and $36.4 million sequentially. Our operating margin increased to 40.2% from 38.7% last quarter primarily due to lower G&A and compensation and benefits when compared to revenue. Please recall that the second quarter of 2018 included a cumulative adjustment to increase the year-to-date compensation to revenue ratio to 33.75%.
Expenses increased 1.7% on a sequential basis as higher distribution and service fees and compensation and benefits were partially offset by lower G&A. On our last call we mentioned at one of our intermediaries deferred the imposition of revenue-sharing and sub TA fees on retirement accounts into the second half of the year.
The increase in distribution and service fee expense this quarter was primarily due to the recognition of these deferred fees, as well as increased expenses associated with higher average assets under management in U.S. open end funds. The increase in compensation and benefits was primarily due to higher salaries and incentive compensation attributable to new hires during the quarter, as well as the full impact from new hires made in the second quarter.
The decrease in G&A was primarily due to fewer sponsored and hosted conferences. Our effective tax rate for the quarter remained at 25.25% consistent with the guidance provided on the last call. Page 15 of the earnings presentation displays our cash, corporate investment in U.S. treasuries, and seed investments for the current and trailing four quarters.
Our firm liquidity totaled $291 million compared with $263 million last quarter and stockholders equity was $324 million compared with $303 million at June 30. We continue to be debt-free.
Assets under management totaled $60.1 billion at September 30, slightly less than the $60.2 billion at June 30. Net outflows in the quarter was $76 million.
As many of you know in mid-August our largest Japanese distribution partner cut the distribution rate on the two largest funds that we subadvised. As a result, outflows accelerated representing the majority of the $314 million of net outflows from subadvised portfolios in Japan.
Distributions for the quarter which included only half of the impact of the August distribution cuts totaled $433 million compared with $566 million last quarter. Subadvised accounts excluding Japan had net outflows of $335 million primarily from the termination of a commodities account and a redemption from the large-cap value account.
Advised accounts had net inflows of the $148 million during the quarter primarily from a preferred mandate in our first multi-strategy real assets separate account. Bob Steers will provide an update on our institutional pipelines. Open end-funds had net inflows of $425 million during the quarter. Distributions totaled $241 million, a $191 million of which were reinvested.
Let me briefly discuss a few items to consider for the fourth quarter. With respect to compensation and benefits, we expect to maintain a 33.75% compensation to revenue ratio. We expect G&A to increase approximately 2% from the amount recorded in the third quarter of 2018 and finally we expect that our effective tax rate will remain at approximately 25.25%.
Now I'd like to turn it over to Joe Harvey, who will provide commentary on our investment performance.
Thanks Matt, and good morning everyone.
In the third quarter our asset classes were not in favor compared with the S&P 500 which returned to 7.7%. Importantly however we delivered strong relative performance with nine of our 10 strategies outperforming their benchmarks. For the latest 12 months, eight out of 10 strategies outperformed. Looking at AUM, 98% of our portfolios are outperforming on both a one year and three year timeframe.
Macro trends influencing our strategies include a strong economy that is broadening and maturing filed by tax reform, deregulation, fiscal stimulus and an increasingly vibrant consumer. With unemployment at 49 year lows, workers are confident enough in the job market and in wage growth that consumption strengthened.
Market factors influencing our strategies included rising short-term interest rates and bond yields and strong energy markets. The 10 year treasury yield rose 20 basis points to 3.06% during the third quarter and subsequently yields capped out in October.
While rising bond yields restraint returns in some of our strategies, our portfolios performed better than it did earlier this year reflecting the interest rate sensitivity has been partially priced in. Our strategies are not direct beneficiaries of the resurgence and consumer spending and China trade wars dampen commodity and resource equity returns. As a result, real asset returns lagged equities.
In spite of rising bond yields, our preferred securities returned 1.1% on the back of spread compression of 35 basis points in the quarter. Low duration preferreds returned 1.4%. We outperformed in our core strategy and underperformed in our low duration strategy. Over the past 12 months however, we outperformed in both. We continue to see expanding investor interest in preferred securities with asset constables embracing them, more institutions are evaluating them as alternative sources of income and wealth firms placing them in asset allocation models.
The appeal of preferred securities has yield. Comparing our open-end mutual funds, our core open-end fund with the symbol CPX, yields 5.6% with duration of 4.6, while our low duration open-end fund yields 4.5% with duration of 2.1.
Midstream energy and MLPs was our best performing asset class with a 6.6% return. We underperformed our benchmark in the quarter, yet have had strong outperformance for the last 12 months and longer-term. We recently received an upgrade to five stars by Morningstar for our open-end midstream energy fund. We expected this frankly based on our strong peer performance and the upgrading rate is meaningful considering the high business priority we have placed on midstream due to our pro-bullish investment thesis.
We had added analysts to our mid-stream team which now totals five. Midstream performed well because oil prices and production are strong. There was some softening of a negative energy commission proposal made in March and more importantly midstream companies have announced positive corporate actions and restructuring.
Private equity continues to be active in midstream energy particularly in the U.S. In the second quarter, we see it as a focus or concentrated version of our midstream portfolio consistent with our strategy of having focus track records in all relevant strategies.
The infrastructure asset class returned to 0.5% for the quarter. We outperformed in both our core and focused portfolios for the quarter and for the last 12 months. Interest and infrastructure continues to expand institutionally including most recently in the Middle East. Part of this interest is connected to the abundance of capital totaling $170 billion earmarked to acquire private infrastructure assets.
The public market is benefiting from the spillover of that capital in two ways. First, allocations are being made to active listed infrastructure strategies, and second private equity funds are buying assets from public companies or are buying public companies out right. Further driving allocations are the diversification benefits where infrastructure sows low correlation to equities of about 0.6 and favorable downside capture of about 50%.
Turning to U.S. real estate securities, they returned 0.8% in the quarter and global real estate returned negative 0.3% in U.S. dollar terms. We outperformed in the quarter and for the last 12 months and virtually every sub strategy we manage. This applies to each regional real estate strategy U.S., Europe and Asia and across a range of portfolio risk profiles from our focus portfolios along the spectrum to core and income strategies.
With respect to real estate and in the spirit of educating on our asset classes, I'd like to address the topic we have faced our entire existence as the firm and is becoming even more relevant today. While we received our fair share of allocations compared with private real estate, we believe listed should get more. This dynamic for private versus listed in allocations may be shaped by the performance in private equity where investors having consistently earned a return premium for forgoing liquidity.
Yet in core real estate, investors consistently over the long term have not earned a return premium for giving up liquidity. In fact, the public market has returned 2.5% to 5% more per year over various 10 to 25 year time frames.
Lately however, the private market has outperformed listed perhaps in part because the public market is discounting interest rate increases and expectations for lower real estate returns in the future. That private is outperforming public is surprising considering the public market continues to evolve with new property types, many new economy property types such as data centers or cell powers while the private market is more heavily represented in core property types including retail.
Because real estate is cheaper and the public market and in the private market and there is $280 billion in dry-powder awaiting deployment for private funds, we're starting to see REITs taken private, a trend not seen since 2007. Sooner or later the GAAP between with the public market foreshadows and what the private market is doing must converge.
While we see the desire for private most prevalent in the institutional market particularly in the endowment and foundation market, it is increasing in the wealth channel with nontraded REITs. Vintage years are always key when investing and considering how long this cycle has run, we do not see an adequate return premium in the private market for real estate especially through nontraded REITs which have fees that can consume 15% to 20% more of investor returns over their life cycles relative to active listed real estate strategies.
On the topic of comparing private and public real estate, 30 years ago we were alone voice, yet today the data is statistically significant and have been analyzed not just by us but by organizations such as Cambridge and Green Street and [Stanger] & Company. We will continue to educate and advocate for listed real estate to garner our greater share of investor real estate allocations as the public market offers a compelling proposition which includes a greater choice of property types with expert management and franchises at a lower cost and with liquidity.
With that investment overview, I’ll turn the discussion over to Bob Steers.
Thank you, Joe, and good morning.
As a reminder and as we addressed extensively in our annual reports, our overarching strategy and our strategic focus is to deliver more for less. To that end as you already known, we've made significant investments in growing our investment teams and productivity enhancing technology aimed at delivering more alpha while also maintaining profitability.
As you heard from Joe but it bears repeating, the performance of all of our core real asset and alternative income strategies remain strong in all relevant time periods. Today over the last one and three year periods between 98% and 100% of our total AUM is in strategies which are outperforming their benchmarks and 86% of our open-end fund assets are rated four or five stars by Morningstar.
The combination of industry-leading performance and competitive fees for our real estate infrastructure and preferred security strategies has translated into sustained positive organic growth in meaningful market share gains versus our active peers. We intend to sustain these trends by staying focused and specialized and going deeper into the real asset space.
For example, we are currently highlighting our five-star and top decile performing midstream energy fund which also offers a total costs that is among the lowest in the industry. This is what we mean by delivering more for less and what will hopefully sustain our market share gains across all of our core strategies.
As you know from our reported results, overall close in the quarter were mixed with continued strength and net inflows in our open-end fund and advisory segments but with net outflows from our Japan and Japan ex-subadvisory businesses. However looking ahead with the exception of Japan's subadvisory which will take time to return to equilibrium, we believe the outlook for open-end funds advisory and even subadvisory ex-Japan is positive.
U.S. open-end funds enjoy $421 million of net inflows in the quarter which benefited from substantially lower redemption rates compared to the first and second quarter. Our low duration preferred and income fund generated $263 million of net inflows which more than offset the outflows from our longer duration preferred securities funds.
We also continue to see net inflows into our U.S. and global real estate funds. As I said earlier, we are seeing meaningful market share gains across each of our real estate, preferred and infrastructure funds. Our non-US open-end funds saw modest net inflows of $4 million in the quarter but we expect to see increasing flows in the coming quarters as the benefits of our expanded bond share classes, new registrations, and additional selling agreements gain traction.
Net inflows in the advisory channel were $148 million driven by fundings of preferred securities and multi real asset strategies. More importantly, our awarded but unfunded pipeline grew to $1.2 billion in the quarter which is the second highest on record. This increase from $535 million in the second quarter was driven by rising real asset allocations, the recognition of strong investment performance and additional market share gains manifested by an increasing number of takeaways from competitors.
U.S. and global real estate strategies contributed the bulk of the pipeline increase in the quarter. While the net outflows of $335 million in subadvisory ex-Japan were disappointing, the outlook going forward is improving. The majority of the outflows in the quarter were driven by two terminations both in non-core strategies, commodities and large-cap value.
Following these outflows 460 million of subadvise large-cap value assets remain and there is no further commodity exposure. Looking forward approximately $450 million of the current $1.2 billion pipeline is earmarked for the subadvisory channel, most of which comes as a result of a takeaway from a global real estate competitor.
Following the second round of distribution cuts, net outflows from Japan's subadvisory increased to $314 million up from $260 million in the second quarter. Distributions in the quarter declined to $433 million from $566 million in the prior quarter and $849 million from the peak in the second quarter of 2017 and the current quarterly run rate is down to approximately $375 million. The factors that will influence when we will return to equilibrium flows versus distributions include both the passage of time and the absolute returns from U.S. REITs.
To sum up virtually 100% of our firm wide AUM is now comprised of core real asset an alternative income strategies which are beating their benchmarks and garnering additional market share in each of the wealth, advisory and subadvisory channels.
Looking ahead following several years of 8% annualized headcount growth, we believe that we are right-sized for our global opportunity set without the need for meaningful additional personnel additions in the near future. In the meantime allocations to real estate, infrastructure, natural resource, equities and alternative income strategies are increasing and thanks to our consistently strong performance we're gaining market share across the Board.
With that, I like the operator to open the floor to questions.
[Operator Instructions] And our first question comes from the line of Ari Ghosh with Credit Suisse. Please proceed with your question.
Sorry, if I miss this in the prepared remarks but just on Japan subadvised business, it looks like industry-wide sales have slowed little as distributors a sort of rethinking the way they sell U.S. REIT funds and are increasing education around the products over there. So, should we expect inflection point here anytime soon or is it kind of more of the same in the near-term as the kind of the sales trend slow a little bit?
That's a great question. I think that inflection points will vary depending on the manager. I think the overarching headwind is going to be not so much the distribution cuts which are largely or completely behind us, it’s the absolute returns from U.S. REITs.
So this year U.S. REITs have generated negative returns and so at least up until this month our technology funds and high yield funds got most of the market attention in Japan. Going forward I think both the passage of time and how U.S. REITs perform absolutely will determine the level of interest on the part of investors.
Secondly, most managers have different distribution arrangements and so whereas I think those managers who distribute exclusively through brokerage or wire house channels, I think will continue to face headwinds whereas those that have more diverse including regional banks and other non-brokerage distributors I think will do better.
And then just a quick follow-up. Given the REIT backdrop right now, which products are you most constructive on as net flow generators over the next 12 months. And then maybe give us a quick update on some of the newer launches including global logistics and your multi-strategy offerings as well.
And then, if I can squeeze another one in there as well kind of talked all this morning, but on the M&A front we’ve been involved in some of the - like late stage due-diligence, recently so curious how the search for potential targets maybe is evolved over the last 12 months. And then on the other side of it, I think also typically seen some ongoing interest yourselves in potential targets. So curious if there has been any uptick in charter there or what that looks like? Thank you very much.
Is that all? I’ll handle the first part of that question and I’ll ask Joe Harvey talk about product pipeline. So looking forward there are number of our strategies that we think are well-positioned to garner significant flows that would include, low duration preferred as we've seen as Joe mentioned it generates significant yield with roughly two year duration, that's frankly been a strong interest on the part of retail and candidly I think it competes well with long short funds for institutional.
Secondly, as both Joe and I talked about our fundamental outlook for midstream energy is extremely positive. It's one of the few segments of the market that is well below its prior highs and looks statistically cheap, and it's not an accident that coincident with us getting our five stars we recently reduced our expense cap on the fund to among if not the lowest in the industry. And so we're putting a very aggressive push on all of our midstream energy strategies and our mutual fund.
Thirdly, we do expect REITs, particularly U.S. REITs to perform well. They've been flat for several years, they've underperformed private as Joe mentioned, and they are statistically cheap, they are many companies selling below asset value and as we've seen in prior cycles and private equity as record levels of dry-powder that tends to provide an NAV floor on the valuations of REITs.
And so we like REIT fundamentals, we love their valuations, and so we think the outlook there is great and then as Joe will speak about we have similar phenomena in infrastructure, lots of dry powder, a great universe of public companies and we think a lot of that dry-powder will find its way into the public markets.
And so, again, we see the fundamentals there strong, we see the technical's strong, and like midstream energy, we're planning to launch a number of new initiatives, and so I'll ask Joe to maybe expand on some of those.
Sure. So, in terms of strategy and product development, there are several dimensions to it and maybe I'll just talk about some of the investor needs that we see out there and - I mentioned in my comments but the first is a need for more active share and we achieved that through creating these very concentrated portfolios which is the antithesis of an index oriented strategy for the talented managers that can deliver that alpha that's where we think that active managers can get paid fairly in the future.
So, for all of our strategies where we think that our focus portfolio is relevant, we either have them seated and are managing them or managing them for clients or we're evaluating whether to package those strategies in LP structures for certain market segments.
Another area that we're seeing is interest in multi strategy portfolio. So, this could range across a spectrum from investing across the capital stack in real estate with real estate equity or prefers or real REIT stat to our multi-strategy real asset portfolios, and we've got three different versions of that which are across the risk and return spectrum.
Then in terms of new markets, we've talked about developing strategies for the multi-family office, dominant foundation and outsource CIO markets where we see the greatest growth in AUM. And these are markets that have very particular needs. They want customized portfolios that are high alpha, that are differentiated, they maybe thematic or more focused across a thinner slice of a particular asset class. So, we have a range of strategies that either we're managing now. We have several focused versions of our real estate strategy which are ideal for those markets, they're also developing other strategies such as ESG real estate, a hedge version of real estate
Then, turning to infrastructure where - it's a very dynamic market based on the capital needs and the activity that's taking place, we've exceeded global logistics and visual infrastructure strategies. We're currently working on others such as a small cap infrastructure strategy.
And as I mentioned, the focused version of our midstream portfolio which could include some private elements to it. So, we've been very busy in the strategy development area and this gets back to a theme that Bob's been talking about, we've return in our annual report which is getting more focused and it starts with being creative and innovative in terms of our investment strategies.
I'm energized along with our investment teams to develop these new strategies and we think we have a lot of opportunity.
Just to answer to your M&A question, there are no current - no conversations going on either side of that question.
Our next question comes from the line of John Dunn with Evercore ISI. Please proceed with your question.
One more on the advisory pipeline, you talked about the big takeaway from a competitor. But can you talk about, like, over the past couple of years how the profile has changed, stuff like there's been a change in the average mandate size or whether it's new clients or existing clients adding to what they already have and maybe any regional changes?
Sure, John. Well, I think it's changed in a number of ways. One is, some of our larger existing clients have access to go deeper and sort of their total solution and real estate or real assets. So, there's a concentration of managers going on institutionally.
Second, in the subadvisory space, I think there is very substantial increasing pressure on large intermediaries, be they insurance companies or OCIOs, consultants, others, manufacturers of retirement products. There's tremendous pressure to replace managers who are not performing and/or who have higher fees and even in some cases where there is a conflict with the parent perhaps.
So, our performance has put a lot of space between us and most of the rest of the industry and so a combination of our performance but also being current with the market on fees and costs is allowing us to go after some significant takeaways in the subadvisory space.
More globally, we're seeing demand for listed everything in areas, in regions that where it didn't previously exist. And that's why we have made investments in our business development efforts both in Europe and the Middle East.
And so - and interestingly most of that interest is coming from very large institutions that already have very significant exposure to real estate and infrastructure through private managers, and now they're very interested in adding to the other side of that which is listed. Whether that's because they subscribed to our thesis that a significant amount of the dry-powder in both areas is going to be deployed in the public markets or simply acknowledging that having investments and the knowledge of both the public and private side of real assets just makes them better investors. So, we'll definitely see a broadening out of institutional demand.
And you guys have been investing for a few years - heavily for a few years now and I think you have another real asset institute in the fourth quarter , and I think you kind of put in place - you've done that through just such an opportunities the MLP fund, can you talk about some of the specific things you've done and invested in, is going to make it so easier to sell this fund because it looks really teed keyed up.
Well we've, as you’ve suggested we've continued to grow headcount both in our wealth channel which includes not just salespeople but national account's people. But also we've grown headcount in our institutional and consultant relations teams. And so, as you touched on it’s a top decile the mutual fund is a top decile performer with the lowest cost. I mean it’s the best performer with the lowest-cost, the story is phenomenal. And so, we've never had more opportunities and voices to help disseminate that story both in wealth and institutionally.
So we feel we’re in pretty good shape as Joe mentioned some of the more recent headcount we’ve added is in the team that is focusing on foundation, endowment, OCIO, multifamily office where I think their interest in energy infrastructure is high and where our ability to create with bespoke solutions in midstream, I think will be greatly appreciated. So we do have new people focused on discussing strategies like this with those newer markets.
[Operator Instructions] And our next question comes from the line of Mac Sykes with Gabelli Funds. Please proceed with your question.
Could we dig into the retirement space a little bit more, what are you seeing in terms of the acceptance of real assets on the retirement platforms in general versus your own distribution products?
Another good question. Retirement has been a space that as you know we made commitment to three years or four years ago. And candidly our penetration of that market while it is improving and it's been slower than we would have expected particularly in the target date space where we're just seeing. I believe until you see serious inflation and some catalysts that tells those product manufacturers that it's time to include real assets or an inflation hedge in those portfolios, there has been relatively less interest there.
Secondly, with DOL having disappeared I think the move to open architecture and target dates has diminished significantly. Conversely we are seeing adoption of real assets in larger not manufactured product areas. So we do see large retirement funds adopting real assets and in particular listed. And so that's where we’re making progress less so in the target date space.
And with respect to capital allocation, can I assume the special dividend or the potential special dividend could be higher this year just given your strong cash generation and also the repatriation benefits that you mentioned earlier in the year?
I've got to give you the same answer we give every year at this time, is that we’re evaluating all of our potential uses of capital which we've talked about in the past both investing internally in exceeding funds and et cetera. And the Board will be taking this up at our next meeting and following that you'll know.
And there are no further questions. At this time, I'll turn the call back to Mr. Bob Steers, Chief Executive Officer for the closing remarks.
Great, well thank you all for dialing in this morning. And we look forward to speaking to you again about the fourth quarter. Thank you.
Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.