Morgan Stanley (MS) Q4 2014 Earnings Report, Transcript and Summary

Good morning. My name is Connor, and I will be your conference operator today. At this time, I would like to welcome everyone to the Eaton Vance live Audio Webcast and Conference Call for the Fourth Quarter 2014 Earnings Release. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer. [Operator Instructions] We ask that you limit yourself to one question with one follow-up question. Thank you. Dan Cataldo, Treasurer. You may begin your conference.

Thank you. And welcome to the Eaton Vance Corp. 2014 fiscal fourth quarter earnings call and webcast. With me this morning are Tom Faust, Chairman and CEO of Eaton Vance; and Laurie Hylton, our CFO. We will first comment on the quarter and then we will take your questions. The full earnings release and the chart we will refer to during the call are available on our website eatonvance.com under the heading Press Release. Today’s presentation contains forward-looking statements about our business and financial results. The actual results may differ materially from those projected due to risks and uncertainties in our business including but not limited to those discussed in our SEC filings. These filings including our 2013 annual report and Form 10-K are available on our website on request at no charge. I’ll now turn the call over to Tom.

Good morning. October 31st mark the end of our fourth quarter and fiscal 2014. In a number of important respects, this was a year of transition and investment for Eaton Vance. We hired Eddie Perkin to lead Eaton Vance Management’s Equity Group and had one of our best equity performance years in recent history. We shifted the leadership responsibilities with our Municipal Income Group and here again, had one of the best performance periods we have had in recent years. At Parametric, we completed the transition to an Integrated Institutional Sales and Marketing Group covering all Parametric’s strategies and saw nearly 30% annual growth in the businesses of the former Clifton Group acquired at the end of 2012. Within our broader sales organization, we focused attention on developing four major emerging growth franchises for which we see significant near-term and long-term potential, multi-sector income, municipal bond latters, Clifton Defensive Equity and Richard Bernstein-subadvised funds. Across these strategies we saw managed assets increase from $3.3 billion to $9.2 billion in fiscal 2014, a gain of approximately 175%. And finally, perhaps, most significant of all, we advanced our exchange traded managed fund initiative to the brink of SEC approval. As many of you are aware, on November 6th and 7th, we announced three landmark developments for exchange traded managed funds. The SEC is issuing notice of its intent to grant Eaton Vance exemptive relief to permit the offering of exchange traded managed funds, SEC approval of the new NASDAQ rule governing the listing and trading of exchange traded managed funds and finally, the selection of NextShares as the branding of exchange traded managed funds. When -- when CEOs described recently completed fiscal years as periods of transition and investment, it usually means that the company's business and financial results did not need expectations. I am pleased to report that was not the case for Eaton Vance in 2014. Adjusted earnings per diluted share of $2.48 for fiscal 2014 as a whole and $0.68 in the fourth quarter were both new records of 19% and 24%, respectively, over the year ago periods. And thanks to solid revenue growth and diligent cost control, our fiscal year operating margins advanced year-over-year from 33.4% to 35.8%. On the capital management front, over the course of fiscal 2014, we spent $322 million to repurchase and retire 8.5 million shares of stock, including 2.5 million shares repurchased in the fourth quarter at the cost of $94 million. The average cost of shares repurchased during the fiscal year was $37.86 a share. In addition to maintaining an active share repurchase program, we also increased our quarterly dividend in the fourth quarter by 14% to $0.25 a share. The increase marks the 34th consecutive year that the company has raised its regular quarterly dividend, which is growing at a compound annual rate of 18% over that period. We finished the year on very sound financial footing, with $541 million of cash, cash equivalents and short-term debt securities held and a seed investment portfolio of $274 million. This compares to outstanding debt of $575 million, $250 million of which comes due in 2017 and the balance in 2023. Turning to our business results, we finished the year with record managed assets of $297.7 billion, up 6% from a year ago. Thanks to the strong fourth quarter for Parametrics Customize Exposure Management business, we finished the year with consolidated net inflows of $2.8 billion, our 19th consecutive year of positive net flows. Looking at just the fourth quarter, we had consolidated net inflows of $6.8 billion, which breaks down a $7.8 billion of exposure management inflows and $1 million -- $1 billion of net outflows from other strategies. In addition to exposure management, we saw positive quarterly net flows for municipal income, multi-sector income, tax managed core, emerging markets equities and defensive equity. Quarterly outflows were concentrated in large-cap value, floating rate income, global income and Atlanta Capital equities. While our overall net flows outside exposure management were negative in the fourth quarter, we did see about $1 billion of improvement from the third quarter for reasons I will discuss shortly, we expect to continue this improving trend in fiscal 2015. Returning to a full year view, our fiscal 2014 flow headwinds came primarily from three areas, large-cap value with $5 billion of net outflows, global income which had net outflows of $3.4 billion and Atlanta Capital with net outflows of $2.3 billion. Bank loan flows were positive $900 million for the fiscal year as a whole, but were minus $1.4 billion in the third quarter and a somewhat better minus $1.1 billion in the fourth quarter. Municipal income net flows started the year poorly, but got progressively better as the year advanced, minus $1 billion in the first quarter, plus $100 million in the second quarter, plus $450 million in the third quarter and plus $700 million in the fourth quarter. Looking forward to fiscal 2014, there are number of reasons why I'm upbeat about our flow prospects. To begin, I don't believe we will see the same magnitude of net outflows from the franchisor that hampered our 2014 flow results and I expect the number of our other franchise to make meaningful contributions to net flows. Much of my optimism is based on our significantly improving investment performance across equity, income and alternative investment areas, including a number of strategies that are now fully competitive in categories garnering significant flows across the industry. Overall, 72% of our fund assets are in funds that have Morningstar ratings of four or five stars for at least one class of shares. One area where we've seen dramatic improvement is an equity fund performance. Over the past year, 75% of our equity fund assets have beaten their Lipper peer group averages. Eddie Perkin took over leadership of our Equity Group this spring and has implemented a series of process enhancements that I am confident will continue to payoff with solid performance overtime. Our fixed income and alternative funds have also had impressive performance, with over 90% of fund assets beating their Lipper peer group averages. Municipal bond funds continued to garner investment flows across the industry and we're fully participating in this trend, financial advisors or investors are taking note of our excellent performance across the Board in munis, including 21 national and single state municipal bond funds now rated four or five stars. As I mentioned earlier, global income strategies were significant drag on net inflows in 2014, particularly in the first half of the year. We have every expectation that this will reverse in fiscal 2015. The investment performance of our suite of global income products has turned sharply upward, offering returns that beat the performance of many competitors to whom we have been losing share. With better numbers it should be our turn to shine in 2015. Among the funds included in our global income franchise is Short Duration Strategic Income Fund, which competes in the Morningstar Short-Term Bond Fund Category. Short-term bond is one of the top-selling asset classes in the industry and our performance here is excellent. The Class A and Class I shares of this fund are in the top 5% of their Morningstar peer group over one, five and three years and are both rated five stars. While hardly a new story, it's a story that we’re increasingly introducing to financial advisors as a focus opportunity. In addition to the improved investment performance and established franchises, this year we made great progress building out the four emerging franchises that I mentioned previously, growing assets nearly $6 billion, or 175%. While it will be difficult to keep these growth rates on a percentage basis, we continue to believe that each of these four new franchises can grow at accelerated rates through 2015 and beyond. To the extent we see opportunities to expand our product offerings within each of these emerging franchises, we are doing it. We recently launched a sister product to the Eaton Vance Bond Fund for the variable annuity market and also recently launched the Eaton Vance Bond Fund II. Like our flagship Bond Fund, Bond Fund II is managed by a team led by Kathleen Gaffney. However, Bond Fund II will not make significant equity investments. We believe this more pure approach could further broaden the appeal of this high-performing rapidly developing franchise. Although Bond Fund II was launched just this month, Kathleen and her team have been managing a separate account under the same strategy for over year and have achieved an excellent investment performance record. We also continue to build out the product lineup within the Richard Bernstein-subadvised franchise, which includes the four-star Morningstar-rated equity strategy and all asset strategy funds. In September, we launched the Richard Bernstein Market Opportunities Fund a long, short all asset fund and we also just started representing the Richard Bernstein-advised ETF models in the major wire houses. Turning to the floating-rate franchise, retail net outflows continued in the fourth quarter for both us and our industry. Consistent with the last quarter, our negative retail flows were partially offset by positive net flows from institutional clients. We believe that the negative retail settlement will abate when the retail market refocuses on the prospects of higher interest rates. Institutional investors clearly recognized the value proposition and protection against interest rate risk that floating-rate loans can provide. We are hopeful that retail investors will return to this understanding sooner rather than later in 2015. Before I turn to the topic of NextShares, I want to spend a moment reviewing results for our Seattle-based subsidiary, Parametric, which continues to be a growth engine inside Eaton Vance. In fiscal 2014, Parametric's managed assets grew 16% to $136 billion, a 10% organic growth rate, contributing meaningfully to our consolidated earnings as well. I know Parametric’s businesses can be confusing, but you should think of them as offering two broad product lines, engineered alpha strategies which comprised $34.6 billion of their $136 billion of AUM and implementation services, which represent the balance. In 2014, engineered alpha strategies led by emerging markets and defensive equities generated net flows of $1.4 billion or an organic growth rate of 5%. Implementation services is made up of our capabilities, tax-managed core, centralized portfolio management, specialty index, and customized exposure management, led by exposure management and Parametric’s implementation services business with the fastest growing part of Eaton Vance in fiscal 2014, with organic growth of 12%. While not generating as high as management fee as our other strategies about 11 basis points on average, implementation services operate at attractive margins and Parametric is among the market leaders across the range of its implementation service capabilities. Heading into 2015, the pipeline for a number of Parametric engineered alpha and implementation services strategies is looking very strong. I'll close with an update on our NextShares exchange traded managed fund’s initiative. As many of you know, NextShares is our proposed new type of open-end fund, combining features and benefits of actively managed mutual funds and ETFs. Like active mutual funds, NextShares seek to outperform their benchmark index and peer funds by applying the managers’ investment insights and research judgments. Like ETFs, NextShares will utilize an exchange traded structure with built-in performance and tax-advantages. Differed from ETFs, NextShares would not disclose their portfolio holdings on a daily basis to preserve the confidentiality of trading information. NextShares will be bought and sold on an exchange utilizing a new trading protocol called NAV-based trading in which all bids, offers and trade executions are directly linked to the fund’s next end-of-day net asset value. This new trading approach should ensure that NextShares can be bought and sold with trading costs that are consistently low and fully transparent in a manner not available for ETFs. As mentioned previously, there were two favorable regulatory developments for NextShares earlier this month, which we believe should position us to introduce the first of this pioneering new fund type in the second quarter of next year. As previously disclosed, our Navigate Fund Solutions subsidiary holds a series of NextShares related patents that we are seeking to commercialize by licensing to Eaton Vance and other fund groups. Our focus with NextShares over the coming months is threefold, first completing the regulatory approval process, second ensuring market readiness for the launch of the first NextShares funds just targeted for the second quarter of next year, and third signing other fund groups as Navigate license fees and supporting them through the regulatory process. Over the 2.5 week since receiving our SEC news, we have been extremely pleased with the marketplace response and the widespread interest expressed by other fund companies. We continue to view NextShares as a significant advance in the evolution of fund investing, a forward leap for active management and a major opportunity for Eaton Vance. With that, I will turn the call over to Laurie to discuss the quarterly financial results in more detail.

Thank you, and good morning. As Tom mentioned, we are reporting adjusted earnings per diluted share of $0.68 for the fourth quarter of fiscal 2014, compared to $0.55 for the fourth quarter of fiscal 2013 and $0.63 for the third quarter of this fiscal year. This represents an increase of 24% over the fourth quarter of last year and an increase of 8% sequentially. On a GAAP basis, we earned $0.66 per diluted share in the fourth quarter of fiscal 2014, $0.45 in the fourth quarter of fiscal 2013 and $0.63 in the third quarter of this fiscal year. As you can see in attachment two to our press release, adjustments from reported GAAP earnings in the fourth quarters of fiscal 2014 and 2013 primarily reflect changes in the estimated redemption value of non-controlling interest in our affiliate that are redeemable at other than fair value. Results for the full fiscal year were also strong with adjusted earnings per diluted share increasing 19% to $2.48 in fiscal 2014 from $2.08 a year ago. The $0.04 of adjustments from our $2.44 at fiscal 2014 GAAP earnings per diluted share again primarily reflects changes in the estimated redemption value of non-controlling interest in our affiliates. Operating income in the fourth quarter increased to 11% year-over-year and 6% sequentially on modest revenue growth. Prudent cost management and lower variable compensation costs drove our operating margin up to 37.8% in the fourth quarter fiscal 2014 from 35.1% in the fourth quarter of last year and 35.7% last quarter. On the strength of those operating results, adjusted net income for the fourth quarter increased 19% year-over-year and 7% sequentially. Results for fiscal 2014 as a whole mirrored our fourth quarter experience. Operating income increased 15% on revenue growth of 7%, with our operating margin improving to 35.8% for the full fiscal year from 33.4% a year ago. Adjusted net income was up 18% and adjusted earnings per diluted share were up 19%. Our fourth quarter revenue increased 3% year-over-year, reflecting a 4% increase in investment advisory administrative fees, partially offset by modest declines in distribution and service fee revenues. Looking specifically at investment advisory administrative fees, the 4% increase year-over-year reflects an 8% increase in average assets under management, offset by decline in our effective investment advisory fee rate. The decline in our effective investment advisory fee rates were 44 basis points in the fourth quarter of last year to 43 basis points this quarter, can be primarily attributed to strong growth in Parametric exposure management business, which operates at fee rates well below corporate averages. The impact of the change in product mix more than offset the increase in performance fees, which were $6.3 million in the fourth quarter of fiscal 2014 and $3.4 million in the fourth quarter last year. We’ve not seen any significant changes in our mandate level effective fee rates, either year-over-year or sequentially and would not anticipate that we would see any significant changes in those rates as we move into the new fiscal year. That said, product mix continues to be the most significant determine of our overall effective fee rate and as we've seen, any meaningful changes in product mix going forward could certainly impact our overall rate over time. Shifting from revenue to expense, operating expenses were down 1% in the fourth quarter of fiscal 2014, compared to the same quarter last year, reflecting decreases in variable compensations and fund-related expenses, offset by fairly modest increases in distribution-related expenses and other discretionary spending. Operating expenses decreased 3% sequentially reflecting single digit percentage decreases in compensations, distribution and fund-related expenses, partially offset by a 2% increase in other discretionary spending. Compensation expense decreased 2% in the fourth quarter of fiscal 2014, compared to the same quarter last year, reflecting decreases in sales and operating income based incentives and stock-based comp, partially offset by increases in base salaries and benefits due to a 5% increase in average headcount. The 6% decrease in compensation expense sequentially can be primarily attributed to decreases in operating income based incentives and stock-based compensation. Looking at the full fiscal year, sales-based incentives were down 15%, reflecting the decrease in retail sales. Operating income-based incentives were up 6% driven by the increase in operating income and fixed compensation cost, which primarily includes base benefits, taxes and stock-based compensation were up 7%, consistent with the 7% increase in average headcount for the year. Looking forward to the first quarter of fiscal 2015 will likely see a sequential increase in total compensation due to typical seasonal compensation pressures, base increases take effect, payroll tax clocks reset, 401(k) contributions are matched and accrual rates for operating income based incentive are expected to increase. As a result, I anticipate the total compensation in the first quarter of fiscal 2015 would represent closer to 32% to 33% of revenue, as we saw in the first quarter of fiscal 2014, as opposed to the 30% we reported this quarter. This increase will obviously have a dampening effect on our sequential operating trends as well. Distribution and service fee expenses increased marginally in the fourth quarter over the same period a year ago and were largely flat sequentially, reflecting relative stability and assets under management subject to these fees. Fund-related expenses were down 13% year-over-year and down 3% sequentially, reflecting lower fund subsidies and other fund-related expenses, partially offset by an increase in sub-advisory expenses driven by growth in sponsored funds managed by unaffiliated subadvisors. Other operating expenses were up 3% in the fourth quarter over the same period a year ago and up 2% sequentially, primarily reflecting increases in travel and information technology spending related to investment management systems projects. Gross and other operating expenses was limited to 6% percent for the full fiscal year, reflecting increases in same spending categories. I would note that our overall cost structure includes approximately $4 million of costs in fiscal 2014, or roughly $0.02 of adjusted earnings per diluted share that we would attribute to our efforts to garner SEC approval on bring NextShares to market. Although we’ve not finalized our NextShares spending plans for fiscal 2015, I would anticipate that our spending on this initiative will approximately double from the $4 million spend in fiscal 2014. Net income and gains on seed capital investments contributed roughly a penny to earnings in each of the last two quarters of fiscal 2014, with no impact on earnings in the fourth quarter of fiscal 2013. When quantifying the impact of our new seed capital investments on earnings each quarter, we take into consideration our pro rata share of the gains, losses and other investment income earned on investments in sponsored products whether accounted for as consolidated funds, separate accounts or equity method investments as well as the gains and losses recognized on derivatives used to hedge these investments. We then report the per share impact net of non-controlling interest expense and income taxes. Changes in quarterly equity of net income of affiliates both year-over-year and sequentially reflect changes in net income and gains recognized on sponsored products accounted for under the equity method. Our 49% interest in Hexavest, which is reported net of tax and the amortization of intangibles in equity and net income affiliates contributed approximately $0.02 per diluted share for all quarterly periods presented. Excluding the affects of CLO entity earnings and losses, our effective tax rate for the fourth quarter of fiscal 2014 was 36.7% 38.5% in the third quarter of fiscal 2014, and 39.3% in the fourth quarter of fiscal 2013. We currently anticipate that our effective tax rate adjusted for CLO earnings and losses will be approximately 38%, as we move into the new fiscal year. In terms of capital management, we repurchased 2.5 million shares of non-voting common stock for approximately $94.1 million in the fourth quarter. When combined with prior quarters repurchases, this brought both our average diluted share count and ending shares outstanding for the fourth quarter down by 3%, compared to the fourth quarter of fiscal 2013. Even with the significant share repurchases, we finished the fiscal year holding just over $540 million of cash and short-term debt securities and approximately $274 million in seed capital investment. Cash balances will go down in the first quarter, as we pay out operating income based incentives and fund our annual profit-sharing contribution. Our outstanding debt consists of $250 million of 6.5% senior notes due in 2017 and $325 million of 3.625% senior notes due in 2023. We also have a new $300 million, five-year line of credit, which we entered into in October to replace our previous three-year line that was due to expire in fiscal 2015. The line is currently undrawn. Given our strong cash flow, liquidity and overall financial condition, we believe we are well-positioned to continue to return capital to shareholders through dividends and share repurchases. This concludes our prepared comments. At this point, we’d like to take any question you may have.

[Operator Instructions] Your first question comes from the line of Robert Lee with KBW. Your line is open.

Thanks. Good morning everyone.

Good morning.

Rob, good morning.

Hi. Tom, I have a question on the ETMF. I’m just trying to -- if I think ahead a couple quarters and you have your products up and running mid-year, call it, how do you envision your sales force, your wholesalers marketing that? If you have just as an example, let's say you have one of the Richard Bernstein products in an ETMF form, are you expecting that your own marketing people will be shifting their focus to that versus say a more traditional structure? I mean, how do you think about managing that internally as you ramp up -- not a competing structure, but a different structure?

Yeah. Okay. I think that’s pretty straight forward. We offer most of our mutual fund products almost all of them in a multi-class structure where we have institutional share classroom where there is no front or back end sales load and no 12b-1 distribution fees. We also have A shares, which have typically a 25 basis point distribution service fee and sometimes offered with a front end load, then more commonly that is waived. And then our third most common class of shares is C shares which has a 100 -- no front end load, 1% CDSC, if redeemed within 12 months but ongoing 1% of distribution and service payment. Where we see NextShares is fitting in, as being competitive with what we call Class I or institutional class shares. That represents about two thirds of our business today in terms of flows. So what I would expect is that, if the example is the Richard Bernstein -- if the Eaton Vance Richard Bernstein Equity Strategy Fund that we would offer, we would continue to offer the mutual fund with multiple share classes and alongside that, we would offer the new NextShares version of that same strategy. I would expect little or no movement of assets from the Class C shares, potential sales of Class C shares from the mutual fund to the NextShares version, maybe some but probably not much Class A activity would move to the new version. But I think it is reasonable to expect that significant percentage of what would've been the Class I shares sales of the mutual fund to shift to NextShares which we expect to have a lower expense ratio. We expect also to have incrementally higher returns in addition to the lower expenses based on the way the funds are structured and the way the funds are effectively sheltered from the cost of accommodating inflows and outflows and the expected higher tax efficiency. So we would expect that that much of the activity in terms of new sales will shift from the mutual fund to the NextShares version of the same strategy. We will not stop marketing the mutual fund. There will be some customers that would take a wait-and-see attitude to see how this new type of fund structure shakes out. But we expect to certainly to put a significant focus on selling the new version alongside the existing product. Of the 18th strategies that we have announced as where we intend to offer NextShares, 17 of those are effectively clones of existing top Eaton Vance mutual funds. We expect from a compensation perspective, which maybe you are getting towards your question, also to compensate our wholesalers on a similar basis, not exactly the same, similar. Although NextShares will be exchange traded products and where we will not be able to track gross sales on the same basis that we’re able to track mutual fund sales. We do expect through most, if not all, broker-dealer systems to get data that would allow us to track growth in the fund assets on a territory-by-territory basis. And we use that -- we use that as the way to compensate our salespeople.

Okay. Thank you. That’s helpful. Just maybe as a follow-up for Laurie, I appreciate the color on comp as we look forward. Just trying to get maybe a little bit more granular feel. So if we think that 32% to 33% range next quarter, how much -- how should we be thinking that the piece of that is kind of the seasonal impact that will -- as we think through next year that will kind of fade away, all else equal. Is it $5 million, is it one or two points in that. Just trying to get a feel for how we should think of that comp ratio at this point for the full year, next year?

Yes, Rob. We generally speaking in the first quarter have fixed compensation costs that kick in. I think I referenced specifically on the call. But I think that you are probably somewhere in the tune to $1.5 million to maybe $2 million in total. And those are the things that we talked about in terms of -- we've got pace increases, we’ve got 401(k) matching that happens in the first quarter, payroll clocks reset, all of that, all of that happens. Likely, we are hopeful there will also be some impact from variables compensation as we hopefully see growth sales pick up again in the first quarter. I can’t quantify what that’s going to look like as we don’t know what the growth sales picture will look like. And then we also picked 10-Q in the first quarter, reset our operating income based bonus accruals. So we wouldn’t anticipate those are going to pick up significantly but we would anticipate there will be some pick up. I don’t have specific numbers to give you at this point. I think I would prefer not to give that kind of guidance. But I would anticipate that in total our compensation as a percentage of revenue will pick up by one or two percentage points in the first quarter.

Great. Thanks for taking my question.

Your next question comes from the line of Chris Shutler with William Blair. Your line is open.

Hey guys. Good morning. On the floating rate assets, looks like the issue in the quarter was just the lower gross sales. But maybe just to confirm, there were no large kind of platform issues like last quarter. And then what do you think ultimately need to happen for the retail side there to stabilize?

Yeah. So there were no -- you're correct, there were no big platform reallocations. I think the thing we’re seeing as you observed were continued steady positive flows on the institutional side and maybe a diminishing of retail interest has expressed more in lower gross sales than higher redemption. What I think is happening now is that institutional investors are perhaps more mindful of the fact that the 10 point interest rates are going to go off and that when that happens, there's a significant performance -- portfolio benefit are being diversified of not having only fixed rate income assets but also having floating-rate income assets. That was a lesson that retail investors were sharply reminded of in the first half of 2013 when our rates started to move up pretty quickly since rates have comeback down that less than it’s moved to the back up of -- I suspect many retail investors mind. But nonetheless like the institutional investors that continue to put money into this asset class, my own view is that it's inevitable that at some point we will start to see upward movement in interest rates. And so what I think will be required to get retail flows into bank loans moving again in a significant way upward from where they are today is something some catalyst that causes either investors or financial visors to be reminded that yes there is interest rate risk and that the best defense against interest rate risk is moving a significant portion of the client assets from fixed rate to floating rate. I don’t have a crystal ball as to when that’s going to happen, but I think it will happen. It could happen soon depending on what happens with the economy. But I think that’s likely to be the trigger.

All right. Thanks, Tom. And then on multi-sector bond, just hoping to get an update there in terms of progress on getting onto additional retail platforms and just the -- how the institutional pipeline looks for that product?

So you’re talking about our bond fund?

Correct.

Yes, so we have, Chris, start over the past few quarters about appending funding that we expect to see in the near future. We’re still waiting for that. So we’re optimistic we will see that. I know institutional group has been talking to the clients and the consultants about the product. And as we’ve said in prior quarters, many of the institutions do want to wait to see the three-year performance record, not all. I mean we don't need to hit three years to have the conversation. So we're hopeful that as Kathleen keeps up her excellent performance that we will continue to gain traction there. And I do believe we have pretty broad coverage on the retail platforms at this point for the municipal bond fund. I think an interesting thing to keep an eye out for there is our progress on the Eaton Vance Bond Fund II. As Tom mentioned that product is more pure play on multi-sector income without an allocation to equity than we did hear from the market, particularly institutional that that would be something that they're looking for. So still everything was very positive there. And we would expect to not only build out the -- increase the assets in bond fund but also build out the franchise with them. These are the products.

All right. Thanks Dan.

Your next question comes from the line of Dan Fannon with Jefferies. Your line is open.

Thanks. Tom, if you could expand a little bit more on the initial feedback you've heard on the ETMF product. And maybe how we should think about the potential signing up of licensee clients, is that something you will be announcing we should hear from? Is it going to come after the second quarter once it's officially announced or we should potentially get some of that ahead of the official launch?

Yeah. Now we would expect -- we will see activity, I would hope significant activity well before that launch in the second quarter. We are quite busy, Stephen Clarke, who runs this initiative for us. I know yesterday was traveling and had meetings with four different fund companies, he told me and spoke to a fifth via conference call. So there's a lot of activity, lots of interest in the space. In some cases, this is a relatively new store. We might have had one or two preliminary meetings but we didn't really get fund committees attention until we got this positive news from the SEC a couple weeks ago. So in some cases, its people moving quickly from a relatively undeveloped state of understanding of the potential opportunity here. In quite a few other cases, however, we've been talking seriously for a number of months, in some cases over a year where we think those companies can move quickly to do two things one -- two things that we’re asking fund companies to do. One is to sign a term sheet with us, which effectively puts in place the broad outlines of our potential agreement on the economic terms of our licensing arrangement. And the second equally important is to file exemptive applications getting themselves in line with the SEC. As we mentioned, couple of weeks ago when we have the call on announcing the next year news, the process that the SEC has prescribed for how licensee can -- should file an exemptive application is designed to be extremely efficient, that is essentially what a licensee has to do, is represent that they will agree to abide by the terms and conditions of the Eaton Vance exemptive order. So rather than the process of filing exemptive order be a potentially multi-month process involving extensive use of outside counsel and producing a document that might be 40 to 60 pages. This is a simplified process that would certainly be done in-house at little or no cost that involves up four to six page document that more or less says, these are the fund that we would initially propose to introduce. We would like this really to apply to both those funds, as well as future funds, we might introduce in the future. And all of these funds would rely on the terms and conditions of the Eaton Vance order. So we view that as extremely important in the development. The SEC embracing this approach in the timeline for not only signing up licensees because it's not a big commitment of resources for them to sign a term sheet and get inline with the SEC. And then second, even more important, this also should greatly speed up the timeframe in which other fund companies are bringing out products to market. So we are very busy. We would expect us to sign up firms possibly this month but we think there's a good chance as certainly before the end of our first fiscal quarter, which is at the end of January that we’ll have announcement. Some of these may come to light by virtue of a press release announced either by us or by the fund company that’s the licensee or it may just be in the form of an exemptive application that gets filed, that would indicate that they are filing for relief and are licensing Eaton Vance technology and are relying on the terms and conditions of our order. So we’re very busy there and certainly, quite hopeful that there will be significant activity over the coming weeks.

Great. And I think you mentioned on the previous call a study that you guys had done and wondering if that's been released about the cash drag. I think that's what it's focused on and the impact that has on performance. If I think about it in a down market, isn't the cash drag a helpful component to performance?

Sure. So there is the study, which we’ve concluded and are releasing on a selective basis primarily, focused on getting that in the hands of potential licensees. The study identifies four primary costs of mutual funds that would either be eliminated or substantially eliminated by moving to the structure. One of those, the most straightforward is probably, one distribution fees which of course don't exist for institutional share classes but across all fund classes, I think average something like 40 basis points on an equal weighted basis and around 15 basis points asset weighted. So no 12b-1 distribution fees for NextShares. If you're comparing NextShares to the institutional share class of mutual funds that cost savings effectively doesn’t apply but what does apply is three other cost savings. The first of which is significantly reduce if not illuminated transfer agent fees that’s a cost of roundly 15 basis points and maybe a little bit more than that for the average fund. The second cost is the one you mentioned which is cash drag, which is variable for different funds depending on how much cash they hold, but also variable of course depending on whether markets are moving up or down over a particular period. And the third avoided cost as we describe it is the cost of the incremental trading that a fund incurs to accommodate cash inflows and cash outflows. And this is for memory, but that cost, as I recall, its about 20 to 25 basis points for typical fund. So the study identified -- which focuses on the broad universe of equity funds over the period 2007 to 2013, identifies the total of I believe 62 basis points of non-12b-1 costs for a typical fund that would be -- that should be avoidable by shifting to this structure, which roundly 15 basis points is transfer agent expenses, 20 to 25 basis points, I believe is the flow-related trading costs and the balance would be cash drag. The study also looks at, if you take historical mutual fund performance and adjust that to remove these cost factors, how does that compared to benchmark ETFs that have the same index over that period in it. And not surprisingly, that if you pull out enough cost that makes a dramatic impact on the percentage of fund -- percentage of active funds that outperformed in a way that I think that will be potentially a very significant in longer-term affecting the balance of active versus passive in the market if this new lower cost structure is widely adopted. The study does not focus on. Though this is an area of significant interest that both for us and potential licensees. This study does not attempt to quantify two things. One is the benefits of fixed income funds, which we also think would be significant and also the benefit in terms of tax savings and both of those are areas of potential future research that we’re started to think about. But the work that we've done is on equity funds. It covers a broad universe of funds over a long period, both up market and down market, and we think is going to be quite instructive to fund companies, as they think about the potential benefits to their shareholders from adopting this new structure.

Thank you.

Your next question comes from the line of Bill Katz with Citigroup. Your line is open.

Hey. Thank you very much taking my questions. So, Tom, just want to follow-up on the discussion with the pipeline for possible licensee applications. Number of your peers sort of come out and expressed some cautionary remarks and a couple of broker dealers look at the complexity of it. So to try and get a sense of maybe triangulate against that versus your optimism? In the conversations you're having with different potential folks that sign-up, can you range the assets that you're speaking about here either in the typical size, average size or some way to get a real sense of maybe the near-term addressable market?

I didn’t follow that. What do you mean range the assets?

What size coming -- I just talking the companies may have $500 billion of assets, that might be looking to do this $25 billion. Just try to get a sense of the foreseeable revenue opportunity on licensing?

We’re talking to companies of, I guess, I would say, all but the smallest sizes, with significant interest expressed from large to middle to small size company, that we don’t see any differentiation in level of interest by fund company size. From our perspective, the entire market is potentially available to us as a potential licenses. We are not aware of significant pushback from fund companies on for the -- about things that you’re talking about?

Got you. Okay. The second question is, you did a nice job of highlighting some of your newer areas? You said about $9 billion some of the emerging franchises? When you speak to the laggards a little bit? Could you range what -- how much in assets you have there between retail institutional and then within that where do you feel most confident in the turn?

So we talked about, let just say, so that, the areas that we identified as laggards for the year, one would be large-cap value, second would be global income and third, Atlanta Capital, I think those were the three areas.

Yeah.

So I mean, I can just speak on each of these, large-cap value we didn’t really talk much about in any detail. This is now. We have about $8.5 billion in large-cap value assets of which some thing like $4.5 billion I think is in the large-cap value mutual fund sort of the flagship product there. You probably recall that at one point that was over $30 billion. So we’ve seen outflows for quite a long time now. We’ve seen those outflows have continued this year. Recall that we went through a transition this year where Mike Mach, long time head of that team retired. Eddie Perkin came in and we have new leadership of that team. We have significantly improved performance. We are having a solid year in that. But the way we view the redemptions we are getting now is, people that view the change in leadership of the team as perhaps the last straw. And we expect that, if we can continue to put up good performance numbers that the outflows there will abate, given that that fund is now a little over 1% of our overall assets and that the overall strategy is a little less than 3% of our assets. It’s -- the ability of large-cap values to pull down our overall flow results as it did in fiscal 2012 and 2013, its just not there anymore. We don't have enough assets in the strategy for that to exert a very significant pull on the company. And we are optimistic based on the improvement in performance in the fact that Eddie is been here since, I guess, almost seven months now that the news of a change in leadership is now well known in the marketplace. On the Global Income side, we talked a little bit about that in my prepared remarks, which is that the trend over the year has been significantly better. We had a pretty lousy first quarter due to disappointment in performance of our Global Macro Absolute Return Fund. The good news is that we are having a strong year there through the end of October. Global Macro Absolute Return Fund is up on a one year basis 3.7% and up 2.9% year to date. The more aggressive version of the strategy, the Global Macro Absolute Return Fund, Class I shares are up just under 7% on a one year basis and just under 6%, year-to-date. And those are very competitive numbers within this asset class. We were put in the penalty box a year ago because we had negative returns, we didn’t kill people, but we lost I think maybe 40 or 50 basis points or so on the Class I shares. So performance numbers are better. We're seeing improved trends there and we also have some products there that are managed by that team where we think we are on the verge of significantly better flows that will highlight our short-term strategic income fund, which is now a five-star fund and which has got top performance over multiple periods as a fund that has been a modest contributor to flows where we expect to see potentially quite significant inflows next year. A third strategy, I would point to as a potential growth area in Global Income is emerging market debt where we've got a couple of different strategies within that category, both with very solid performance and this is an asset class that continues to attract assets and where we think we’ve got significant growth potential. I mean, if I had to guess I would guess that next year that we’ll see continued outflows from large-cap value though at a reduced level from where we were today. If I had to guess, I would predict that Global Income, we have a decent shot of turning to positive flows in total and potentially of quite significant flows. The third area that I mentioned as a source of outflow for the year is Atlanta Capital Management and that encompasses - primarily, Atlanta Capital has three areas -- growth equities, core equities and fixed income. All of them were in net redemption for the year. The biggest source of that was their growth product, which is largely based on a performance. But they had an important client in the first half of the year that shifted away from active management that hurt the overall flow results there. But they've been -- Atlanta Capital is focused on quality investing. This has been a difficult period, not just 2014 but the last few years for quality investing. They’ve lagged their benchmark and that’s hurt them. They had a good performance month in October for what that’s worth, which helps them on a year-by-year basis. But they are sticking to their knitting and working hard and not really in a position to say whether next year is likely to get better or worse there, but I don't see a significant risk that it's going to get a lot worse. But on overall basis those are the franchises that hurt us in the year. And as we said, we are optimistic than on balance, those will get better, which will help us on an overall basis also as we grow some of these emerging franchises. We also had a couple of areas that I didn’t realty talk about that -- but for performance reasons, we are pretty optimistic about going into the New Year. One of those in particular, I would highlight would be high-yield bonds where we have really a terrific track record over multiple periods having a great year, but also really excellent long-term performance as well. Another area that I would highlight where we saw growth this year but at a reduced level that I think could certainly accelerate is Parametric’s Emerging Market equity strategy. You may recall at the beginning of this year, there was pretty strong negative sentiment about emerging market equities and as that's abated over the year. And a lot of people have come to the view that emerging market equities maybe one of the best sources of value across the global equity markets. We've seen increased interest there. So strong performance, they've had over many years with a systematic structured strategy and we are saying we think a pickup in interest there that should point to stronger flows for them in 2015.

Okay. Thank you for the great perspective.

Your next question comes from the line of Ken Worthington with J.P. Morgan. Your line is open.

Hi. Still morning, so good morning. Do you need to see the NextShare products and if so, how much would you expect to contribute?

Our understanding is that the exchange has a minimum of 1 million shares to list a new fund. We're thinking this hasn’t been finalized but we’re thinking of an initial value of $20 a share, so $20 million of seed capital. We haven't really gotten fully into how we would finance that, but 20 times -- 18 is not insignificant -- $20 million times 18 is a not an insignificant amount of money. We could conceivably finance that internally if we thought that makes sense. But we would be open to other avenues of financing that as well.

Great. And then I think you implied that you’ll be compensating wholesalers on a net basis for NextShares rather than a gross basis? Have you ever compensated your sales force on a net basis for any product before and if so how did that work out? And is it challenging to make net compensation as attractive for wholesalers as gross?

I didn’t say that we were going to be compensating them on net sales. I said we are going to be measuring the growth in assets of the strategy on a basis that looks at essentially the book value of the position in account. So, we're quite aware of the complexities of compensating wholesalers on net basis that’s not been our traditional approach. But we do think that as we move into exchange-traded products, it will likely become more important to use NextShares -- to use net sales. Sorry, too confusing here, to use net sales as a primary determinant .But it won't -- certainly it won't be the only determinant of sales force compensation going forward.

Okay. Okay. Thank you.

Your next question comes from the line of Michael Carrier with Bank of America. Your line is open.

Thanks. Laurie, just two number of questions, just on both the distribution and service revenue and expenses, a little bit more of a stepdown sequentially and just wanted to see if there was anything different besides mix there? And then on the performance fees, just when we look at either the sequential and then the year-over-year trend, obviously a relatively good quarter. So when we think about going forward, any shift in terms of the products that are generating the fees in terms of assets basis or performance on some of these products?

Hi, Michael. In terms of the distribution service fees, there really was no seismic shift, there is just a question of asset mix. Those are just a straight basis points on assets that are subject to those fees. There is no magic there. In terms of the performance fees, we have only a handful of institutional accounts that have significant performance fees. One of the largest is in the fourth quarter of each year. So we see this activity in the fourth quarter and then there is minimal activity in the rest of the fiscal year.

Okay. Thanks. And just as a follow-up. Tom, recently the SEC has been looking for the entire industry on some of the potential issues down the road on fixed income products or illiquid products and trying to figure out what they might do in terms of increased regulation or increased cash balances. Just wanted to get your sense on, obviously it’s very recent and we got a ways to go in before anything is proposed. But just want to get your sense on the risk that you see? And then more importantly, is it just more of a lower return for certain products for investors or would there be any negative impact for the industry in terms of keeping the assets or assets going elsewhere?

I’m aware that the SEC is interested in the topic of liquidity and the fixed income markets and interested in particularly how that affects funds that offer daily redemption privileges and maybe also particularly how that affects ETFs that offer intraday pricing and intraday price-based liquidity. And we've spoken to the SEC on these topics. I've not heard either directly or indirectly or maybe I have missed this that there is a proposal that would require fixed income funds to maintain a cash reserve. I would find that very surprising if that’s currently under consideration at the SEC, but I’m not aware of that.

Okay. Thanks a lot.

Your next question comes from the line of Greggory Warren with Morningstar. Your line is open.

Good morning. Thanks for taking my questions. You guys mentioned earlier in the call that you’ve seen some interest from other asset managers out there. I’m just kind of curious, has any of this interest come from parties that were more or less pursuing kind of their blind trust structure that BlackRock and Precidian were pushing for the SEC, in particular I'm thinking State Street, Invesco, Capital Group, American Funds?

I won’t speak to specific fund companies that wouldn’t be appropriate. But I can say that certainly there are companies that we’re talking to that were looking at or considering alternative models. So the kinds of things that we’re offering, which is the ability to present active strategies in a structure that preserves the confidentiality of current funds trading information while still capturing the potential cost efficiencies and tax efficiencies and exchange traded structure. Those same things would have attracted people to Precidian as attract us, as attract people to us. So it’s not surprising to us that the people that might have been interested in that structure would also have an interest in talking to us about our structure.

Okay. And I guess maybe just as a follow-up there. In your conversations with the SEC, did you ever get a sense that they didn't necessarily want to have one firm having a monopoly over this? Is there potential that maybe -- I know T. Rowe Price has filing up and that’s not necessarily blind trust filing, but whether or not the SEC was looking for potentially other mousetraps to offer if they were settled on just one?

We've made it clear that we don't intend to have a monopoly here. Our goal is to license this technology broadly across the industry. We expect not only Eaton Vance but essentially all comers in our industry to have access to this technology at what we think will be reasonable licensing fees to make available to their customers. I would point out this is not the first, but it is the second approved the way that an active manager can offer exchange traded products. There is the fully transparent version that was approved in 2008 and there is now the NAV-based version that we believe we’re on the verge of approval of in 2014. I wouldn’t want to speculate whether they will or will not be other versions that might be approved at some point in the future.

Right, okay. Thanks for taking my questions.

That’s all the time we have for questions today. I'll turn the call back over to the presenters for closing remarks.

Okay, great. Thank you for joining us this morning. We hope you all have a happy and safe Thanksgiving. And enjoy the holidays. And we look forward to reporting back to you at the close of our first fiscal quarter in February. Thank you.

This concludes today’s conference call. You may now disconnect.