DWS Group GmbH & Co KgaA

XETRA:DWS

Earnings Call Transcript 2022-Q2

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome, and thank you for joining DWS Group's Q2 Investor and Analyst Conference Call. [Operator Instructions]

I would now like to turn the conference over to Oliver Flade. Please go ahead.

[Oliver Flade, executive]

Yes, operator, thank you very much, and good morning, everybody from Frankfurt. This is Oliver from Investor Relations, and I would like to welcome everybody to our earnings call for the second quarter of 2022. And as always, I hope you're keeping healthy and safe. And before we start, I would like to remind you that the upcoming Deutsche Bank analyst call will outline the Asset Management segment result, which has a different parameter basis to the DWS results that we are presenting today.

I'm joined by Stefan Hoops, our new CEO; and Claire Peel, our CFO. And Stefan will start with some opening remarks and Claire will take you through presentation afterwards.

For the Q&A, please could you limit yourself to the 2 most important questions, so that we can give as many people a chance to participate as possible? And I would also like to remind you that the presentation may contain forward-looking statements, which may not develop as we currently expect. And I therefore ask you to take note of the disclaimer and the precautionary warning on the forward-looking statements at the end of our materials.

And with that I will pass on to Stefan.

[Stefan Hoops, executive]

Good morning, ladies and gentlemen. Welcome to the Q2 2022 results for DWS. As the new joiner on the call, I would like to quickly introduce myself. My name is Stefan Hoops and I took on the role of CEO on June 10. I spent the first 15 years of my career on the market side and the last 4 years in corporate banking. While working in markets, I covered global asset managers for fixed income and equities with a focus on structured products and private credit. And while running the corporate bank at Deutsche Bank, I got to know the engine room of asset management where collateral management, custody, clearing and cash management takes place. Throughout my career, I've learned a lot about how to manage disruption, starting with the global financial crisis in 2008.

The last couple of years in transaction banking has been particularly intense for 2 reasons: Firstly, the perfect revenue storm for a business that holds deposits and hands out loans, when in early 2020, we faced plummeting rates and a breakdown in global trade, reducing the need for trade finance. Secondly, we've seen complacent incumbents across several financial services sectors, notably in payments and retail banking being disrupted by the emergence of fintechs and other new tech-first competitors. Therefore as I settled into my new role, I wonder, could the future of asset management also face a similar fate with a perfect revenue storm? And could fintechs drive another shift towards a new disruptive market structure in our industry?

There have certainly been sickness of a secular regime shift with a number of so-called unprecedented events, all taking place at the same time. And which make me believe that we're moving towards a New Now where trends such as deglobalization, new geopolitics, populism, quantitative tightening and a commitment to Net Zero are all leading into the same direction of higher inflation and interest rate regime shift, more uncertainty, more regional and less global GDP development.

These are having significant impacts on the asset management industry as we've seen in the second quarter with rising rates, wider spreads, lower equity valuations and greater FX volatility resulting in lower levels of assets under management. As a result, I don't think the terms volatile, difficult market environment or turbulent quarter, quite do justice to what we're experiencing because these terms imply that we could go back to what the world looked like 9 months ago, which I don't think we will. I will outline what this could mean for DWS later in the outlook.

Before that, I would like to share some of my initial impressions of DWS so far. I've spent the first 6 weeks of doing job meeting with clients and colleagues across Asia, the U.S. and Europe. What impressed me during my many conversations is the strength and stability of our franchise, which you can see in our financial results. Despite the challenging environment, DWS continues to deliver profitable growth. Adjusted profit before tax increased by 11% year-on-year in the first half of 2022. This was supported by strong half year revenue growth, including resilient management fees in both the first and second quarters.

Our investment teams have continued to focus on markets and are doing a great job investing clients' money. This can be seen clearly in our strong 5-year investment outperformance of 78% versus the benchmark. And we have a highly competent client coverage for us that is providing high-touch service to our valued clients. These trusted partnerships enabled us to achieve EUR 5.5 billion of net inflows, excluding cash in the first 6 months of 2022, reflecting the strength of our diversified business model to meet our clients' ever-changing needs. And while net flows into cash were negative in the second quarter, we've seen the majority of these flows return at the start of Q3, helping to bring our AUM levels back to above EUR 870 billion.

Finally we achieved our strong Q2 results without compromising our cost discipline and while continuing to invest in growth, reporting an improved adjusted cost-income ratio of 59.4% in the first half of 2022. Altogether our financial results give me confidence that our business remains firmly on track. And that we continue to create value for our shareholders in 2022 and beyond.

With that, let me hand over to Claire to provide more detail.

[Claire Peel, executive]

Thank you, Stefan, and welcome, everyone. Today I will present the results and activities for the second quarter of 2022, starting with the key financial highlights.

Adjusted profit before tax remained stable in Q2, totaling EUR 273 million, despite the significant market downturn in the second quarter. Adjusted cost income ratio stood at 59.3% in Q2 and 59.4% in the first half of 2022, supported by resilient revenue growth. Net flows were negative in the second quarter and almost flat excluding cash, primarily due to institutional cash outflows, which offset positive flow momentum into high-margin alternatives and active retail flagship funds.

Moving on to the financial performance snapshot for the second quarter. Starting on the top left, AUM decreased to EUR 833 billion, down 8% quarter-on-quarter, primarily due to negative market performance in Q2. On the top right, adjusted revenues totaled EUR 671 million, down 3% from Q1, reflecting a quarterly decline in other revenues. On the bottom left, adjusted cost decreased further to EUR 398 million, down 3% quarter-on-quarter as a result of lower adjusted compensation and benefits costs, and this supported an adjusted cost-income ratio of 59.3% and an adjusted profit before tax of EUR 273 million in the second quarter.

Let's recap on the market environment. The second quarter of 2022 was even more turbulent than the first quarter. Political uncertainty and growing flares of recession dominated the markets and exacerbated ongoing concerns over inflation and pricing pressures. This is evident across major equity indices, which continued to decline sharply in Q2, while the U.S. dollar continued to strengthen against the euro. Overall market conditions remained extremely volatile in the second quarter, both in equities and in fixed income, which had a significant impact on our AUM.

As I'll outline now, assets under management decreased to EUR 833 billion in Q2, down 8% quarter-on-quarter. Once again, ongoing industry pressures continue to negatively impact equity and fixed income market performance, which more than offset favorable FX movements in Q2. The challenging markets also affected our flow performance in the second quarter as investors continued to reposition their portfolios in response to heightened market volatility, which I'll now highlight.

In the second quarter, we reported total net outflows of EUR 25 billion and EUR 0.3 billion, excluding cash. Quarterly redemptions were primarily driven by institutional outflows, which more than offset inflows into alternatives and active retail flagship products. As we saw in the first quarter, institutional investors are continuing to withdraw cash holdings amid ongoing concerns over growing levels of inflation. This is a trend that we have seen most prominently in the U.S. and which accounted for the majority of the total quarterly outflows in Q2. However we continue to see volatility in the asset class with the majority of cash inflows already returning at the start of Q3.

Excluding cash, our flow performance was slightly negative as the turbulent markets had a greater impact on our passive business than we saw in Q1. And on our ESG front, which reported total net outflows of EUR 0.8 billion in Q2, primarily from cash and fixed income, which offset positive ESG flow momentum into all other asset classes.

Passive recorded EUR 3.3 billion in net outflows, amid reduced investor appetite for both ETF and passive mandates in line with broader market as seen in the decline in ETF flows industry-wide in the second quarter. However we continue to attract net inflows into our passive ESG funds, reaffirming the sustained investor demand we see for ESG ETFs.

Despite reporting overall outflows in Q2, we remain encouraged by the sustained flow momentum that we see into high-margin investment strategies. Alternative inflows increased to EUR 1.6 billion in the second quarter, reflecting growing investor interest in alternative strategies to diversify portfolios and generate higher returns in response to inflationary pressures. In Q2 the majority of our alternative inflows were driven by liquid real assets with additional contribution from infrastructure. And we also reported alternative inflows across all 3 regions in the second quarter.

Active equity inflows totaled EUR 0.7 billion, driven by our retail flagship offering Top Dividende and further supported by active ESG equity funds. This is a continuation of the active equity inflows reported in Q1 and remarkable achievements given the increased levels of volatility seen in the equity markets during the second quarter.

Active multi asset also sustained flow momentum with EUR 0.6 billion of net inflows in Q2, including significant contributions from our flagship retail fund Concept Kaldemorgen. Strong retail demand also led to an improvement in active SQI, which attracted EUR 0.4 billion of net inflows in Q2, marking a reversal of outflows in Q1.

Overall retail continues to be a key driver of net inflows at DWS with EUR 3.5 billion of net inflows in Q2 and EUR 8 billion of net inflows in the first half of the year. Our flow performance is also a testament to our investment outperformance and our global and diverse range of investment solutions, as I'll now explain further.

The asset management industry like so many other sectors is currently experiencing significant market volatility. And while we cannot make all of our products immune to the environment, we are able to offer our clients greater portfolio protection through our diverse range of investment solutions and styles to help navigate such challenges. On this slide, we outline 2 examples of these are Active Equity Flagship Fund, DWS Top Dividende and the DWS Invest Global Infrastructure Fund. After falling out of favor in 2021, Top Dividende has seen a strong recovery in performance, both in relative and absolute terms since 2021, as demand for value-orientated income strategies has begun to pick up again, to compensate for the overweight in growth within other asset allocations.

Meanwhile the DWS Invest Global Infrastructure Fund has sustained its positive investment performance from 2021, reflecting the appeal of its pure-play approach and ability to endure inflation. As a result, the fund has attracted more than GBP 1 billion of net inflows in the first half of 2022, helping us to sustain stable revenue growth.

Moving on to new launches and product pipeline. Since our IPO in Q2 2018, new product launches have attracted EUR 46.2 billion of cumulative net inflows and an overall management fee margin of 38 basis points. This includes EUR 1.7 billion of net inflows from new fund launches in the second quarter, primarily from new passive fund launches. There are additional contributions from new fund launches in active excluding cash and in alternatives as well as from new ESG product funds, which reported stronger inflows in the second quarter compared to Q1. This is a testament to DWS' focus on clients and markets as well as our ability to identify new opportunities through product innovation.

Looking ahead to the second half of 2022, we will expand our investment offering across a range of asset classes, mainly in areas where we see growing demand. We will continue to scale our passive business through ETF launches, including our Net Zero Pathway Paris Aligned UCITS Series. And we will continue to strengthen our range of alternatives with a particular focus on infrastructure funds, including a new offering that targets German retail investors. As we have seen clearly in the second quarter, new product launches are extremely important to sustain positive flow momentum and support top line revenue growth, which is why we remain committed to product innovation in 2022 and beyond.

Moving on to revenues. Total adjusted revenues were EUR 671 million in Q2, down 3% quarter-on-quarter, but up 7% year-on-year. The quarterly decline attributed to a decrease in other revenues, driven by a less favorable change in the fair value of guarantees and a lower contribution from our Chinese investment harvest among other movements. This more than offset stronger performance in transaction fees, which increased by 20% quarter-on-quarter due to the recognition of an alternative performance fee in Q2.

Management fees and other recurring revenues remain stable in the second quarter, reflecting sustained client demand for alternatives and active flagship retail products. And the management fee margin increased to 28.4 basis points in Q2, benefiting from a mix of low-margin cash outflows and high-margin inflows into active equity and alternatives.

Moving on to costs. Total adjusted costs decreased further to EUR 398 million in Q2, down 3% from Q1 and supporting an adjusted cost-income ratio of 59.3% in the second quarter. This was driven by a quarterly decline in adjusted compensation and benefits costs in Q1 included -- as Q1 included carried interest compensation expenses relating to a future alternative performance fee. This more than offset a slight increase in adjusted general and administration expenses in Q2, which primarily reflects higher spending in marketing and travel expenses. As a reminder, total adjusted cost base excludes EUR 15 million of investments into our infrastructure platform transformation in Q2 in addition to other nonrecurring expenses.

To conclude, despite challenging markets, DWS reported a solid financial result in Q2. Adjusted revenues remained resilient, supported by stable management fees. And the management fee margin increased in the second quarter, driven by a favorable mix of net inflows. Notably we continue to attract strong client demand for high-margin alternatives and active retail flagship funds, enabling us to generate net new revenues. This is testament to our global and diversified business model as well as our strong 3 and 5-year investment outperformance of 75% and 78%, respectively.

Looking ahead, we will remain focused on cost control to help navigate our business and our clients through this highly volatile environment, but we also expect continued investment into growth and therefore an adjusted cost income ratio of around 60% in 2022.

Thank you. And I will now hand over to Stefan for closing comments.

[Stefan Hoops, executive]

Thank you, Claire. By the way, I noticed that Claire has the calm voice of a veteran and the excitement of doing my first quarterly earnings probably got the better of me. So to ensure that all of you on the call don't have to put your volume up or down, I will now pretend that I've been doing this for all my life.

So ladies and gentlemen, knowing that you're ready to ask us questions, allow me to give you an outlook of what we'll focus on over the coming months. This is just a glimpse of our ideas and thinking and not a full-blown strategic review of where we stand and where we are heading to. We will update the market on our strategic outlook later this year in detail. It goes without saying, DWS remains fully committed to our clients and to creating shareholder value. And we will achieve this by doing what we do best, focusing on clients, navigating markets and investing our clients' money.

In particular, we remain disciplined on costs while continuing to invest in growth. And we will continue to focus on product innovation as well as on investment outperformance. Of course, we remain committed to advancing our sustainability agenda further. I will reiterate what I already said at our AGM. Restoring DWS' credibility on ESG is paramount and one of our top priorities.

And lastly, we will continue to scan the market for M&A opportunities that help us accelerate our organic growth. Looking ahead, we need to stay on top of our game by responding to a multitude of secular changes that will impact the asset management industry in the future and to pave the way forward for DWS in the New Now. As part of these efforts, we will target a number of additional growth opportunities. We are convinced that digital assets and currencies are here to stay, which is why we will aim to add resources and intensify our efforts in this space. To be clear, this is not to be confused with data strategies or digital channels, which are already on the DWS agenda.

In alternatives, we will assess each of our business areas regarding potential operational synergies and how to improve cross-collaboration to enhance our product offerings and capitalize on growing client demand. We also believe that there will be a renaissance of active asset management, i.e., the ask for experienced asset allocation in a highly volatile world, which plays to one of our core strengths. As we have seen in the second quarter, DWS is already well positioned for this trend with our active flagship funds continuing to report strong investment outperformance that's enabling us to maintain positive flow momentum and protect our management fee margin.

Regarding our multifaceted relationship with Deutsche Bank, we will stay the course and double down on our efforts to become independent from an infrastructure, policy and procedures perspective. At the same time, we will find better ways to leverage their distribution and sourcing capabilities, especially with the corporate bank and the investment bank.

Looking beyond DWS, we see a significant need for our expertise to help Europe handle current challenges. We are convinced that Europe has a bright future, but that a range of transformation investments are needed. This includes investments into ESG and the transition to Net Zero, increased research and development into new business models. And finally, new ways to gain supply chain independence, especially during times of geopolitical tension as we're experiencing now.

Europe is short of risk capital, but will over time benefit from the Capital Markets Union. Until this is achieved, we think this is a call to action for asset managers and banks alike. We can and should provide the expertise as well as the access to global capital pools to channel risk capital into the European transformation. I personally believe that DWS is uniquely positioned to provide these capabilities and be part of a broader European transformation. As mentioned, we will provide a more comprehensive update on this and all other points I outlined at our Capital Markets Day in early December.

But for now, allow me to quickly recap. DWS delivered profitable growth in the first half of 2022, a significant achievement given the highly volatile market environment. We remain committed to our financial targets and at the same time, want to pave the way forward for DWS to remain competitive and successful in the future. In the upcoming months, my team and I will work hard to enhance our strategy to address the key trends I just outlined with further details to follow at our Capital Markets Day.

And as I reiterated earlier, we'll continue to do what we do best: Focus on clients, navigate markets and invest money while remaining disciplined on costs to ensure we continue creating value for our shareholders. Thank you.

Claire and I look forward to your questions, and I will now pass over to Oliver for Q&A.

[Oliver Flade, executive]

Yes. Thank you, Stefan. And operator, we're ready for Q&A now.

[Operator]

[Operator Instructions] First question comes from the line of Hubert Lam from Bank of America.

[Hubert Lam, analyst]

And welcome Stefan into your new role. If you don't mind me asking, Stefan, in terms of strategic priorities, are there any major change in strategic priorities for you? What do you plan on doing differently? And I guess, tied to this on M&A, where do you see the opportunities? And which areas you think DWS is currently underweight and would like to grow more in? That's the first question.

And the second question is on the ongoing green washing investigation. Any update you can provide us there? How are you approaching this situation? And any timing on a resolution as I think it continues to be an overhang on the business and the stock.

[Stefan Hoops, executive]

I was wondering what my first ever question would be. I suspect the second question of yours would be the first, but I think you're very smart in the way that you prioritize.

So let me start with strategy and M&A and then come to the ESG allegations. So in strategy, as we said, we are fully committed to our financial targets and fully committed to the strategy we have. However, as we pointed out, I mean, there are massive changes in the market environment. And I think that any management team of any asset manager is currently trying to make sense of what that means. And look, I mean, we are convinced that we're not going back to what we've seen during the 2010, right? It's like all markets doing great. It will be more difficult. And obviously, our strategy will be adjusted accordingly, and we'll provide more guidance and clarity during the Capital Markets Day.

When it comes to M&A, we are ready. I mean we are ready to do M&A. However, M&A should really be done and not talked about, right? So we're obviously realistic with our current multiple, and we are realistic that we have to conclude our IT transformation as quickly as possible. But as I said, I mean, we are ready, we're scanning the market and are looking for opportunities in the consolidation.

When it comes to the ESG allegations, I will start, as you would imagine, Claire and I have 20 pages of talking points on this topic. So I just give you in my own words, my view and then hand over to Claire. This is the highest priority for us, right? And we are fully focused on addressing that. As you would imagine, we are fully cooperating with the various authorities that are currently investigating that. Obviously, we are continuing and always continuously improving processes, but I also want to be clear that we stand by our disclosures.

Claire is nodding, so I think there's nothing to add at this stage.

[Operator]

The next question is from the line of Jacques-Henri Gaulard from Kepler Cheuvreux.

[Jacques-Henri Gaulard, analyst]

Dr. Hoops, welcome as well. First question for you maybe on morale. You talked about your meeting clients. You haven't talked about meeting staff and how you feel about the moral generating in the organization and how confident you are that you will be able to retain people in the turbulent times we are leaving?

And the second question is on costs. There were materially more one-off costs this quarter than there are usually at about minus EUR 44 million, if I added that properly, if we could have a bit of a breakdown in comments on these costs and whether some of them are recurring in the next couple of quarters?

[Stefan Hoops, executive]

Thank you for taking note of my academic background, which was a lot of hard work. So when it comes to morale, I would give like my feeling, which is probably more a qualitative assessment and then some quantitative assessment. So I think qualitatively, I mean, obviously, the first part of June was tough. I mean, obviously, when you read about your employer in the press, it was tempting to just hit click, read the headlines, and I think we made it clear that we didn't want anybody to become click bait of the headlines. And really just focus on what we like to do, which is focus on clients, focus on markets, investing money and so on.

So I see that probably starting second week of -- or third week of June, everybody just went back to business. And there wasn't too much talk about the, let's say, DWS idiosyncratic challenges. Obviously, the market is hot, right? And we have incredibly talented people across the various functions. And obviously, we've seen attrition be higher than what we've seen in 2021. They are pretty recent nuances. There are nuances across seniority levels, there are nuances across the type of expertise one has, right? I think it's fair to say that alternative is really hot and maybe hotter than some other parts of our franchise.

So as the management team, we are sawing laser focus on any area in which we so like lose more than we should lose more than the market. So far, the attrition we have seen is not more than our largest competitors. So I think that we are united in ensuring that people see the beauty of asset management and don't go to other parts of the financial industry. But so far, and hopefully, you see that in the numbers, everybody is really focused on what they're supposed to do, including our excellent client coverage teams who are really focused on our clients.

On costs, I would just make one statement and then hand over to Claire for more detail. Obviously, we dislike cost and we like investments, right? So even in the current time, we'll continue to invest in those areas which we have previously designated as areas of growth. So we will continue to do that because, frankly, shareholders would expect that in clients deserve that. But at the same time, I think like everybody, we're incredibly disciplined on unnecessary cost or maybe it's like nice-to-have stuff. And have already like been incredibly crisp and precise on some of the things we probably don't need to do any longer. But over to Claire for more detail.

[Claire Peel, executive]

I'll address that one regarding the non-operating and exceptional costs that we have in the second quarter, which are higher than we've seen in previous quarters. The first item is the transformational charges of EUR 15 million, which relates to our IT transformation project. This project is ramping up in execution phase. So we do expect to see costs attached to the project in upcoming quarters, but of course, not on a recurring basis once the project is completed, and we'll be discussing more details of that in the Capital Markets Day.

We also have severance and restructuring costs, which were higher in the second quarter of 2022 than previous quarters. We wouldn't expect to be operating at that run rate going forward. And we have other cost adjustments, which were EUR 21 million in the second quarter, and this included a regulatory enforcement provision, which we made, which amounted to EUR 12 million relating to a regulatory investigation by the SEC regarding employees use of unapproved devices and record-keeping requirements. And again, that is a provision. It's not an item that we would expect to repeat, but it is a provision. So that's the adjusting items. So the one that we would expect to see going forward would be the transformational IT platform project expense.

[Operator]

The next question is from the line of Arnaud Giblat from BNP Paribas.

[Arnaud Giblat, analyst]

I've got 2 questions. If I could come back on cost. You did say, I think, in response to Hubert's question that you were still committed to the 60% cost-to-income ratio this year looks quite feasible given H1. But I'm just wondering about further down the line '23, '24. If markets stay at current levels, you should be seeing roughly a EUR 30 million headwind in terms of on management fees at current market levels. So what can you do to compensate -- I mean what sort of cost action can you compensate to achieve these targets? I appreciate that markets are a bit of unknown, but you do have income ratio target after all.

And second question is on the fair value of guarantees and the other line. My understanding on the value of guarantees is that it had an inverse relationship with interest rates. So I'm just wondering why that's not really working out this quarter. And if I could just follow up on harvest as well. Could you detail maybe the decline we've seen in profitability over the quarter?

[Claire Peel, executive]

I can take those. So firstly, on the cost income ratio target, we have a medium-term target of 60%, which takes us out to 2024. So we recognize -- we've indicated the outlook for 2022 to be around 60%. And we think we have a clear path to achieve that during 2022. And then as we move out to 2024, yes, the outlook for revenues weakened with the macroeconomic environment. But we have some options that we can pull within our cost base within that 2-year time frame. So one, of course, will be efficiencies that we will generate from our IT platform transformation project, which should give us some benefits at the outer point of that time frame. We have variability in our general and admin expenses, which is related to levels of AUM. And we will, of course, be cautious in the investments that we're making within this window of time. So those are the areas that we focus on. We're not giving specific guidance for the year of 2020 at this point in time, but we focus on the outlook for 2024.

On the fair value of guarantee, for the period of Q2, we had a positive impact from the fair value of guarantee, but it was less positive than the impact that we saw in the first quarter, hence, the quarter-on-quarter decline. And just a reminder that we do have a hedge as well on the volatility that we see to manage the volatility in the long-term interest rate, so we take that into account. So there is a positive effect from the improvement in long-term interest rates, but that's mitigated by the balancing that we have with our hedge position.

And then on harvest in the second quarter, we saw EUR 15 million of return from the harvest contribution, and that's obviously affected by the impact on Chinese markets. Albeit if we look at the cost base for the first half of the year in harvest asset management that has been managed downwards, but we think at this point in time is probably a reasonable run rate given the market environment for harvest.

[Arnaud Giblat, analyst]

So if I can just come back on the 60% medium-term target for 2024. Do you feel that, that is achievable at current market levels with a recovering market?

[Claire Peel, executive]

Yes, we're standing by that commitment of a 60% cost income ratio by 2024. We recognize that next year, in particular, that will be challenging, but we have a period of time to manage across the whole cost base. And just to remind you as well, of course, on the management fees that we've certainly seen a negative market impact from the equity-linked portfolios, but we've also seen a positive return from the alternative franchise. So the diversification within management fees has enabled us to have a stable management fee revenue between Q1 and Q2.

[Operator]

The next question comes from the line of Bruce Hamilton from Morgan Stanley.

[Bruce Hamilton, analyst]

Welcome Stefan for me as well. Firstly, on the sort of alternative strategy, I know we'll hear more in due course. But I'd be interested in any sort of initial thoughts on a change of emphasis based on what you're hearing back from clients in terms of demand areas. You mentioned an increased effort on cross collaboration. But do you expect there'll be more of a tilt in favor of certain private market assets versus others? And how does that sort of impact your thinking?

And then secondly, I'm afraid on sort of ESG stuff, again, given your sort of range of meetings with clients, what's your sense of any risks to the, say, institutional pipeline linked to the uncertainty and the overhang from the ESG investigations. And it sounds like we shouldn't read too much into the outflow from ESG in Q2, but just to check how you're thinking on that in the near term before we get a bit more clarity on the investigations.

[Stefan Hoops, executive]

So I intend to spend the next 22 minutes talking about alternatives because that's a topic I'm very passionate about. So look, obviously, clients are highly interested for a variety of reasons, one being that some of them are pretty good hedge against inflation. But I think that just because clients like something doesn't mean it's good for us because it doesn't nectar mean that we can provide the products. However, in this specific case, we actually have really good products that work well in a higher inflation environment.

Now personally, and like if you time travel back to 2010. And in 2010, asked the question, which asset manager is most likely to drive the move to alternatives in the 2010, I think you would have bet on Deutsche Asset Management, DWS at the time, right? And the reason being that Deutsche Bank had by far the best structured credit, alternative credit, commercial real estate franchise in the street. I was one of them.

Now when you look at the [indiscernible] back from 2010 out of 30 more senior people, really only 2 kind of state, I'm one of them and I move to DWS. But the other people went to all of the big competitors and drove the drive into alternatives from the -- and I'm not going to mention all of the competitors, but that's what they've done or set up their own hedge funds. So the point I'm trying to make is it's definitely in our DNA, definitely, that's what I've spent like most of my career on to focus on very complex private credit markets.

Now when you look at our franchise, I think we have really, really good individual products, the real estate businesses, particularly in the U.S. and in Europe. Our liquid real asset business, which is awesome, the infrastructure business, even the private equity secondary's business that we have. So I think we've really good individual businesses. We just don't really have like a one alternative setup. And so we're not going to change the orchard. So we're not going to create another board level role for alternatives that would just cause 6, 12 months of confusion reorganization. So we don't want to do that. But we definitely will spend time on how to really get the best out of the overall approach of alternatives, the cross-sell, the kind of synergies with the various teams working together. So that's on alternatives.

I'm and happy to take more questions on that topic. When it comes to ESG, maybe I will start, and then Claire will have more specific views. So first, obviously, I like your interpretation of the flows, meaning that one shouldn't read too much into it. But I think to be more precise, I mean, obviously, to be frank, we had a couple of pipeline items that will take longer than expected because of the allegations against us. I mean, to be realistic, I think it would be silly for us to say that this is not the case.

I think what we've also seen is just I think people asking themselves, what is ESG really all about. And I think us across the industry really have to agree on terms and standards. I mean, obviously, you have regulation, you have taxonomy. But I think there also needs to be an understanding whether a green fund should include gas and nuclear and weapons or not, right? We believe it shouldn't. Others believe it should. And I think that the Alstom is leading when you look at ESG performance. So we could go into more detail what needed more, but I think your question was specific on flows. So I'll hand over to Claire for more insights.

[Claire Peel, executive]

Yes, on the ESG fund flows that we saw in the second quarter, overall, we saw EUR 0.8 billion of outflows. But as noted, it was driven by fixed income predominantly and a little bit of cash, whereas the other asset classes within ESG, including equity and passive, we're showing inflows in the second quarter. So I think that is a continuation of the path that we've seen in previous quarters, and it also demonstrates the focus that we've got on product innovations and new fund launches, which is also focusing on ESG fund launches, particularly in the passive space with the Net Zero Pathway Series, et cetera. So I think it's very much the new fund launches in the ESG, ETF territory, which is attracting flows, and likewise, systematic funds within equity.

It's difficult to give a pipeline outlook. It's not something we track specifically. But so far, those trends we have seen continuing. And so in the absence of any other changes in the macro environment, we would expect to see a continuation in the pipeline go forward as well.

[Operator]

The next question comes from the line of Angeliki Bairaktari from Autonomous.

[Angeliki Bairaktari, analyst]

First of all, a clarification on the management fee margin, which actually increased quarter-on-quarter. I hear your explanation on the net flow mix, but I just wanted to double check if there was any one-off elements in there and perhaps anything on the alternative side that could have helped management fees in the second quarter and might not be repeated. That's the first question.

And then second question, you mentioned that your relationship with Deutsche Bank could present an additional growth opportunity. Can you please elaborate a little bit further on what you have in mind there?

[Stefan Hoops, executive]

And I love the sort of precision on detail, right? I mean, Stewart was the one who quizzed me more than anybody in 2019 on the deposit charging and really wanted to get to the bottom of it, which then turned out to be a great success story. So love the -- just like in-depth question.

Claire will take the one on management fee margin and then I will talk about our majority shareholder.

[Claire Peel, executive]

So on the fee margin we saw in the second quarter 28.4 basis points and is compared to Q1 of 27.6%. There is no special items in there in this particular quarter. So I know that we have had that in the past in alternatives with equalization fees when we've had large inflows attached to fund launches and so on. That's not the case for the second quarter. But of course, we do have cash outflows, which do affect the results in the second quarter, and that would be a 0.4 basis points impact. So if those cash outflows were to return, which indeed we have predominantly seen so far in July, noting volatility, then the effect of that would be about 0.4 basis points.

[Stefan Hoops, executive]

And Angeliki, on the question on what I call the multifaceted relationship with Deutsche Bank. So obviously, it has the element of independents, which we will double down on both from an IT integration policies, procedures and so on. And that was not your question, but I just want to make it clear that we are not getting closer from a getting back into the Deutsche Bank overall holding structure. However, it is a great advantage to have a majority shareholder, which has excellent divisions in the private bank, which obviously we've been leveraging forever. But I think we've underleveraged the Corporate Bank and the Investment Bank, right?

And when you think about our competitors, nobody would quite have that sort of access and I'm not going to mention all of our competitors, but none of them -- none of the independent asset managers has access to an investment bank and the corporate bank. Now I think that there are at least 2 elements, one is sourcing of interesting risk for our clients. And the second one would be distribution. If we start with the distribution, obviously, we have long-lasting relationships with wealth management, with the retail division. But we don't have the same with the corporate bank. Now obviously, that's a division I know reasonably well.

And I think when it comes to enabling corporate clients to deploy liquidity into money market funds, fixed income, whatever funds and really including our fund Arsenal into the liquidity portal of the corporate bank, that is a really interesting area of upside, really both for the clients, but then also for the Corporate Bank in DWS, right? So that's one, let's say, distribution of our products, solving the excess liquidity challenges that corporates are facing.

When it comes to sourcing, could go into more detail. But quite obviously, if we want to grow alternative credit, if we want to grow private credit, having access to the pipeline in the Investment Bank and at the same time, being able to potentially add products to the corporate bank toolkit are 2 pretty interesting ways of sourcing risk for our clients, right? With the investment bank, there would be the like typical pipeline you could think about really across different types of alternative credit.

When you think about the corporate bank, you would have typical corporate loans that the corporate bank can hand out to clients and by the way, has done pretty successfully if you've seen the second quarter. What they wouldn't be able to do is hand out mezzanine loans or maybe even equity to, let's say, German mid-caps. But that's something which we could do in conjunction with the corporate bank, so essentially have products, which our clients would be interested in, but then simply add to the toolkit of the corporate bank.

[Operator]

The next question comes from the line of Nicholas Herman from Citigroup.

[Nicholas Herman, analyst]

2 follow-ups, actually on Angeliki's questions. So one on the deal relationship and one on margin. On the relationship, just you talked about doubling down on efforts to accelerate the independence and separation of DWS. Just curious what you mean by that. Is there anything incremental there?

And then on the margin point, I appreciate that the group fee margin is stronger there were no material one-offs. But notwithstanding that, it does appear that there have been some notable declines in the fee margins within the individual products. So active equities, which is down 2% to 3% versus 2021, fixed income down 5%, multi-asset, down 8%. Just curious on what mix shift effect is going on there we should be aware of, just because I would thought that were sales in higher-margin products, particularly on the retail side, would have seen more resilient product margins?

[Stefan Hoops, executive]

So on your first question on like the doubling down of becoming independent, I would say 2 things. The first, I think DWS has made really, really good progress on the IT transformation, the IT independence. I think we probably could have made more progress, and we'll focus more on the asset management specific policies and procedures, right? So obviously, becoming independent, sounds great, but it's hard work to actually draft your own policies, which are more appropriate for the asset manager. And I think there, we simply need to double down our efforts.

Secondly, yes, you will see more in due course on what specifically or how we'll do that. So like sit tight, please. In the next couple of weeks, it will become more clear.

[Claire Peel, executive]

Yes. And just picking up on the question on the fee margin. I think certainly on the alternative side, we have seen an increasing share of management fee revenues coming from the alternatives portfolio as a proportion of total management fees over time. So that's obviously having a positive factor on the average margin. And conversely, we've seen a decline in the revenues coming from cash and coming from fixed income. So there is certainly a mix effect that's taking place with some of the higher-margin strategies contributing to the mix effect.

We had originally in our outlook, going back to last year, would have anticipated to see a higher proportion of passive inflows also below the average of the fee margin of DWS overall. But the market environment is obviously leading to a shift in asset allocations, not so much towards passive, but more into active and alternatives. So I think that is the mix effect that we are seeing in the fee margin.

And if we look to the outlook for this year, I know we normally indicate around 1 basis point of fee margin dilution across the year. And we clearly anticipate to see less than that within this year, and we're more conservative on that particular outlook.

[Operator]

The next question comes from the line of Haley Tam from Credit Suisse.

[Haley Tam, analyst]

Just 2 for me, please. Firstly, on ESG and then secondly, on the New Now strategy. So in terms of ESG, I apologize for focusing on the EUR 0.8 billion net outflow in Q2. I heard that you said that we had still seen inflows into equity impact and other active classes, but out from fixed income and cash. Could you quantify those numbers for us at all, just so we can understand that? And I guess given the strength of net inflows into ESG that you've seen in the past, I think you saw EUR 9 billion in 2020 and EUR 19 billion last year. Is there anything we should be aware of in terms of asset class mix or potential additional vulnerabilities as you look at it in terms of possible outflow risk in the future?

And the second question on the New Now environment. Thank you very much for the outlook slide. I'm looking forward to what you have to say in December when you've had more than 6 weeks to think about all of this. But if I can ask you one question, it seems to me that you are very enthusiastic about the transformation capital for Europe opportunity. And I just wondered if that was something specifically that's come out of conversations with clients or whether you have a particular idea in mind in terms of the nature of the opportunity, whether it's public or private assets or any structuring there, that would be great.

[Claire Peel, executive]

Yes, happy to give a bit more color on the ESG net flows, recognizing that there is some attention on that. So the equity flows were just higher than EUR 0.2 billion of inflows and the passive quant flows were also just higher than EUR 0.2 billion with slightly lower the difference coming within multi-assets and lesser in alternatives. So really, the lion's share of the outflow is coming from fixed income and to a lesser degree, cash. It was EUR 0.8 million coming from fixed income and EUR 0.4 million coming from cash. So that's the mix that we've seen within the second quarter. So I think to some degree, it's correlating the asset class allocation that we're seeing in our non-ESG funds as well. So I think it's very much an asset allocation choice in the market environment rather than any other specific factors.

And your second question, sorry, was regarding the AUM overall. If I may ask you to repeat that one?

[Haley Tam, analyst]

Yes. No, I just wanted, given the strength of ESG inflows you saw in the past, I think you saw EUR 9 billion in 2020 and EUR 19 in 2021, whether there was any particular maturity of those or particular things we should be thinking about in terms of possible risk given the green washing investigations at the moment?

[Claire Peel, executive]

Okay. I mean, there's nothing specifically that we can point to. We don't track a pipeline for the specific ESG fund inflows. But I think what we've seen consistently over respective quarters is that the mix of flows coming into ESG funds is a similar asset allocation to non-ESG funds effectively.

As Stefan said earlier, that there is some on some institutional mandates, there is more time, and I would say, more of a wait and see in some cases, but that's not across the board. I think that's just some more caution given the backdrop that we are operating within. And when it comes to product innovations and fund launches, certainly the new fund launches that we make in -- particularly in the decarbonization space, the net zero space. Those funds are certainly an area of interest. We continue to launch those, and we continue to see inflows in those categories.

[Stefan Hoops, executive]

And Haley, so obviously, some of your colleagues became more skeptical on our stock after I took on, and I will try to win their confidence. You are one of the few that I inherited being skeptical. So I will try to persuade you that we actually have a bright future. And I will start with the European transformation. So yes, it's something which I've been hearing for the last 12, 24 months on the corporate side. So let me start with the, let's say, demand for capital, and I'll come to the supply of capital.

So when you think about what Europe will have to do over the next decade really is significantly invest in LNG terminals, project finance, building gas pipeline, solar and so on. Europe needs to significantly invest in research and development for new business models. I mean, we have phenomenal companies producing stuff. We don't have phenomenal internet companies. And if internet of things becomes relevant, that's a huge area of investments.

And I think thirdly, what has become incredibly clear over the last couple of months, we simply don't have commodities in Europe. And we actually have unlearned how to process commodities in Europe. So right now, we get commodities from all over the world, but they don't come directly to Europe. They come through a couple of countries in Asia that process everything on our behalf. And the question is simply whether Europe will want to relearn those capabilities, which based on the feedback I've received over the last couple of years, Europe wants to. But it will require massive investments.

Now when you think about the structure in Europe, and just look at Germany. Most of German corporates are the Mittelstand, the mid-cap corporate that actually not publicly traded. So to get risk capital into Europe is actually not that easy because you would have to IPO many companies, which is not realistic, right? So much of that is going to be private, like much of that is going to be partaking in government-sponsored projects where you could just provide, let's say, a more junior version of credit to the more senior version that the government is providing.

So I think the demand side is probably pretty clear. Now the supply side of capital has been challenging because people just didn't put risk capital into Europe, and that's a long-term challenge, which has been pointed out by many. But I think now is the time. And yes, what I've heard from investors in Asia and in the U.S. It's in the questions like, look, like whether or not people are bullish on Europe, everybody sees that there's going to be significant investments. And whether or not they're bullish on Europe, they believe that you will be able to repay. So there's a lot of demand from investors in partaking in these investments, these transformation investments. And I think that DWS is better positioned than any other asset manager in really bridging the demand and the supply for that transformation capital.

[Operator]

The next question comes from the line of Michael Werner from UBS.

[Michael Werner, analyst]

And welcome, Stefan. Just 2 questions for me, please. One a follow-up. I think earlier you said one of the maybe impediments to M&A and the immediate future is the platform transformation and having an independent IT. Can you just give us a little bit of insight as to kind of when that's going to be targeted for and how exactly that is progressing? I know you may speak about it later in the Capital Markets Day, but just from a timing perspective.

And then second, with regards to the ongoing green washing investigation. Can you provide a rough estimate as to kind of the incremental costs that are being incurred as a result of the investigation? And ultimately, just confirm whether those costs are included in the adjusted base or the reported base.

[Stefan Hoops, executive]

So when it comes to -- and I will start with M&A and then Claire will answer your second question. So the point I was trying to make is, as we're doubling down on becoming independent from Deutsche Bank and have our most competent people in control and infrastructure functions focused on the IT transformation, drafting policies and so on, it would sort of be the same people that would do a large-scale M&A integration. So the point I was simply wanted to make is, obviously, we're scanning the market. Obviously, bolt-on acquisitions would be doable. I just wanted to be realistic that in the current market environment and with all the stuff we would have going on, we just need to be realistic in what we can sort of integrate. And that's the point I wanted to make. Will be giving more color, but I think that's the way -- it's only the same sort of people. We just need to be realistic in the day, only having 24 hours.

[Michael Werner, analyst]

Very clear.

[Claire Peel, executive]

With regard to the costs that we will incur to manage the allegations against the organization, we don't consider those to be operating expenses as we don't consider them to be repeating expenses, but they are, of course, expenses, including legal fees that we have to incur at this point in time. These are represented as other cost adjustment outside of the operating cost base. And for the first half of the year is in the region of EUR 13 million.

[Operator]

The next question comes from the line of Mandeep Jagpal from RBC.

[Mandeep Jagpal, analyst]

The first one is on the net outflows in passive products. Would you be able to provide any color on the destination of these passive products once they've been redeemed by clients? For example, how much was reallocated to active and alternatives within DWS? How much went to competitors and how much has just taken out of the market? And the reason for asking that question is the rate of passive outflows over the quarter was quite high compared to previous quarters. So it would be useful to understand how much of this was market environment related and how much is DWS specific?

And then the second question is on retail, where net flows remained positive over the quarter. Are you able to let us know the average fee margin on the retail business and how this compares to institutional?

[Claire Peel, executive]

On the first one, on the passive flows, I can confirm that within that, half of that is coming from exonerated products and half of that's coming from mandates. We can't really isolate how much of that is being reallocated client by client into other asset classes. But effectively, that is the shift that we're seeing. We're seeing more inflows into the active asset classes and less so within the quarter within passive. And as I say, that's including ETPs and mandates. I must say, looking at public data in July, we see that turn around a little bit. So it is a little bit volatile. And again, I would point out that within ESG, ETFs, we have seen positive inflows within the second quarter.

On the retail side, we have indeed seen inflows coming through in retail in both the first and the second quarter, EUR 3.5 billion of net inflows into retail in Q2 and EUR 8.1 billion of inflows for year-to-date. And institutional is where we're seeing the other direction to that more so in the cash asset class. So the retail channel is also an indication of what is supporting and holding up the management fee margin and the resulting management fee revenues overall.

[Operator]

The next question comes from the line of Pierre Chedeville from CIC.

[Pierre Chedeville, analyst]

Welcome, Stefan. For me, it's also my first quarter with DWS, as I recently initiated the coverage of the company. So I hope my question won't be too naive. My first question is, when I'm challenging your model with the one of your major listed competitor in Europe. I was quite astonished by the fact that your relationship with Deutsche Bank network were not so close in terms of asset under management. And I was wondering -- I understand that your model is a pure open architecture model. But I was wondering if you could not intensify your distribution with the model company networks. And also, if you were thinking in order to stabilize your business model in difficult times, try to have some long-term contract relationship with some networks, smaller networks. In Germany, for instance, where we know that the distribution is very spread. And if it could be an evolution of your strategy in the future.

My second question is a follow-up on M&A. As far as I understand, M&A was really focused on Asia by the previous CEO. I was wondering if you were a little bit more open in terms of geographics considering what you said on what is at stake in Europe?

[Stefan Hoops, executive]

Yes, thank you very much for your questions, which are actually very specific and not naive. Let me try to answer that, and then Claire will tactfully complement with more detail if needed.

So when it comes to Deutsche Bank, yes, you're right. They have open architecture, and we need to compete based on performance. For those funds, where our performance is strong, obviously, we're doing really well through the retail distribution of Deutsche Bank. But they have their interest like their clients interest in mind, and that's what they will focus on. But I think there's definitely upside with other parts of Deutsche Bank, right? As I've outlined with the Corporate Bank Investment Bank, in addition to the retail in wealth management franchises.

When it comes to other strategic partnerships, yes, we have very close relationships with some of the large distributors in Germany. Could we do more? One could always do more. We're obviously focusing on new channels, like digital channels. What I've seen in payments over the last couple of years is that people really move away from the traditional way of targeting products, buying products and going through platforms or other new channels. So that's something we focus on. But 100%, there's probably upside with the other divisions of Deutsche Bank, where we haven't historically been very close to.

When it comes to your question on M&A and Asia, I think the reason why there was focus on Asia was simply that we are not on the ground in all that many countries. And when you look at Asia, and obviously, you need to be quite nuanced, right, which one would be looking at India, China, ASEAN, Korea, Japan, you want to say, APAC at Australia. So it's not that anybody would have a like one size fits all, Asia strategy. But as we look at the various countries, which like historically in my previous roles, I spent a lot of time in Asia. For every country, we'll simply assess, well, the market opportunity, these like incumbents and does it actually need anybody new.

But then you would always assess whether you can do it organically and inorganically and simply because we're just not on the ground in, let's say, India, I think that's why previous -- my predecessor focused so much on M&A in Asia, which we'll continue to focus on.

[Operator]

The next question is from the line of Tom Mills from Jefferies.

[Thomas Mills, analyst]

I just have 2 questions, please. Firstly, sorry to dwell on the alleged green washing topic, but I know you said you've got 20 pages of talking points there. So I'd hate for all of that to go to waste. I appreciate the candor you provided that a few counterparties on the institutional side are sitting on their hands while the investigations are ongoing. Have you had any sizable institutional counterparties warning you that they would be compelled by policy to cease their relationship with you if you were to receive some kind of conviction related to the issue or you don't expect it to be as cut and dry as that?

And then secondly, I wondered if you could speak about how well positioned you are to capture flows from Middle East and Sovereign Wealth Funds, given the perhaps the strongest single asset owner beneficiaries of current macro conditions. Can you give us an idea of how much of your asset base does that comprise at the moment?

[Stefan Hoops, executive]

Tom, thank you very much for thinking about the many people that contribute to what Claire and I are saying, it's like drafting all those pages. So I can confirm that we have not received such a super negative statement or warning from clients. And we could go into the different types, whether they are retail distributors where they have a different type of, let's say, responsibility for the distribute. Or institutional investors that invest for themselves, right?

The reason why [ Doug Gergen ], who runs our global client coverage and I sort of traveled the world for the first month, is to have a lot of one-on-one discussions with our biggest clients to provide more clarity on what's actually happening, right? Some of the stuff we just can't say in public, but we are allowed to say in private, which we have done.

And I think the reason why our flows are so strong in the second quarter is because clients sort of gave us a benefit of the doubt, if I may just say that. And while I understand that for some people, it's like tempting to write a big headline about the outflows in money markets, which all of the analysts understand have mostly reversed. I think when you look at the substance of our client relationships, that's really portrayed through the inflows in multi-asset, active alternatives and so on, where clients continue to trust us.

I think your second question when it comes to Middle East, I think that some -- like that's an area in which we could increase our coverage efforts, quite honestly, right? So I haven't traveled there. Historically, I think there has been a strength, particularly of the U.S. investment banks and U.S. asset managers.

So quite honestly, Tom, the way that we would always look at opportunities is just because somebody is investor in something doesn't necessarily mean that there's space for us. We will be realistic in what we can and cannot do. But it's definitely an area in which we want to increase our efforts, particularly because they are so interested in alternatives, and we've actually seen inflows from them in alternatives and because they're so interested in European transformation, right? So they will definitely increase the efforts, but definitely in area in which we can do more.

[Operator]

There are no more questions at this time. I hand back to Oliver Flade for closing comments.

[Oliver Flade, executive]

Yes. Thank you very much, and thanks, everyone, for your questions and dialing in, took a little bit longer than usual, but shows your interest in DWS. So thank you very much for that. And as always, if there are any follow-up questions, please feel free to contact the IR team. Otherwise, I wish you a great day and a healthy time or the best. Bye-bye.

[Stefan Hoops, executive]

And thank you from our side. Thank you very much for your questions.

[Operator]

Ladies and gentlemen, the conference is now concluded, and you may disconnect your telephone. Thank you for joining, and have a pleasant day. Goodbye.