Cohen & Steers, Inc. (CNS) Q3 2015 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Cohen & Steers Third Quarter 2015 Earnings 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, October 15, 2015. I would now like to turn the conference over to Adam Johnson, Senior Vice President and Associate General Counsel of Cohen & Steers. Please go ahead.

Thank you and welcome to the Cohen & Steers third 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 Factor section of our 2014 Form 10-K, which is available on our website 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 pro forma metrics and their GAAP reconciliations, you should refer to the financial data contained in the earnings release we issued yesterday as well as in our previous earnings releases, each available on our website. Finally, 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 will 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. And with that, I'll turn the call over to Matt.

Thank you, Adam. Good morning everyone and thanks for joining us today. Before getting started, I'd like to introduce our third quarter earnings presentation, which is available on our website. The earnings presentation is supplemental to the earnings release and is designed to facilitate the earnings call by providing slides to complement our prepared remarks. Yesterday, we reported net income of $0.37 per share compared with $0.40 in the prior year and $0.45 sequentially. The third quarter of 2015 included a non-operating loss of $2.8 million and an adjustment to the tax rate to account for a valuation allowance on the non-operating loss. Operating income per share was $0.43 compared with $0.45 in the prior year's quarter and $0.43 sequentially. Page 5 of the earnings presentation reflects the current and trailing four quarter trend in revenue and breaks out investment advisory fees by vehicle. Revenue was $79.7 million for the quarter compared with $80.8 million in the prior year and $83.5 million sequentially. The decrease in revenue for both the prior year and the sequential quarter is attributable to lower average assets under management. Average assets under management for the quarter were $50.7 billion compared with $51.6 billion in the prior-year's quarter and $53.3 billion sequentially. Operating income was $31.5 million compared with $32.3 million in the prior year and $31.2 million sequentially. Our operating margin increased to 39.5% from 37.3% last quarter. The increase was primarily due to lower compensation and distribution and service fee expense relative to revenue. Pre-tax income, net of non-controlling interest was $28.6 million for the quarter compared with $28.9 million in the prior year and $33 million sequentially. Non-controlling interest represents third-party interest in the funds we have consolidated. Page 6 of the earnings presentation reflects the current and trailing four-quarter trend in expenses, which decreased 8% on a sequential basis, primarily due to lower compensation, distribution and service fees, and G&A. The compensation to revenue ratio was 32.5% for the quarter, consistent with the guidance we provided on our last call. The decline in distribution and service fee expense was consistent with the lower average assets under management in our open-end no-load mutual funds, and the decrease in G&A was primarily due to lower international travel and fewer hosted events during the summer months. We reported a non-operating loss, net of non-controlling interest of $2.8 million for the third quarter compared with a non-operating gain of $1.8 million last quarter. The non-operating loss for the quarter was primarily due to realized and unrealized losses from our seed investments, the majority of which were held in our commodity strategy. Our effective tax rate for the quarter was 40%, which included the cumulative effect of adjusting the rate from 37% to 38% for the year. As mentioned earlier, the adjustment was due to a valuation allowance that was recorded on the tax benefit associated with the non-operating loss. Page 7 of the earnings presentation reflects our cash, cash equivalents, and seed investments for the current and trailing four quarters and breaks out U.S. and non-U.S. cash and cash equivalents. Our firm liquidity totaled $197 million compared with $181 million last quarter. Stockholders' equity was $246 million compared with $242 million at June 30, and we remained debt free. Assets under management, which can be found on page 8 of the earnings presentation totaled $49.7 billion at September 30, a decrease of $404 million or 1% from June 30. The decrease in assets under management was attributable to net outflows of $239 million and market depreciation of $165 million. Page 11 of the earnings presentation reflects net flows by investment vehicle. Because of the unique characteristics related to fund distributions in Japan, we thought it would be useful to show the net flows from Japan separately. Assets under management in institutional accounts totaled $24.6 billion at September 30, an increase of $100 million from the second quarter. The sequential increase in institutional assets under management was due to market appreciation of $137 million, partially offset by net outflows of $37 million. For the quarter, advised accounts recorded net inflows of $150 million resulting primarily from the funding of a global listed infrastructure mandate. Excluding sub-advised portfolios in Japan, subadvised accounts recorded net inflows of $98 million, which included the funding of the Australian global listed infrastructure closed-end fund sponsored by Argo and inflows into commodities portfolios. Subadvised portfolios in Japan recorded net outflows of $286 million for the quarter, which included distributions of $554 million. Excluding distributions, subadvised portfolios in Japan recorded net inflows in each of the last five quarters. If you annualize third quarter flows, institutional accounts had a decay rate of less than 1%. Bob Steers will discuss our institutional pipeline in a moment. Open-end funds had assets under management of $16.1 billion at September 30, a decrease of $95 million or 1% from the second quarter. The decrease was due to net outflows of $202 million, partially offset by market appreciation of $107 million. Net outflows included $277 million from U.S. real estate and $90 million from global and international real estate, partially offset by net inflows of $212 million into preferred securities. If you annualize third quarter flows, open-end funds had a 5% organic decay rate. Assets under management in our closed-end funds totaled $9 billion at September 30, a decrease of $409 million or 4% from the second quarter due to market depreciation. Let me briefly discuss a few items to consider for the fourth quarter. With respect to compensation and benefits, we expect to maintain 32.5% compensation to revenue ratio. We expect G&A to approximate the amount recorded in the second quarter of this year as we resume investments in our real assets institutes. And finally, we project that our effective tax rate will remain at approximately 38% for the fourth quarter and the full year. With that I’d like to turn it over to Bob Steers.

Thanks, Matt and good morning. The stretch of calm recently experienced in the equity markets ended up roughly in the third quarter. Concerns regarding China’s growth prospects around commodities, especially energy and the potential knock-on effects in emerging economies, all weighed heavily on the capital markets or especially equities. With the icing on the cake being the Fed’s In Action, which did little to inspire investor confidence and in fact stoked fears of a potential global economic slowdown. US equities in response endured a spike in volatility and the worst market decline since 2011 down over 6% with commodity and energy related issues plunging 20% or more. The US REITs posted positive returns for the quarter delivering the portfolio diversification benefit that investors have been searching for from liquid alternatives. The fixation on the Fed’s next move and related speculation about the future direction of interest rates continues to roil the markets. It’s worth reiterating, in this environment that historically REITs have had virtually no correlation to interest rates and that fundamentals are strong and improving and valuations are attractive. Given that backdrop, our investment performance in the quarter was mixed with five of 10 core strategies finishing ahead of their respective benchmarks. Still year-to-data, eight of these strategies have outperformed. All three of our real estate strategies solidly beat their benchmarks as did preferred securities. In fact, according to Morningstar, our top performing US REIT fund is ranked in the top-decile for one, three and five years and our Global REIT fund ranks in the top quartile for the one and three-year periods. Our energy related strategies, including MLPs, infrastructure, commodities and real assets underperformed in the quarter, as did a majority of our peers. As Matt disclosed, we experienced firm-wide outflows of $239 million or about 2% organic decay rate. The wealth and Japanese sub-advisory channels accounted for the net outflows, while the advisory and sub-advisory ex-Japan channels delivered positive organic growth. As we’ve been saying, our most critical corporate goal is to achieve positive organic growth in all four of these segments and we continue to see good progress towards that objective. In contrast to the institutional market, retail investors remain highly focused on the near-term direction of interest rates as well as drawdown risk. And so in the quarter, capital continued to flow into our preferred security strategies and out of reach. Total net outflows in the wealth channel were $202 million in the quarter. The institutional advisory channel by comparison had a quiet, but positive quarter, with no meaningful outflows and an additional $150 million global listed infrastructure funding. Importantly, we saw a meaningful uptick in institutional interest in the listed real asset space. Preqin reports that private real estate and infrastructure funds raised over $50 billion in the quarter, which is the highest in two years. On the listed side, we’ve seen a similar increase in RFP activity across the entire array of real asset strategies, but especially for global listed infrastructure where we’ve already won three large mandates this year. The capital requirements for global infrastructure are enormous and institutional investors are eager to capitalize on this opportunity, which is very reminiscent of the evolution of the REIT market in the early 1990s. Lastly, our institutional pipeline of unfunded mandates remains robust at about $500 million. Sub-advisory inflows ex-Japan of $98 million were positive, but also mixed. As we previously disclosed, Argo Global Listed Infrastructure Limited, the Australian listed infrastructure company that were sub-advising raised $213 million, which was funded in the quarter. Additionally, we experienced positive flows into our active commodity strategy, which despite large drawdowns has registered positive flows since its inception in the second quarter of 2013. Partially offsetting these inflows were outflows from REIT strategies likely tied to retail investor interest rate concerns. The sub-advisory flow trends in Japan remain about the same as the second quarter. Net inflows before distributions were $269 million, but post distributions of $554 million, net outflows were $286 million. Our strategy there remains unchanged; work with our partners to market their existing funds, while also developing new strategies to achieve flows in excessive distributions, while also cultivating and growing an institutional client phase. I believe we are making good progress on both fronts. Looking ahead, we remain confident that we will achieve organic growth in all four of our distribution channels. Our REIT listed infrastructure and preferred securities track records are among the best in the world and we anticipate the client demand for each of these important strategies will increase as the cycle progresses. In an effort to capitalize on the increased demand for infrastructure investments, in September, we launched a global listed infrastructure UCITS fund, which will be actively marketed in both Europe and Asia. In the US, we also registered to launch a low duration preferred fund, which given our expertise and track record should compete well for the float of capital coming into low duration funds. We hope to make this open to investors before the end of the year. I am going to stop there and ask the operator to open the floor to questions.

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

Thank you and good morning. You were just mentioning some pretty good success with the preferred strategies. Just wanted to get your thoughts and comments on the level of issuance there and any capacity constraints that might be in those strategies?

This is Joe Harvey. The issuance in the preferred market has been very strong and one of the biggest drivers of that has been increased regulations, primarily in the banking and insurance sector to increase capital requirements and buffers for those industries globally, so that’s been a very dramatically growing universe. In addition, the complexity of those securities has increased, which plays to our strength. In terms of our research and portfolio management capabilities, there has been a new type of security called a contingent capital security or CoCo security, which is a subordinated security to help banks achieve these capital requirements, and we are very excited about these trends and our ability to add value in the markets. In terms of our strategic plan, we’re starting a new strategy as Bob mentioned, low duration open-end fund strategy and that opens up another market for us, and in that area, we’ve got very substantial capacity. In terms of our core preferred strategy, there are ultimately limits, but I am not going to quote numbers here, but we have substantial capacity to take on the inflows that we are seeing in our open-end fund. And I’d add, we expect to have a broadening interest from other types of investors, including some interest in the institutional market. Historically, it’s not been a market that institutions have been interested in, but because of the yields available, because of the value that can be added due to the credit, we think that there is a place for preferreds and institutional portfolios as well.

That’s good detail. Thanks, Joe. And then I wanted to ask about – a little about the timing of flows in the quarter. I know, I am sure you don’t want to get too picky about that, but just in terms of the Fed’s no-go decision, whether you saw any infection in flows or institutional interest around that? Thank you.

Adam, I don’t think, we really noticed any meaningful change in flows sort of before or immediately after the Fed’s announcement. We have been very aggressively telling our clients that where REITs are valued today and particularly in the context of the current economy that investors should be increasing their allocation to, particularly to U.S. REITs, and we think it’s a compelling proposition, and we're seeing some positive response to that.

Okay, sounds good. And then lastly, thanks for taking all my questions. You mentioned the institutional advisory business in Japan which still seems pretty small, but I know you've been increasing your efforts there. Just wanted to get to your comments and thoughts on where that stands, what products you are seeing interest and what types of clients. Thank you.

Yeah, as you mentioned, it’s not only small, it really doesn't exist yet. But as you noted, we’ve been developing relationships and dialogs in that marketplace for almost two years now, and an answer to your question, we've been pleasantly surprised that in addition to interest in discussing infrastructure and listed real estate, we’ve been particularly pleased with the interest in preferreds as Joe noted, particularly on the part of some financial institutions, insurance companies, and the like in Japan. So while -- as I said, we're starting virtually zero, we very much like the quality and quantity of discussions we're having, and we're delighted that it reaches beyond one or two strategies.

Thanks. Sorry, just to follow-up. Do your relationships in the sub-advisory channel help with advisory prospecting or are they just separate channels?

No, they do help quite a bit, because some of the companies that are dominant distributors in the retail marketplace have trust company cousins, if you will, that are very significant gate keepers in the institutional marketplace. So we have a very strong brand recognition in the retail space there, particularly in real estate infrastructure and preferreds, and as we've said in the past, institutionally from the government on down, there is a push to reduce fixed income and add risk investments to client portfolios and pension fund portfolios, and in particular real estate and infrastructure are being highlighted. And so, we're getting -- virtually all doors are open to us. Everyone wants to hear what we think on the listed side, which is not their first thought with respect to real estate and infrastructure. It’s first private, but the volume of assets that will likely flow into those asset classes, will easily dwarf the ability of the private market to put that money out. In addition, there are institutions, they are like insurance companies, which need liquidity and some of these investments. So again, at this point, there are serious discussions, but we don’t have anything to report yet.

Makes sense. Thanks very much. Appreciate it.

Our next question comes from the line of Ann Dai with KBW. Please go ahead.

Hi, good morning and thanks for taking my question. I wanted to start with the Real Assets Institute. As that continues, is there any data or anecdotal points that you could point to just something to kind of show the progress with that road show?

No, we really don't have any specific data that we can share. We find that and our commitment to the institutes almost two years ago were mainly focused at the time on educating the market, selling the knowledge gap and at the same time building the preeminent brand in the space. And given the fact that most investors that the institutes are targeted towards really had very little knowledge or understanding of real assets in contrast to the institutional market, we committed to doing this well in advance of there being any ground swell of interest in the space. We have seen as we are conducting institutes, if it’s in that particular month or quarter. The investment performance of the underlying strategies is strong. We do see a correlation to flows and then in quarters where that's not the case, we don't. But our view has been that just like in REITs, we want to plant the flag early and before anybody else, establish ourselves as the thought and investment leader. And when we think inevitably investors are interested in allocating to real assets broadly or individually, we will be the go-to guys, because we've got the performance and we've got the thought leadership and we've made the commitment to the marketplace.

Great. I appreciate the color. I also wanted to touch briefly on the net cash investments breakdown that you guys provided and also thanks for providing that supplement. It’s very helpful. So if we look at that breakdown and we think about the $1 special dividend from last year and frame that against the U.S. cash position you had as of fourth quarter last year, it seems that at that point the company was comparable with returning most of its unencumbered cash to shareholders in the form of the special. Is there anything you see that’s different in your operating environment today that might impact your views on capital return, for instance, maybe some higher CCAP requirements that may be you have yet to be funded?

Hi, Ann. This is Matt Stadler. First of all, thank you and we welcome you to the call.

Thanks, Matt.

I think just how we think about our cash and it’s coming up to that time. We have done specials in each of the last five years. We go through a pretty robust exercise where we consider other deployments of cash and ultimately what’s in the best interest of the company and the investors. As you pointed out and Bob had mentioned in his remarks, we have a global listed infrastructure CCAP that we just recently launched and we are going to be launching a low duration fund. And that's going to require increased amounts of seed than what we had seen in the past in order to get on the appropriate distribution channels. So that’s going to be a competing input into the exercise. We've also seen, while there is nothing to report, increased activity on the M&A front on things that would be interesting to us, but nothing that were that far down the road and so we would want to have just based on the activity levels this year versus where it's been in the past that's also a consideration for seed. So I think you are right to ask the question, but I think that unlike prior years, we've got other competing inputs and you will be finding out after our board meeting next month.

Okay, thank you all.

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

Good morning, gentlemen, and thank you for those new slides, it’s helpful.

Thanks, Mac.

Maybe just highlighting a little bit more about the Australian relationship, I guess what’s the next step there? Does it depend on the success of this new launch and perhaps how do think about the potential size of the opportunity in that region?

Matt, this is Joe. So I think that we should look at that existing – the fund that we just created, the Argo Listed Infrastructure Fund is sort of a discrete event. We talked in the past about the fact that that fund can grow in size due to the structure of the offering and the fact that there's an option for those investors to double their investment in the fund if the assets perform well and the NAV is above the offering price. And we won't know how that plays out until the first part of 2017. That said, we think it's important and just to back up in terms of that specific relationship, this is the first or the largest new closed-end fund that’s been done in that market for some time eight years. It’s the first new fund that our partner, Argo, has done in many, many years, they’ve been a very conservative and very successful asset manager in their own right. But what's important about the offering is that it really showcases us to a broader audience in Australia. It's a market that does like hard assets, real estate infrastructure both in the private markets as well as in the listed markets and it’s a market that we're interested in doing more in, but we don't have anything to report at this time.

Great. And just as a follow-up on the preferred in the insurance opportunity, when you -- in your history of other institutional products, when you engage in insurance company, you're talking about potentially setting up a product. What is the typical development time or to building relationship maybe getting to launch or an asset man in that front, how long does it take to germinate?

Are you referring to the discussion of preferreds in the Japan market?

Actually, I did not mention it. Perhaps, maybe the Japan market and also the US as well.

Well, the Japan market is very unique and we’re very active in talking to different asset managers and distributors, both in the wealth management area as well as the institutional area. And in wealth management, it's a very active process of the distributors trying to think about what the market wants and then align that with asset managers that can produce the strategy or the characteristics that the market wants. So we are routinely working with the distributors to present different types of portfolios, different customized versions, in this case, in the preferred market for a specific distributor, a specific market and it often revolves around, in the case of preferreds, the yield and the duration of that strategy. Institutionally, it can be a much more involved process where we’re evaluated by asset consultants, very similar to how we would be evaluated by an asset consultant and a traditional institutional process here in the United States.

Okay. Thank you for taking my question.

Thanks, Mac.

[Operator Instructions] Our next question comes from the line of John Dunn with Evercore ISI. Please go ahead.

Good morning, guys.

Good morning, John. Welcome.

Thanks. Can you give us an update on the opportunity in the institutional advisory, Asia ex-Japan channel and then also talk about the sort of the composition of the assets in the other sub advisory channel domiciled?

An answer to the first question, which I think was what are our growth prospects institutionally in the Asia ex-Japan market --

Yes.

And I don't know if the genesis of the question is that because we've had some good success there over the last year or so, I would say that we’re still active, but the market is not better or worse than we’re seeing anywhere else. It’s still -- there is still interest, but I wouldn't say it’s as interesting as the Japanese market, which is I think much deeper and much further along.

John, as far as the composition of the other, the 5% in other, the majority of that’s large cap value, which we now show in other and then commodities makes up -- commodities and our fund to funds product makes up the balance. It’s primarily large cap value.

Got you. And then I think Matt had said that there was, you saw some inflows into commodities, how do you picture that at the present time, the commodities and natural resources and what do you think the institutional investor sentiment is for those products?

That's a great question, John, because and the numbers send the same message and that is the wealth channel is thinking and acting substantially differently this year and currently than the institutional market. In the institutional market, we’re seeing strong interest in real assets. Generally, allocations are rising. We see in an environment where almost every trade feels crowded and overvalued. When you see areas of the markets, be it commodities, be it resource equities, MLPs, there is so much liquidity out there, looking for high returns that we are saying a significant number of institutions that are committed to the real assets space and in those areas within real assets, where there has been underperformance, may be significant underperformance. That gets them interested and that's attracting frankly just what we've had, flows and institutional accounts, unsolicited coming in, in both natural resource equities and commodities. As I mentioned earlier, I feel very strongly that we're seeing -- in the midst of seeing the same thing enlisted real estate. Jon Gray of Blackstone and other private equity investors have made no secret of the fact that they've raised record amounts of money for private real estate, when listed real estate is showing at $0.90 on the dollar and that’s going to be better if that relationship remains, the best use of that capital will be the public markets. So we are seeing and the reason I mention institutional flows into private real estate and infrastructure was to, one, point out the almost insatiable demand institutionally for real assets that are challenged put the money out and with REITs and MLPs and resource equities, being historically undervalued. We're not surprised that capital is -- net capital is flowing into that space. And conversely, with think that the wealth channels, in our view, misguided concern about interest rates and REITs and infrastructure will be short lived and is providing a tremendous opportunity and we think we are beginning to see some changes there as well.

Got it, thank you very much.

Thanks, John.

And there are no further questions on the phone lines at this time.

Great. Well, thank you all for dialing in this morning and we’ll stay in touch. Thank you.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.