Janus Henderson Group PLC

NYSE:JHG

Earnings Call Transcript 2017-Q4

[Operator]

Good morning. My name is Nicole, and I will be your conference facilitator today. Thank you for standing by and welcome to the Janus Henderson Group Fourth Quarter and Full-Year 2017 Earnings Conference Call. [Operator Instructions].

In today's conference call, certain matters discussed may constitute forward-looking statements. Actual results could differ materially from those referenced in any such forward-looking statements due to a number of factors including, but not limited to, those described in the forward-looking statements and risk factors sections of the company's registration statement on file with the SEC. Janus Henderson Group assumes no obligation to update any forward-looking statements made during the call.

Thank you. Now, it is my pleasure to introduce Andrew Formica, Co-Chief Executive Officer of Janus Henderson Group. Mr. Formica, you may begin your conference.

[Andrew Formica, Co-CEO & Executive Director]

Welcome, everyone, to the fourth quarter and full-year 2017 earnings call for Janus Henderson Group. Today I am joined by Co-CEO, Dick Weil, and also Roger Thompson, our CFO. Similar to prior quarters, the presentation today has three sections. Firstly, I'll touch on the full-year 2017 result and then take you through the fourth quarter business result covering off on investment performance, client flows and a few financial highlights. I'll then turn it over to Roger to review our financial result in greater detail, and to wrap up the presentation, Dick will provide an update on all that has been accomplished in this landmark year for our firm and also give you a sense of where our focus will be in 2018. After our prepared remarks, we'll be happy to take your questions. Now before we jump into the quarter, let me give you a brief summary of 2017. Firstly, this has been a monumental year for us as we have completed our merger and laid down the foundation for our future growth.

Our investment performance remained strong and it improved across all time periods compared to this time last year. This improvement is a testament to the truly world-class investment professionals that we have here at Janus Henderson. Looking at net flows for the year, clearly they were disappointing. This result was driven by a significant concentration of outflows in the first quarter and included the impact from some losses attributable to the merger. Assets under management in 2017 increased 16% to $371 billion on the strength of global markets and FX. Financial result improved year-over-year and displayed the enhanced operating leverage we anticipated would be created when we made the combination of Janus and Henderson. Later in the presentation, Dick will discuss in more detail the firm's accomplishment in 2017, but for now if we shift to the fourth quarter result. The story of the quarter had three parts. One, continued strong investment performance.

Two, asset growth driven by robust markets partially offset by net outflows. And finally, a strong set of financial results that reflect solid top-line growth, ongoing financial discipline and the benefit from the merger all translating into increasing profitability. Looking at investment performance, as of the end of December, 66% of firm-wide assets were beating their respective benchmark over the 3-year time period. While this is a decline from the prior quarter, it is a strong result and I am very encouraged by the fact that a significant majority of our assets under management our outperforming their respective benchmark over the 1-, 3- and 5-year time period. With respect to net flows, total group net flows reverted back to negative territory for the quarter after posting inflows in the previous quarter. Despite these outflows, total assets under management as at year-end increased 3% versus the prior quarter. On the financials, we saw the combination of growth in assets, an increase in performance fees and good expense management lead to strong results.

Fourth quarter adjusted earnings per share of $0.73 was up 30% compared to the prior quarter. Finally, consistent with prior quarters, the board declared a $0.32 per share dividend for the fourth quarter. Turning now to Slide 4 and a look at our investment performance in more detail. Performance in our equity capability improved year-over-year on a 1- and 3-year basis with the most notable change in the 1-year numbers. At the end of December, 64% of equity assets were outperforming benchmarks over the 1-year time period compared to 30% at the end of last year. The improvement was driven by the excellent work in the investment team and was further supported by our bias toward growth stocks in the majority of our larger strategies. This bias benefitted from growth outperforming value in 2017 as the Russell 2000 Growth Index returned 22% in the year compared to 8% for the Russell 2000 Value Index.

Looking now at INTECH, in 2017 we saw marked improvement in its 1-year result compared to the same time last year. After a very difficult second half of 2016, which resulted in only 7% beating their respective benchmarks to the year ending 2016, the quantitative exiting strategies of INTECH responded and in 2017 finished the year with 90% of assets beating benchmarks on a 1-year basis. That's a great result for the year. That said, as at year-end, the percentage of assets beating benchmark over the three-year time period dropped to 27% from 61% last quarter. This change was a result of several of the larger strategies underperforming during the quarter driven by the rotation in markets as a result of the tax reforms announced in the U.S. in December.

Lastly, as you can see, performance remained very strong across our fixed income, multi-asset and alternative capabilities. Overall, our investment performance continues to be strong, which is providing a solid foundation for future growth. This is particularly significant given all the noise and change as a result of the merger and demonstrates the resilience of our team and shows that the robust investment processes we have in place have been unaffected. Now if we move on to client flows. Fourth quarter net outflows were $2.9 billion compared to inflows of $700 million in the prior quarter. The quarter-over-quarter change was a result of a 30% increase in gross redemptions driven primarily by redemption from institutional clients in the equity, quantitative equity and alternative capabilities. Dick will discuss the trends we saw on a full-year basis later in the presentation, but for now let's look at our fourth quarter flows by capability that are shown on Slide 6.

Our equity business switched to net outflows this quarter driven by the absence of the large $1.8 billion mandate that funded in the third quarter as well as higher redemptions in the Asia Pacific and EMEA regions. Our fixed income business was positive again at $200 million as we saw positive flows across our Asia Pacific business as well as in EMEA institutional clients. Quantitative equity saw net outflows of $1.6 billion compared to $500 million net outflow in the prior quarter. This increase in outflows reflects the lumpy nature of this business, which is predominantly institutional. Multi-asset net outflows were $200 million broadly in-line with the prior quarter. Finally, alternative net outflows were $600 million. This decline from inflows in the prior quarter were due to outflows from our absolute return bond strategy as a result of performance and a portfolio manager departure that was announced in September. While the net outflows do not fully reflect the strength we are seeing across the business, I am encouraged by the feedback and interest we are receiving from clients and remain optimistic about the opportunities I see across the globe.

Before I hand it over to Roger, I would like to emphasize just a few points. First, investment performance remained strong across capabilities and this is laying a solid foundation for future growth. At Janus Henderson we are blessed with a broad and deep array of investment talent and I am pleased with the way our global investment teams have come together following the merger. Secondly, engagement with our global clients continues to grow and strengthen and we've been grateful for the support they have given us through this year of transition. And finally, 2017 required an enormous amount of effort form our employees. As the merger moves farther into the rearview mirror, in 2018 the majority of our employees will be shifting focus from integration toward initiatives that will drive future growth. This represents a great step forward for our business. With that, let me turn it over to our CFO, Roger, Thompson, to review our financial results.

[Roger Thompson, CFO]

Thanks, Andrew. The financial results begin on Slide 8. Before I get started, I wanted to give a quick reminder as to how we'll discuss the financial results. The results are shown in U.S. GAAP, pro forma U.S. GAAP and adjusted non-GAAP. We believe adjusted non-GAAP is the best way to look at the ongoing operations of Janus Henderson and that's how I'll speak about the business today. Slide 9 looks at the financial highlights. The great news is that in looking at this page whether quarter-over-quarter or year-over-year, you'll notice it's all green reflecting an improvement in the metrics presented across the board. Overall, fourth quarter results are strong reflecting positive markets and performance fees in addition to some favorable one-off accounting adjustments relating to compensation, which I'll touch on in a bit. Average AUM in the fourth quarter increased 4% over the third quarter primarily driven by positive markets and beneficial currency movements.

The increase in average assets coupled with strong performance fees resulted in 11% increase in total adjusted revenues in the fourth quarter and for the full-year '17. Adjusted operating income in the fourth quarter of $220 million was up 31% over the prior quarter primarily as a result of higher average assets, the seasonality of performance fees and a benefit in the LTI line related to an adjustment to the purchase price accounting for the merger. Fourth quarter adjusted operating margin was 43.6% compared to 37% in the prior quarter. For the full year, adjusted operating margin was 39.6% compared to 33.9% in 2016 pro forma. These results demonstrate the enhanced economies of scale provided by the merger. Lastly, adjusted diluted EPS was $0.73 in the fourth quarter compared to $0.56 in the prior quarter. Before I move on, one comment on the fourth quarter GAAP EPS of $2.32 per share. I wanted to clarify that this includes a $1.67 per share benefit from the $341 million adjustment in our deferred tax liability derived primarily from the reduction in U.S. taxes from the U.S. tax reform legislation passed during the fourth quarter.

On Slide 10 I'll speak to the 11% increase in quarterly revenue change in a little more detail. Management fees increased 3% from the prior quarter, roughly in-line with the increase we saw to average AUM. Net management fee margin for the fourth quarter was 44.9 basis points compared to 45.2 basis points in Q3. AS we discussed last quarter, AUM subject to performance fees in the fourth quarter is significantly higher than the third quarter therefore this quarter you saw a material increase in performance fees of $34 million compared to a negative $2 million in the third quarter and were also up considerably from the $3 million in the same period last year on a pro forma basis. The fourth quarter performance fees were driven by strong performance in our quantitative equity, U.K. Absolute Return and Global Technology strategies as well as the better year-over-year result from our U.S. Mutual Fund performance fees.

Moving on to the operating expenses on Slide 11. On a U.S. GAAP basis, te3h fourth quarter had integration adjustments as well as some non-deal costs. There were approximately $20 million of integration costs incurred in the quarter. The main items impacting this number was severance paid to employees and the write off of legacy SAP platforms as we implemented our new integrated general ledger. So far, we've recognized approximately $203 million of the $250 million deal and integration costs that we expect to incur. Non-deal costs adjusted out of operating expenses in the quarter were roughly $4 million and mostly consisted of intangible amortization of the investment management contracts offset by a release to contingent consideration. Adjusted operating expenses in the fourth quarter were $285 million compared to the third quarter amount of $286 million, a slight decrease quarter-over-quarter. Fourth quarter adjusted operating expense includes quite a bit of noise so I want to spend a few minutes walking through some of the more significant items impacting the results.

Adjusted employee compensation, which includes fixed and variable staff cost, was up 1% compared to the prior quarter. Given the higher performance fees and consequently the improvement in profits, you might expect higher compensation than we've recognized so let me provide a bit more color here on why this isn't the case. First, as we do every year, we finalized our bonus pool and the split of cash versus non-cash compensation. This led to a reduction in fourth quarter accounting compensation of roughly $9 million as a result of adjustments to accruals. Second, third quarter compensation included approximately $4 million of one-off additional expense associated with discontinuing legacy Henderson compensation schemes. And lastly, the fourth quarter includes the realization of around $18 million of comp synergies from the merger, a slight increase over the prior quarter. Adjusted long-term incentive compensation was down 28% compared to third quarter primarily due to a one-off adjustment of $13 million related to the purchase price accounting.

With these adjustments to both employee compensation and LTI during the quarter, our fourth quarter comp-to-revenue ratio was 39.1%, which is an abnormally low percentage and not indicative of what we would expect in 2018. Turning to non-comp operating expense, collectively these saw an increase of 14% quarter-over-quarter. The main drivers were marketing and G-and-A. Marketing expense increased $3 million over the third quarter primarily due to seasonality and our focus on further awareness-building of the Janus Henderson brand. G-and-A was up $6.5 million or 13% as the firm is returning to a more business-as-usual spend as post-merger. Non-comp expenses in total for the full-year '17 increased 7.5% compared to annualized first half, slightly higher than our pervious guidance of 5%. This is primarily due to higher G-and-A. Turning to Slide 12 and a look at our profitability trends.

We continue to generate strong operating profits and EPS. The fourth quarter adjusted operating income of $220 million is a significant increase over the last quarter and the prior year's fourth quarter, driven by performance fees, favorable accounting adjustments made to compensation and LTI that I've just talked about, and the realization of synergies. As we begin 2018, I wanted to provide some initial insight into what we anticipate in our expense base going forward. For compensation, as a result of the cost synergies realized as part of the merger, we're expecting an adjusted comp ratio in the low 40s% for 2018 compared to 44% in 2017. For non-comp expenses, our current expectation for 2018 is a 12% to 14% increase in these lines compared to 2017. This increase is driven by investments we're making in the business and full year of normalized spending. Additionally, in 2018 we will begin taking the cost of investment research onto our P&L as a result of MiFID II.

Our current budget for this added expense in 2018 is $19 million. However, as we've noted previously, the cost of research is still evolving. With these points in mind, it's important to note that the level of profitability of the fourth quarter is exceptional. Looking forward, the full-year 2017 adjusted operating margin of just less than 40% is a good proxy of where we think 2018 will be with quarterly fluctuations driven by the direction of markets, business results and particularly the impact from performance fees. And finally, based on U.S. tax reform, we believe our annual statutory rate will be in the range of 21% to 23% in 2018. The range reflects quarter-to-quarter fluctuations that are the result of the geographic mix of profits. The actual effective tax rate will also be impacted by the various book to tax differences that occur each quarter. Finally, a look at the balance sheet. At the end of December, Janus Henderson had total cash and investment securities of $1.5 billion and we're in a strong net-to-cash position.

During the quarter, we received early conversion notices from holders of 2018 convertible senior notes, which were settled in cash for $42 million. These early conversions reduced our total debt by 7%. Additionally, since the end of the quarter we've received an additional $48 million of notices bringing the outstanding balance on these notes down to less than $10 million. The board has approved a quarterly dividend of $0.32 per share payable on the 2nd of March to shareholders on record as of the close of business on the 16th of February. With this dividend, the full-year dividend payout ratio was 48% based on pro forma dividends of $1.20 and adjusted pro forma diluted EPS of $2.48. Lastly, as we think about our capital philosophy going forward, the liquidity position of the firm is strong. We do have some meaningful near-term needs for cash in the form of annual bonuses, which will be paid at the end of this month, but as we get through this period and begin generating excess cash, the board will evaluate the uses of cash and balance the ongoing investments that the business requires with external opportunities and, of course, returning excess capital to shareholders.

With that, I'll turn it over to Dick for a review of our 2017 accomplishments and our 2018 priorities.

[Richard Weil, Co-CEO & Director]

Thank you, Roger. Thanks, everyone, for joining us today. Turning to Slide 15, 2017 was a landmark year. I'm amazed when reflecting back on all that was accomplished and equally excited when I think about the opportunities that those accomplishments will create going forward. When we first announced our merger, we said that the benefits of the combination were as follows. First, we highlighted that it would expand our distribution, enabling us to better serve our clients around the world. Second, we said it would strengthen our world-class global investment teams, positioning us to deliver more consistent results across a broader spectrum of products for our clients. Third, we said it improve our financial strength and flexibility, allowing us to withstand any shocks, to appropriately invest in our business throughout market cycles and to deliver stronger returns to our shareholders. In presenting these three things as the main strengths of our merger, we also noted that success would hinge on key fourth element; that success would hinge on our ability to build a common culture across our entire firm that attracts and retains the most talented professionals in our industry.

Today, nearly a year-and-a-half later I am more convinced of the value of this merger than I was when we started down the road. I am confident we can achieve the 4 key elements I outlined above, creating value for our clients, our shareholders and our employees. Looking at eth accomplishments of 2017, first I'd like to highlight the investment performance. I'm extremely encouraged with the performance of our investment teams, how they have delivered through this merger and integration process and avoided becoming either disrupted or distracted. You can see their results. Our teams have performed very well. It is particularly pleasing to see the significant improvement in INTECH's results. After the toughest second half of 2016, the toughest six months actually in their firm history, they delivered substantially better results in 2017. Second, as we seek to expand our distribution efforts and better serve our clients, I want to call out some highlights around our global client relationships.

First, the response we have seen from our clients around the world since the merger has been extremely supportive. Going through a merger is never easy especially for our clients, and we couldn't be more grateful for how they understood the rationale of this merger and stood by us. This outcome could not have been achieved without the stellar work from ladies and gentlemen on the distribution team so thank you all for your hard work on behalf of our clients. Second, despite the $10 billion of outflows during the year, which included outflows of nearly $8 billion from INTECH and several billion dollars of merger-related outflows, we are seeing signs of strength in many areas of our business. In the U.S. intermediary channel, we are gaining share in the equity market. During 2017, our Equity Mutual Fund business outpaced the industry by 180 basis points, which was a great result. In institutional space, we saw good global traction across a diverse breadth of strategies. The 10 largest net inflows for the year were sourced from 9 different strategies. With better performance and the merger further in our rearview mirror, opportunities for flow improvement in 2018 are meaningful. Third, let me turn to the subject of revenue synergies.

Dai-ichi continues to be a first-class partner. It completed the $500 million incremental into our products and has been in the market purchasing shares of our company. For the second quarter in a row, Global Equity Income was our top-selling U.S. mutual fund and we are seeing increasing opportunities with clients of the respective legacy firms investing in multiple strategies. Finally, consultants and institutional clients across the globe are taking our firm off watch status, which is very encouraging. Turning to financial discipline, in 2017 our financial results were very strong. They provide good evidence of the improved economies of scale our merger represents. Based on all the hard work and dedication from our employees, integration is ahead of expectation and we increased our cost synergy target during the year to $125 million from the originally stated $110 million.

The expansion of our strategic partnership with BNP is going well and it will support our global operating model going forward. Lastly, our balance sheet and liquidity position remain very strong and the business is generating strong cash flow. All of these achievements have translated into value for our clients and for our shareholders, and we have set a very strong foundation for our company going forward. Turning to Slide 16, let's look at our priorities for 2018. While these priorities are not radically different from areas we focused on 2017, we believe they represent a progressive step towards building a leading global active asset manager.

First, we will be focused on achieving organic growth by bring a trusted partner for our clients delivering first-class investment performance, insights and experiences. This will take time, but the pieces are in place with a fully-integrated global distribution team and a very strong investment team. Additionally, as a larger and more global asset manager, we are convinced that we're in a good position to build further strategic relationships with our clients as they seek to reduce the number of asset managers they do business with. Second, in 2018 we will leverage our enhanced distribution strengths and product breadth to deliver on revenue synergies. Global distribution team is now approximately 600 people strong with meaningful brand and market presence in North America, in the U.K., in Continental Europe, in Japan and in Australia. We are very optimistic about the opportunities to capture flows in 2018 and the years ahead. Third, we are well on our way to delivering the cost synergies that we promised. We will continue to execute on the integration and to realize the remaining synergies for our shareholders.

Fourth, we will continue to maintain a disciplined approach to the management of cash and capital, balancing the ongoing investment needs of the business with returning excess capital to our shareholders. Fifth and finally, we are particularly focused on building a common culture, embodying our ethos of knowledge shared. Turning to Slide 17, I want to provide some insight around how we will strategically move forward as an organization and what will drive our success. First, we believe that culture drives success in everything that we do so we will continue to investment in our people and our culture. Second, investment excellence is paramount. We must deliver returns for our clients and we will remain focused on this going forward. Third, we must operate as a client-centric organization, translating those words into actions for our clients. Fourth, we must build long-term, deep-rooted relationships with our clients by focusing on the client experience and partnership.

And fifth, we must embrace technological innovation and efficiency to ensure our firm is prepared and well-positioned as our business environment evolves. Being successful in these elements will create value for our clients, our shareholders and our employees, and they will help us build a leading global active assert manager. With that, let me turn it back to the operator for questions.

[Operator]

[Operator Instructions]. Our first question comes from Andrei Stadnik with Morgan Stanley.

[Andrei Stadnik, Morgan Stanley]

Congratulations on a pretty solid result. The first question if I may ask. The performance within equity franchise particularly it would seem to be within Europe equities, just wanted to see if you had any extra color because the 5-year performances benchmark dropped from 82% in September quarter to 67% beating index in a single quarter, which is a quite a large movement for the 5-year now. So just wanted to see what your thoughts were around Europe equities performance and any though on how various strategies might have been positioned for what's unfolding in 2018 year to date.

[Andrew Formica, Co-CEO & Executive Director]

Thanks for your question and you're right. 2017 has been a solid year in terms of what we've done and we're pretty pleased with the progress made on the financial side. To your point around the flows in particular Europe equities, you are right that the situation in our equity business overall we're pretty pleased with performance generally, but Europe equities collectively were probably a bit softer where some of our funds are more sort of middling in sort of second quartile, third quartile, which does mean as growth towards Europe equities or flows towards Europe equities came back, we didn't capture as much as we may have liked.

We don't think there's anything structurally wrong in terms of the investment performance or the team there. It's just really the positioning of where they saw bull markets last year, which you've seen sort of a softening in some numbers, which probably means that we would have liked or hoped to have done a bit better in Europe equities more generally in terms of flows than we did. We still have a very strong bench across the team there and very happy with what we've got. But we've just sort of a few things that sort of didn't deliver to where we'd like as we have done in a number of other equity parts of our strategies.

[Andrei Stadnik, Morgan Stanley]

And my second question around the uplift in inflows from the merger or the revenue targets. You've previously sort of spoken about being up to 3% at least in inflows from the combination. I mean how would you quantify the uplift in 2017 and then how confident are you in that early guidance or target of about 3% uplift inflows from the merger?

[Roger Thompson, CFO]

Andrei, it's Roger here. We always said that the cost synergies would come pretty quickly and the revenue synergies would take longer. I think in 2017, as we've talked about before, there's definitely some green shoots. We point to things like the sales of previous -- or Henderson-managed product in the U.S. market. Global Equity Income as we've talked about is the largest selling product in the U.S., in our U.S. Mutual Fund range is selling multiples of what it was selling when we were Henderson alone. So there's just an example of what we're seeing. But yes, this is multi-year growth opportunity so very little in 2017, as we would have expected, but certainly some areas in the U.S. and elsewhere around the world where we are still very hopeful and expecting that revenue synergy to come through.

[Operator]

And we will take our next question from Dan Fannon from Jeffries.

[Daniel Fannon, Jefferies LLC]

I guess just thinking about the outlook for 2018, if you kind of look at your 5 segments and thinking about asset growth, I guess where do you see the biggest opportunities for improvement? And can you talk maybe a little bit about broadly the kind of backlog or kind of institutional framework kind of setting up to start this year? I know historically for Janus that's mostly INTECH, but it's a little bit more broader, obviously, on a combined entity. So any color there would be helpful.

[Richard Weil, Co-CEO & Director]

Hi, Dan. Dick Weil here. I think when you look backwards across this past year, the first thing that leaps out at you in terms of flows in $7.6 billion out at INTECH. And so job one has to be to continue recovering from that horrible second half of 2016 and getting that franchise back to strength. The other thing that contributed into our net flows for the year were some small, considering the overall size of the firm, but still noticeable dislocations from some of the merger activity. You're never quite sure whether it's all the merger or just partially the merger and partially other stuff, but we've identified a few billion in net flows that was certainly materially affected by some of the changes of the merger. So we take responsibility for both those pieces, of course, but ex those pieces, the rest of the business was flattish and probably positioning giving us confidence that there are opportunities with improvements across that range of things to get that part of the business moving meaningfully forward.

So yes, we accept that we've had some negative flows in INTECH that are material and painful and we need to get that moving in the right direction. We also accept there's been some dislocation around the merger, which hopefully is behind us. And we're optimistic that across a range of retail and institutional products and locations, we have good opportunities going forward and we've seen the green shoots that Roger mentioned in retail U.S. and institutional Europe and help from Dai-ichi in Japan and some great things happening in Australia, we're optimistic across a range of retail and institutional markets around the world. So it's hard to just focus on one.

[Daniel Fannon, Jefferies LLC]

Okay, that's helpful. And I guess, Andrew, in your prepared remarks you mentioned higher redemptions in Asia Pacific and EMEA. Can you discuss that in more detail? And is that kind of one-off stuff or is that something that you think kind of pervasive here into 2018?

[Andrew Formica, Co-CEO & Executive Director]

Yes. In the EMEA outflows, I'd say we had a portfolio management change in our fixed income business and that triggered outflows associated with assets associated around that manager and that team. And I wouldn't say it was just the whole combination and those changes were the final straw. And that we wouldn't envisage any further outflows from that book of business associated with that change. It was dealt with. The change itself happened in September and the outflows all concentrated in fourth quarter.

Similarly, in the APAC region, institutional account, which we had always expected there at some point we would lose. It was a relatively large mandate. But it was in a client that we knew were looking to move toward passive from active and had been conducting a review for a while now, actually, and we were one of the last active managers in their lineup. And they removed that at the end of the fourth quarter, which again, whilst the timing was never known, we expected at some point to come. And again, with that mandate having moved, there have been no further. So both of those are sort of one-off. One I would categorize as merger-related. One I'd categorize as business as usual. But both shouldn't have any recurrence going forward.

[Operator]

And we will take our next question from Alex Blostein with Goldman Sachs.

[Alex Blostein, Goldman Sachs]

A couple of questions around just the expense outlook at margins. I guess first a bit of, I guess, clarification. So when you guys guide to non-comp expenses for the year, I'm assuming the $19 million of research cost is already embedded in that. Are there any other MiFID II kind of related expenses, whether it's compliance, reporting, et cetera, that are kind of elevating this non-comp growth rate? So more of a one-time kind of step up or we should be thinking about this kind of low-teen growth in non-comp more of a sustainable run rate given the investments you need to make in the business?

[Roger Thompson, CFO]

Hi, Alex. It's Roger. I think on the last piece, in terms of the one-time costs of MiFID II treating research aside, then systems are built, processes are in place. Yes, there are ongoing costs of running that, but the one-off costs of arranging that is done and we're in good shape. The MiFID costs that I've called out from a research point of view, as I said in my remarks, is our budgeted number. That's as good a guess as any, but the cost of research is continuing to evolve as you know. So bringing back more generally then, as we said I guess in Q3 -- Q2 rather -- we'd expect our costs, non-comp costs, to increase in the second half because we were running light as we were doing the merger. We were very low in marketing and G-and-A. And those costs have risen, as we expected, in Q3 and particularly Q4. And we'd expect to see that level continue into next year. I wasn't quite sure what you said -- how you described it in the beginning. But the $19 million is on top of the 12% to 14% increase in 2017. But again, if you look at the run rate, if you project forward Q4, that's probably about the right run rate to use and then add the MiFID costs on top of that.

[Alex Blostein, Goldman Sachs]

Got it. That's helpful. And I guess just bigger picture, when you guys think about the margins on the business as a whole, I think late last year we discussed roughly high 30s% net operating margin once all the synergies are baked in. I guess what are the synergies that are still left? And just given the performance of the business, is the high 30s% operating margin on the net basis still the right number? Or do you guys think that could drift higher?

[Roger Thompson, CFO]

Yes, I mean as we said, we're at very high 30s% for the full year of 2017. So as I said, treat the fourth quarter with caution because there are obviously some one-offs in there. But the full year, it would hit very high 30s% and as I said that's, all other things being equal, that's what you should expect for 2018. So yes, very high 30s% op margin is a decent number and low 40s% for a comp ratio. In terms of synergies, yes, we increased the synergy number from $110 million to $125 million at the last quarter. We're well on track to deliver that. We're probably about $85 million now. We talked about being at $90 million by the end of the first year. So a little bit more to go, but that is -- so we know where we think that's coming from, but $125 million is still the right number.

[Andrew Formica, Co-CEO & Executive Director]

And Alex, it's Andrew here. Just other points around outlook for the op margin. Firstly, we don't know where markets will go and that will obviously have an impact on our business. And the last couple of days have clearly been different to where they were in the early part of the year. But to your point about investments and the like, is as we move through this year, there are a number of opportunities for us to look to do things that neither firm could have done on their own, as part of our strategy focus and development. 2017 was about the merger and the integration and making the key decisions. 2018 as we work toward or through this, will be about looking to areas we can extend our investment teams and extend the way we engage with our clients, which some of those will require investments.

We also think there are efficiencies we can gain through the use of technology and the like. And how much one can fund the other, we don't know at this stage, but I think it would be wrong to assume that the operating margin will drift significantly higher from here because I have always said on record that I think you can justify sort of mid- to high-30s% on the operating margins, but you need to continue to reinvest in your business. So you should think that we will be looking to invest in the business as we work from the integration phase into the more investment and forward-focused phase as a group.

[Operator]

We will take our next question from Rob Lee from KBW.

[Robert Lee, KBW]

And I apologize if maybe you had gone over this a little bit, because I missed a little bit of the call. But as you pivot towards focusing more on growth versus getting the combined companies together next year could you give us maybe a little more granularity on which specific distribution channels and maybe with which specific strategies you think you have the most potential to maybe go back to inflows and accelerate sales?

[Richard Weil, Co-CEO & Director]

Hi, Rob. Dick Weil. I think I probably answered that as well as I can. We see opportunities in the U.S. for continuing success of this Global Equity Income product that has previously been mentioned. We've talked on earlier calls about Emerging Market Equities that has had some take-up on institutional. We have a range of things moving in other markets like Australia and Japan. We had a very successful year in European institutional. And as we pointed out I think in the notes, that isn't product-centric. I think there were 9 different products in the 10 biggest wins on that. So that's a little hard to summarize in the way that your question requests. So we have a very broad a deep team of client-facing folks and we have a very broad and deep set of investment strategies. And it's not just one thing that's going to drive us. I would be remiss, also I should mention Global Life Sciences is another strong opportunity for us from a legacy Janus side that we're optimistic about on a go-forward basis. But there are many different strategies and that's part of the strength of the combination.

[Robert Lee, KBW]

Okay, great. And then maybe just sort of a follow-up. Understanding that you have some continued cash needs in the short term, but as you look ahead to '18 and particularly since you will benefit from a lower U.S. tax rate as indicated by your tax guidance, at a minimum is it reasonable to think as we get into calendar '18 that your dividend at least kind of gets adjusted to reflect your historic payout ratio and the benefit of the lower taxes?

[Roger Thompson, CFO]

I think the short answer to that, Rob, is yes. Yes, we have kept with the same dividend for the quarters of this year. The board will obviously look at that and set a dividend for the first quarter that given the earnings we're looking at the moment you good expect to be higher.

[Operator]

Our next question comes from Ken Worthington with JP Morgan.

[Kenneth Worthington, JPMorgan Chase & Co.]

Can you talk about Janus' presence in volatility-based products? You've run VelocityShares I think XIV and others. Do a number of these funds shut down as a result of the spike in VIX? Were these making a lot of money for Janus? And then I think you guys when you bought VelocityShares were really looking to kind of maybe pivot the model away from the double- and triple-levered ETFs and focus more on the traditional smart data in ETF products. So does what's happening in VIX right now maybe allow that transition to more fully take place?

[Richard Weil, Co-CEO & Director]

Hi. It's Dick Weil. Let's see. What to say against that? I think the XIV product that's gotten a fair amount of attention today and last night is a product which is a note offered by Credit Suisse and they're the ones probably who have the most direct information about what's happening there. But it looks to me like it is performing as advertised. When VIX goes up as extraordinarily as it did overnight and yesterday, I think a short VIX strategy could be expected to have the sort of change in value that it had. So from what I can see, the volatility products offered are performing as advertised and that's obviously very important to us and we'll keep a close eye on that. In terms of VelocityShares more generally, when we bought them we paid primarily for an exchange-traded note business and we were seeking to capture the possibility that we could also move into ETFs.

Most significantly, we've managed to launch a short-term bond ETF in the U.S. with the help of our friends from VelocityShares & Vanilla; VNLA I believe is the symbol. And that one has done well for us and is growing and is our biggest success to date in ETFs. But I wouldn't say that the current market volatility or the pattern in ETNs has much to do. Those are 2 separate business lines run by our friends at VelocityShares and we think there's a place for both of them to be successful; one more professional investment tools for not your buy-and-hold investors primarily and one a more traditional product like VNLA.

[Roger Thompson, CFO]

And Ken, this is Roger. On your question around managed fees, the license fees on these come through our other revenue line and would represent single digits for this product.

[Kenneth Worthington, JPMorgan Chase & Co.]

Okay, great. And then just on INTECH. Performance obviously great this year, but kind of a rough 4Q. Has the great performance in 2017 changed the narrative at all with the consultants? And what is the outlook here given where the performance of the franchise stands in terms of cross-selling INTECH into Europe?

[Andrew Formica, Co-CEO & Executive Director]

Yes. It's Andrew here, Ken. I'll be happy to pick up that. Look, I think INTECH -- obviously, INTECH wobbled in 2016 in performance terms. It sort of also coincided with a large part of their institutional constituents, which were in U.S. equities sort of debating at a plan level of whether they go towards passive. So they had the headwinds of the active-passive debate coupled with poor performance. Obviously what you saw in '17 was a significant improvement in performance so you removed one of those. The headwinds of the active-passive debate particularly around U.S. equities particularly by U.S. plan sponsors continues to be there and that I think will be a challenge for anyone in U.S. equity institutional space. Though I think performance in '17 is helping the arguments around value of active versus the costs of looking at it purely on a cost basis.

I think to your point on cross-selling and opportunities however at the time of the merger or the merger announcement INTECH was seen as one of the real positives from the historical Henderson distribution teams because of what it offered and its approach in a lot of the client discussions that we'd had. Its poor performance clearly put a dampener on immediate uplift in that going into the merger itself and the improvement in '17 has enabled us to sort of start spending more time talking to our clients to that in Europe and also in Asia Pacific region. So I do see the INTECH story being supported by the non-offshore distribution REIT that comes through the Henderson side. I think that will go partly towards the way of Dick mentioning sort of addressing the decline that we saw in INTECH flows last year as one of our significant priorities. I think that could be point of it.

The other area is product extension. INTECH through the period of 2017 launched a number of long-short strategies; so taking their sort of strategy and approach and applying it in a sort of market-neutral absolute return priority or focus through product design. And those numbers have performed very well, not surprisingly given the INTECH engine delivered solid alpha. That comes through in those numbers as well. So that's very early days for those products, but a very encouraging first year of performance for them. And what's notable about that area is it doesn't have the headwinds of active-passive and it also significantly higher fees than what INTECH has previously earned on its traditional long-only area. So I think both of those trends are encouraging towards the longest-term story for INTECH with the non-U.S, distribution reach probably the closest opportunity for us to address flows in there. But I think the product extension is also of equal value though it may take another year or so of just making sure the performance of '17 continues to drive strong growth there.

[Operator]

Our next question comes from Simon Fitzgerald with Evans and Partners.

[Simon Fitzgerald, Evans & Partners Pty. Ltd.]

My first question just relates to MiFID II in terms of your thoughts about potential adoption in the U.S. maybe longer term and just how Janus Henderson may be operating its business across its geographies at the moment with regards to MiFID II noting that initially you've spoken about that being exposed to European and U.K. mandates.

[Andrew Formica, Co-CEO & Executive Director]

Look, in terms of the changes in research and the charges that Roger mentioned put into the budget, is at the moment, the first thing I'd say it is only applying to our European client base or our MiFID II client base. And the number we've put in is really our best estimate at this stage. So I would say that pricing is still fluid and the adoption that we take in terms of our services as unbundling really takes could see that alter. And so we're trying to be realistic as well as prudent in that. To the point of whether there's a risk of this going to the U.S., I think certainly in the fourth quarter, late third quarter, there was probably more talk about it extending to a global franchise. I think since -- a global framework.

Since the SEC qualified and gave relief for MiFID II payments to be made for research, they did qualify that to be limited to MiFID-based firms and therefore did not extend that exemption to all payments, which makes it hard to do it globally or certainly for U.S.-based research by U.S.-based clients. And the client push that you saw significantly in Europe has not at this stage manifested itself in the U.S. So as I'm sitting here today, I don't see a huge push that it's likely to be extended on a global basis today. I think at some point it would be unrealistic not to think that a global standard will develop say 5 years from now. But the period between now and 5 years is unknown and it doesn't feel like any immediate pressure sitting here today other than what we announced around the MiFID side of our business. I hope that helps.

[Simon Fitzgerald, Evans & Partners Pty. Ltd.]

Yes, that's helpful. Second question just relates to some of the market movements that we've seen in the last sort of few days. Could you just sort of make any comments just in terms how your institutional client base might be feeling? And if this were to sort of continue on for let's say another month or so, could this put your institutional pipeline at risk and potentially sort of put some mandates on hold?

[Andrew Formica, Co-CEO & Executive Director]

So look, so obviously what we've seen is a return of sort of volatility to the markets, which some people may say is unhelpful. I actually think it's been probably relatively helpful and 2017 was just too benign, didn't feel realistic. There was too much crowd and people in a position I think Dick's on record of saying the most crowded trade was short volatility and it did seem people got very complacent. So I don't think this is anything to worry about. And even if we do see sort of the fall I'm not in the business of being able to predict day-by-day or week-by-week sort of movement in indices. But I'm not worried about what we're seeing. I don't think the reasons given out there or any data that's been published that short of be seen as a trigger for this are anything I would worry about. We've had higher strong global growth leading to a reassessment of interest rates rises particularly in the U.S. and that's bad for equities.

Well actually, in the longer term, global growth is good for equities with earnings numbers we're seeing are generally quite supportive of equity valuations. And whilst you'll see some shake-out in terms of valuations and positioning, I don't think it will be a long-term impact. From a client perspective, I think again this is where the active side of the debate is quite helpful. Clients are ringing us to just talk to us about what our thoughts are. And it's an opportunity for us to engage with our clients and talk to them about our investment ideas and theses, how we're seeing markets. And they really appreciate that interaction. I think it's an often misunderstood and mis-valued approach that active management also in times of distressed is incredibly valuable to our clients, both institutional and retail, and we actually spend a lot of our time here at Janus Henderson utilizing that by engaging with our clients through that.

So whilst it may cause some clients to delay and think about the timing of investment in mandates, in other cases we'll see them accelerate as they see opportunities to use the liquidity in markets to position their portfolios where they want them to go. So I don't think it will have any -- certainly nothing in such a short window that we've seen as market turmoil would give me any impact of having a significant shift in our outlook for how markets are. Obviously if it keeps falling from here you may have an impact on that. But again, I'm pretty confident that where our business has been positioned and the merger has given us quite a lot of strength in investment talent and a very strong balance sheet that we can lever this if it is more than just a small storm.

[Operator]

We'll take our next question from Chris Harris of Wells Fargo.

[Christopher Harris, Wells Fargo Securities]

I want to come back for the cost guide for 2018 for a minute. Just curious if you guys can talk to us a little bit about how much of that increase in spending is growth versus more maintenance, regulatory requirements. And then with respect to the growth spending, can you elaborate on what you guys are investing a little bit?

[Roger Thompson, CFO]

So I think a lot of it, as I said, Chris, is us returning to the full level of spend in areas, but we certainly are making investments in the business as we move out of the pure integration phase into leveraging the deal. But yes, a relatively small amount, but certainly some investments in 2018. So the second half of your question?

[Christopher Harris, Wells Fargo Securities]

Yes, I was just hoping you could maybe elaborate on what those investments are specifically for growth.

[Roger Thompson, CFO]

I mean they're in all sorts of areas. Areas as to how do we -- particularly how do we look at technology and use technology. But as we look -- Dick teed up the ongoing view of the business and I think we'll talk to you more in the early part of year as to our ongoing strategy and probably talk a little bit more about it then.

[Operator]

We'll take our next question from Brian Bedell with Deutsche Bank.

[Brian Bedell, Deutsche Bank AG]

Maybe just one more on the non-comp expense. Just I have this right. I think the base that we're using for 2017, correct me if I'm wrong, was just under $300 million on an adjusted basis. Is that correct? And then growing 12% to 14% from that and then adding the $19 million of the research costs.

[Roger Thompson, CFO]

Yes, that's about right. For the year it's slightly over $300 million. I think we're $307 million for this year and then yes, 12% to 14% on top of that plus $19 million, yes.

[Brian Bedell, Deutsche Bank AG]

And as we move into 2019, you've got another $40 million of expense synergies to go, just using the math of the $125 million minus the $85 million. So as we move into 2019, should we think about that $40 million being achieved and then obviously growing the expense base from there? And maybe just how we should think about that sort of long-term sort of secular growth of the expense base given the investments you need to make in the business.

[Roger Thompson, CFO]

I think as Andrew said, we'll look to continue to investment in the business. So you should achieve returns to a sort of normalized level. You can see we've actually taken quite a lot out of the cost base over the last year. Our non-comp will increase next year, as I've talked about, partially because of the regulatory change. Again, that's part of the reason -- those regulatory changes are part of the reasons why the strength of the business double the size it was before. But yes, we'd return to a more normal level. But we'll continue to manage the business appropriately and invest both where it needs it and where the margins allow it.

[Operator]

Our next question comes from Nigel Pittaway with Citi.

[Nigel Pittaway, Citigroup]

Just one more question, sorry, on the non-comp costs. Can we just clarify the shifting costs for the BNP contract? Is that included in the 12% to 14% plus $19 million?

[Roger Thompson, CFO]

You are quite right, Nigel. There is a small element of that that's in there. So yes, that is included in that. So as we complete the BNP transaction in the U.S., a number of staff will move from bring on our payroll and therefore comp to non-comp and that is included in that number, yes.

[Nigel Pittaway, Citigroup]

Okay, fine. And then I know tax can be a bit volatile quarter to quarter, but I think it was up to that 32.3% in the quarter on a sort of adjusted basis. Is there any particular reason why it was quite so high?

[Roger Thompson, CFO]

Yes, there's a couple of elements in there, Nigel. One is the PPA adjustment that we talked about that we called out of about $13 million. Obviously that's all in the U.S. so it's taxed at the U.S. rate. And there was a couple of other small one-offs. So the rate is slightly higher this quarter, but largely due to one-offs.

[Operator]

We'll take our next question from Patrick Davitt with Autonomous Research.

[Patrick Davitt, Autonomous Research]

There's been a lot of chatter about potential pressures in the U.K. pension market, be it from the regulatory side or even just some of the consolidation that's going on there. Could you remind us how much exposure you have there, if any, and your thoughts around the potential fee or flow headwinds that could be coming through the CMA review and other things?

[Andrew Formica, Co-CEO & Executive Director]

I haven't got the exact details of the size of our business around U.K. institutional pension businesses is a reasonable book of business. In terms of some of things you talk about, there's been a couple of reforms over here around, certainly around the local authorities of whether they sort of merge smaller schemes there into larger schemes. You've also seen the trend toward buyouts of defined benefit schemes and the like. Given our experience and relationships with those we see ourselves as continuing to service that market and having very strong products and certainly very strong links in those markets. Of course, as you get consolidation and larger mandate sizes, you do see price have come down, that pricing pressure in the U.K. market is a reasonably competitive market, probably not the most competitive market in the world, but it's certainly not the best market in terms fees either.

So I think it's pretty competitively priced at the moment, but you should expect, as we always would in the institutional space, that volume are offset by fees. So I think we're probably well-positioned in terms of contact for a consolidation or a conglomeration of mandates as they sort of move into some of these things, but it could be at modestly lower margins than what we're getting at the moment. But there's nothing I would -- would cause either concern or significant opportunities than what we've been seeing. That market has been a good market for us and the number of the new capabilities come over from the old Janus side should be quite attractive in that marketplace including, as I mentioned earlier, the INTECH proposition I think would satisfy particularly if they're very fee-conscious given the price point that INTECH has relative to some of our capped strategies, which have more capacity constraint would limit our opportunity in those.

[Patrick Davitt, Autonomous Research]

Okay, helpful. And then a quick follow-up on the VelocityShares question. Could you clarify if that single-digit gains you gave with basis points are millions? And should we expect the flows into AUM from the CS-branded product to flow through your numbers in the first quarter?

[Roger Thompson, CFO]

On the AUM, we don't include the ETM flows in our AUM or flow numbers. We include the ETFs but not the ETM. So that wouldn't be in there. I think I was talking about single digits and probably nearer the lower end of that number than the higher end of that number in millions. So I was referring to the fact it's a relatively small number on a large revenue number.

[Richard Weil, Co-CEO & Director]

Yes. In basis points it's competitive with management fees on retail products.

[Operator]

And we will take our final question from Michael Carrier with Bank of America Merrill Lynch.

[Michael Carrier, Bank of America Merrill Lynch]

Just a question on distribution. Since the merger and with integration, I just wanted to get a sense on whether it's on the retail platforms, how many products that you guys have on? What's the trend been there? And then same thing on the institutional side in terms of consultants. How many are recommending the products? Which ones are you still in the penalty box versus getting the green light?

[Andrew Formica, Co-CEO & Executive Director]

Look, I haven't got the numbers in front of me in terms of the number of platforms. What I would say is we've had good success of broadening through the various retailer platform operating now whether it's in the U.S. or outside, of the rest of the world, of bringing the legacy product from the other firm onto those. We're actually seeing quite good pickup in that. Dick mentioned the old Henderson Global Equity Income product being the best-selling in the Janus Mutual Fund range now after being adopted in sort of June last year. Seeing similar success with things like the Global Life Science being able to get through the Europe distribution and the like. So we are definitely seeing the ability to bring products through to platforms and use our selling agreements and broaden our offering to clients. And in some cases, we're seeing some good early success. I think in others we'll see that build.

To the institutional point, look pretty much '17 we were generally in the penalty box with consultants. They wanted to see the merger go. They wanted to see how it would all settle down. And as we moved towards the end of the fourth quarter and into this quarter, we're having a lot more discussions with consultants to look to remove any sort of flags or holds on those. So I'm not saying we're through all of those, but we're making some pretty god progress and people are very encouraged about the stability in the business and what they've seen and what we've been able to achieve in such a short space of time. And I guess it's helpful when a number of other mergers in our industry have gone on over a similar period or over the last couple of years.

So they've got some benchmarks to judge how well we're doing relative to that and I think we stand in pretty good ground in terms of the decisions we've made, the progress we've made, and that's been very helpful with the consultant community. So I think from an institutional point of view, the ability to start talking about our new capabilities is definitely there from now. And it really has only been the last few months we've probably been able to get through that that merger hold period that you would have had.

[Michael Carrier, Bank of America Merrill Lynch]

Okay, thanks. And Roger, just one quick clarification on the guidance that you gave. Everything makes sense in terms of the comp and the non-comp. Just on the remaining synergies, is any of that in the guidance for '18 or from a timing standpoint is it going to be more weighted towards 2019? Just an update on when you expect to realize those and if it's in the numbers.

[Roger Thompson, CFO]

No, the majority is weighted towards '18. There are some projects which obviously will run out a little bit longer. But I guess the next phase for you to look for would be the completion of the BNP outsourcing, which the big part of that is on-track for an end of March closing. So that's probably the next piece to look for. But as I said, we're on good track. The vast majority of the remainder will happen in '18 with a little bit left to go in '19.

[Operator]

And ladies and gentlemen, that does conclude today's Q&A session. I would like to turn the conference back over to Andrew Formica for closing remarks.

[Andrew Formica, Co-CEO & Executive Director]

Thank you, operator, and also thank you, everyone, for joining the call today. Obviously I just want to provide some concluding remarks and just really pick up on some of the strong points that both Roger and Dick mentioned in their sections. When you look at the business especially the movement across the equity markets over the last several days is not insignificant, but I do think it also reflects the fact that the correction, in our view, was overdue. We couldn't predict when it would come. We're not concerned about what's come. We think, if you look from our perspective, the global business fundamentals remain solid. Global macro conditions continue to appear supportive.

So there's certainly not anything we see that's worrying or concerning us at this stage. I think additionally that as an active manager that market volatility actually provides an opportunity for our investment teams to shine. This is when the investment discipline that active managers sort of have in place, the collaboration and the idea generation that's sort of been formed by the new investment teams can really set ourselves apart as well as I mentioned the ability for us to engage with our clients which is a way to sort of deepen those relationships. So all in all, we're not worried about what we're seeing the markets at this stage. Also I'd say that as we enter 2018, we do have strong investment performance across all capabilities. That does position us well for growth as our distribution teams bed down and begin a much more proactive approach to engage with our clients, as the merger becomes much more in the rearview mirror for them.

So I think that will be important because despite whatever you're doing, a merger will be distracting as you have to sit down develop policies and procedures. With those now being done, it enables us to really look forward. I think I'd also highlight that client support over the last year has been better than we could have anticipated. There's been very strong client engagement by our distribution teams. And whilst that hasn't been reflected in the flows in 2017, I expect to see us make inflows -- inroads into that into 2018. I think there's some significant opportunities ahead of us. And finally, as you heard, the integration efforts continue to be ahead of expectations. And the hardest thing of an integration of this size is actually getting the key policies and principles and the organizational structure right, the IT systems you're going to adopt, the operating model. And we've made all those key decisions.

Whilst the implementation of those stretch out a number of years, the decision-making is actually now behind us and enables us to look forward and move forward on that. So yes, I think all in all putting that together, it sort of shows that the business is in pretty good shape. And it was really a pretty monumental year for Janus Henderson and I think we couldn't have asked to be in a better place today for what we have been able to achieve over that period. If there are any follow-up questions, obviously John and the team are here to help answer your questions. Otherwise, we look forward to speaking to you with our first quarter results in early May. Thanks a lot.

[Operator]

Once again, ladies and gentlemen, that does conclude today's conference call. Thank you for attending.