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 2019 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Thursday, October 17, 2019.
I would now like to turn the conference over to Brian Heller, Senior Vice President and Corporate Counsel of Cohen & Steers. Please go ahead.
Thank you, and welcome to the Cohen & Steers third quarter 2019 earnings conference call. Joining me are our 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 statement. Also, our presentation contains non-GAAP financial measures that we believe are meaningful in evaluating our performance. These non-GAAP financial measures should be read in conjunction with our GAAP results. A reconciliation of these GAAP financial measures is included in the earnings release and presentation. The earnings release and presentation as well as links 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, and thanks for joining us this morning. My remarks will focus on our as-adjusted results. A reconciliation of GAAP to adjusted results can be found on Pages 18 and 19 of the earnings release and on Slides 16 and 17 of the earnings presentation.
As a reminder, on August 1, we began including model-based portfolios in assets under management. All periods included in both the earnings release and the earnings presentation have been recast to reflect this reporting change. Revenue, operating income, and margins were unaffected, but our effective fee rate decreased by about 1.5 basis points as a result of including these assets and fees in the calculation.
Yesterday, we reported earnings of $0.65 per share compared with $0.64 in the prior year's quarter and $0.62 sequentially. Revenue was $104.9 million for the quarter compared with $98.2 million in the prior year's quarter and $101.8 million sequentially. The increase in revenue from the second quarter was primarily due to higher average assets under management and an additional day in the quarter, partially offset by lower investment advisory fees from Cohen & Steers Realty Shares or CSR, our flagship mutual fund.
You will recall that last quarter we informed you that effective July 1, CSR reduced its expense ratio by approximately 10% and that we expected this would reduce second half management fees by approximately $2 million. We also mentioned that incremental net inflows into CSR would represent higher margin business as there is a lower revenue share component associated with it.
Our effective fee rate, which now includes model-based portfolios, was 55.9 basis points for the third quarter, compared with 56.5 basis points last quarter. The decrease was primarily due to the full-quarter effect of the reduction in CSR's expense ratio.
Operating income was $40.7 million for the quarter, compared with $39.4 million in the prior year's quarter and $38.8 million sequentially. Our operating margin increased to 38.8% from 38.2% last quarter.
Expenses increased 1.9% on a sequential basis, primarily due to higher compensation and benefits and G&A. The compensation to revenue ratio was 35.75% for the quarter, consistent with the guidance provided on our last call, and the increase in G&A was primarily due to higher recruitment fees.
Although distribution and service fee expense was relatively flat from the second quarter, it is noteworthy that the increased costs resulting from higher average assets under management in US open-end funds was more than offset by a $520 million redemption from a high-cost intermediary that eliminated its real estate allocation during the quarter. Our effective tax rate was 25.25% for the quarter, consistent with our prior guidance.
Page 15 of the earnings presentation sets forth our cash, corporate investments in US Treasury securities, and seed investments for the current and trailing four quarters. Our firm liquidity totaled $246 million at quarter end, compared with $218 million last quarter, and stockholders' equity at quarter end was $279 million compared with $256 million at June 30, and we remain debt free.
Assets under management, which now include model-based portfolios, totaled $70.8 billion at September 30, an increase of $4.2 billion from June 30. The increase was due to market appreciation of $3.8 billion and net inflows of $1.1 billion, partially offset by distributions of $644 million. This marks the first time since the second quarter of 2011 that we have recorded net inflows into each of our vehicles, open-end funds, advisory, Japan subadvisory, and subadvisory ex-Japan.
Advisory accounts had net inflows of $441 million during the quarter, which included six new mandates totaling $274 million, three of which were included in last quarter’s pipeline, and an additional funding from an existing client. Inflows, which were broadly based, went into global real estate, US real estate, preferred and global listed infrastructure portfolios. Bob Steers will provide an update on our institutional pipeline of awarded unfunded mandates.
Japan subadvisory had net inflows of $9 million during the quarter, compared with net outflows of $224 million during the second quarter. Distributions from these portfolios totaled $304 million compared with $333 million last quarter. Subadvisory excluding Japan had net inflows of $62 million, primarily due to an additional funding from a strategic OCIO partner into a global-listed infrastructure portfolio.
Open-end funds recorded net inflows of $616 million during the quarter, which, as mentioned earlier, included $520 million redemption from an intermediary that eliminated its real estate allocation. Distributions totaled $213 million, $165 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 35.75% compensation to revenue ratio. We project the G&A for 2019 will be in line with the $46 million we recorded in 2018. And 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 discuss our investment performance.
Thank you, Matt. This morning, I will address our investment performance, share some high-level thoughts about our US REIT strategy, and summarize our common attributes that define our strategies. Our investment performance both absolute and relative has continued to be very strong, reflecting favorable macroeconomic conditions of positive economic growth and low interest rates as well as ongoing returns from the investments we have made in our teams and processes.
In the third quarter, eight of our nine core strategies outperformed their benchmarks. For the latest 12 months, the same eight of nine core strategies also outperformed. Measured by AUM, 96% of our portfolios are outperforming on a one-year basis, 98% are outperforming over three years and five years. These batting averages are consistent with last quarter, and we are obviously pleased with them. 88% of our open-end fund AUM are rated four or five star by Morningstar.
Against the favorable macro backdrop, in the quarter, concerns about slowing growth prompted the Fed to cut short-term rates by 50 basis points and the 10-year Treasury yield declined to 1.7%. A new round of quantitative easing in Europe also helped to pin down yields.
This benefited absolute performance for REITs for infrastructure and preferreds. Trade wars and concerns about global growth pressured commodity prices, which contributed to negative returns in the quarter for resource equities and midstream energy.
This quarter, I'd like to spotlight our US REIT strategy. REITs began to outperform in the fourth quarter of last year when it became likely that interest rates had peaked. While some investors fear they have missed the rally, one factor that is misunderstood is that most generalist equity managers underweight REITs.
On average, the data show they are just 75% weighted versus the GICS sector weight. As a result, I believe there is meaningful demand potential that based on our experience, we will chase performance. Another question we feel relates to investor concerns about how REITs would perform in a recession, remembering the last one when REITs were disproportionately hit by the liquidity crisis.
We believe that REITs should perform differently and defend well in the next recession assuming it is an average one, because the banking system is much better capitalized, and commercial and residential real estate ecosystems are much healthier. This year and for the latest 12 months, we are on track to have one of the best periods of alpha generation in our US REIT strategies since the financial crisis.
Specifically, our core US REIT strategy returned 25.8% over the past year, outperforming by 550 basis points. Earlier this year, we changed our benchmark to include a broader universe of real estate sectors, including higher-growth digital real estate sectors. This benefited our clients and that -- this index has performed better than our prior benchmark.
As important, we have gotten a lot of sector and stock selection positioning correct, including being overweight the new economy property types and underweight regional malls. Tom Bohjalian, who heads our US REIT effort, has done a great job leading this team.
Recently, we announced the soft close of one of our US REIT mutual funds, Cohen & Steers Real Estate Securities Fund or CSI. The soft close demonstrates our commitment to delivering our excess return objectives. CSI, which has a five-star rating, is managed differently than our core US REIT strategy.
It invests across the market capitalization spectrum of REITs and opportunistically invests in option strategies and REIT debt or international real estate securities. In contrast, our core strategy focuses on high-quality, larger cap, real estate equities.
We have meaningful US REIT capacity, which will allow us to continue to offer our core strategy in a variety of vehicles and solutions. Our core REIT strategy is offered through two mutual funds which are managed similarly. Cohen & Steers Realty Shares is rated four star and recently added a full range of share classes, and Cohen & Steers Institutional Realty Shares, which is designed for institutional investors, and just earned its fifth Morningstar star.
Shifting topics. We recently held our Annual Investor Conference and I'd like to share a portion of my presentation, which frame the common attributes of our strategies. This overlay helps guide our new strategy development. First, our strategies are grounded in great secular investment ideas.
Examples include the securitization of real estate, first in the US and then globally; the massive need for infrastructure investment including a subset, which is the build out of North American energy infrastructure; and the growth in the preferred market due to bank regulatory capital changes.
Second, our strategy is focused on asset classes that complement stocks and bonds by virtue of being return enhancers, yield enhancers or diversifiers. Our flagship refund Cohen & Steers Realty Shares is a great example of a return enhancer having generated 11.9% annually over 28 years. An example of a yield enhancer is preferreds, which are increasingly being used by institutions searching for alternative income, particularly insurance companies.
Third, specialists like Cohen & Steers have a competitive advantage in our asset classes through dedicated uninterrupted research, the application of that research, or through in-depth knowledge of complex security structures, as in the case of preferreds. Just think of an expert specialists advantage versus a generalist who is spread across 11 GICS sectors.
Fourth, our holdings offer tax efficiencies, either through their corporate structures or the tax treatment of their dividends. Tax efficiency is becoming more appealing in the wealth channel as investors seek relief from taxes and contemplate a potentially higher tax regime going forward.
Finally, our asset classes are experiencing rising portfolio allocations, typically at the expense of stock bond and core style box allocations. This stems from the asset allocation dilemma were fixed income doesn't come anywhere close to meeting a pension's 7% return target and investors are leery of drawdown risk with equities and are increasingly using our strategies in new ways, such as multi-strategy solutions, focused approaches, or completion strategies to better achieve portfolio outcomes.
With that, I'll turn the call over to Bob Steers.
Thank you, Joe, and good morning, everyone. As the third quarter progressed, the star seemed to come in alignment for many of our strategic priorities. Most importantly, as Joe pointed out, investment performance remained strong across all of our key portfolios and investor demand remained high for real asset and alternative income strategies.
This powerful combination of strong performance and in-demand strategies produced $1.1 billion of net inflows. Matt's earlier comment on flows bears repeating because it's important. Each of the wealth, advisory and subadvisory channels, including Japan, were net positive in the quarter for the first time since the second quarter of 2011.
Consistent with the recent trend, the strong net inflows into the wealth channel were driven by sales into our US REIT and preferred securities funds. In addition, wealth benefited from a significant acceleration in DCIO flows and modestly positive open-end fund results in Europe. Advisory experienced positive net flows in the US, Europe, Middle East and Asia.
As we've spoken about in the past, our overarching goal is to leverage our strong investment performance and growing distribution platform to achieve positive organic growth in all channels simultaneously, which we realized this quarter. While we don't expect to be able to deliver these results every quarter, our current product and distribution plans give us a good opportunity to continue to do so when the economic and capital market stars are aligned as they are now.
Turning to our results by channel. Wealth generated $616 million of net inflows in the quarter. However, as Matt pointed out, even these strong results are understated as they're net of a $520 million redemption out of a brokerage firms model portfolio following the decision to eliminate its entire US and global REIT allocation.
With regard to our DCIO initiative, we generated $112 million of net inflows in the quarter and $431 million year-to-date versus only $4 million one year ago. Charlie Wenzel, who leads this team along with national accounts and the rest of the wealth group, deserve recognition for building a valuable franchise in the retirement space.
Advisory had a solid quarter with $441 million of net inflows primarily derived from six new clients, including three from the EMEA region. Not unlike our DCIO initiative, Marc Haynes, who leads our EMEA business development team, has successfully grown this initiative from early green shoots to another secular growth opportunity.
In addition, we're beginning to capture some important new advisory mandates in Japan, which also has been an important strategic initiative. The pipeline of awarded but unfunded mandates ended the quarter at $578 million, just slightly below the $618 million beginning backlog, and activity levels remain elevated.
Subadvisory ex-Japan produced $62 million of net inflows. And as we disclosed earlier this year, we've elected to retain only those relationships that we view as strategic. To that end, we have terminated most of our single product subadvisory mandates and have launched an initiative to reach out to leading OCIOs and similar intermediaries who are committed to our asset classes. Long term, the goal is to improve gross inflows, while reducing the potential for entire asset class redemptions such as we saw in wealth this quarter.
Japan subadvisory posted $9 million of net inflows pre-distributions and 205 -- $295 million of after distributions. This marks the first quarter of net inflows since the second quarter of 2017 and was driven primarily by exceptionally strong absolute and relative returns in our US REIT -- real estate strategies.
Looking ahead, we're encouraged that our absolute and relative performance is strong and that every distribution channel is generating positive organic growth. In addition to the momentum that we are experiencing in our traditional distribution channels, the closed-end fund marketplace, after being dormant for years, has recently reopened.
We are the sixth largest issuer in the closed-end fund marketplace. And in the current environment, a number of our existing funds are trading at premiums. Not surprisingly, several closed-end fund distributors have expressed serious interest in partnering with us in the near future, and we are currently pursuing a number of options.
Lastly, we announced that Dan Charles has joined Cohen & Steers as Executive Vice President and Head of Global Distribution, overseeing all business development activities worldwide. Dan served in a similar role at William Blair and before that at Janus Capital Group. This new position reflects the growth of our distribution platform, the convergence of the institutional and wealth marketplaces, and our goal of sustaining positive organic growth.
I will stop there and ask the operator to open the line to questions.
Thank you. [Operator Instructions] And our first question is from the line of Michael Carrier with Bank of America. Please go ahead.
Good morning, and thanks for taking the questions. Maybe just the first one, given that you guys do have the strong performance in the products, you hired the Head of Distribution. Just wanted to get your take on the opportunities or the areas that you -- when you kind of look at the landscape where maybe Cohen & Steers historically has not been capturing as much opportunity as maybe others in the industry and you see more potential growth. It seems like in the wealth space you guys have done a great job. So just on the institutional side, where are those kind of pockets of opportunity?
Good question. Obviously, we're pleased that we are earning inflows in each of our key channels. That said, there is the open-end fund or SICAV lineup in Europe performing well from an investment standpoint, but we're not where we want to be in terms of business development. And we're in the process of bringing in some new leadership there, Dan Charles, and Marc Haynes are leading that up.
And so, we expect better things coming out of our wealth business in Europe going forward and as well as advisory is done, we think we can be more productive there both in the US and internationally. So those are the two areas where you should -- we should look for improvement. Nothing is broken, but we think we can do better in both of those.
Okay. That's helpful. And then, Matt, I think, recently like over the past year or two, I think when we thought about expenses and margins, you know just given some of the investments, MiFID costs, it seemed like margins were going to be kind of around on these levels, but I guess just given the strength that we're seeing in the performance additional -- in addition to the net inflows, just how are you thinking about the margin in this environment?
It seems like things have gotten better. I don't know if there is additional expense initiatives that are in place so that would ramp up or if we could potentially see more operating leverage in this type of environment if it continues.
Yes. I think the latter part of what you just said is probably most on point with the leverage. When we -- looking at our revenue growth so far year-to-date versus how G&A is trended, I think that's been very well controlled, so having G&A kind of like flat year-over-year is a big positive, and I think everybody in the firm is taking cost control very seriously. Non-client related activities are really being scrutinized, and we're seeing the fruits of that with these projected results. Where I think the leverage would come from would be obviously on the comp line, where over the past three or four years, we've been hiring selectively where we needed to get some departments up to scale and then just from ongoing regulatory and IT challenges, continuing to address those and selectively adding to our investment teams.
That said, we think we're pretty much built to the extent that we don't create new vehicles and new strategies that would be a little complex and would need some specific staffing. I think you could look to see the headcount expansion kind of leveling off now for the most part, so that's where in 2020 and beyond, we should be able to see some expansion in the margins.
Okay. Thanks a lot.
Yes.
Our next question is from the line of John Dunn with Evercore ISI. Please go ahead.
Good morning. Looks like flows in Realty Shares improved each month over the course of the quarter. Are you guys seeing -- let's -- I know real estate securities hasn't yet soft closed, but are you seeing any flows getting redirected from real estate securities to Realty Shares or is it just a pickup in demand for this strategy?
Yes, we're seeing CSR sales in the quarter, up 33%, and it went from outflows to inflows in the quarter.
But I think part of the plan is for possible flows that we're going to go into real estate securities getting shifted to that fund. Is that -- have you seen any evidence of that?
Not really. I mean sales in CSI were up 3%, net inflows up 7%. I think what we are seeing is redemptions in both declining substantially.
Got you. And then you mentioned advisory in Japan. It's been a while since you've talked about that. Can you give a little more color on where those mandates were and with whom maybe?
Yes, sure. I'd say our institutional effort is picking up in Japan. And in terms of our newly awarded mandates, we've got three in Japan, two for global real estate, and one for listed infrastructure. So that shows the breadth of our reach in Japan. I would note that on the -- both of the real estate mandates, there are takeaways from existing allocations, where our competitors have not performed, and that's a trend that we're seeing globally.
On the infrastructure front, that is a third allocation for the existing investor, so we're the third manager, and so that demonstrates the growth in infrastructure allocations, and we're seeing that institutionally not so much in wealth.
John, also heretofore, given our current licensing status in Japan, we've only been able to develop new business through intermediaries. Our license is about to be upgraded before the end of the year for sure, so that will free our team up over there to go direct to institutional investors.
And so, we're getting some good traction with one arm tied behind our back. So, I think the fact that we're becoming better known, we're gaining mandates from very well-known pension funds and insurance companies. Once our license is upgraded, we would hope to build on that momentum.
Got you. And just one quick one. I think the pipeline is seasonally been strong going into the end of the year. Any outlook on where activity might go in the fourth quarter?
It's hard to say, John. All I can say is that the stars do seem to be in alignment for what we do. There is a strong demand institutionally for non-cyclical stable income, non-correlated asset classes. And on the wealth side, particularly as we wind into an election year next year, tax-advantaged strategies which many, if not most of ours are -- is really gaining quite a bit of traction in the wealth channel.
Thanks guys.
Thanks, John.
Our next question is from the line of Robert Lee with KBW. Please go ahead.
Hi, this is Jeff Drezner on for Rob Lee. Thanks for taking my question. Just had a quick question on the special dividend. Is there any reason not to expect another year-end special dividend this year? And also just a reminder on the cash -- the operating cash balance you'd like to maintain?
Well, as we say every year, the Board at its fourth quarter meeting discusses our cash needs. And as you pointed out, we have in recent years had a special distribution to shareholders and I'm sure that will be a topic of discussion at the Board meeting.
Okay. Thanks. And then maybe a quick follow-up. Are there -- are you seeing any upward pressure on the expense side on distribution or tech spending? I know you touched on some other line items for the expenses. Thanks.
Distro expenses tend to be episodic if you will, because it's -- we've had a pretty steady state of late, but those are things that they -- discussions happen adhoc. We haven't seen one in a while, but we've had some in the recent past. Tech spending has been incorporated in our run rate. We look at our cash spend and much of that is capitalized and amortized over time.
So that's all included in G&A. And so we've been able to appropriately accelerate where necessary. Our technology spending, which is now mostly pivoted to helping to generate alpha, so there's initiatives with the technology department and our investment department to maximize alpha. And that's also built into our cash spend and has been capitalized and being amortized. So when we say G&A is going to be flat year-over-year, that includes our tech spending.
Got it. Thank you very much.
[Operator Instructions] Our next question is from the line of Mac Sykes with Gabelli. Please go ahead.
Good morning, everyone.
Morning, Mac.
I have a couple questions. The first is on ESG. Maybe you could just talk about your strategy there and then marketing side, product innovation, perhaps incorporating [ph] some of the principles in the investment process?
Sure. Well, look, that's getting greater and greater focus here and we've invested quite a bit already and it's really an area where -- well, first, we believe in it, but increasingly it's part of the game. And in terms of having ESG integrated to -- into your investment process and we've got a long history on the G part, the governance part of that as we help shape the governance for the REIT strategy so that just gives you a sense of our commitment to it in our understanding of how it can influence security evaluations and our investment process. So we are -- have incorporated ESG into our investment processes. We also are communicating that with our investors and asset consultants.
But looking forward, we're also, in the lab, developing investment strategies that are more specifically tied to alpha sources in ESG and the two strategies that are top of the list are -- in real estate and renewables kind of a subset of infrastructure. So this is going to become very important for the industry and we've calibrated our commitment and investment commensurately.
Great. And then this is a two partner for the closed-end funds. Maybe you could just expand on your statement about the opportunity, is this about product innovation or increasing asset -- assets in the existing vehicles? And then secondly -- thirdly, do you anticipate the costs for asset raising to be lower for more favorable than in the past cycles?
So as I mentioned earlier, the closed-end fund market has been pretty active this year, both in IPOs and rights issues, most of which have been very successful. And so we are evaluating both of those options. If on the IPO side, it would be a -- it wouldn't simply copy an existing strategy and would likely have a tax-advantaged aspect to it.
Rights issues, similarly, if our funds are trading at significant premiums, that's something that we would opportunistically consider. As you're probably aware the cost of raising new money for the sponsor ourselves in the closed-end fund market is actually significantly higher than it has been in the past as the sponsors essentially pay a 100% of the underwriting distribution costs, which could range as high as 4% of the total raise.
And by our calculation, if we were able to have a substantial raise and I think the raises this year have ranged from around $200 million, $250 million to an excess of $1 billion at those levels, the ROI, even with a 4% cost, would be very attractive for permanent or semi-permanent capital.
Great. Congratulations on a nice quarter.
Thank you.
And there are no further questions on the phone lines at this time. I'll turn the call back to Bob Steers for the closing remarks.
Great. Well thank you all for dialing in and for your questions. And we look forward to speaking with you at the end of 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.