Cohen & Steers, Inc. (CNS) Q2 2015 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Cohen & Steers' Second Quarter 2015 Financial Results Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded Thursday, July 16, 2015, and I would now like to turn the conference over to Mr. Adam Johnson, Senior Vice President and Associate General Counsel. Please go ahead, sir.

Thank you and welcome to the Cohen & Steers' second quarter 2015 earnings conference call. Joining me are Chief Executive Officer, Bob Steers; Executive Chairman, Marty Cohen; our President, Joe Harvey; and our Chief Financial Officer, Matt Stadler. Before I turn the call over to Matt, I want to point out that during the course of this conference call we may make a number of forward-looking statements. These forward-looking statements are subject to various risks and uncertainties and there are important factors that could cause actual outcomes to differ materially from those indicated in these statements. We believe that some of these factors are described in the Risk Factors section of our 2014 Form 10-K, which is available on our Web-site at cohenandsteers.com. I want to remind you that the Company assumes no duty to update any forward-looking statements. Also, the presentation we make today may contain pro forma or non-GAAP financial measures, which we believe are meaningful in evaluating the Company's performance. For disclosures on these pro forma metrics and their GAAP reconciliations, you should refer to the financial data contained within the press release we issued yesterday as well as in our previous earnings releases, each available on our Web-site. This presentation may contain information with respect to the investment performance of certain of our funds and strategies. I want to remind you that past performance is not a guarantee of future performance. This presentation may also contain information about funds that have filed registration statements with the SEC that have not yet become effective. This communication shall not constitute an offer to sell or the solicitation of any offer to buy these securities. For more complete information about these funds, including charges, expenses and risks, please call 1800-330-7348 for a prospectus. One additional note before I turn the call over to Matt. Because the currently effective registration statement for Cohen & Steers' common stock expires in September, we anticipate filing a replacement registration statement with the SEC on or around the filing date of our next 10-K. And with that, I'll turn the call over to Matt.

Thank you, Adam. Good morning everyone and thanks for joining us today. Yesterday we reported net income of $0.45 per share compared with $0.49 in the prior year and $0.45 sequentially. Operating income per share was $0.43 for the quarter compared with $0.43 in the prior year's quarter and $0.47 sequentially. Revenue for the quarter was $83.5 million compared with $78.4 million in the prior year and $83.8 million sequentially. The increase in revenue from the prior year's quarter was attributable to higher average assets under management. Average assets under management for the quarter were $53.3 billion compared with $50.7 billion in the prior year's quarter and $55 billion sequentially. Operating income was $31.2 million compared with $29.7 million in the prior year and $34.5 million sequentially. Our operating margin decreased to 37.3% from 41.2% last quarter. The decline was primarily due to higher compensation and G&A costs relative to revenue. Pre-tax income, net of non-controlling interest, was $33 million for the quarter, compared with $33.9 million in the prior year and $33 million sequentially. Non-controlling interest represents third-party interest in the funds we have consolidated. Assets under management totaled $50.1 billion at June 30, a decrease of $4.5 billion or 8% from March 31st. The decrease in assets under management was attributable to market depreciation of $3.8 billion and net outflows of $741 million. Assets under management in institutional accounts totaled $24.5 billion at June 30, a decrease of $2.2 billion or 8% from the first quarter. The sequential decrease in institutional assets under management was due to market depreciation of $1.9 billion and net outflows of $268 million, the majority of which represents sub-advised U.S. real estate portfolios in Japan. Excluding distributions, which average approximately $550 million per quarter, we recorded net inflows from Japanese sub-advised portfolios in each of the last four quarters. If you annualize second quarter flows, institutional accounts had a 4% decay rate. Bob Steers will discuss our institutional pipeline in a moment. Open-end funds had assets under management of $16.2 billion at June 30, a decrease of $1.8 billion or 10% from the first quarter. The decrease was due to market depreciation of $1.4 billion combined with net outflows of $454 million. Net outflows included $546 million from U.S. real estate funds and $121 million of platform related redemptions from our European real estate SICAV, partially offset by net inflows of $168 million into our preferred securities fund. If you annualize second quarter flows, open-end funds had a 10% organic decay rate. Assets under management in our closed-end funds totaled $9.4 billion at June 30, a decrease of $533 million or 5% from the first quarter, and was primarily due to market depreciation. On a sequential basis, expenses increased 6%, primarily due to higher compensation, G&A and distribution and service fees. Employee compensation and benefits included the cumulative effect of an adjustment which increased the year-to-date compensation to revenue ratio from 31% to 32.5%. The adjustment which resulted in a 34% compensation-to-revenue ratio for the quarter was the result of lower revenue growth than originally forecasted. The increase in G&A was primarily due to higher rent and occupancy attributable to expansion space at our 280 Park Avenue Corporate Headquarters as well as increased international travel associated with the two newly awarded global listed infrastructure mandates. The higher distribution and service fee expense was primarily due to additional intermediary payments being absorbed by the advisor. On a sequential basis, non-operating income, net of non-controlling interest, increased $3.3 million from a loss of $1.5 million last quarter to a gain of $1.8 million in the second quarter. The non-operating gain for the quarter was primarily due to higher unrealized gains from our seed investments, the majority of which were held in commodity, MLP and midstream energy strategies. Currently, non-operating income will only be affected by the seed investments in our commodity strategy. Our effective tax rate for the quarter was 37%, consistent with the guidance provided on our last call. With respect to our balance sheet, our firm liquidity totaled $181 million compared with $158 million last quarter. Stockholders' equity was $242 million compared with $228 million at March 31st, and we remain debt free. Let me briefly discuss a few items to consider for the second half of 2015. With respect to compensation and benefits, we currently expect to maintain a 32.5% compensation-to-revenue ratio. We expect G&A to increase between 2% and 3% in the second half of 2015 compared with the first half of the year. And finally we project that our effective tax rate will remain at approximately 37% for the remainder of the year. Now I'd like to turn it over to Bob Steers.

Thanks, Matt, and good morning. As you know by now, the market environment for many of our real asset strategies was challenging in the second quarter despite the backdrop of an upswing in global economic growth. There's little or no doubt that expectations of prospective interest rate increases are weighing on the minds of REIT investors in the short run, as evidenced by the 10% decline in U.S. REIT indices in the quarter. This in turn spurred redemptions across the U.S. REIT fund and ETF sectors. Time will tell but our analysis of past trends and the relationship between interest rate and REIT share price movements indicate that these concerns are almost always misplaced, especially during periods of economic expansion. In any event, we remain very positive regarding real asset fundamentals, current valuations and the outlook for future returns. I'm pleased to say that as has been the case for several years, our investment team has delivered strong relative investment performance in the quarter. Seven out of our nine core strategies outperformed their benchmarks and eight out of nine are ahead on a year-to-date basis. Our U.S., international and global real estate strategies continue to perform especially well. It's also noteworthy that our preferred securities team is on track to outperform their benchmark and peers for a 10th consecutive year, which is a truly unique accomplishment. As I said, the challenging market for real asset strategies, especially U.S. REITs, had a meaningful impact on mutual fund flows in the quarter. Open-end fund net outflows in the wealth management channel totaled $454 million, but U.S. REIT net outflows of $546 million was clearly the biggest change in the quarter. While the decline in REIT share prices drove outflows, the declaration and payment of significant capital gains distributions from our flagship U.S. REIT funds exacerbated the magnitude of these outflows. On the plus side, as Matt mentioned, our preferred securities fund registered solid net inflows of $168 million and has now experienced net inflows in 19 of the 21 quarters since its inception in 2010. In contrast to the retail marketplace, the trends in our institutional advisory and sub-advisory channels were solid and are improving. Advisory net outflows were a modest $27 million and toward the end of the quarter we won our largest global listed infrastructure mandate to date $450 million which is expected to be funded during the balance of this year. Notably, we're also experiencing a solid uptick in RFP activity across the range of real asset strategies. Not unlike the advisory channel, sub-advisory flows extra pan were slightly negative, roughly $13 million, but the pipeline has likewise improved. On July 1, we disclosed that our previously announced sub-advisory mandate with Argo Global Listed Infrastructure Limited and Australian Listed Investment Co. will initially amount to $220 million and has the potential to grow affecting the Company's outstanding options. Incorporating the new $450 million GLI advisory mandate into our pipeline and adjusting for the Argo initial raise, our unfunded institutional pipeline currently stands at $814 million, which compares favorably to $404 million at the end of the first quarter. Finally, flow trends in Japan have also shown improvement. Before shareholder distributions, we experienced solid net inflows of $316 million, our best quarterly results since 2011. However, after accounting for distributions, total net outflows were $228 million. The expanded team in Tokyo is continuing to work on adding products and distributors and at the retail sector, while simultaneously developing new business in the institutional marketplace. Looking ahead to the balance of the year, as always we remain focused on things that we can control, which is investment performance and business development. Notwithstanding the short-term volatility experienced by the U.S. REIT sector during the quarter, we remain confident that our strong investment performance combined with growing secular demand for real asset and income strategies positions us well for future growth. With that, I'll stop and invite questions.

[Operator Instructions] Our first question comes from the line of Adam Beatty with Bank of America Merrill Lynch. Please go ahead.

First, just a quick question on the capital distribution that you mentioned, I think you gave an average amount of $550 million per quarter. Can you disclose the amount for 2Q?

We don't give specific guidance but it's for several years now it's been $2 billion or slightly more than that annually, and it will change depending on the distribution strategy of our client for whose funds we are sub-advising.

Okay, got you, so it's not necessarily seasonal or anything?

It's not what?

It's not necessarily seasonal if it wouldn't spike in 2Q or other quarters?

No.

But just to be clear what Bob just referred to was the distributions from our sub-advised funds in Japan, Adam, were you referring to that or to the other reference made to the capital gain distributions in our U.S. mutual funds?

I guess it was the capital gain distributions, yes.

Okay, that's not the $500 million or the $2 billion number that you were asking about. This was simply, we decided that at midyear that we would declare and distribute realized capital gains from our four U.S. REIT mutual fund portfolios, and that's not a regular thing, it's simply as gains are realized – as you know, each fund in their fiscal year has to distribute those gains and so that was a one-time event.

Okay, and that was in the flow number as well?

That would be in depreciation, and typically the way it works is you distribute those gains, some of them some investors are up to reinvest those assets and so they find their way back in the funds, some leave the funds and don't come back.

Sure, got it. Okay, thank you very much. I appreciate the explanation. And then just on the comp, could you maybe add a little bit of detail about the nature of the adjustment and what that was?

It's pretty straightforward. The comp ratio moved up because with a 10% decline in U.S. REIT share prices in the quarter, our revenue projections are slightly lower and so even just keeping the comp constant the ratio rises.

I would add that I think it illustrates that REIT so far in the first two weeks of July are up more than half of what the decline for the entire second quarter was. So it's something that moves around a lot and I think it illustrates the leverage that we've been speaking about that we have in our business. So absent the 10% decline, the comp ratio doesn't adjust the 32.5%, it stays at the 31% level. It's just something to keep in mind. I mean it's going to adjust as our results adjust and as the flows in appreciation/depreciation adjust.

As Matt mentioned, the combination of a significant decline, U.S. REITs are about 50% of our total AUM, so it's meaningful. In addition, we did see industry-wide outflows in the quarter. So it was material enough that we wanted to recognize it in the comp ratio. As Matt said, comp ratio can change quarter to quarter. Obviously we prefer to keep it as stable as possible, but also as Matt said, REITs are up about 6% since June 30. So who knows, but we're simply recognizing the significant changes in the second quarter.

Got it. So with the dollar amount going up, part of that was an accrual or retroactive recognition?

Yes, it was, exactly.

Got it, okay. Thanks very much. I'll leave it there and get back in the queue. Thank you.

[Operator Instructions] Our next question comes from the line of Mac Sykes with Gabelli. Please go ahead.

Just two questions, more on the strategy aspect. Just from a REIT perspective, does your investment strategy in terms with that change in a rising rate environment or potentially rising rate environment? I mean what things would you change in the portfolio potentially?

This is Joe Harvey. If our view is that the economy is going to be improving and likely bond yields will be rising with that, we would be shifting the portfolio to companies that have more economic sensitivity, more cyclicality as opposed to more defensive companies which the share prices are going to be more sensitive to movements in a bond yield. So our portfolios have been and continue to be positioned more cyclically.

Then just moving to the infrastructure, congratulations on that win this quarter, if you think about the current environment, we have potentially higher rates with certainly lower energy prices, macro instability, however you want to measure it, potentially about favorable budgeting here in the U.S., maybe if you could just talk about what makes you feel more confident now that this is a good time for infrastructure spending versus perhaps a couple of years ago?

This is Joe again. So let's take a step back and look at the big picture. We're in the early stages of acceptance of listed infrastructure as a real assets allocation to investor portfolios, and that's being driven by their total return potential, their stable cash flows and potential for growth in their cash flows. Those are characteristics that many types of investors, both institutions and individuals, are very interested in. At the same time, the universe of companies that we have to invest in is growing and it relates to the capital needs for a lot of different types of infrastructure. And keep in mind, for a broad global listed infrastructure strategy, there are probably 10, 12 different subsectors all of which target different parts of the economy and have different drivers of their fundamentals and different profiles, and they range from cell towers to airports, seaports, et cetera. So, it's very hard to generalize but the big picture is that the investor wants the characteristics of the strategy and there are very significant capital needs that in many areas can be solved through the public markets. So we're very optimistic about the whole combination of factors here that are going to drive the growth in our business. You mentioned one which I think deserves some comment and that's the energy space. One sub-segment of infrastructure is the midstream energy segment here in the U.S. which has been related primarily to the MLP group, and because of the correction in energy prices, it's going to reduce the demand for the pipelines and midstream energy assets and so we expect a slowdown in the growth of that segment but that's a cyclical thing and will be sorted out as supply/demand gets back in balance.

Great. Thank you very much.

We have a follow-up question from the line of Adam Beatty with Bank of America Merrill Lynch. Please go ahead.

Just wanted to ask a broad question about the international exposure of Cohen & Steers in your various fund strategies. It looks like we're facing the prospect of a bit of a bifurcation which hasn't happened in a while, U.S. rates rising and rates elsewhere being relatively flat. How would that affect your investment?

When you look at our strategies, as Matt I think referred to in his starting points, our U.S. REIT strategy is the biggest part of our AUM, but after that we have some very meaningful strategies that are global in nature, infrastructure as I just talked about, real estate, and then preferred stocks as well. So in terms of what's going on globally, we're positioned in each of those strategies in different ways to capitalize on different regional trends. So for example in Europe it's been a very favorable investing environment because interest rates continue to be low and there's continued stimulus. At the same time the economy is getting less bad and a little bit better. So those have been – the investments in Europe have added to the returns that our portfolio managers have generated. In the preferred stock area, because of regulations in the banking sector, it's been an environment where there's been a lot of issuance of new types of preferred securities and that's also been a target rich environment for our team that's very adept at harvesting the alpha opportunities from those securities. So again, it's a very general question but for each strategy we can talk about how we capitalize around the world, but as we look at the global environment we think that growth is still positive and the investment environment is attractive because of central bank policies and stimulus around the world.

Adam, I would just add just more broadly and relating it to product, so whereas in the second quarter, U.S. REITs, both passive and active, had about $5 billion of outflows, there was flows into the global REIT sector albeit active was slightly negative, passive was about $1 billion positive, we had modestly positive inflows into our global REIT product. So we're hopeful that as capital flows move around the world, whether it's because of interest rates or currencies or economic factors, within the real asset space, whether it's infrastructure, real estate or commodities, we'll have something that will satisfy investors' interest given the environment that we're in.

Thanks very much. It was a [right] [ph] question. I appreciate getting a couple of different angles on it. That's all I had today. Thanks.

We have another follow-up question from the line of Mac Sykes of Gabelli. Please go ahead.

Your comments on the preferred and then the 10 year track record very interesting and the growth there has certainly been very healthy. I was curious if you think that there is further opportunity to maybe accelerate that growth there and what might be done to be able to do that?

I can answer that from a product and market share standpoint. At this point not surprisingly we have I think by a wide margin the strongest track record there, 10 consecutive years of outperformance by roughly 300 a year, and so our market share of the total preferred pie continues to grow substantially. So again in the latest example, and these are not precise numbers, but in the quarter there was roughly $400 million of outflows from the preferred stock sector here in the U.S. We had $200 million of inflows. And so the market is absolutely recognizing this extraordinary team and their track record and the income generation capability that they have. So we are absolutely out there marketing and promoting this fund as much as possible. Unfortunately it's overwhelmingly a retailer wealth management product. We have some institutional interest particularly on a limited duration side but it is mainly a retail product.

I'd just add to that. There's a market for preferred in Japan. Late last year we became the sub-advisor to a new fund that was created in Japan and we are in ongoing discussions with both other retail distributors and institutional prospects in Japan. Bob also mentioned the limited duration approach to preferreds. In the closed-end fund market we have our core strategies and we have a limited duration version of that. In the product development stage, we're looking at a limited duration version for the open-end fund market as well. We're also developing a strategy focused on the more recent CoCo preferred. We think there's interest there potentially both in Europe and in Asia for a standalone strategy.

Great. Thank you.

We have another follow-up question from the line of Adam Beatty with Bank of America Merrill Lynch. Please go ahead.

Sorry, just one quick check. So the initial funding for Argo was in 2Q, is that correct?

No. We made the announcement at July 1 of the amount, the deal had closed and had been quantified. We didn't start investing that until this quarter, which is why we included that and the $450 million GLI mandate in the pipeline of awarded but unfunded mandates.

Got it. Thank you. Much appreciated.

That does conclude today's conference call. We thank you for your participation and ask that you please disconnect your lines.