Janus Henderson Group plc (JHG) Q3 2018 Earnings Report, Transcript and Summary

Good morning. My name is Nicole, and I will be your conference facilitator today. Thank you for standing by, and welcome to the Janus Henderson Third Quarter 2018 Results Briefing. [Operator Instructions] In today's conference call, certain matters discussed may constitute forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements due to a number of factors, including, but not limited to, those described in the forward-looking statements and Risk Factors section of the company's most recent Form 10-K and other more recent filings made with the SEC. Janus Henderson assumes no obligation to update any forward-looking statements made during the call. Thank you. It is now my pleasure to introduce Dick Weil, Chief Executive Officer of Janus Henderson. Mr. Weil, you may begin your conference.

Welcome, everyone, to the third quarter 2018 earnings call for Janus Henderson Group. I'm Dick Weil, and I'm joined today by Roger Thompson, our CFO. Today, Roger will be taking you through the results for the quarter, and then after his prepared remarks, we will be happy to take your questions. As you know, we take a long-term view of our business versus the short-term view that is inherent in quarterly reporting. To that extent and similar to our first quarter call, Roger will be providing you with updates on the quarterly flow, performance and financial results. We will use the second and fourth quarter calls to address these same items, along with a more robust discussion of our business and strategy. We believe this set up will help better align our calls with the way we manage our business. With that said, let me turn it over to our CFO, Roger Thompson, to walk you through the third quarter results.

Thank you, Dick, and thank you, everyone for joining us. Driving straight to results. Investment performance remains solid with 60% of firmwide assets meeting their respective benchmarks over the 3-year time period as at the 30th of September. While we're pleased with this result, there are pockets of short-term underperformance in key areas such as European equities, INTECH, and Fixed Income that need to improve. These sorts of performance challenges happen in the diversified business such as ours, and we're focused on improving the results and the strategies that we're experiencing challenges in. Net outflows declined to $4.3 billion in the quarter, as a result of some of the short-term underperformance. While we're disappointed with the results, it does not define our long-term value proposition or derail our plan to deliver organic growth. And there are areas of our business that are doing very well, which I'll touch on a little bit later in the presentation. Assets under management improved to $378 billion at quarter-end, reflecting market gains, which more than offset the net outflows and slight FX headwinds. Finally, financial performance remains strong, with adjusted EPS of $0.69, and adjusted operating margins of 38.5%. Additionally, we returned approximately $135 million of cash to shareholder in the quarter via dividends, share repurchases, and the repayment to the remaining convertible notes. Moving to Slide 3, and our investment performance. Overall investment performance remains solid, and despite a dip in the metrics through the end of September compared to the other periods presented, the majority of AUM is outperforming benchmark over the 1-, 3- and 5-year periods. In looking at the capabilities, the Quantitative Equities capability, which is the INTECH business, experienced the biggest change from the prior period. INTECH's one year performance of 21% of assets meeting benchmark compared with 47% in the second quarter, and the 3-year performance of 8% of assets meeting benchmark compared with 25% in the second quarter. The decline in investment performance of INTECH was driven by 2 factors: First, strong performance in the U.S. markets during the third quarter with the results of outperformance by mega cap growth stocks. This high concentration in U.S. equity markets was a headwind for INTECH's U.S. strategies which seek diversification. Conversely, INTECH's non-U. S. and global strategies benefited during the quarter due to their diversified approach as non-U. S. markets showed less concentration and more breadth in general. Second, specifically impacting the 3-year results, performance from the third quarter of 2015 represented a particularly strong period of outperformance for the firm and that rolled out to the measurement period in this quarter impacting the overall result. Now turning to total company flows. For the quarter, net outflows were $4.3 billion compared to $2.7 billion last quarter. The quarterly results reflects an increase in institutional Fixed Income outflows, primarily in North America and Asia-Pacific. Despite this quarterly outcome, the global institutional pipeline is seeing a growing number of opportunities in North America, the Middle East, China and Australia, which we remain very encouraged by. We did see an improvement in intermediary flows during the quarter, and while still negative in total, all regions improved compared to the prior quarter and North America and APAC at positive net flows. Moving to Slide 5, which shows the breakdown of flows in the quarter by capability. Equity net outflows for the third quarter declined to $3.1 billion, primarily as a result of fewer mandate findings compared to what we experienced in the second quarter, and ongoing outflows in the European Equity Funds. Flows into Fixed Income were negative in the quarter at $1.6 billion. This resulted from the mandate losses in our North America and APAC institutional plan that I mentioned earlier, partially offset by improvement in flows across our intermediary clients in North America and EMEA. Flows at INTECH were breakeven, driven by improved gross sales compared to the prior quarter. Multi-asset net inflows were strong at $900 million in the quarter. This result was driven by $1.3 billion of net flows into the balanced fund as a result of the strategic exceptional investment performance and the global strength of our distribution team. Encouragingly, the funds generated positive flows across all 3 regions of business, including both intermediary and institutional clients, showing the cross-selling benefits of the merger. The biggest impact in the quarter was seen in North America, which had almost $900 million of balanced fund net flows. This result drove notable market share gains during the quarter in the active U.S. Mutual Fund market, which we were pleased to see. This is a perfect example of the type of results we expect the combined firm to be able to deliver, and we hope to have more success stories like this in quarters to come. Finally, alternative net flows were negative $500 million, which was a slight improvement over the second quarter. Slide 6 is our standard presentation of the U.S. GAAP statement of income. Turning to Slide 7, where I'll look at a few of the financial highlights. Our third quarter adjusted financial results are strong. Average AUM in the third quarter increased 2% over the second quarter, primarily driven by positive markets, which were partially offset by outflows and negative currency movements. Higher average assets drove an increase in management fee revenue, which was offset by the expected seasonal decline in performance fees, resulting in a 2% decline in total adjusted revenues from the prior quarter. Adjusted operating income in the third quarter of $181 million was down compared to the second quarter, primarily as a result of the seasonally lower performance fees, compared to the third quarter of last year, adjusted operating income was up 7%. Third quarter adjusted operating margin of 38.5% compared to 40.1% in the prior quarter and up from 37% a year ago. Incremental margin in the third quarter relative to the same period last year was 85%. A strong indication of the firms effectiveness to converting higher revenues into higher profits. Finally, adjusted EPS was $0.69 for the quarter, compared to $0.74 for the second quarter and up from $0.56 a year ago. On slide 8, we've outlined the revenue drivers for the quarter. Performance fees were the biggest driver of the quarterly change in adjusted total revenue. Third quarter fees were negative $6 million compared to the positive $14 million in the second quarter and a negative $2 million in the same period last year. As we've discussed on prior calls, the third quarter had significantly less AUM subject to performance fees compared to the second quarter. And therefore in the third quarter, you saw a decline. In addition, the performance fees on U.S. Mutual Funds declined quarter-over-quarter, primarily as a result of a decline in the 3-year performance of the Forty and Mid Cap Value Funds. Management fees increased 1% from the second quarter, directionally in line with the increase in average AUM. Net management fee margin for the third quarter was 44.1 basis points down very slightly compared to the prior quarter and the same period a year ago. The decrease was primarily due to mix shift as we've seen continued outflows from our European Equity strategies. Moving to operating expenses on slide 9. The third quarter had adjustments associated with integration as well as non-deal costs. It was approximately $19 million of integration costs incurred during the quarter, which includes costs associated with the sole CEO announcement. This brings the total deal and integration costs we have recognized to approximately $235 million. We expect the remaining costs of completing the deal and achieving the merger synergies to be $25 million, making a total spend of $260 million compared to our original estimate of $250 million. Non-deal costs adjusted out of operating expenses in the quarter were roughly $13 million, and mostly consisted of intangible amortization of investment management contracts and contingent consideration. Adjusted operating expenses in the third quarter were $288 million compared to the second quarter amount of $286 million, a less than 1% increase quarter-over-quarter. Adjusted employee compensation, which includes fixed and variable costs increased 4% compared to the prior quarter. The increase relates primarily to accounting for interest credits associated with the firm's pension in the UK, whereby these credits were previously recognized as offsets against compensation. Going forward, the interest credits will no longer be an offset against compensation, but rather will be booked through the other non-operating income line. And the third quarter includes a year-to-date adjustment for this change. Adjusted long-term incentive compensation was down 6% from the second quarter, primarily due to the impact of grants rolling off, partially offset by a true-up in the mark-to-market adjustments to mutual fund share awards. Turning to the prior quarter, in the appendix, we provided further detail on the expected future amortization of existing grants, BTUs in new models. The third quarter adjusted compensation to revenue ratio was 43.2%. When adjusting out the onetime portion of the accounting changes I just mentioned from the pension interest credit and the mutual fund share awards, the ratio is 41.8%, which is in line with the low 40s that we've communicated previously. Turning to adjusted non-comp operating expenses. Collectively, it was a decrease of 1% quarter-over-quarter. The main drivers of the decrease were lower marketing costs, partially offset by higher G&A, and investment admin costs. The decrease in marketing was primarily due to seasonality. Looking forward for the fourth quarter, we do expect to see a seasonal increase in non-comp spending, however, the full year non-comp spend will be below the guidance we have previously provided, and we now expect to see that up approximately 8% year-over-year. Turning to Slide 10, and a look at our profitability trends. We continue to generate strong operating profits and EPS. Our financial results represent the continued efforts towards costs synergy execution, and our commitment to maintain financial discipline. We've achieved $119 million of our committed $125 million of annualized costs synergies at the end of the third quarter and expect to reach our $125 million target by year-end. Remember, this compares to our original target of $110 million to be achieved by May 2020. So we're very proud of this result, and I wanted to thank all of our employees for their continued efforts. Whilst there are still efficiencies to unlock in our business, some of which are still to come from the merger. We will not continue to separately report on synergies once we've delivered the committed $125 million, as we want to focus on running our business for the future rather than measuring on a backward-looking metric. You will see these future efficiency saves continue to come through our results and our margin. Turning to EPS. The third quarter adjusted EPS of $0.69, is down over the second quarter, but 23% better over the same period a year ago. There were a few non-operating items impacting EPS this quarter. First, we had investment losses of $8.3 million, which were driven by losses on the seed book and other investments, partially offset by the gains recognized on the mutual fund share awards for those discussed earlier. With these losses, they're also corresponding offsets in non-controlling interests, which totaled $6 million in the quarter, so you should think of these on a net basis. Second, in the other non-operating income line, you see the impact of the change to the treatment for the pension interest credits, which made up most of the income in that line this quarter. Finally, our recurring effective tax rate for the quarter was 23.7%, making the year-to-date recurring effective rate 22.5%. This higher quarterly tax rate compared to the previous quarters of 2018, reflects a year-to-date adjustments on estimated tax income from a regional standpoint as more income is being generated in the U.S. Going forward, we still anticipate the statutory rates of 21% to 23%, and the effective rates will be impacted by the various differences which arise quarter-to-quarter. Slide 11 is a look at the recent capital return initiatives which we've executed. As we sit here nearly 18 months since the mergers closed, we are delivering the capital return plans we've communicated previously. And I wanted to spend a moment reviewing the results and discussing how we think about these efforts going forward. Currently, our business generates roughly $500 million of operating cash flow per year. Over the last 1.5 years, we've been focused on working through many of the near-term cash needs we had in our business. These needs included a period of elevated cash spend associated with deal and integration costs, and the repayments of the 2018 convertible notes. With deal and integration costs winding down, and the repayment of the convertible notes complete, which resulted in an aggregate cash outlay of more than $390 million in 2017 and 2018, there were fewer ongoing demands of cash going forward. Accordingly, in the third quarter, we initiated a stock buyback program and completed $50 million of the $100 million authorized. This $50 million of repurchase activity reduced our outstanding share count by approximately 1.8 million shares or roughly 1% of shares outstanding. In relation to this, I think it's important to reiterate that when it comes to granting employees shares of company stock as part of compensation, as a firm, we've adopted a practice of purchasing shares on market for these annual grants. And therefore, we do not annually dilute shareholders as part of our compensation practices. What this means is that each share that the firm repurchases under its current buyback authorization is accretive to shareholders. In addition to buybacks, we're paying a fairly healthy dividend, which at today's price offers a very attractive yield to shareholders. Looking forward, we're generating excess cash, which allows us to continue to follow the capital return philosophy which we've previously laid out for you. We will evaluate and balance the ongoing investments the business requires with the external opportunities that we see, and when excess cash remains, we will seek to return that capital to shareholders. So in conclusion, before we open it up to Q&A, let me sum up where things stand. Our financial results are strong, reflecting stable management fee margins, disciplined expense management, and continued realization of cost synergies, and we remain committed to returning capital to shareholders. The flow result for the quarter is disappointing. However, our long-term outlook for the business has not changed. We're seeing encouraging results in several areas of the business where we're gaining market share, and we remain confident in our ability to achieve positive organic growth. In the short term, our focus remains on delivering on the promise of our merger, by completing the infrastructure integration, and development projects over the next 6 months, and effectively and efficiently delivering the full lineup of investment solutions through the full range of our client relationships over the next 12 to 18 months. As we continue forward, we'll keep our clients at the heart of everything that we do, and focus on delivering excellent investment performance and a great client experience. With that, I'd now like to turn it over to the operator for questions, which Dick and I will be happy to answer.

[Operator Instructions] And we'll take our first question from Ken Worthington from JP Morgan.

Hi. Good morning and thank you for taking my question. Maybe first on the Fixed Income business. You identified outflows that took place this quarter. What I'm really interested in maybe is, why the outflows are taking place? You had outflows in each of the quarters of 2018 and aggregate outflows in '17, but the performance of the products at least in aggregate appears to be not just strong, but particularly strong. So what's the connection here? Why the kind of ongoing outflows in your Fixed Income operation?

Ken, it's Roger. I think the performance against benchmark is pretty good as you say. When you look across the board, the overall percentages are pretty good. When you look more on a comparison, comparative basis, so looking at the mutual funds as an example, you'll see the numbers are, they're okay, but they're not spectacular. So our overall performance has been good, but probably not as good as we'd like it to be. And that's where Jim Cielinski joined us about a year ago. Now has been really looking at the process, where we are taking risk. And looking to obviously, continue to improve that overall performance. So yes, I think the, that is one of the cases where looking at benchmark only tells a part of the story. So our numbers as I say, performance numbers, they're okay, but we'd like them to continue to be better. In terms of the short-term numbers, the outflows in the third quarter were probably a little bit more tactical than that. There were some more cash in short term, short duration money that was taken off the table by clients in the third quarter.

Okay, great. And then maybe talk about Dai-ichi. To what extent are we seeing Dai-ichi investment in Henderson products? And maybe if you can talk about the outlook for any strengthening of this cross-selling relationship between Dai-ichi and Henderson, and maybe legacy Janus as we look forward to 2019?

Sure, Kenneth, it's Dick. Thanks for the question. So the Dai-ichi relationship continues to be as strong as it's ever been. And we remain very optimistic about the opportunities that it brings for us. They have about $2.8 billion of their general account assets invested with us. I'm not sure how much more it fits in their general account investment strategy to invest with us. That's probably not the biggest area of opportunity. But we're very grateful for that support and we'll see how that develops. Then they have an affiliate group, which includes Asset Management One on the ground in Tokyo. They've helped distributed over $6 billion of assets to third parties over time. And we continue to be really optimistic about our partnership with them and grateful for their help. The truth is, they've also been going through a merger of their own, on the ground in Tokyo. And I can't promise that I have perfect insight into what's going on inside of Asset Management One. But I think that, that likely affected the size of the opportunities we've had with them lately. The next piece of the puzzle with Dai-ichi support is, they're fully owned subsidiaries and the business we can do with them. We manage roughly $2 billion of Fixed Income assets for TAL down in Australia, and they also have some other subsidiaries around the world. And we're optimistic that in the future, we might have the opportunity to earn some more business across that set of affiliates. And so it's not going to be every quarter that we report a big step forward with those folks, but it wasn't too long ago that we reported the TAL investment with us, and we're optimistic that in each one of these buckets in the future, we continue to have a good upside.

And we'll take our next question from Michael Carrier from Bank of America.

Maybe first one just on the flows. So Roger, I think you mentioned the Fixed Income and European Equities, you're kind of weighing on the flow trends. You mentioned multi-assets, but any other areas of strength, and I guess just on the European Equity side, what's the, when you look at the performance, what's dragging it down? Or what, whether it's an environment where you could start to see that turn around?

Mike, let's take it into pieces. Yes, European Equity, we've, we, obviously had some poor performance in over the last 18 months. Actually, in terms of, it's almost the opposite of the comment I just made on Fixed Income. Of course, our performance is actually improving quite dramatically. But we're still behind benchmark. So some of the bigger funds there are in behind benchmark are approaching top quartile in this year-to-date. There's certainly some, there's certainly been some, there is more of a value bias in a number of those portfolios. And as we've obviously seen a very significant growth and particularly momentum bias in portfolio or in returns, which hasn't benefited. And in addition, there's certainly been some individual stocks which haven't gone our way. So there are a number of things in there. The teams are strong. These are fund managers with incredibly strong track records. We've added several other teams. And, but they're very stable and very long-term teams. So it is what it is. We continue, we've had outflows. We're still seeing outflows. And that is of the back of weaker performance. On the plus side, yes, Balanced is the shining star of the quarter. As I say, selling in the intermediary and institutional markets in all 3 market, in all 3 regions, in the U.S., in Europe, and LATAM, and in Asia. So that's a perfect example of the sort of, we've described it before on green sheets for the merger. Again, I will reiterate what we said 18 months ago, which is that revenue synergies will take 3 to 5 years to be fully bedded in. But that's an example of something that's going very well. What else is selling well? And some of the U.S. equity portfolio, so Triton, Enterprise, Global Emerging Markets. And then on the fixed, sorry, so that's really the success stories in equity.

Okay. And then maybe just one on the expense side. So as you think about, once you realize the synergies and you look at kind of the investments that you're making to maybe ongoing efficiencies. Give us some sense of what like the core expense growth should you had? And then 2 small things that you just mentioned, the long-term incentive comp plan. I know you guys have that table in the back, any sense of like the 19 grants on like how that all impacted? And then on the UK pension cost, if you could just run through those numbers again and more importantly, just how it impacts the forward?

Yes. So taking the last bit first. That's just an accounting change between what's in a net reduction, which is the reduction in the comp line and is now effectively a number that's grossed up between compensation and other income. The net change there is -- I guess, we've given you both -- it's about -- in total across the 2 things we've adjusted in the quarter, you can -- we do need the ratio, but you can work it out. It's a sort of $6 million or $7 million adjustment that we put through in the quarter. Going into 2019, we're just in the early days of our budget process for 2019 at this stage, I might say, it's a bit too early to say. But yes, there's a combination of synergies that are still coming out of the business. Short-term things that you have to do and things we have to feed in our business and strategic investments that we want to make to continue to grow -- to continue to see the success and growth of the business. But I think probably best to pick that one up with full year earnings.

And we'll take our next question from Kieren Chidgey from UBS.

Hi, guys. Two questions. First one on INTECH flows. I'm just wondering what the client response and discussions have been like following the sort of more volatile performance over the past 2 quarters, particularly so soon after the weaker performance at the end of '16? Has that thrown up more questions around the process there? And sort of -- what sort of discussions have you been seeing?

I think it's too early to give you a -- this is Dick Weil, I'm sorry. I think, Kieren, it's too early to you give you a direct answer to that question. I think that's all just unfolding as we speak. We obviously anticipate a lot of questioning from clients on this basis. INTECH, I think, is well prepared to address those things. But you're right, we're uncomfortably close to the second half of 2016, and we expect there will be a lot of questions. But I think it's a bit too early to answer that intelligently yet.

Well, but the -- I mean, surely the work you've done in terms of what's driven that weaker performance, I mean, is it consistent? Are you still comfortable with the process? And sort of how that's working?

Yes. I think one of the -- as I said, one of the biggest drivers going through Q3 on the U.S. portfolios was the strength in those mega cap stocks. And the incredibly concentrated nature of those and what they represent in the U.S. market. And the INTECH process, which is a more diversified process would by definition have been significantly underweight those stock. So yes the underperformance in Q3 makes sense and is very explainable. Obviously, some of those stocks have taken a bit of a tumble over the last month. So I would just say, that's too early to say what's going on next. But yes, we totally understand where we are as of the third quarter and it makes total sense.

And we'll take our next question from Dan…

And I guess -- sorry, operator. I think the last bit on that is, yes, and I think clients will also think that makes total sense. But as Dick said, there will be conversations -- plenty of conversations going on. Sorry, operator. Thank you.

And we'll take our next question from Dan Fannon with Jefferies.

Hi thanks. Good morning. I guess just a follow-up on that. Can you just talk about, obviously, backlog INTECH mostly institutional, kind of the gross sales, kind of dynamic, anything you may know as of now? And then also October, I know it's very short term, but it was obviously a very volatile month, can you characterize how the INTECH strategies kind of did in that kind of short period of time as well?

Yes. Dan, I mean, we -- as I think most of you know, I don't like doing quarterly earnings let alone, and we don't like talking about quarterly flows or monthly flows or monthly performance. So that is way too short of time period to draw any conclusions from. So let's look at it on a long-term basis, please.

Okay. But I guess then just your long -- the backlog, which would be focused on the 1-, 3- and 5-year numbers that we know or your clients in terms of now, is there much you can say? And maybe talk for leave out the institutional maybe beyond INTECH?

Yes. Okay. Yes, well, yes, 2 things. So taking INTECH first. I guess we were particularly, yes, we're very pleased, but with a flat number in the quarter. And as you -- as I said on the call, we actually saw some growth inflows there, which were higher in the third quarter from the second quarter. So this business being one, that business continues to develop. The -- but again, as we've talked before, the sort of -- the jewels of possibility are quite large. There are some very large lumpy institutional mandates. And INTECH will hopefully continue to win some large lumpy institutional mandates. But we are very aware. And the management team there are very aware that with poor performance comes risk of lumpy outflows as well. So I think where we are at the moment, the quarter looked good from a flow point of view, it didn't look great when it's -- from a performance point of view as we talked about and that creates some risk for the future. There is nothing that you should -- we're not hiding anything from you about massive outflows, which we're seeing, no. But it'll be what it'll be going forward. Institutional more broadly. You know there's some -- definitely some continued growth in our relationships there. As we've grown the institutional footprint around the world, post the merger, we're optimistic about a number of product areas, whether it be multi-asset around adaptive allocation, diversified risk premier, our emerging markets franchise continues to win business. So we've got plenty of products which are interesting in the institutional space. And we've got geographies, where we're currently very underpenetrated. And we've got better, more established teams on the ground. Again, that takes time. But we've got more discussions going on in the U.S., I think I told you on the prior quarter, it might have been in the one before, I think it was the second quarter about our first win in the Middle East for a long time. There's good potential there for 1 or 2 more. We've obviously got a good business in Australia, where we've been winning institutional business. So the institutional opportunity set is something that we're positive on in looking forward. Institutional will be more lumpy than intermediary. So -- and we've got to be patient.

We'll take our next question from Craig Siegenthaler from Credit Suisse.

Thanks, good morning. So Enterprise is your largest fund, Triton is your fourth, and they both have soft closes in place. So can you talk about your ability to grow these 2 funds organically despite being close? Because we've noticed from the third-party retail data that there's, they're both still inflow on a net basis?

Yes. They're closed to new clients. They're open to existing clients. So that's what, a soft close is there to protect the existing clients and ensure that the managers are able to do their job efficiently. As you can see from the performance, managers are doing their jobs very efficiently. But whilst they're soft close, they are continue, they can continue to take money from existing clients. And pleasingly, they are doing that. At some point, yes, you would have to consider whether they are moving to a position of a hard close, where you have to say no additional money at all. That's something that you, we manage very carefully and look very long way down, look a long way down the tracks. So we're in a good position with those funds, the managers are happy where they are, with them being close to new business, but existing to or rather bit open to existing clients. I think you might have said the balance was closed there? If you did that's wrong.

No, no.

They're not closed. Okay, good. That has a lot of capacity.

Yes, not balanced. But, so, and Enterprise being $19 billion and Triton being $12 billion, how far are each of them from the hard close?

That's not a number we publicly disclose. But we're in regular communication with the portfolio managers and we'll, as those numbers become appropriate, we'll disclose them. But at this point, we don't have anything to announce and the managers are quite happy with where they sit today.

And we'll take our next question from Alexander Blostein with Goldman Sachs.

So the first question just around Brexit. How I guess is Janus positioned? I know they are further in this process. Operationally, any changes do you guys envision you might have to make if things don't go smoothly? And when it comes to the client experience, any pullback you're seeing in terms of gross sales, specifically related to Brexit concerns? And I guess your expectations of a continued being a bit on a limbo here, could that continue?

Yes. Nothing has changed from what we've previously told you. We're in very good position in terms of having a very established European business that is based in Europe. So we have actually 2 Luxembourg ranges and a Dublin range. As I talked about before, we are adding a little bit of resource into that that is all agreed with the regulator. And we're probably half the way through recruiting it. To be brutally clear, it's adding 12 people in Luxembourg, some of those roles are, moves of roles from London. So it's probably a net out of 6 or 7 people. And again, as we've always said in operations, operational risk, compliance-type roles. So we're very well positioned there. There's a little bit of work we have to do in terms of restructuring entities. But again, we're well progressed there. Like you say, the client impact is something that we take very seriously, to try and ensure that we're not causing clients undue hassle. There is a little bit of repapering we'll have to do. We're obviously trying to keep that to a minimum. But net-net, we're in a very good place. The sort of nuclear option we've talked before is delegation. We are, we have to make, we make it. So we're prepared for a hard Brexit, I guess is a summary for the first part. If there was no delegation of investment management to the UK on the 29th of March next year, that would be a problem. Yes, and, but that is a consistent problem across the industry. The regulators in all jurisdictions are being very, very clear that, that is not something we should be planning for, and that will get sorted. But I'm sure it will take a little bit longer to get those bilateral agreements between Lux and Dublin and the UK sorted. But that's, that would probably be my tail risk. But I'm being told very clearly by European Lux, Irish and UK regulators and governments not, that, that is a, that, that will get sorted.

Got it. And then my second question is just around performance fees. Obviously, you guys have a lot of transparency on the U.S. side, but as we think about the SICAVs and it really just a non-U. S. part of the business, how should we think about the watermarks? How, high watermarks, how we should think about kind of the prospects for those performance fees over the next 12 months given the non-U.S. performance has been quite challenged?

Yes. So I guess, there's 2 pieces. There is a, we've laid out the timeline of when we've got accounts with performance fees on them and as you know, they're significantly less in the third quarter. So this quarter shouldn't surprise you. And the fourth quarter is a seasonally strong quarter. So we've got a number of portfolios with performance fees, performance fee windows open if you like in the fourth quarter. In addition, we've got the quarterly performance fees on the UK Absolute Return Fund, that's sort of $8 billion or $9 billion fund. That fund is slightly behind its benchmark at the moment. So it's obviously got to make that back before we'd start to earn anything in the fourth quarter. And on the annual performance fees on the long only funds, yes, it's an incredibly diversified portfolio. Performance is probably, I guess, when you look at overall performance, it's a bit weaker than it was a year ago. So it is a real mix, it'll be where it'll be on the 31st of December. I guess when you, I can say, when you look at overall performance, it's a bit weaker than where it was in Q4 last year. So on average, you probably expect a slightly less, a slightly lower number on that than last year. But I guess, saying it is portfolio by portfolio. So I guess I've only just given a guess just to what it might be. And we'll see what it is at the end of the year.

And we'll take our next question from Patrick Davitt with Autonomous Research.

From the other side of Alex' question about Brexit. I guess there's some news today that it's perhaps going in a more constructed direction, although I think people are skeptical. Any sense of, if it does go in a more constructive direction if there's a pool of kind of relief flows on the sidelines that could come back in to the system and into your franchise, if there is a much more positive resolution than I guess the people were originally thinking?

I don't think we have a great sense of that answer. The nature of this Brexit process is, people will teeter up to the edge of the cliff, they'll look over, they'll take a few steps back and they'll get feisty again and get up right next to the edge of the cliff, and frankly, we try not to overreact to the daily news one way or the other. There's a lot of edge, and you never know which is really indicative of the future and which is just noise. So I wouldn't react too much to it. In terms of a pent-up, good news story of flows from Europe, we can hope for it, but I don't go anyway that we have to scientifically really estimate it or feel it coming. So sort of logically speaking, would I expect something? Probably as a gut -- as an intuition, yes, I probably would. But as a real, sitting here with any facts to back that up, I don't really have any. So you know, it's just a guess.

Probably more markets the FX.

Yes. You know what's going on in the overall global markets at the same time, where the people are derisking in the face of fear in equity markets, that will have a lot to do with behavior beyond just the Brexit piece. So it's going to be a complicated menu of things that set people's appetite, and that's pretty hard to predict at this point.

Okay. Fair enough. And then last quarter, you noted some risk to AUM from the management changes, both CEO and distribution. Any pieces related to that in the outflows this quarter? And any update on client conversations around those changes now that we're a few more months in?

Yes. No, the client conversations are fine. And none of that -- none of -- to our knowledge, look, we don't always have perfect knowledge of all the different factors that drive people's decision, but as far as we're aware, none of the flows were really affected by the CEO change, leadership change at all. So there's none of that in there and we're not looking for that to be a big influence on flows going forward. We don't understand that to be driving anybody's behavior at this point.

Thank you. We'll take our next question from Brian Bedell with Deutsche Bank.

Great, thanks. Good morning folks. Maybe just a quick one on the look into the fourth quarter given the backdrop. I guess one question would be, or one, I think that maybe we can -- maybe you can begin to observe is, the fee rates obviously went down in the third quarter due to mix and as we think about how performance -- how beta trends have been playing out so far in October, would you expect that fee rate decline to continue just in the way averaging works in the fourth quarter? And then related to that, how should we think about how the operating margin might play out, given that we're going to get the rest of the costs saves coming through? And the performance fee challenges that you mentioned?

Sure, hi Brian. Yes, without a doubt the -- with the equity markets rallying over the last few years, that has masked the fee pressure. And I'm -- as I said before, I'm a bit of a stock record on fee pressure. We do see it like everyone. And we estimate it to be about 1 basis point a year. But if you look at our fee rates, it really hasn't come down by much. It was 45 basis points in '16, it was 44.7, I think in '17, and we're at 44.1 in this quarter. So we -- but -- so that equity market rise has masked some of the fee pressure. And should markets fold, that would get unmasked. You would start to see that fee pressure about 1 basis point a year coming through. And there's no change in the story on fee pressure, it's still there. And we still turn away a lot of business because we're protective of -- we're protective in the margin and we're very cognizant to the earlier question around capacity. So yes, it's easy to win business. It's a hell of a lot easier to win good business -- hell of a lot more difficult to win good business. So yes, I'd expect fee margins to continue to move around. And you will see more of a decline in a falling equity market than in a rising equity market. In terms of our overall -- fees will be variable as they are every quarter. In terms of our overall margin, nothing's changed from the very high-level guidance that -- we've said before, that we hope and expect to run a business in markets like this with a margin that's around 40%.

And then just on the -- just one quick one on the European Equity Funds. The flow outlook, you mentioned, Roger, I think obviously, the value tilt there. So October, theoretically, might be better. I know you like -- don't like to talk about one month, but I guess, is there a hope that, that might be turning around? And what's the level of AUM that you would sort of still classify as -- in that condition?

Let me take the -- this is Dick, let me take the first part of your question, and Roger can take the second. Yes, obviously, a value manager should be doing well -- a conservative manager should be doing well in some of the market upset that we're seeing, and hopefully, the portfolios that we would expect to do well in that environment are doing well. I think at a high level, I'm seeing a lot of results that accord with that when I look at the public mutual fund results on an ongoing basis. And so I think that happened, but the really special thing that's more important to us that's happening is, there are an awful lot of good companies for sale at attractive prices now. And when we buy good companies, they could still fall further in this kind of a market environment. It's not a short-term thing. But the decisions that our folks make today will drive our success over the next few years because in difficult markets, if you can pick the right, good companies that are for sale at attractive prices, that can be the engine that really drives you to returns on the forward-look. And so we have a lot of managers here who think they've bought really good companies at really attractive prices and then the next day they wake up and the price has gone down even further and they sort of scratch their head and said, wait a minute, cash on the balance sheet, cash flows, these things make a ton of sense, and they still like them, but we're going have to have patience to be rewarded for having made those right choices. So our mindset is, take advantage of these opportunities and buy great companies at great prices and then the future will take care of itself so long as we're patient. And that's the real opportunity in this market set for us, not just in value portfolios, but across all of our portfolios and that's the thing that our leadership is stressing with our investment teams and it's a major push for us right now to make sure we -- we're focused on those opportunities, rather than distracted by a lot of the market noise. In terms of the amount of value assets we have or -- I don't know, Roger...

Well, I guess in the funds that we've seen the largest outflows from would probably -- I'm sorry, in front of me, but probably $5 billion or $6 billion.

I don't know the aggregate amount of value assets that we have. I don't have that number at my fingertips, I apologize.

We'll take our next question from Chris Harris with Wells Fargo.

Thanks guys. Roger, appreciate your comments on the potential for more efficiencies as we get into next year. Is it possible for you to guide us with respect to the potential size and timing of those efficiencies?

I guess the longer the timeline, the longer the -- yes, we're constantly looking to run our business in a more efficient fashion. And that's, but, like I said, that's a future-looking thing. And we're no different than any other business in any other industry, that we look to do, what we're doing now more efficiently going forward. And that will be, that's the offset to additional costs in other areas, whether they'd be regulatory or fee pressure. So that's a constant pace. And we will look to continually run the business more efficiently. That's how we'll try and continue to have a strong overall margin going forward. Starting with a margin of 40%, and we're throwing off free cash flow of about $500 million. So we start in a good position, and the more efficiency we can find to allow us to either maintain that and/or invest in the business for new areas. That's what we want to do.

And we'll take a question from Robert Lee with KBW.

I guess looking forward to these, I think, it'd be helpful, maybe try to get a little bit more granular sense of where you're maybe investing for growth? I mean, certainly as you come out the back end of the merger distraction, I'll call it and start kind of pivoting towards growth or investing for growth. Could you maybe prioritize 3 or 4 places, areas that you're trying to emphasize? Whether it's U.S. distribution, products structures, whatever it may be. Just trying to get a sense of what your focus is?

Sure. So the first focus is taking the best possible care of our existing clients. That job has to be job number 1. And if we don't do that well, then we don't have permission to do a lot of the new stuff we want to do. Underneath that, we have to take a look at alpha generation, risk control and building the right client relationships, brand, et cetera. And make sure that we have the right things going on in each of those areas in terms of technology and people and efforts. And so that's all part of that job number one, that is the most important thing. Once you feel like you've done what you can do in that, then you take whatever flexibility you have left and you start to apply it to the discretionary or sort of developmental projects. We've been clear that we want to develop more in multi-asset and alternatives and that's clearly a focus. We've been clear that we have some geographic areas where we think we are underpenetrated and we have more opportunity, there's, particularly in the institutional channel, I think there's opportunities to raise our game in wealth management and DC and these are areas that we're focused on. There are legal vehicles, particularly ETFs, not just in the U.S., but around the world we have opportunities to take a look at different legal vehicles and potentially push them and those things forward. And so we're in a constant process of trying to prune some of the stuff that we're doing back to make sure that we're focused and efficient and as simple as we can be, and then take the limited discretion we have to do new things and apply it effectively to get in front of faster-growing client demand, and that's the strategy process and the budget process that's ongoing right now here. But hopefully, some of those things that I called out give you a sense of the priorities around here.

Okay. And maybe as a follow-up. You called out intermediary in the U.S. being a relative bright spot. And that's -- it encompasses still many different sub-channels, I guess. And I know historically, you've had pretty strength in the kind of Schwab type of platforms. But could you maybe give us a sense of, in the U.S. at least, where you're seeing the, which intermediary channels have been particularly strong? And how you kind of think about your positioning in the, from the others? And maybe specifically the RIA channel? And then also the kind of regional wirehouse channel?

Yes. I can't give you that breakdown in quite that detail. I can tell you that our advisory business as opposed to the platform business that you talked about, worked with the financial advisors. It is really been a strong spot for us. That said, there's an opportunity to make it even better. We're serving those advisors. We're asking their opinions about what we're doing well, and where we need to improve. And we're seeing, we're getting feedback. You learn the most from people who are critical of you. We're getting some feedback that includes areas that we can improve. And so that is a bright spot for us and a strength of the firm. But it's also a place where we think we can continue to raise our game and we see things that we can do better. So we're optimistic about that. I can't give you, I don't know, Roger, if you have anything to say on RIA, but I can't give you a better breakdown on sub-channels at this moment, I just don't have that data right in front of me.

I guess the only thing I'd say is the third quarter was a strong quarter in the U.S. intermediary business in a market that isn't growing. We're obviously taking market share if we see positive net flows. So yes, as Dick said, there's things we definitely want to improve. We definitely listen to our clients. We want to see more, but it was pleasing to see a black number in U.S. intermediary.

And we have time for one more question from Nigel Pittaway with Citigroup.

I just wanted to delve just a little bit further into the explanation for the management fee margin decline in the quarter. And I think you said it was due to the outflows in European Equities, but I just note that average equities fund was up 4% against average firm up 2%. So and we've actually saying that margins on European Equities are higher than the average for equities overall? Or is there just further explanation there?

They are Nigel. They are a little higher. That's, I'm sort of giving you one answer of a piece. We saw a full in the third quarter, but that is, as I said, it's a pretty small fall compared to when you look over a, particularly over a longer period and there's a bit of noise in the quarterly numbers sometimes. So yes, but yes, European Equity is higher fee.

And that does conclude today's Q&A session. I would like to turn the conference back over to Dick Weil for any concluding remarks.

So thank you, everybody. Thanks very much for joining us today. In conclusion, look, our third quarter financial results were pretty strong with year-over-year revenue growth and margin expansion that I think demonstrate our effectiveness in converting higher revenues into higher profits and the discipline that we're exercising on behalf of our owners. We are on track to achieve our targeted cost synergies of $125 million by the end of 2018, nearly 1.5 years ahead of schedule. Which is a testament to the hard work of so many dedicated employees. And seriously, thank you to all those employees for your effort. Net flows and recent investment performance are not where we need them to be. But it's true that we're also seeing in a lot of important areas very good results. And so it's a mixed bag. We're encouraged by the good results and we're working hard on those things that need to get better. Going forward, we remain committed to our goals of growing market share profitably in each of our key markets and delivering an exceptional client experience to all of our global clients. And so with that, thank you very much for joining us today. We look forward to speaking with you again in February.

And once again, that does conclude today's conference. We appreciate your participation today.