Artisan Partners Asset Management Inc. (APAM) Q1 2014 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Artisan Partners Asset Management’s First Quarter 2014 Earnings Conference Call. My name is Gary, and I will be your conference operator today. [Operator Instructions] As a reminder, this conference call is being recorded. At this time, I will turn the call over to Makela Taphorn with Artisan Partners. Please go ahead.

Thank you. Good morning, everyone. Before we begin, I would like to remind you that our first quarter earnings release and the related presentation materials are available on the Investor Relations section of the website. I would also like to remind you that comments made on today's call and some of your responses to your questions may deal with forward-looking statements that are subject to risks and uncertainties. Factors that may cause our actual results to differ from expectations are presented in the earnings release and are detailed in our filings with the SEC. We undertake no obligation to revise these statements following the date of this conference call. In addition, some of the remarks this morning may include references to non-GAAP financial measures. You can find reconciliations of those measures to the most comparable GAAP measures in the earnings release. And with that, I'll now turn it over to our Chief Executive Officer, Eric Colson.

Thanks, Makela. Good morning. Welcome to Artisan Partners Asset Management business update and quarterly earnings call. I'm Eric Colson, CEO; and I'm joined today by C.J. Daley, CFO. Thank you for your time today, and I hope you find this discussion useful. As with past calls, I want to reinforce our business model relative to the quarter and go deeper into our business philosophy and approach that drives the results over a longer and more meaningful period. This quarter, I will spend time on the evolution of our high-value added investment strategies towards increased degrees of investment freedom. More specifically, I want to explain that evolution as it relates to 2 secular market trends: globalization and investment policy evolution towards passive and alternative investing. Once I'm done, C.J. will take the lead and walk you through our financials. On the first page, I would highlight 2 points for the quarter. First, our overall AUM has increased to over $107 billion, owing to positive net flows and market appreciation. Second, although the sliver of pie is small, our credit team is live with its first strategy, Artisan Partners' high income. We expect the team to represent a small percentage of the firm assets for a while, as we allow Bryan and his team to focus on investing. We are discussing the strategy with early adopters that are familiar with our firm and interested in Bryan's strategy. I will elaborate on the credit team and the high-income strategy later in the call. The next 2 slides provide the current view of our long-term investment results. As a reminder, we analyze performance around several key points, faithfulness to a stated investment process, solid absolute performance and performance compared to peers and the index. All of our strategies continue to execute their distinct investment processes with integrity. As of March 31, 8 of our 11 investment strategies that have a 5-year track record have added value relative to their broad performance benchmarks over the trailing 5 years and since each strategy's inception. All 7 of our investment strategies with a 10-year track record have added value over the period relative to their broad performance benchmarks. Over the trailing 5 years, from the historic market bottom in 2009, U.S. fee markets pending style and market capitalizations have rallied 200% to 300%. Our U.S. Mid-Cap Value and U.S. Small-Cap Value have participated strongly in the extraordinary rally by each trails of benchmark. We expect these strategies to participate in up markets and to protect in downmarkets relative to the index. The global market rally impacting the relative strength of our Emerging Markets strategy has also been extremely strong. Slide 4 further reinforces the impact of our performance philosophy across our asset base and illustrates the lumpiness that stems from process consistency over a variety of market environment. The impact of those factors can be seen in the 1-year returns, but over a longer period with normalize cycles we have compounded well for clients and outperformed the indices across our asset base. Before leaving this page, I think these quarter results provide a great opportunity for perspective around 2 items. The first is the fact that overreliance on a single factor can drive misinformed outcomes. We believe we are in a judgment business. The results of our non-U.S. growth strategy provide a great example. A number form is indexed by a single basis point for the trailing 1-year period, taking our percentage outperformance for the period from 78% to 55%. The second is that quarter-to-quarter and year-to-year measurement periods are extremely short periods for truly active or high-value added portfolios. To create value, you have to be different, and different to mean being wrong at times. Howard Marks at Oaktree articulated this very well in his quarterly letter dare to be great, too. And I'm paraphrasing, but in short, he says that superior investment results require unconventional behavior coupled with superior judgment. Following the herd leads to middling results, but standing out from the herd requires the courage of your convictions. You need to be open to being different than the index and peers and willing to look long over short periods. If you're not, a high-value added outcome is not feasible. Slide 5 illustrates the outcomes of our business discipline around asset diversification. Our broker dealer channel continues to be a solid source of flows for the firm, with 5 straight quarters at the distribution channel with the highest net inflows. Our institutional channel has been experiencing outflows driven by asset allocation, policy decisions, our commitment to fee discipline and performance. The largest outflow in the channel occurred at the end of March. Our client attention fund communicated that determination was a result of their decision to consolidate assets with a smaller number of managers and reduced their overall cost structure. It is evidence of the lumpiness that we expect in our fee discipline, which is one of our cornerstones of our financial model. We are extremely disappointed about losing that long term-oriented client. However, consultants and clients evolve their strategy and allocation policy. Change is inevitable. If we evolve with every consultant and client change, our business would explode with complexity, including custom outcomes, lower fees and much more distraction for our investment talent. We have a talent-driven business model and in such a model that commitment to fee discipline as required to protect strategy, integrity and retain talent. Since an investment team generates more revenue on fewer assets to compensate its investment professionals, portfolio integrity is more likely with greater odds of above-average performance. To see this point of law, strategies typically make up the revenue by gathering relatively more assets, which puts the strategy's integrity at risk and increases the likelihood of talent turnover. There's a vicious cycle with a lot of complexity which requires consistency. And this is true in all of our business development. Over the past couple of years, non-U.S. clients have remained a stable part of our asset base. We are experiencing growth from clients outside the U.S., but the complexity of the market requires consistency and thoughtfulness. A recent report showed that there are nearly 100,000 share classes available in Europe. 2013 alone saw more than 15,000 new share classes issued. Despite that, we are making nice strides developing relationship with clients that we align well with, and we are meaningfully growing our client list. C.J. will elaborate further in his comments. On Page 6 of our presentation, you can see the 3 core principles that define who we are. We are a high value-added investment firm designed for investment talent to thrive in a growth-oriented culture. We manage our business with a mindset similar to that of our investment team and managing their strategies. We operate for the long term and execute with a commitment to our business philosophy. Last year, I took the time to explain in detail our talent-driven business model and software approach to growth. Today, I will emphasize our high value-added focus. Let's move to Slide 7. Our business strategy evolves based on broad, sometimes obvious trends that we believe will impact our business model. We don't pivot because of fads or short-term outcomes. They can be distracting, and a part of the investment world where we operate just doesn't change that fast. The trends that matter to us, those that impact how we think, last a long time. This is where we focus. Since the mid-2000s, our business and investment strategy have been impacted by globalization. From an investment standpoint, this trend has driven us to create more degrees of freedom in our investment strategies, allowing our team to invest with looser geographical constraints. On the business side, that pushed up to leverage our distribution with intermediaries and consultants around the world. Client investment policy statements have evolved -- also evolved over time to incorporate more diverse asset classes and risk inputs driven by events like the TMT bubble and global credit crisis. We are seeing clients increasingly alter our asset allocation methodology away from a traditional mean variance model to a risk-based asset allocation, even categories that are more geared towards market exposure or beta on the one hand and value-added or alpha on the other. For the next few slides, I'll take a closer look at those trends, and then discuss how we have evolved our investment strategies and respond to those trends. The concept shown on Slide 8 is probably familiar to many, but maybe not all. There's one we like to highlight because it presents in a very simple way the income systems used between asset allocation and investment decision-making. On the left, we have 2 highly recognized indices and their geographic exposure based on company domicile. On the right, you have the revenue exposure of the companies in those same indices. Index construction by design requires rules, but reality doesn't reflect those same rules. As a result, as businesses have globalized, investment decisions have consistently diverged from asset allocation decisions based on company domicile. Investors want to understand the revenue and cost structure of a business. And if done properly, they will manage portfolio economic risk and exposure through that analysis. So on Slide 9, you can see the evolution of investment policies. Globalization has definitely been a contributing factor, but so has the shift from traditional mean variance allocations to risk and outcome-driven allocations. We showed 2 public plans here to illustrate the point. During the '90s and certainly at the inception of Artisan Partners, investment policy statements, asset allocation and manager structure were fairly homogenous, except for a few endowments and foundations. Today, due to technology, information, security innovation, market events and liability dependence, client portfolios are more customized, but also more flexible in terms of investment options. As illustrated in the CalSTRS example, equity-specific allocations such as U.S. equities, non-U.S. equities and emerging market equities historically each had independent return, risk and correlation forecasts and then collapse into one global equity allocation. To us, this clearly provides the path for increased demand for Global Equity strategies. At the same time, it does not mean the elimination of U.S. and non-U.S. allocations. The Alaska Permanent Fund example shows another aspect of investment policy evolution. Risk and outcome needs have changed the model altogether while creating a growing interest in strategies and solutions that are needs-based. Over the long term, we think this means more customization and client-specific demand and pure category demand. So we expect less herd outcomes in the institutional marketplace relative to the '90s. And those trends have driven changes in institutional strategy demand. On Slide 10, we showed the meaningful growth in demand for passive, unconstrained alpha and alternatives relative to traditional equity strategies. Traditional equity strategies have over $13 trillion and over 20,000 products. However, asset strategies are approaching 6,000 products and nearly $8 trillion dollars. And alternative strategies now have over $2 trillion. And with the growth in product launches, we expect those numbers to grow higher. From the financial crisis, there was an effort towards meaningful consolidation in the industry as decision-makers rationalized their product lineup. Product proliferation is on the upswing again, and clearly, the industry has adopted increased degrees of freedom paired with market exposure. Slide 11 is a great simplistic representation of where managers can compete given the secular trends I have discussed in strategy demand. The highly constrained alpha and constrained alpha portions of the spectrum are generally where the largest amount of assets reside. There are strategies typically confined to style boxes for those that are aligned with benchmarks. As I just noted, the growth is generally becoming more prevalent in passive or beta and unconstrained alpha areas of the market. Unconstrained strategy is being broadly defined as go-anywhere strategies. The primary reason for this is that highly constrained strategy, index hovers in exposure-orient products. And even many constrained alpha managers have not distinguished themselves from index products based upon net of fee performance. As a result, assets formally in those strategies have supplies the flows into passive, unconstrained alpha and alternative strategies. For investment managers to grow over time, they will need to evolve accordingly. Historically, we generally had a focus in the constrained alpha category. We've constrained ourselves based on market capitalization, geography and security instruments. With the market evolving towards higher degrees of freedom, we continue to evolve our existing strategies and develop new strategies with a heavy bias towards unconstrained strategies. The investment trends towards increasing degrees of freedom and unconstrained alpha-generating portfolios has impacted both our first generation and second generation of investment products, which we have illustrated in a timeline on Slide 12. For simplicity, we consider our strategies launched prior to 2004 as our first-generation products and strategies launched after that as second-generation. When we developed our first generation of products, the investment industry was still focused on U.S. allocations versus non-U.S. allocations. The transfer of globalization within investment allocations was just in its infancy. As markets have evolved, and we launched our second-generation products, we have excluded or reduced many standard portfolio construction limitations from inception. The strategies remain aligned with their definitions, where we have provided our experienced investment teams with more flexibility to add value in that space. We have constructed our second generation products to provide our teams with greater freedom to add value, which the teams want, and which aligns with the trends I have been discussing. New strategy development continues along that path. Last month, we launched the credit team's first strategy and the firm's first fixed-income strategy. Slide 13 provides an overview. Team's portfolio manager, Bryan Krug, came to us with exceptional experience in the high-yield space. As we do with all of our portfolio management teams, we gave Bryan the opportunity to develop an autonomous investment team, providing him with the freedom and resources to do that in the way he feels best suits his investment process. The high-income strategy represents a natural extension of our high value-added investment lineup. It is a strategy that relies on fundamental research, on the talent of the team to generate results. In addition, we have structured the strategy to allow Bryan's team to invest in a broad universe with high-yield bonds and loans with relatively few restrictions on the construction of the portfolio. Bryan invests primarily in the high-yield debt, but has the flexibility to invest across a company's debt structure and without limitations on region. The development of his team is an exciting evolution that has diversified our business and enhanced our operational capability for existing strategies, new strategies and new investment talent. Just as important is the natural extension of our high value-added philosophy here at Artisan and a great indication of our intention to continue to expand degrees of investing freedom for existing teams and new investment teams. Let me now turn it over to C.J. to discuss our financials.

Thanks, Eric. Good morning, everyone. I'll begin a review of our first quarter March 31, 2014 financial results on Slide 14. In summary, for the quarter, AUM increased to $107.4 billion and net client cash inflows to $1.4 billion. This is our tenth consecutive quarter of positive client cash flows and represents a 5.4% annualized organic growth rate. Revenues for the March quarter were $201.8 million, up 2% over revenues in the preceding December quarter of 2013, and up 36% over the corresponding March 2013 quarter. Our adjusted operating margin rose to 45.1% as the result of higher revenues with lower operating expenses. Net income per share on an adjusted basis was $0.78 per share compared to $0.77 per share in the December quarter. Our Board of Directors declared a regular quarterly dividend of $0.55 per share. On a GAAP basis, we recorded a loss of $2.29 for the current March quarter. The GAAP loss per share was a result of the market price per share of the common stock sold in our March follow-on offering exceeding the per share carrying value of the convertible preferred equity we repurchased with a portion of the operating proceeds. On an adjusted basis, we reported earnings per share of $0.78 for the current quarter. Our earnings measures remove the accounting impact of certain transactions related to our IPO and the March follow-on offering. These non-GAAP measures provide investors with the same financial metrics that we, as management, use to manage the company. Slide 15 is the review of our AUM for the current quarter. Ending assets under management of $107.4 billion were up 2% from assets of $105.5 billion at December 31, and up 29% from assets a year ago. Average assets for the March quarter were $106.2 billion, up 5% from average assets from the December 2013 quarter. The increase in AUM during the March quarter was due to $1.4 billion of net client cash inflows which equates to a 1.3% organic growth rate for the quarter and 5.4% annualized rate, as well as 1 point -- 1% of market appreciation. Excluded from client cash flows for the March quarter was a client redemption of $141 million in late March, which was reinvested in the other product within the same team on April 1. We've broken up that client transfer separately. In addition, as Eric mentioned, the March 2014 month-end quarter included outflows of $722 million resulting from a single-client termination in our Value Equity strategy. The pension fund client communicated the termination was a result of its decision to consolidate assets with a smaller number of managers including us as an overall lower fee structure. After evaluating the opportunity, we chose not to continue our relationship at a lowered fee which resulted in our termination. This termination is an example of the lumpy nature of institutional flows in general, and it also reflects our commitment to be disciplined on our theories, which is one of the cornerstones of our financial model. Over the long term, our financial model has been critical for our ability to attract and retain investment talent, deliver strong financial results and produce a stable and diverse business, and able to weather various market environments. We previously announced the closing of our Global Value team's strategies to most small investors. The team's strategies have been a significant source of our growth over the past 2 years. We expect flows and the strategies will continue to slow in future quarters as the result of the additional closing. In the March quarter, we saw strong growth in the assets managed by our Global Equity Team, particularly from the broker dealer channel for centralized decision makers as broker dealers are reweighting their allocations more heavily to international mandates such as our non-U.S. growth strategy. Throughout our history, our growth has been lumpy and has come from certain strategies and teams bearing distinct profits at times. Looking ahead, we continue to see encouraging interest in pipeline in our non-U.S. growth, Global Equity and Global Opportunities strategies. On Slide 16, you will see that our non-U.S. client AUM remained at $11.9 billion, up 29% from $9.2 billion a year ago. While non-U.S. growth was flat this quarter, we continue to see strong demand overseas. Progress in the last year has been encouraging with our 1-year non-U.S. organic growth rate at 8% and the 3-year rate at 23%. The number of non-U.S. client and investor relationships has increased 75% since this time last year, and our pipeline continues to be robust across Europe and Australia. As a proof point, a large client of our global value chain since 2010 announced last week the addition of our global opportunity strategy to its global managed and global funds mandates. The addition of Global Opportunities will allow the client to continue to add assets managed by Artisan, while enabling our Global Value team to continue to manage the funds currently it manages. The financial results begin on Slide 17. For the March 2014 quarter, revenues were $201.8 million on an average AUM of $106.2 billion. That's an increase in revenues of 2% for the preceding December quarter and a 36% increase from the corresponding March quarter of 2013. The December 2013 quarter included $2.5 million of annual performance fees earned and recorded in December. The weighted average management fee for the current quarter was 77 basis points. Our adjusted operating margin, which excludes pre-operating share-based compensation expense, was 45.1% for the current March quarter compared to 42.9% in December 2013, and 37.0% in the corresponding first quarter of 2013. In addition to higher revenues, our adjusted operating margin benefited from the falloff of expenses related to the pre-IPO investment team retention award that we have highlighted over the past several quarters and from a reduction in recruitment costs related to our new fixed income fee. The impact of these lower expenses was partially offset by seasonally higher first quarter benefits and payroll tax expenses. The March 2013 quarter included severance costs, which reduced the margin in that quarter by approximately 400 basis points. Our technology expenses have begun to tick up as projected, and we expect that trend to continue and settling in around a run rate of $5 million a quarter. While excluded from our non-GAAP earnings last quarter, we completed the process of obtaining the necessary client approvals in connection with the change of control for purposes of the investment company and Investment Advisors Act that occurred in March 2014. And we occurred an additional of $100,000 of costs in the March quarter. That process is now complete. Adjusted net income for the March 2014 quarter was $56.0 million or $0.78 per adjusted share. That's a 2% increase in adjusted net income over the preceding December quarter and a 69% increase over the prior March 2013 quarter. Slide 18 highlights our compensation ratio. As you know, our compensation expense in the current March quarter continues to include the amortization of pre-IPO equity compensation, and you can see the elimination of costs associated with the cash retention award we granted 3 years ago and indicated would end at December 31, 2013. As we layer in the full expects of first IPO equity-based compensation awards which will generally last over 5 years. And excluding the pre-IPO expenses, our compensation ratio should settle in the mid-40s. We expect the next firm-wide equity grant will occur in July 2014. So our September 2014 quarter will include additional costs related to equity-based compensation. As you know, our compensation ratio can and will fluctuate, and will be impacted by our rate of growth and the cost of future equity-based awards, which is largely dependent upon the size of future grants and a stock price at the time of the grant. Last slide is our balance sheet highlights. Our balance sheet remains strong. Our cash balance is healthy ending the March quarter at $208 million, down slightly from $212 million at December 31. During the quarter, we returned capital of $140 million to our shareholders in the form of a quarterly and special annual cash dividend. We plan to continue our practice of returning the majority, if not all, of our earnings to our shareholders. On April 22, the Board of Directors declared a quarterly dividend of $0.55 per share across a common stock payable on May 30 to shareholders of record on May 16. As a result of sales, 9.3 million shares of Class A common stock went public in the March follow-on offering. The Class A common stock outstanding now represents 41% with a combined number of outstanding shares of common stock and convertible preferred stock. As a result of that offering, we recorded $287 million of additional preferred tax assets and $244 million of amounts payable related to the tax receivable agreement with selling partners. Our stockholders' equity is $120 million at March 31, down slightly as the result of the quarterly and special annual dividend paid in February, offset in part by the equity added in the March follow-on offering. Our debt remained at $200 million, and our leverage ratio further reduced to 0.6x EBITDA. Overall, we are very pleased with this quarter's results. We returned meaningful capital back to our investors, extended our public ownership with quality investors in a second follow-on offering, produced healthy organic growth in a volatile market environment and continued a trend of strong earnings and healthy margins. I look forward to your questions, and I'll now turn it back to Eric.

Thanks, C.J. And now we'll open the call up for questions.

[Operator Instructions] And our first question comes from Bill Katz with Citigroup.

Okay. First question, just coming back to the dynamic between sort of the unique alpha generation that you sort of see through your degrees of separation, if you will, versus this sort of more structural movement to lower cost beta exposure. Is there further pressure on any parts of the business that we should be concerned about in terms of other lumpy mandates that may be coming out? Maybe the converse is are you seeing an increasing traction for your value alpha generation?

Bill, it's Eric. We haven't been on notice or given any indications from current clients that fees are in issue right at now. Those things pop up from time to time, as I mentioned in the call, as people start reevaluating. And as people want to increase the beta exposure and then also a barbel back and go into more degrees of freedom, sometimes we'll get caught in the middle there. And with regards to our current products and new product suite, I'm seeing that trend just increasing freedom. So whether it's one of our mid-cap products where we're just increasing the ability to use non-U.S. exposure or global, international fix -- global and international value being able to use more fixed income within their portfolio, we've been taking those strides to increase the freedom to distinguish our products. And that's been working quite nicely. And the majority of our clients, if not all of them, are adjusting their investment policy statement to allow us to use that freedom.

Okay. So this is a bit of a one-off for now, the way to think about it that way?

Yes.

Second question is, and I appreciate the details in some of the other line items, but as I look at into the second and third quarters, it does seem to be a few more moving parts in the comp line. So when you look into the second quarter, C.J., I'm sort of curious, any sense of where the actual number may settle out here a little bit? Because I think you had maybe a fuller impact from buildout of the high-yield team or perhaps maybe it's already embedded in the first quarter. So any thoughts how we should be thinking about that? Because obviously, Q1 was a pretty good quarter.

Yes. I mean, I think in the second quarter, you're largely going to see the comp ratio very similar to the first quarter here. We've built in most of the costs of our new fixed income team. There'll be a little bit more but nothing material. Where you will see the change will be in the September quarter when we layer in the next grant of equity in July. So I think next quarter would largely be consistent with the first quarter and react as you would expect with the increases or decreases in AUM levels.

Okay. And just one last one for me. You highlighted the opportunity for outside the United States, but if you look back, the absolute dollars have still been relatively small in terms of the net new business. Do you sort of size the potential that, that distribution channel might be? And then maybe as a second part of the question, what is your institutional pipeline today maybe versus where it was 6 months -- 3 months ago or a year ago?

The pipelines are tough to measure there. The pipelines we see -- feel right now give us quite a bit of opportunity, and as C.J. said on the call, much more robust outside the U.S., in Europe and Australia is where we're seeing quite a bit of activity. And despite the asset being flat year-over-year with 11% of our total assets in non-U.S., we've had 28 new clients year-over-year join us there. So in some of those clients, we'll seed with a smaller amount and then we'll build assets over time. So we're seeing quite a bit of activity outside the U.S. despite the flat percentage there year-over-year with 11%.

The next question comes from Mark Irizarry with Goldman Sachs.

Great. So just a question in terms of the buildout of the -- if you look at the investment strategy spectrum and maybe some of the more alternative-based product, what should we be thinking in terms of adding additional teams and product there? And when you think about just the barbelling between low cost beta and high value alpha, I guess the pricing on the alternative side in terms of fees, I mean, when you think about the teams that you're adding, should we be thinking about more of the alternative next year growing over time?

Mark, it's Eric. Yes, certainly through the graph we showed in the presentation, Artisan has definitely directionally increased those degrees of freedom and get into the alternative space. So the strategy that we think could come online down the road may not have as much capacity with regard to assets, but they'll have a higher fee rate. And so we will see new strategies that would come on would give us an uptick in fee. But as you guys know, the capacity that -- an alternative strategy that has quite a bit of degrees of flexibility will be limited.

Okay. And then just -- I might have missed this in terms of capacity. How much of your flows went into product that was soft closed in the quarter? And maybe you can give us an update just on the existing sort of trends as you see them today in retail maybe through April?

Yes. I'll let C.J. take a look at the capacity numbers there. But with regards to the trends in retail, we haven't -- given our small percentage in retail, we haven't been analyzing what flows have occurred in what buckets over the first quarter. Our retail business is relatively small. We don't stack a lot of assets towards that. We have seen in the intermediary channel quite a bit of activity since that's where the bulk of the activity is in the intermediary space for us with high demand in non-U.S, equity as C.J. said. And so we saw good growth rates in our non-U.S. growth strategy.

Yes, mark, so majority of our flows this quarter were in strategies that were opened, led by international growth and opportunities strategy that we've talked about where we've had capacity and we've had interest. So certainly, a tilt towards open strategies.

Were there flows in closed strategies?

Yes, absolutely. When we close our strategies, we consider them soft closed. We -- some strategies we push harder than others to limit flows. But there's always opportunities for existing clients in open platforms to add dollars, and that always happens.

Okay. And then just one follow-on, if I can. We're hearing some pensions talk about maybe the funding status is improving and moving into more LDI strategies. Is that something out there that you think is -- you expect to see that on the comp or you hear -- is that not as much of a concern for you on the equity side?

It's been a concern over the years. We've seen quite a few pension plans moving to an LDI. We haven't heard or seen our client base talk about that as much these days as in probably, say, 3 to 5 years ago.

The next question comes from Robert Lee with KBW.

I guess my first question is -- I guess it's probably a little technical in nature. But with the deferred tax assets in TRA, for you guys, what's kind of the ongoing kind of incremental kind of cash tax benefit you expect to get kind of maybe on an annual basis? Was it -- because I'm coming up with something kind of $5 million, $6 million, $7 million or so. Does that seem right?

Yes. I mean, it's initially very small because we have to amortize that tax deduction over 15 years. And it's measured at the time of the exchange. And that's why we booked that whole entire tax deduction in the balance sheet, the asset, as well as the amount payable to the selling shareholder. And then as you know, we retained 15%. So roughly, if you look at 15% of that deferred tax asset, and over 15-year period, that would be the amount that we would eventually realize.

Okay. Eric, I'm just curious, you kind of talked a little bit in the past about the DC business kind of being -- well, you have -- several years ago, you had a good growth business. Now it's been probably more mature for you guys. So is there any signs you see that as you talked about changes in the institutional landscape more unconstrained, any signs that you're seeing any kind of shift in the DC landscape that could mean more opportunities for you guys or -- I guess that's my question.

Yes. We're starting to see a bit of activity in the middle market for the -- excluding some of the really large DC plans there. And we saw a positive growth rate in the DC channel for us this quarter. And the large plan market where we would see more opportunity and customized target date funds is still moving slowly. We've seen a few consultants build out customized funds and moving away from the proprietary target-based funds. But that's going to be a slow process. That's always been a little bit more of an investment and an administrative sale as opposed to the straight DB [ph] business. So we continue slow movement, but no tipping point, Rob.

And maybe just one last follow-up, if I could. I'm just curious, I mean, do you continue to look to grow your non-U.S. business and relationships there? Has becoming a public company at all helped some of those conversations? Does it have no impact? Or I mean, how does that tend to be received outside of the U.S.?

Well, most of our business comes from the consultant channel and intermediary channel outside the U.S. That's our major leverage point. From that standpoint, being public has been -- has not been an issue there or a benefit. When it gets to the end client, being public has actually helped out. They put up our name or our name has been out more often. So we have a slight positive there. And then obviously, it's helped out with regards to new teams as well as more investors become aware of Artisan. So it gives us more opportunities outside the U.S. to find investment teams. So I would say that outside the U.S., being public has given us a slight positive overall.

The next question comes from Cynthia Mayer with Bank of America Merrill Lynch.

A question on industry trends. I guess given the move toward barbelling which you were talking about between active and passive, are you seeing any more competition among traditional managers who will introduce a lot of unconstrained products? And is that leading to any more pressure on fees, any more fee competition? Or should we just view the pension redemption as kind of a one-off?

Cynthia, it's Eric. We view our -- the one client that we lost as a one-off there. We do see quite a few competitors creating strategies that have more and more degrees of freedom. They can be -- their name is quite a few things as we've seen. Let's go anywhere to alternatives. I mean, calling something a hedge fund today is a very broad term. So we clearly are going to see more competition there. We're going to see more product come out to the marketplace. We haven't seen much movement on fees, though, in that space. As you've added degrees of freedom, as you create strategies that are differentiated from indexes, fees have been holding tight there.

Great. And just on the emerging market strategy, it looks like the outflows there picked up in the quarter, and the assets left in there are getting smaller. Are the outflows at this point creating further pressure on the performance in the remaining assets? And is there anyway you can stabilize those?

We did have a bit of outflow there at the Q1 for emerging markets. The performance we saw uptick with the January and February and then rolled off a bit in March. And so we continue to hold tight with the strategy. But the strategy, for it to really stabilize, we'll have to start reducing performance above the index. But at this point, we haven't seen the outflows putting any pressure on performance though.

The next question comes from Eric Berg with RBC Capital Markets.

I still want to home in on this large outflow in March institutionally. The client said he wanted to save money by consolidating his money managers. But it seems to me people are more interested in saving money when they don't think the product -- and I don't care whether it's money management, TV sets, cars, what have you -- is delivering the value. How do you know that when the client says it's a price issue, it really wasn't about the performance? And it's still unclear to me. This is sort of a 2-part question. How do you know this wasn't about performance? After all, it was in the -- with the team that has been struggling at least over the 1-year period. And why are you expressing optimism that this is a one-off?

First -- Eric, it's Eric Colson here. The strategy was producing alpha over that period. So the strategy, we felt, was well positioned. The client told us it was well positioned. But they were reducing their number of managers there and then increasing the allocation of those dollars to the existing managers. And with that increase in assets and consolidation, they expected a significant fee discount for higher assets. And the significance of that fee discount was, in our mind, fairly extreme. So we opted to not participate. It was very clearly to us a cost-cutting measure. Every manager was given the same discussion. So -- and it was a fairly long conversation that occurred over months. So there are times, though, I'll agree with you that you'll get a reason for being terminated. And you're not really quite sure if that was the exact reason or was it just a polite reason to move you along. I would -- in this case, in this example, we had a good dialogue. And it was a good long-term client that we didn't want to lose, but we had to move on.

And so if I could just follow up, you mentioned that this was in the value team's effort, right?

Yes.

Okay. My only remaining question is this. Your answer was very responsive and very helpful. Exhibit 6 shows -- in your materials shows that over the last 1 year, all 3 of the strategies have been pretty -- have not been creating alphas. So when you say that the strategy was creating alpha, what are you referencing?

I have to look back to that exact client and their inception date. I mean, inception date is a very important component to every account. And that team's alpha -- let me open that Exhibit 6, the large cap value, the 1-year period of underperformance. The year-to-date we have is -- I'm sorry, I was looking at the year-to-date of a positive 108 versus just the 1 year over -- year-over-year. But for that client, I will have to go back to the inception date so we can get specific numbers on it to see where they were at. But it wasn't a performance issue with that client.

Your next question comes from Michael Kim with Sandler O'Neill.

First, just a follow-up on the non-U.S. opportunity. Just based on some anecdotal evidence, it does sound like investors outside of the U.S. seem to be re-risking portfolios maybe a bit quicker relative to individuals here in the U.S.. I know it varies by region, but just curious how that dynamic could potentially set up for your growth prospects, particularly in the context of where you may have the most capacity as you look across your investment teams.

Michael, this is Eric. I'm not sure if we've had direct dialogue around client specifically saying we're re-risking. I do think that our global strategies are performing quite well versus the index and the peers. And we're clearly getting good opportunities. And as people look at equities outside the U.S., the interest is into -- is in active or high-value added, global strategies that tend to be a little bit more concentrated and are distinguished from the index. And our strategies are showing up quite nicely in the peer groups, and we're getting some good opportunities overseas.

Okay. And then maybe just one for C.J. I know a big part of your expense base is variable. But just curious to get your take on sort of the outlook for margins just given equity comp is stepping up and you talked about maybe a bit of a pickup in IT spending going forward versus ongoing revenue growth and obviously your focus on fee discipline.

Yes. I think you saw in this quarter what -- the leverage that we have in our model as we ticked up a couple of hundred basis points in our margin as a result of higher average AUM and the roll-off of some of those expenses that we had highlighted. So our expense base right now from a fixed cost expense other than that technology, which is guiding $0.5 million or higher so, is largely -- the fixed base is largely where we expected to be until we make that next equity grant. So I think formulaically, you could see our P&L react as you would expect in the second quarter. And then based on the size of the equity grant and the stock price at the time, we could see up to a couple of hundred basis points degradation in the margin as we layer in that. But over time, as we've guided, we think as layer in all those effects with our growth assumptions that we'll still settle back in the mid-40s on the margin, which is approximately where we were this quarter.

The next question comes from Surinder Thind with Jefferies.

Just a follow-up on the redemption. So in light of that, can you provide some color maybe around how many other large accounts you may have within the SMA segment or maybe perhaps some color just around the average size and range? I mean, I think in the K, you guys talked about like a minimum investment is roughly $20 million to $50 million, and there's roughly 140 client relationships with maybe like 200 accounts.

Yes. Surinder, this is Eric. Those sound about right for the numbers. I mean, the minimums range from $20 million to $30 million up to $50 plus million depending on the strategy. But otherwise, your numbers sound approximately right there with regards to the number of accounts and average size there.

Okay. And so I guess just related to that, are there other -- do you have a few other clients in there that are maybe, let's say, $500 million or more in assets? I guess that's kind of what I was trying to ask, if there's other large concentrations of clients.

Yes, we certainly have a handful of clients above the $500 million mark that would in that mix.

Okay. And then one other quick question. I think you guys were mentioning you guys are beginning to see some good traction in your Global Equity strategy, especially within the broker dealer channel. I think if you take a step back, I think there was a PM change a little over a year ago. Kind of given that it's got a terrific 3-year track record now and that it's been more than a year with the new PM there, is that enough kind of for the consulting community? Or has there been additional dialogues there? Or can you maybe elaborate on that?

Yes, certainly. If you went back a year ago, we had co-portfolio manager structure. And then we did lose one of those portfolio managers who was leading the Global Equity strategy. The team of the Global Equity team was supporting that Global Equity product, though, from research. So with the co-manager, the addition of 2 other individuals as portfolio managers on the strategies to replace the individual and the consistency of the performance and the product integrity, consultants and clients look at those factors. Clearly, the single portfolio manager loss will be brought up in discussions. But I do think now with a year timeframe and the consistency and the outperformance will help the strategy move forward to build its pipeline and opportunities.

The next question comes from Chris Shutler with William Blair.

So the Global Op strategy, I know that's beginning to get some traction, particularly overseas. Can you talk about where you're at right now with consultants on that one? Are you -- do you feel like you're where you need to be? Or is there still a good bit of work to educate the consultant community?

We feel like we're in a good spot with the Global Opportunities. We're in searches. We are looking at finalists. And so that's clearly given us signs that consultants are putting us as a buy rating or putting us into opportunities. And so we see that pipeline moving in forward quite nicely. The strategy is definitely distinguished versus many strategies that we go up against given its concentration and its growth orientation. So we feel it's still very well positioned.

All right, great. And then last question for me. So Eric, I know that you said historically that growing number of strategies at Artisan is going to be both a balance between both new teams and existing teams rolling out new products. So really just curious on the latter, where you see opportunities right now with the existing teams.

Right now, we're focusing on the credit teams. And as I mentioned in the call, just broadening out our operations with fixed income. I think some of the other existing teams may look at that as an opportunity to use those instruments and securities that broaden out strategy. But at this point, we have no new strategies that will be launched in the near term off of an existing team. We're in constant dialogue with our groups to see what strategies we'd want to incubate and roll out. And we also think that's a great way to help build out new decision makers over time to build out succession. So it's a constant dialogue. But we have nothing on the docket right now to announce.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Colson for any closing remarks.

Good. Thank you for your time today. We appreciate your participation.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.