Artisan Partners Asset Management Inc. (APAM) Q2 2015 Earnings Report, Transcript and Summary

Welcome to Artisan Partners Asset Management Second Quarter 2015 Earnings Conference Call. My name is Laura and I will be your conference operator today. [Operator Instructions]. this time, I would like to turn the call over to Makela Taphorn with Artisan Partners. Please go ahead.

Thank you. Before Eric begins, I would like to remind you that our second quarter earnings release and the related presentation materials are available on the Investor Relations section of our website. Also the comments made on today's call and some of our responses to your questions may deal with forward-looking statements which 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 our remarks made today include references to non-GAAP financial measures. You can find reconciliations of those measures to the most comparable GAAP measures in our earnings release. I will now turn the call over to Eric Colson.

Thanks, Makela. Welcome to Artisan Partners Asset Management's business update and quarterly earnings call. I'm Eric Colson, CEO, joining me is C.J. Daley, CFO. As always, we'll use most of this valuable time to discuss the business philosophy that will drive our results. We expect markets to normalize over the long term. So we design and operate our business to take advantage of strategic asset allocation, manager structure and investment policy statements and avoid short term fads. This quarter we return to the topic of talent management; as we said before at Artisan Partners, everything we do is designed to create an investment culture that will allow our talent to thrive. We'll also discuss quarterly business results to provide insights about how short-term outcomes relate to our long-term objectives. Once I finish, C.J. will walk through our second quarter financial results. On slide two, you'll see that our total AUM increased slightly to $109 billion as a result of limited market appreciation. Firm-wide net outflows of approximately $300 million were relatively muted compared to the first quarter. Given our business model, we expect flows to vary quarter-to-quarter and year-to-year. We will continue to emphasize investment integrity and stability to generate thoughtful long-term growth. You can also see on this slide that the investment team AUM pie chart now includes seven teams. We launched the developing world team's first strategy at the end of June. Thanks to a lot of hard work across the firm, despite negative flows within our institutional distribution channel over the past year, we continue to see signs in the marketplace and financial press of significant interest in broadening investment choice within proprietary solutions and target date funds, as well as more choice within intermediary platforms in Europe and Asia. Moving on, slide 3 shows our long-term investment results. As you know by now, we analyze investment performance in several different ways. First, we look for process consistency because faithfulness to the stated investment process is critical to maintaining the trust and confidence of our clients. In addition, we want our strategies to perform well on an absolute and relative basis compared to both indexes and peers. In the past, this slide only included value-added performance. It now shows average annual gross returns as well, so that you can get a better idea of how our strategies have compounded client wealth over time. This strategies managed by our U.S. value team have struggled during recent periods on a relative basis. However we think long-term, average annual growth returns of 14%, 11% and 7% are very solid, especially for a team that we believe has remained true to the value-oriented philosophy that has historically delivered outperformance in down markets and lags in a momentum-oriented bull market. We believe that investors will continue to globalize our investment mandates which should increase interest in our global strategies as well as our newer high degree of freedom strategies, high income and developing world. Turning to slide 4, several relative performance metrics are shown on this page. As of June 30, over 80% of our AUM was in strategies outperforming their respective benchmarks over the trailing one-year, three-year and five-year periods, while 96% of AUM was in strategies outperforming over the trailing 10-year period and 97% since each strategy's inception. The one-year and three-year percentages have increased considerably compared to December 2014 and the end of the March quarter of this year. That highlights how lumpy short-term performance can be. We focus on long-term over which the strategies with the vast majority of our AUM have outperformed the relevant benchmarks. In most cases, the outperformance is considerable. The pie graphs at the bottom of the page show how our investment performance on an asset weighted basis stacks up to peers based on Lipper and Morningstar ratings. Slide 5 illustrates the current outcomes of our long-term asset diversification strategy. For the quarter, we had net client cash outflows of approximately $300 million. I want to spend a minute discussing flows. First outflows then inflows. Industry-wide over the last year, U.S. small and mid-cap strategies have seen higher rates of redemption compared to other equity asset classes. We've experienced this trend with year-to-date outflows of $500 million in our U.S. small cap growth strategy, $1 billion each in mid-cap growth and U.S. small cap value and $2.3 billion in mid-cap value. Our closed status to most new investors has exacerbated our net outflows as has the U.S. value team's relative results during the bull run. So I think we're also experiencing more general market wide allocation away from the U.S. small and mid-cap sectors, where the benchmark indexes had average annual returns over the last 5 years of 18% and 17%. We also continue to experience clients rebalancing more actively for using re-enrollment to increase their use of passive or exposure oriented strategies. Based on our experience, it's best to stick to who we're with integrity and discipline. We won't attempt to be all things for the sake of asset growth, will remain deliberate and focused on what we know; we think that makes more sense than impatiently launching new products that are outside our current expertise such as passive ETFs or smart beta products that compete on scale and fees. We believe that these decisions will maximize our long-term business value. On the other side of the ledger, our non-U.S. growth and global opportunity strategies continue to experience strong client demand recognizing net inflows of over $1 billion and nearly $900 million during the second quarter. As I mentioned earlier, we believe the global strategies are gaining additional traction with non-U.S. institutional investors. And in the DC area, we continue to see the transition to open architecture and white label target date products. Our global strategy should fit very well within those trends. In addition, we're excited about the growth opportunities for our newest teams. In the last two years, we've added the credit team led by Bryan Krug and the developing world team led by Lewis Kaufman. We're providing them with resources and freedom to do what they do best. It will take time, but we're confident their talent combined with the Artisan model will result in long-term growth. Slide 6 which we include in each quarterly presentation, outlines who we're, we're a high value-added investment firm designed for our investment talent to thrive in a growth-oriented culture. Last quarter, I discussed how we continue to expand investment degrees of freedom to meet the demands of evolving institutional asset allocations. Today, I want to focus on how our economist team structure gives our portfolio managers the flexibility to build a team and a process that is uniquely their own. Once teams are up and running, we work to manage talent lifecycles, so that top talent has space to grow and evolve at Artisan. The daily work that we do to grow and evolve our existing talent is every bit, if not more important, than finding and on-boarding new teams. Turning to slide 7, we recognize there is no single right way to build or run an investment team. Just like there is no single optimal investment process or philosophy. So we give our portfolio managers the latitude to design and run their teams in the way that works best for their investment processes. As the diagram shows, each investment team draws on our centralized business infrastructure and people for things like IT, compliance, marketing, legal and accounting. But because each team is autonomous, each has control over the aspects of team design and function that are most relevant to their day-to-day work as investors. Most importantly, each team has its autonomy over its investment process; we don't have centralized research or a firm-wide Chief Investment Officer. Each team's investment decisions are a product of that team's research, process, hard work and judgment. Truly great investment talent has deeply passionate beliefs about their investment philosophy. We don't want to water down that passion or those beliefs, we want to embrace, enhance and magnify it. Autonomy also promotes an ownership mindset; portfolio managers and other team members, they all experience real ownership over the team's process, designs, results, growth and future. The ownership mentality fosters responsibility and accountability and a long-term perspective which aligns the investment teams of clients and shareholders. On slide 8, you'll see the aspects of our autonomous structure that easiest to represent visually, the geographic dispersion of our talent. Talented investors can be found across the world and we believe that great investors do their best work in a place where they want to be. Our firm was founded in Milwaukee on 1994, when Mark Yockey joined the firm a year later and wanted to be in San Francisco, we opened an office there. Mark now works out of our New York office. More recently, when Bryan Krug joined ours in a year and a half ago, he wanted to stay in Kansas City, so we opened an office there and that's where our credit team is today. We also believe that it's very important for each investment team to have its own physical space, there's no reason to think that the same office space will be right for different teams with different personalities processes, hours, taste, etc. For example, in San Francisco, our global equity and global value teams each have their own separate offices in different buildings. And our developing world team will soon be moving into its own space. Separate space helps preserve economy and investment integrity. It also promotes our ownership culture, providing a new portfolio manager with his or her own four walls, within which to build an investment team and a tangible way of reinforcing the ownership mentality and entrepreneurial commitment necessary to create a great investment franchise. On slide 9, we use the growth team as an example for the long and deliberate process of evolving an autonomous team into an established franchise. It requires finding the right talent, developing that talent and providing the talent with new opportunities and responsibilities. We spend a ton of time on people management. Andy Stephens founded the growth team in Milwaukee in 1997. Jim Hamel was Andy's first analyst. In 2007, the team launched the Global Opportunities strategy which expanded the team's investable universe. In 2009, we merged the U.S. small cap growth strategy and portfolio manager Craigh Cepukenas into the team. By 2013, we were in the position to create lead portfolio manager roles for Jim, Matt Kamm and Craigh on the global opportunities, U.S. mid-cap growth and U.S. small cap growth strategies respectively. With those roles, each was given primary responsibility for the assigned strategy. This powerful and deliberate succession planning has helped us to keep the team's top talent at Artisan. It also allowed Andy to step down from portfolio management responsibilities last year without causing disruption. Our global equity team has also evolved considerably over the years, though it has taken a very different path and looks a lot different than the growth team or any other team within Artisan. Over the past decade or so, we have increased the team's breadth of resources with more research analysts and associates to develop internal growth. We increased the team's office locations to include New York, London and Singapore. We hired a chief operating office for the team, so that managing human capital and information flow don't take too much time away from investment decision making. We also invested in technology to process information and research and to facilitate communication. And we launched new strategies by developing existing talent and bringing in new talent. Andrew Euretig and Charles Hamker have joined Mark as co-portfolio managers of the global equity strategy and associate portfolio managers of the non-U.S. growth strategy. Charles also co-portfolio manages on the team's two small cap strategy. Today Mark, Charles and Andrew provide strong leadership to a team with a 20-year history and great growth prospects in the front of it. The global equity strategy just achieved an outstanding 5-year track record and over $700 million in AUM. To give you an idea of the possibilities, take a look at the global opportunities strategy shown on the slide. It had $357 million in AUM after its first 5 years, now it has $6.7 billion in AUM from clients globally. Our global value and U.S. value teams have also expanded opportunities in broadening decision making; in 2007 after 5 years of work on the non-U.S. value strategy, the global value team launched the Global Value strategy which expanded the team's investable universe and increased Dan O'Keefe's responsibilities. On our U.S. value team in Atlanta, we have four portfolio managers that all work on the team's three strategies. That team which started with Scott Satterwhite and Jim Kieffer has added George Sertl and Dan Kane over the years and produced a unique decision making environment with an analyst oriented culture. Given our autonomous structure, we expect each team to grow and evolve in its own way. Each of the teams has taken a different path to where it is at today and the teams are at different stages of development. The important point is that each team appreciates the importance of deliberate and long-term decision making that's necessary to developing and maintaining an investment franchise. Turning to slide 10, our job is to deliver investment results. We focus on people with the goal of delivering thoughtful outcomes for our clients and investors. People grow, evolve and change, our business management team recognizes this that people are dynamic. So we think about each employee, investment team and franchises as having a lifecycle and we strive to produce a unique environment that earns the trust of talented professionals such that they will grow and prosper at Artisan over their entire careers. On this slide, we've tried to illustrate a very simple way the things that I've been speaking about. Provide an autonomy, opening offices, starting new strategies, expanding teams, planning for succession, providing technology solutions, all of these are part of talent management. If we manage talent well, we can grow a team into a franchise with a defined culture, proven track record and multiple decision makers. We're in the early developmental stage with our credit and developing world teams helping them establish a structure and define their culture. Effective talent management is also necessary to maximize the value of our existing franchises and prolong their time as mature franchises. The phase at which teams are the most productive and most valuable. That's where we believe in doing with our global equity, growth, U.S. value and global value teams for a number of years now working with them to stay on the up slope of the lifecycle curve. Over the years, we have developed a lot of experience and expertise in managing talent to build and maintain investment franchises. I'm very confident that we can draw on that experience and deploy that expertise to possibly grow our firm over the long term. I'll now turn it over to C.J. to discuss our financial results.

Thanks, Eric. Good morning, everyone. A summary of our quarter and 6 months ended June 2015 financial results begins on slide 11. For the quarter, ending AUM increased slightly to $109.2 billion resulting from approximately 1% of market appreciation, partially offset by net client cash outflows of $300 million. Average AUM increased 3% quarter-over-quarter and revenues increased by 4% as a result of the higher average AUM and an additional calendar day in the June quarter. Our adjusted operating margin for the June 2015 quarter was 42.1%, up from 38.4% in the March quarter. Adjusted earnings per adjusted share was $0.74 in the June quarter compared to $0.65 in the March quarter. For the 6 months ended June 2015, revenues were $415.1 million, up 1% from revenues of $410.3 million in the corresponding 6 months ended June 2014. Our adjusted operating margin was 40.3% compared to 45.8%. The decline in margin was largely driven by investments in existing investment teams through equity compensation and the investment in our newest team in the March quarter of this year. Adjusted earnings per adjusted share was $1.39 for the 6 months ended June 2015 compared to $1.62 for the corresponding 2014 period. Our Board of Directors approved a regular quarterly dividend of $0.60 per share. The dividend will be paid August 31 to shareholders of record on August 17. Slide 12 details AUM and client cash flows. During the June 2015 quarter, AUM improved slightly from March to $109.2 billion, a result in market appreciation. Net client cash outflows were $300 million, a significant improvement from net client cash outflows of $2.2 billion in the March quarter. As Eric touched on, during the June 2015 quarter, our mid and small cap domestic equity strategies had outflows of $2.4 billion. While we believe relative underperformance in our domestic value strategies has caused some of these outflows. We also continue to see outflows as a result of client reallocation decisions following generally strong absolute performance across domestic equities over the last several years. The net outflows in those strategies were almost entirely offset by $2.2 billion of net inflows into our non-U.S. growth, global equity, global opportunities, value equity and high income strategies which together experienced over 20% in annualized organic growth this quarter. Slide 13 highlights our non-U.S. client AUM which rose slightly to $14.2 billion or 13% of total AUM. Non-U.S. net client cash flows were a positive $200 million in the June quarter as we saw net inflows into our global opportunities strategy. Our financial results begin on slide 14. For the June 2015 quarter, revenues were $211.5 million, up 4% from the March quarter on 3% higher average AUM of $111.4 billion. Higher AUM and an additional day in the quarter drove the increase in revenues. For the 6 months ended June 2015, revenues were up 1% to $415.1 million as a result of market appreciation in our AUM, offset by net client cash outflows. Our weighted average management fee for the June 2015 quarter and for the 6 months ended June 2015 was 76 basis points and was consistent with the March quarter. Turning to slide 15, adjusted operating margin which excludes pre-operating share-based compensation, it was 42.1% for the current June quarter compared to 38.4% in the March 2015 quarter and 46.5% in the second quarter of 2014. Our improved margin quarter-over-quarter was primarily due to the absence of the new team on-boarding costs and higher seasonal expenses incurred in the March quarter. In addition to the factors that I've already mentioned impacting our operating results this quarter, I also want to touch on a couple other expense items. First, distribution and marketing expenses this quarter remained flat despite an increase in revenues generated from our intermediary business. This was the result of Artisan Funds' launch of an advisor share class for a number of our strategies. The advisor shares were launched to meet the needs of certain intermediaries and their clients who want a lower share class option. The amount we pay to intermediaries for distribution and administrative services with respect to the advisor shares is less than the amount paid with respect to investor shares. So far, approximately $6 billion of assets has transferred from investor share into the advisor share class which reduced our third-party distribution expense by $600,000 in the June quarter. This savings translates into approximately $3.5 million of lower costs on an annualized run rate basis. Second item I want to touch on is communication and technology expense which rose to $6.4 million in the June quarter, up 23% from the March quarter. As we've mentioned before, we expect to continue to invest in technology to support our investment teams, distribution efforts and scalable operations. So far this year, our technology efforts have included increased focus on information security and scalability and business operations and distribution. On an adjusted net income per share basis, we earned $0.74 in the June quarter, up from $0.65 in the March 2015 quarter. For the 6 months ended June 2015, our adjusted operating margin declined to 40.3% reflecting additional equity compensation expense and the investment we made in our developing world team earlier this year. These investments back into our business erode margin in the short term, provides the firm with long-term growth opportunities. Slide 16 highlights the components of our compensation expense, when comparing the June quarter to the March quarter, keep in mind that the March quarter included costs associated with the on-boarding of our developing world team and higher seasonal compensation expenses. After removing the impact of these, our compensation ratio has remained consistent with the March quarter. Compared to the second quarter of 2014, our compensation ratio has increased as a result of increased equity-based compensation expense and an increased number of full-time employees. Slide 17 is selective balance sheet highlights. Our balance sheet hasn't moved much and remains strong with a healthy cash balance, borrowings of $200 million are supported by strong earnings and cash flows and our leverage metrics remained very strong with our leverage ratio at half times on a gross basis. Net of excess cash, leverage would be around a quarter of a turn to annualized EBITDA. The last slide summarizes the quarterly dividends we paid since our IPO in June 2013. In the 3rd quarter of 2015, our Board of Directors declared a regular quarterly dividend of $0.60 per share. This is consistent with our previous quarterly dividend; consistent with our dividend policy at the end of this year, we expect our Board will consider paying a special dividend taking into consideration our adjusted annual earnings, business conditions and the amount of cash we want to retain at that time. Over the last 4 quarters, between both quarterly dividends and our special annual dividend we, returned cash of $3.25 per share to our shareholders based on a share price of $46 that represents a yield of approximately 7%. Our financial model continues to act as design to produce predictable earnings and provide meaningful cash returns to shareholders, while maintaining a healthy balance sheet. And it is a model that is designed to weather the volatility of the business that is subject to fluctuations of the worldwide securities markets. I will now turn it back to the operator for questions.

[Operator Instructions]. And our first question will come from Robert Lee of KBW.

Just a couple of things, first one is I'm just curious non-U.S. growth you've had, great performance wise, values came fairly large. How do you think about capacity remaining in that specific strategy? I'm assuming that you feel pretty good about it, but just an update would be helpful.

Sure. Rob, it's Eric. I mean it's a tricky topic. There's a lot of nuances to it and it's hard to boil it down to any single number. People like to get fixated on trying to create that exact number and with the international growth strategy, the team has four strategies and they're somewhat interconnected. So you have to look at the overlap of securities, you have to look at the potential concentration in each strategy and just as we look at our international growth and we look at the global equity, both are mid to large cap growth strategies that can grow to a fairly larger size than a more concentrated all cap strategy or something that has more small cap in it. So right now, we feel that the international growth and the global equity have capacity for producing a nice growth rate. The exact number, we're uncertain of until we see more of a trend line in global equity. And as we see that trend line, we might get more conservative with international growth. If global equity just keeps on at a slower pace, well, that international growth go a little longer. So right now the team has, I think, probably the strongest capacity in the firm, especially when we look at global equity assets, we talked about their 5-year record just happened last quarter, 650 bps above the index. That's realizable growth, not just capacity for the sake of it or wishful capacity. So I think from that team, we'll look at those strategies and manage it on a go-forward basis.

And then maybe C.J., you highlighted a couple of items in the P&L. I guess I am just kind of curious, maybe on a forward-looking basis, maybe you look at technology, G&A, you talked about some investments in making and then also equity-based comp. On tech and G&A, should we think that these are kind of the reasonable run rate kind of going forward as these kind of bring your best up to new levels or anything that's more temporary in those and I'm assuming equity-based comp as we look out, as you get to for the next year you'll have another step up in growth.

Yes. I think, your direction, Rob, on all those is correct. Yeah, you can't put an exact number on it, but communication technology is probably a good run rate, although that's going to fluctuate based on project lifecycles. G&A, we do have fluctuations there; in the first quarter we had annual director compensation charges. T&E fluctuates but generally if you look over the margin in the June quarter, somewhere in that range is sort of a good range and then I think on equity-based comp you hit the nail on the head that we have more layering-in to do, given our 5-year vest and that will pick up again with the grant likely at the January Board meeting.

And then maybe just one last question and then I'll get back in the queue, I guess. With capital management, clearly healthy distribution, you talked about the likelihood of another special year-end and [indiscernible] comes up in each call but particularly as the stock has been trading at least the last couple of quarters. What points should we think that maybe share repurchase does start to flow into to mix, the amount of flows increased the last year and a half and couple of times since the IPO and now you see some inside exchanges over time at a measured pace, so. As we start to feel like we couldn't get enough that you are going to [indiscernible] do you feel more comfortable including share repurchases, as part of capital management?

Yes, I mean Rob, I think at some point that will come into play and we still have a considerable amount of employees and initial founder investment in the firm and we'd like to see a little bit more liquidity, but I do think at some point down the road stock repurchase will become a part of the conversation, but I don't see any meaningful conversation in the next several quarters, but maybe sometime next year, we'll start that discussion and I think we'll give you guys a heads up when we think that becomes more of a likely scenario. But for now, I think you know we've always had a history of paying out 100% of our cash earnings and given still a large ownership of employees and initial founders, yes that going to be our course for likely the next several quarters to a year.

And our next question will come from Bill Katz of Citigroup.

Maybe C.J. we start with you for a couple housekeeping items. So just on that employee-based stock compensation, will the increases that you layer in in January be more than what's rolling off of the pre-actual grants is nothing but the cash flow dynamics of that?

I would say that the roll on would be similar to prior post IPO roll on tranches. So given that pre-IPO grant was marked up and affected by the IPO itself in the valuation, we're not really thinking in terms of that pre-IPO, we think of a more of -- we said we'd be in the range of our public peers on grants and you know we've been 150 to 200 basis points approximately on a grant. So that's how I would think about it.

And then in the comments about the distribution and marketing stage, at this point, the $6 billion, is that about what you think of sales or is there an opportunity to move more of the assets plus the asset classes and then have a further leverage on that line item?

Yes, I do think there is opportunity. It would be hard to put a number on it. Could it be another $6 billion, it could be, but I wouldn't be layering in any additional, I mean, I think these transfers and conversions are dependent upon some of our partners in the wire-house is having the technology and the ability to make the transfers. So some of it is out of our control, but it's both an opportunity to transfer existing clients into the lower share class as well as from a competitive standpoint to gather more assets, because we're a bit more competitive in the channels. So, there is more opportunity but very, very hard to put a number on it.

Does that lead you to a lower management fee as an offset or is that purely a pass-through on the distribution side?

Yes. There is no lower management fee now, no effect on revenues.

It's just a maximum revenue share that's differentiated between the advisor share and the investor share is the lower number.

Eric, you mentioned that the growth in some of the non-U.S. global equity which is I think we're seeing you cross all those reported so far. You talked a little bit about maybe two aspects of that. One, where the mandate is coming from, is this just replacement of poor performing platforms where you're just taking over the mandate or is it coming from other asset classes? And then sort of really a [indiscernible] just talk a little bit about where we might be in terms of leveraging high yield and World funds, just given where they might be in their performance timelines?

Sure, Bill. The international growth AUM is coming primarily from the intermediary channel, you see it in the mutual fund flows the most and that is just a re-balancing that's going on in their asset allocation as opposed to taking share from another investment manager and that flow has being muted a bit by the institutional channel which I think has been a pretty common theme in the marketplace as well as institutional clients are rebalancing and using a little bit more of a Smart beta or a exposure oriented indexes comp and also they are complementing that with some alternative in the private equity, real estate and the likes. And so the international growth has a positive intermediary and a little bit offset on the institutional. The global opportunities is another strategy that we're seeing the growth and that's primarily coming from overseas, we're getting good traction in Europe as well as Asia with that strategy and that strategy gets exposure over there with various advisors and consultants, we think that's a good positive sign for global equity coming behind it. With regards to the high yield in the developing world, the developing world is obviously in a very early stage here. We just launched the Funds at the end of June. We're fairly optimistic right now given the interest that we see and the inquiries that we have by institutional clients primarily, but also a good healthy interest in the intermediary channel. The high yield has produced a strong performance. It's laid the right foundation for its first year and a half. I think the high yield marketplace is quite noisy right now with regards to clients' expectations of the asset class. And so I think we've seen muted flows across the asset class as a whole. And I think we'll primarily pick up some growth there, but until there gets a stronger tailwind around asset allocation, it should just be a steady growth.

And the next question comes from Michael Kim of Sandler O'Neill.

So first just to maybe follow-up on the discussion around investment talent. Just wondering if you are maybe taking a bit of a pause, if you will, in terms of focusing on sort of building up the developing world team and then just stepping back, any color on sort of the backdrop for recruiting today versus what you've seen in prior cycles.

Yes, sure, Michael. The talent management, we did focus our comments really around our existing teams and the importance of making sure that they are structured and designed for a sustainable outcome. I think a lot of investment managers look at a single individual and it's almost the guy and the fund concepts and we want to avoid that structure and build out our teams for that long duration. And our focus is that we make sure that our current teams are functional and don't get dysfunctional, but we're always going to be in the marketplace for new talent. And we do get calls and sometimes you just get that call from an individual that you didn't think was out there and you take those in, but there was always going to be those both type of calls going on. But we're not heavily pushing right now just to do as many strategies as we can and we've always thought of our firm as a relationship-oriented firm as opposed to a deal oriented firm. And the deal oriented firms miss that long relationship with their existing teams so that they continue to thrive and with our four more mature strategies or teams with the growth team, the value team, the global equity and the global value, you have to stay on top of making sure that those are functioning correctly and then we want to reinforce that that's something that we don't forget.

And then maybe just one or two for C.J.; coming back to sort of expenses maybe a bit differently. Just assuming the markets remain volatile and I know there's variability in the comp and the distribution line items, but how much flexibility do you have to maybe dial back on some discretionary spending, assuming that sort of environment or would you just sort of continue to invest through the cycle, if you will, perhaps at the expense of some near term margin points?

Yes, I think the beauty of our model is that 60 some percent of our expenses are going to adjust automatically with changes in the revenue. There certainly is some additional leverage points, I think we would likely invest through the cycle for the long term, but as it did during the crisis if things get really bad, there are levers we can pull but the most meaningful levers by far are already built into the model.

Okay. And then just one quick one in terms of performance fees. I think they were typically higher than we've seen in the second quarter in past years, so was there any step-up related to maybe some frontloading or any implications as we look out to the fourth quarter?

No, no it was a new account that we had brought on last year that had a measurement period in the June quarter. So it's really a new situation and we'll see that opportunity now each June quarter that we didn't have before.

[Operator Instructions]. And our next question will come from Michael Carrier of Bank of America Merrill Lynch.

This is Adam Beatty in for Mike, just wanted to get an update on your non-U.S. distribution strategy. You had positive flows there this quarter whereas some other firms have faced headwinds. And you mentioned the traction that some of the global products have gained there. Was the positive activity primarily product driven and what's the outlook for distribution maybe on the investment side, but also in terms of additional traction you might gain?

Sure, Adam. The non-U.S. for us is even a little bit more lumpier than what we see in the U.S. in that most of our growth has been occurring in the institutional channel and within the institutional channel, we've been dealing with some fairly large entities, whether it's in Europe or Asia, Australia. And so I think it's easy to look at other firms out there and how a single account can skew the quarter. We've had a positive lane that's primarily been driven by the strength of our strategies, the global opportunities and the global equity strategies are at top of the peer group. They're outperforming indexes. They're both in realizable capacity mode which is they have a proven philosophy and process, they have the track record, they have the scale, they're going to meet the criteria for searches. It's just not wishful capacity of starting a strategy, right now developing world and high income I'll put in that wishful capacity. When it gets to the two-year, three-year, four-year mark and it has a history, it phases in the realizable and so we have some strong strategies that are driving the results overseas.

And our next question is from Eric Berg of RBC.

That strong performance also extends to your global value team and yet you had a couple of quarters now of outflows. I'm kind of surprised given the strength of the numbers. What's your sense, Eric, of what's happening there?

It's that institutional rebalancing, that strategy, specifically any of our global value, global equity or global opportunities has been skewed towards institutional clients, especially overseas. The global value is made up of a more institutional base that has been consistently rebalancing. I think we've seen this in the institutional marketplace over the last -- [indiscernible] the financial crisis that institutional clients have increased their rebalancing. Some have gotten fairly tactical in that rebalancing has been to our detriment of strong results here at the top of the peer group and with that more active rebalancing, we've seen some clients pull some money from us, but the clients with us, it's not terminations, it's just pure re-balancing.

And that re-balancing would be in favor of what?

Since we don't have all the strategies across the spectrum, I don't have that data. My belief or thought is that it's moving more into an exposure oriented and smart beta or passive or it's going into the more alternative space. It is going to be real estate or timber, people are just trying to increase non-correlated assets into the asset allocation.

And next we have a question from Chris Shutler of William Blair.

Eric, you stressed earlier on the really strong performance in global equity and the 5-year record, I think 5 year is kind of the inflection point naturally for global op. But it does seem like it's maybe been a little bit tougher on the global equity side. So maybe just talk about what's going on behind the scenes, [indiscernible] with consultants, how that's trending and how the pipeline is building et cetera. Thanks.

Sure. At first, the more competitive spaces such as large-cap or global equity, there's quite a bit of competitors in the marketplace, there's a lot of strategies around buy lists across consultants versus say a small cap strategy or an emerging market strategy. I think the inflection point there is a lower asset -low hurdle 3-year record since strategies close more in that space, the inflection point is earlier in the cycle. With global equity, I think it's actually a little bit ahead of global opportunities. Global opportunities was roughly $350 million, it's a 5-year track record and global equity has already doubled that at the 5-year record. So apples-for-apples on the 5-year record, we're a little bit ahead and we're just waiting for that inflection point. And even if you hit that inflection point, you're still waiting on the trend and the opportunity of searches, we could hit a spot like the high yield market right now, right at the inflection point. So it's not a magic number of 5 years since it's getting to 5 years and then somewhere in the 5, 6, 7 year you should expect cycle that you can have meaningful growth there, but it's dependent on the marketplace and where clients and consultants are putting dollars to work. So we're optimistic about where global equity is at and feel over the next couple of years, we should be able to realize it.

And our next question is from Surinder Thind of Jefferies.

Just related to an earlier question about the global value team, my understanding is that both funds have been soft post release about a year and a half now. Any thoughts on may be launching another strategy there or maybe how effective those discussions have been?

We're always thinking about various ways to build out new strategies with existing teams, we talk to all of our teams about opportunities in the marketplace with the global value and in international value strategies are closed. We're managing flows there so we don't get into the destructive capacity mode which is the something I refer to Alpha. And these strategies can also be destructive unless you have the team set up correctly that you design the strategy thoughtfully and it fits the natural philosophy and process of that team. So we'll have a dialog there, but I don't think there's anything on the docket right now that we would put forward with that team.

And then maybe a quick question about just with more and more global products, it seems like we're kind of in an environment where there's a lot of movement in the central banks and any thoughts around how active maybe some of the strategies are in hedging currency or at least how much of a consideration is it all?

Currency is getting more and more interest across the institutional client base as well as intermediaries, I haven't seen too much of an uptick on any type of currency overlay strategies which is always the leading indicator on institutional clients who are wanting to see that embedded in more of their portfolios, we've been a little bit more active embedded in our three global strategies as well as the emerging market strategies, but I don't see that as a major of a driver to what we do. I think we're primarily focused on just fundamental stock selection in those strategies and you might see a little bit more currency management, but I don't see that as a meaningful uptick in what we do.

The next question will come from Bryan Sullivan of Credit Suisse.

I know there has been talk in the past about the potential launch of a liquid alternative strategy and can you give us an update here. And is it something that you think could be done with an existing team or is there a need to go outside the firm, maybe just as a way to also help retain some of the institutional assets you're seeing leaving in favor of alternative re-bouncing and non-correlated products? Thanks.

Sure. I'm not sure, I don't recollect really bringing up a strong interest in liquid alts I think the marketplace has seen some asset growth in the last 2013 and 2014, you saw quite a bit of asset flow in non-traditional products in the 40 Act structure, I think this year it's been very muted. I think at best, there is a little over a billion of net flows in those type of strategies. Our interest is if we find a strategy that could be in that wrapper of a 40 Act or liquid alts, we're okay with that. But we're certainly not out there searching for liquid alts. And I'm little bit skeptical on how that strategy would fit long term. So we're not opposed to it, but it's not something that we're actively seeking to put into line up.

And next we have a question from Alex Blostein of Goldman Sachs.

A quick question for you guys on the U.S. value team and obviously the team is seeing some struggle with performance for quite some time now and so far the pressure points have been a little more concentrated on the mutual fund channel. Just curious if you guys have seen in your discussions with institutional clients any signs of potential risk for their outlets from that whole team if we were just kind to think about a way to [indiscernible] risk of future outflows? Thanks.

Yes, sure, the U.S. value team on a relative basis, clearly has its struggles there; as I mentioned the absolute return and since inception for some of our clients we believe has been strong. However, we've clearly seen the flows go negative in the intermediary channel, primarily registered investment advisor space and we're seeing some outflows on the institutional and we're clearly on watch list across most of our clients there with the U.S. small cap value and the U.S. mid-cap value. So we expect to see more outflows there in the short run. Okay. I think that's it. So thank you very much. Talk to you next quarter.

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