Eaton Vance Earnings Call Insights: Retail, Offensive & Defensive Opportunities
On Wednesday, Eaton Vance Corporation (NYSE:EV) reported its second quarter earnings and discussed the following topics in its earnings conference call. Here’s what the C-suite revealed.
James Howley – Sandler O’Neill: This is actually James Howley filling in for Michael this morning. Just as you look across your retail franchise which strategy you think are going to drive organic growth over the next 12 months or so whether it be munis, bank loans, high yield, absolute return, and then just assuming that at some point retail investors do begin to (re-risk), how do you think your asset mix (sets up) for that type of environment?
Thomas E. Faust, Jr. – Chairman, President and CEO: If I heard that, that was focused on retail, correct?
James Howley – Sandler O’Neill: Yes, it’s correct.
Thomas E. Faust, Jr. – Chairman, President and CEO: I guess one thing I would say in just to start is that I think most of the listeners are probably aware, we have a significant business in both municipal income and tax-managed equities that is quite sensitive to the tax environment, and although fund is not getting a lot of play, we think that over the next several quarters we will see increased focus on the issue of federal tax rates in the U.S., and therefore increased focus on tax-efficient invest. We’re certainly aware that as that environment unfolds that we could be in a position where input in our tax-managed and tax-sensitive products goes up. We are in a position – and I am speaking particularly on the muni side where our performance has gotten significantly better, we have a broad range of products and feel like if there is a significant surge in interest in either muni investing or tax-efficient equity investing that we’re positioned to be a significant beneficiary of that. So, depending on how things fall, that could be a significant driver of our growth over the next several quarters. Beyond that, much depends on what kind of environment we’re facing. We’ve got an array of products that span a broad range of risk categories; risk-on, risk-off, across the broad range of things we’re certainly covered. On the low risk side, we are best positioned in the absolute return space where our Global Macro Absolute Return Fund is one of the flagship products in that category. You may recall that we closed that to new investors in October of 2010 and reopened that in October of 2011. We feel like we’re now pretty well back with that product now being in front of investors who would pull away from it because we weren’t making available to new investors. But certainly if we’re going into an environment or continuing environment where caution about the economy, caution about equities, I think our absolute return strategies and particularly Global Macro Absolute Return are well positioned for that. Similarly I would say that if there is concern about interest rates or the possibility of rates going up, our floating rate products, floating rate funds, Floating-Rate Advantage, Floating-Rate & High Income Fund and institutional strategies that follow similar mandates, I think all are exceptionally well positioned for an environment of rising rates. If it looks like and this doesn’t seem to be (indiscernible) today at the moment but if it looks like enthusiasm for equities is growing based on a better economic outlook and what looked like pretty good valuations for equities, we’ve certainly got a broad range of products there. I mentioned that our large cap value strategy has seen a notable pickup in performance over the last couple months and now is at least above average in its category for year-to-date 1, 5 and 10 year performance and in fact top quartile for 10 years. Certainly one of the best sources of incremental net flows for us is a slowing in redemptions from large value. We think if we’re entering a more cautious an equity environment, which seems to be the case, that this is historically been the kind of environment in which large value has performed relatively well given our focus on risk management and downside protection, and we would be hopeful, haven’t seen it yet, but we would be hopeful that we’ll see an improvement in our net flows not from increased sales but reduced redemptions and outflows from that strategy, which we commented were over $3 billion in the second quarter. So, a better outlook for large value even if it doesn’t involve significant sales growth would likely lead to better net flows just based on the likelihood of reduced redemption.
James Howley – Sandler O’Neill: Then maybe just one for either Laurie or Dan, if you could just give some forward guidance on how should we think about the other expense line. (Does that) IT spend come up again? And then if you could just disclose the interest income portion of the gains and losses on other investments? I noticed you guys didn’t give that this quarter?
Laurie G. Hylton – CFO: Yeah, I’ve got the at least the interest and other income. It was about 1 point – just shy of $2 million for the quarter.
Daniel C. Cataldo – Treasurer: In terms of other expenses, I mean I would think of it as modest upward pressure. I mean, we continue to feel pressures on investing in systems to support the various investment disciplines around the Company. We did go through a big SAP installation over the past couple of years in 2009 call it through 2011; that is over, but we do expect that we will continue to have to increase investments in – sorry, in IT for our investment infrastructure
Offensive & Defensive Opportunities
William Katz – Citigroup: Just want to start on the capital management discussion. You mentioned that slowdown a function of both price and other uses. Can you comment a little bit on another uses at this point in time particularly since your stock price is coming relative to larger buyback last quarter?
Thomas E. Faust, Jr. – Chairman, President and CEO: Yeah. Well, remember the stock is coming and mostly since the turn of the quarter. So, we were looking at over the course of our second quarter generally higher average stock prices than during the first quarter. So that’s one point I would make. The second point, I guess, relates to your observation about – our comment about other opportunities, and there are both opportunities that we see offensively and perhaps some defensively. Just maybe covering the defensive first, probably isn’t lost on people that we’ve seen some significant – starting to be significant retraction in the market in recent weeks and months and that to us is generally a good environment to be cautious and conservative and how we use our cash. We found out in 2008, 2009 the great business benefit that can be derived from a generally conservative financial posture, so that’s the defensive side. On the offensive side, we have said publicly that we are interested in acquisitions and there have been certainly some properties that have been – I talked about publicly that we’ve had some interest in; can’t obviously comment specifically on plans there, but if it proves to be an opportune time for attracting for – transacting in attractive properties, we certainly want to have the finance or whatever relative to consider that, and we think keeping a little more powder dry in terms of slightly reduced share repurchases makes sense at this time. We can reverse that at anytime. We are aware of the fact that the stock is down at the moment, but over the course of the second quarter, you’re right, that we did take the foot off the pedal a little bit in terms of our stock repurchases.
William Katz – Citigroup: And then just my second question for you guys, just so, Tom, you mentioned that you’re very close (wins) of your peak level AUM, I was just sort of looking back at where both your earnings and your margins were then versus where they are today, and certainly appreciate the volatility of the AUMs subsequent to those 12 months. But as you look at the business today at the end of the incremental business, is it equally profitable, particularly listening to Dan talk of IT expense a little bit, or margin is sort of still trending lower?
Thomas E. Faust, Jr. – Chairman, President and CEO: It’s a little hard to say. One of the things that when you talk about profitability, it’s important to think about, I guess maybe in two or – at least two and maybe even in three dimensions. One is, profitability per dollar of revenue, which is what you will normally think about in terms of margins. Second is profitability per dollar of asset managed, and then the third, if you want to think about that that way, might be value of asset managed. It not only looks at profitability, but also the longevity of assets that we’re bringing on to the books. One of the things we did comment on in the quarter is that we are seeing a pretty significant run-off in our – in B and C share assets and therefore the mix of our assets is shifting more towards products that have known that distribution or service fees have very low levels and that’s not a new trend but it seems to be if anything accelerating both within our fund business moving more to A and I share but also just at the moment the faster growth than we’re seeing in our non-fund business versus fund. Those things are driving down realization rates on an overall basis per dollar of managed assets, but they do also have a positive effect on margins because the embedded service and distribution revenues are offset largely by associated expenses. So one of the things that’s happening is as our business changes we’re seeing some upward pressure on margins, maybe somewhat (perversely) as we move from B and C share business to A and I share business. I would note though that doesn’t necessarily mean its better business. Profitability per dollar of asset is likely down a little bit as a result of that because we have made some – generally small but have made some profit on those incremental revenues we’ve gotten in connection with distribution and service. So it depends a little bit on how you look at it whether you’re looking at it on margin per dollar of asset, margin per dollar of revenue. In terms of the third dimension I referred to, the stickiness of the assets, I think that’s one of the great frustrations I and others that try and run asset management businesses (they have) at the moment is that based on changes (encased) in share classes and maybe even more se based on changes in technology, the value of the assets that we raise and this is probably more through retail than institutional, but somewhat through there as well. The value of those assets is going down because the assets don’t stay on the books as long; there is a faster run rate of assets, it’s easier for financial advisors to move from fund A to fund B. The switching costs to the investor that’s doing that are close to zero, if not zero. So we’re seeing a lot higher velocity of money. Funds like our large cap value fund that go through a period of underperformance when their style is out of sync with what the market is doing for over a period of couple of years get punished more in terms of outflows than I think would have been the case five or 10 years ago. So, there’s a real cross current of things. If you try and get underneath; is our business is a new business, we’re bringing on somehow better or worse than what it’s replacing. I think I have a hard time answering that in aggregate. One of the things I guess I would point to is, as we talk about this muni ladder business which is (of a) – we said under 20 basis points for that business, so small, only about $300 million, so just a drop in the bucket; but brand new business that we’re excited about; think that we can grow. Low fee, low profitability per dollar of managed assets. We think it will be relatively high margin because we can manage these assets pretty efficiently, but also we think there are attractive assets because we think they’ll be on the books for potentially many, many years. So, how do I think about that business? I look at the total value of those assets that we’re raising. What is the cost of bringing the assets in, what are they worth to which is a function of revenue realizations, cost to manage the assets and how long we expect those assets to remain on the book? So maybe a longer answer than you’re looking for, but there are a lot of things that drive our margins up and down on a secular basis. I am not sure I could really prognosticate whether on an overall basis margins go up or down on a percentage of revenues, but certainly there are many competitive pressures on our business, and second, on an overall basis, this is very big picture how company like Eaton Vance it grows margins, it’s generally by growing scale. There remain significant economies of scale in our business and incremental $1 billion or $5 billion added to the assets of an establish investment team that tends to be pretty profitable if we’re out creating new strategies and building new teams or have existing strategies or teams that are not at their full potential in terms of assets, those are going to be less profitable. So, if we can grow deeper and stronger in areas of core expertise I see no reason why we can’t see upward pressure on margins. If we’re unable to do that I think there’s a pretty good chance that we’ll see pressure on margins because this is a very competitive business. If you stand still in this business your prices are going to go down, your costs are going to go up squeezing margin. So, I feel like growth is imperative, innovation is imperative, performance excellence is imperative to maintain and improve upon margins.