Morgan Stanley (MS) Q2 2018 Earnings Report, Transcript and Summary

Good morning. My name is Amy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Eaton Vance Corp. Fiscal Second Quarter Earnings Conference Call and Webcast. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session [Operator Instructions]. I would now like to turn the call over to Laurie Hylton, Eaton Vance's Chief Financial Officer. Please go ahead.

Good morning. And welcome to our fiscal 2018 second quarter earnings call and webcast. With me this morning are Tom Faust, Chairman and Chief Executive Officer of Eaton Vance; Dan Cataldo, our Chief Administrative Officer; and Eric Stein, our new Treasurer and Director of Investor Relations. As many of you are likely aware, Eric joined the Eaton Vance last month to replace Dan as Treasurer and Director of Investor Relations following Dan's promotion to Chief Administrative Officer upon the retirement of Jeff Beale. Welcome Eric and congratulations Dan on your new responsibility. In today’s call, Tom and I will first comment on the quarter and then take your questions. The full earnings release and charts we will refer to during the call are available on our Web site, eatonvance.com, under the heading, Press Releases. Just a reminder, that 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 2017 Annual Report on Form 10-K are available on our Web site or upon request at no charge. I'll now turn the call over to Tom.

Thank you, Laurie, and good morning everyone. Earlier today, Eaton Vance reported adjusted earnings per diluted share of $0.77 for the second quarter of fiscal 2018, which is up 24% from $0.62 of adjusted earnings per diluted share in the second quarter of fiscal 2017, and down 1% from $0.78 in the first quarter of fiscal 2018. For the first six months of fiscal 2018, we reported adjusted earnings per diluted share of $1.54, an increase of 34% from $1.15 in the first half of fiscal 2017. Of the $0.39 per diluted share increase in first half adjusted earnings, $0.23 was attributable to growth in operating income, $0.12 is the net effective lower income taxes and the remaining $0.04 reflects the lower interest expense and other non-operating items. We ended the fiscal second quarter with $440.1 billion of consolidated assets under management, up 14% or $53.1 billion from a year earlier. The year-over-year increase in consolidated managed assets reflects net inflows of $28.6 billion and market price appreciation in managed assets of $24.5 billion. Consolidated assets under management declined 2% from the end of the fiscal 2018 first quarter, reflecting second quarter consolidated net inflows of $4.4 billion and $13.6 billion of market driven price declines in managed assets during the quarter. The $4.4 billion of consolidated net inflows in the second quarter equates to 4% annualized internal growth in managed assets. Excluding the $3.6 billion of net outflows from exposure management mandates, which are both lower fee and more volatile than the rest of our business, we had $8 billion of consolidated net inflows in the second quarter, an increase of 7% over last year’s second quarter and up 43% from the first quarter of fiscal 2018. Reflecting strong inflows into a number of higher fee strategies, we generated annualized internal growth in consolidated management fee revenue of 7% in the second quarter, matching the first and second quarters of fiscal 2017 as the highest quarterly organic revenue growth rate we’ve posted since we began reporting this metric a couple of years ago. As we define organic revenue growth is the change in our consolidated management fee revenue, resulting from that inflows and outflows, taking into account the fee rate applicable to each dollar in and out and excluding the impact of market action and acquisitions. By this measure, we believe Eaton Vance’s among the fastest growing of U.S. listed public asset managers. A key contributor to our continuing strong internal growth is favorable investment performance. As shown on Page 14 of the call slides, at the end of April, 50% of our U.S. mutual fund assets were in funds ranking in the top cortile of the Morningstar category on a three year basis, and 55% of our U.S. mutual fund assets ranked in the top cortile among pure fund on a five year basis. We ended the second quarter with 67 U.S. mutual funds rated four or five stars by Morningstar, including 23 five star rated funds. As we highlighted last quarter, our second key contributor to our strong quarter results is the broad range of high-performing strategies we offer in investment areas, having particular appeal during periods of rising interest rates, such as we are now experiencing. These include our floating rate income, short duration fixed income and absolute return strategies. At the end of April, we had two floating rate bank owned funds, four short duration income funds and a global macro absolute return fund, all rated five stars by Morningstar. Each of these strategies is a current focus of our sales teams. Drawing down into our quarterly net flows by investment mandate, the three leading categories were floating rate income, fixed income and portfolio implementation, all with between $2.2 billion and $2.4 billion in net inflows for the quarter. Within the floating rate loan category, second quarter net flows were well balanced between retail and institutional and between U.S. and non-U.S. clients. Japan remains our most important market for bank home mandates outside the U.S., and contributed significantly to second quarter net flows. Within fixed income, the largest flow contributor was the laddered bond separate accounts, which had $1.5 billion in net inflows during the quarter. Other leading contributors to fixed income category net inflows were high yield bonds, emerging market debt and short duration U.S. government inflation protected and strategic income mandates. On an overall basis, we grew fixed income across funds and separate accounts, and with both retail and institutional clients. In portfolio implementation, net flows in Parametric Custom Core separate accounts offered to retail and high net worth investors, continued to dominate the category, accounting for $2 billion to $2.2 billion total category net inflows in the second quarter. After a slowdown in the first fiscal quarter, likely relating to uncertainty about the new tax bill while it was being deliberated, net flows in the custom core mandates rebounded sharply in the second quarter, increasing by nearly 40% sequentially. As in other recent quarters, flows in our alternative asset category were driven by Global Macro Absolute Return mandates, which had net inflows for the quarter of just under $0.5 billion. Within equities, leading contributors to quarterly net inflows included EVM Growth, Parametric Defensive Equity, Calvert Emerging Markets and Calvert Responsible Index Funds. As previously mentioned, our exposure management business had net outflows of $3.6 billion in the second quarter of fiscal 2018. This compares to net inflows of $5.4 billion in last year's second quarter and $1.5 billion of net inflows in this year's first quarter. As a reminder, this Parametric offering applies financial futures and other derivative instruments to help large institutional investors efficiently manage the equity, duration, currency and other market exposures within their portfolio with Parametric serving on either a discretionary or non-discretionary basis. The exposure management outflows we experienced in the second quarter reflect net withdrawals from client position on which we earn a management fee. Substantially, all of the net flow outflows are attributable to declining balances and continuing client accounts rather than loss of clients. Despite the volatility of this business contributes to our quarterly for reporting and fee rates averaging only 5 basis points annually, we continue to view exposure managements the core offering with solid profitability and good growth prospects. Having a strong exposure management franchise also helps us establish and maintain closer relationships with a client roaster that would be the envy of any asset manager. In many cases, Parametric client relationships that started with exposure management mandates, have migrated to also include other strategies. In recent investor communications, I’ve talked about Eaton Vance’s five strategic priorities for fiscal 2018, which are; capitalizing on our strong investment performance and favorable positioning to grow and active management; extending the success of our Parametric Custom Core and EVM bond laddered separate account franchises in specially passive and quasi-passive management; becoming a more global company; leveraging the Calvert acquisition we made at the end of 2016 to become a leader and responsible investing; and finally, positioning NextShares to become the vehicle of choice for U.S. investors and actively managed funds. Here's a brief progress report on each of those initiatives. As I mentioned earlier, we view our broad lineup of high performing funds and separate accounts and our leadership and investment strategies that are well positioned for it in environment of rising interest rates, as presenting significant opportunities to Eaton Vance to grow in active management, even as the overall market for active management continues to decline. Our confidence and the growth potential of our active strategies was born-out in the second quarter. During the quarter, net flows into our actively managed funds and accounts totaled $4.2 billion, equating to 8% annualized internal growth in managed assets. Based on results for the first three weeks of May and visible pipeline, we expect positive active strategy flows to continue in the third quarter. In the marketplace and internally, we sometimes refer to are Parametric Custom Core and EVM bond laddered separate account strategies offered to the retail and high net worth market as custom beta, these high value strategies to continue to demonstrate broad market appeal and significant growth. During the second quarter, net flows into our custom beta separate accounts totaled $3.5 billion. This equates to 18% annualized internal growth in custom beta managed assets. As with our actively managed strategies, results were made to-date and the pipeline of one not funded new business give us confidence that strong growth of our custom beta franchise will continue. Our business outside the United States remain significantly underdeveloped, representing only about 6% of our consolidated managed assets. Both in terms of globalizing our investment offerings and expanding our distribution reach outside the U.S., we continue to pursue growth opportunities. During the second quarter, net flows into funds and accounts managed for Eaton Vance clients outside the U.S. were $1.4 billion, which equates to 22% annualized internal growth and assets managed for non-U.S. clients. As we near the 17 month in our ownership of Calvert, we feel good about what we've accomplished and even better about the opportunities ahead of us to capitalize on Calvert's leading brand and leading expertise and responsible investing. While we are still in the early stages of repositioning Calvert beyond its historical roots in the U.S. retail market, Calvert branded strategy has generated just over $500 million of positive net flows in the second quarter, which equates to 14% annualized internal growth in managed assets. With a host of new business initiatives now in progress at Calvert and investor interest in responsible investing continuing to build, we are confidence that Calvert's best growth lies ahead. Finally, with NextShares, our focus continues to be on achieving commercial success for our distribution relationship with UBS, and using that success as a springboard to gain broader distribution reach and entering into licensing arrangements with more fund sponsors. There are currently 17 NextShares funds from eight fund families listed from market trading, including those from six unaffiliated fund groups; Brandis, Causeway, Gabelli, Hartford, Ryan Hart, and Allen Ried. About half of those 17 funds are currently available for purchase at UBS with the balance working their way through UBS’s due diligence. Sales today at UBS have been modest with it just beginning to open as more funds cleared due diligence, more advisors complete required product training and more wholesale retention gets devoted to NextShares. In the long journey to commercialize NextShares the coming 12 months will be pivotal. We now have an initial range of approved NextShares funds, and a major distribution partner committed to working with us to bring these funds to market. Now it's the time to begin translating that potential into sales success. In closing, these continue to be good times at Eaton Vance. Our business has strong current momentum, driven by high performing investment franchises well positioned for the current market environment, a range of specialty offerings with the broad and growing market appeal and strong distribution and client service. Longer term, we believe that Eaton Vance is a culture, inheriting the capital structure distinctively supportive of continued business success as the management industry evolves. That concludes my remarks. And I'll now turn the call over to Laurie.

Thank you, and again good morning. As Tom mentioned, we’re reporting adjusted earnings per diluted share of $0.77 for the second quarter of fiscal 2018, an increase of 24% from $0.62 of adjusted earnings per diluted share in the second quarter of fiscal 2017, down 1% from $0.78 of adjusted earnings per diluted share reported in the first quarter of fiscal 2018. Second quarter’s seasonal factors, primarily reflected three fewer fee days and three fewer payroll days in the quarter, reduced earnings by approximately $0.02 per diluted share sequentially. As you can see in attachment two to our press release, adjusted earnings trailed GAAP earnings by a penny per diluted share in the second quarter of fiscal 2018 to reflect the reversal of $1.9 million of net excess tax benefits recognized from the exercise of employee stock option, investing of restricted stock awards during the period. Adjusted earnings per diluted share matched GAAP earnings per diluted share in the second quarter of fiscal 2017, and exceeded GAAP earnings in the first quarter of fiscal 2017 by $0.15 per diluted share, reflecting the impact of tax law changes, a newly adopted accounting standard addressing the treatment of stock-based compensation and the expiration of the Company's options to acquire an additional 26% ownership interest in our 49% owned affiliate tax vest. Our operating income in the second quarter fiscal 2018 was up 13% from the second quarter of fiscal 2017, down 2% sequentially. Our operating margin was 32% in the second quarter fiscal 2018 versus 31.5% in the second quarter of fiscal 2017, and 32.2% in the first quarter of fiscal 2018. Operating margin for the first six months of the fiscal year improved from 30.6% in 2017 to 32.1% in 2018. Ending consolidated managed assets of $440.1 billion at April 30, 2018 were up 14% year-over-year, driven by strong net flows and positive market returns, and down 2% sequentially, primarily reflecting market price declines in February and March, partially offset by strong net inflows. Average managed assets in the second quarter of fiscal 2018 increased 17% from the second quarter fiscal 2017, driving 11% increase in revenue. Revenue growth trails growth in average managed assets year-over-year, primarily due to the decline in our average annual life management fee rate from 34.7 basis points in the second quarter of fiscal 2017 to 33.3 basis points in the second quarter of fiscal 2018. This decline in our average annualized management fee rate is primarily attributable to outsized growth of our lower fee portfolio implementation and bond ladder businesses. Our average managed assets for the second quarter were up 2% from the first quarter of fiscal 2018. Second quarter revenue was down 2%, reflecting the impact of three fewer fee days in the second quarter and a modest decrease in our average annualized management fee rate. The sequential decline in our average annualized management fee rate from 33.7 basis points to 33.3 basis points primarily reflects the continuing shift in our business mix, driven by strong net flows into our lower fee portfolio implementation and bond ladder businesses. Strong net inflows into several higher fee strategies in the second quarter helped mitigate the mix driven fee rate decline. Performance fees, which are excluded from the calculation from our average management fee rates, reduced earnings by $0.5 million in both the second and first quarters of fiscal 2018, and were negligible in the second fiscal 2017. Tom noted, in the second quarter of fiscal 2018, our annualized internal growth and management fee revenue of 7% outpaced our annualized internal growth and managed assets of 4%, primarily reflecting the impact of net inflows into higher fee strategies during the quarter. This compares to 7% annualized income growth in management fee revenue on 14% annualized internal growth in managed assets in the second quarter fiscal 2017. A 5% annualized internal growth in management fee revenue on 7% annualized growth in management in managed assets in the first quarter of fiscal 2018. Based on current sales trends and the visible pipeline of pending flows, we continue to be optimistic about our ability to achieve positive organic growth in management fee revenue over the balance of fiscal 2018. Turning to expenses, competition expense increased by 9% from the second quarter of fiscal 2017, reflecting higher headcount, year-end increases in base salaries, increases in our corporate 401(k) match and other benefit costs, increases in operating income and performance based bonus accruals and higher stock based compensation, partially offset by a decrease in sales based incentive compensation. Sequentially, compensation expense decreased by 5% from the first quarter fiscal 2018, reflecting lower stock-based compensation, a decrease in operating income based bonus accruals, lower sales based incentive compensation and a decrease in base compensation, driven by fewer payroll days in the second fiscal quarter. Non-compensation distribution related costs, including distribution and service fees and the amortization of deferred sales commission, increased 4% from the same quarter a year ago, and decreased 3% sequentially. The year-over-year increase primarily reflects higher marketing and promotion cost, higher commission and amortization for private fund and increases in intermediary marketing support payments, mainly driven by higher average managed assets. The sequential quarterly decrease primarily reflects reduced intermediately marketing support payments and lower distribution and service fees, driven primarily by lower average managed assets and share classes that are subject to these fees and the impact of three fewer fee days in the second quarter. Fund related expenses increased 29% and 3% versus the second quarter of fiscal 2017, and the first quarter of fiscal 2018 respectively, primarily reflecting increases in fund subsidy accruals and higher sub advisory fees paid. Other operating expenses increased 14% and 10% versus the second quarter of fiscal 2017 and the first quarter of fiscal 2018 respectively, primarily reflecting increases in information technology spending, as well as higher facility, professional services and travel expenses. We continue to spend approximately $2 million per quarter in connection with our NextShare initiative. Net gains and other investment income on seed capital investments contributed a penny and $0.02 for earnings per diluted share in the second quarters of fiscal 2018 and fiscal 2017 respectively, and were negligible in the first quarter of fiscal 2018. When quantifying the impact of our seed capital investments on earnings each quarter, we take into consideration our pro rata shares of gains, losses and other investment income earned on investments in sponsor strategies, 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, within the per share impact, net of income taxes and net income attributable to non-controlling interest. We continue to hedge the market exposures of our seed capital portfolio to the extent practicable to minimize the associated earnings volatility. Net gains and other investment income in the first quarter of fiscal 2018 included $6.5 million charge to reflect the expiration of the Company's option to acquire an additional 26% ownership interest in Hexavest under the terms of the option agreement entered into when we acquired our initial 49% ownership interest in 2012. We excluded this one time charge from our calculation of adjusted net income and adjusted earnings per diluted share for the first quarter. Consolidate CLO activity contributed $800,000 and $1.6 million to non-operating income in the second and first quarters of fiscal 2018 -- second and first quarters of fiscal 2018 respectively. Turning to taxes, our effective tax rate for the second quarter fiscal 2018 was 26.7% versus 37.5% in the second quarter of fiscal 2017, and 36.3% in the first quarter in the first quarter of fiscal 2018. The Company's effective tax rate for the second and first quarters of fiscal 2018 reflect net excess tax benefits of $1.9 million and $11.9 million respectively related to the exercise of stock options investing of restricted stock awards during those periods. New accounting guidance adopted in the first quarter requires these net excess tax benefits to be recognized in earnings. The Company's income tax provision for the first quarter of fiscal 2018 also included a non-recurring charge of $24.7 million to reflect the estimated effect of U.S. federal tax law changes enacted in the first quarter. As noted previously, our calculations of adjusted net income and adjusted earnings per diluted share remove the effect the net excess tax benefits recognized in the second and first quarters in connection with the new accounting guidance and the non-recurring impact of the tax reform recognized in the first quarter. On this basis, our adjusted effective tax rate was 28.2% and 26.7% in the second and first quarters of fiscal 2018 respectively. On the same adjusted basis, we estimate that our quarterly effective tax rate for the balance of fiscal 2018 and the fiscal year as a whole will range between 27.5% and 28%, and our fiscal 2019 effective tax rate will range between 25.3% and 25.8%. During the second quarter of fiscal 2018, we used $36.2 million of corporate cash to pay quarterly dividends and $0.31 per share -- of $0.31 per share, and repurchased 1.3 million of shares of non-voting common stock for approximately $73.1 million. Our weighted average diluted shares outstanding were $123.8 million, up 7% year-over-year and substantially unchanged from the first quarter. We finished our second fiscal quarter holding $791.4 million of cash, cash equivalents and short term debt security and approximately $369 million in seed capital investments, and with outstanding debt obligations of $625 million. We continue to place high priority on using the Company's cash flow to benefit shareholders. Even as we support strong business growth, we maintain significant financial flexibility. This concludes our prepared comments. At this point, we'd like to take any questions you may have.

[Operator Instructions] Your first question today comes from the line of Patrick Davitt of Autonomous. Your line is open.

The fee rate, particularly in floating rate, came down a little bit more than we would have expected. Are there any timing issues around when flows came in and out, or is there anything you want to that you would point out? And in particular, is there a mix shift within the floating rate bucket driving that to come down so much?

The main thing going on, I believe, during the quarter was continued growth on the institutional side of the business, which has for us and for market generally, has lower fee rate than in our recent product. So you'll see that rate bounce around, primarily reflecting mix of retail and institutional. I talked about -- we had good growth offshore in the second quarter and that largely was in bank loans and that was largely institutional. So hope that gives you a little flavor.

And then on the pipeline commentary, I appreciate that. Could you maybe scale that relative to last quarter and this point last year?

So that's on pipeline on our business generally or on specific…

I think -- you're talking about…

I don't have that on my fingertips, I don't recall where that was last quarter versus -- or the year ago quarter. We're looking at for the quarter on the order of $3 billion or so of net flows for which we see a visible pipeline. Understand that includes a mix of both active and passive businesses, and a fair bid of that is Parametric business, including that exposure management where we do expect net inflows. But I would say on an overall basis, the pipeline is robust. We've got multi-hundred million dollar visibility and to growth macro absolute return franchises, Parametric emerging markets, high yield bond, custom core the sense of equity and exposure management.

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

This is Geoff filling for Mike, thanks for taking our question. So just looking at the $800 million of cash and equivalent in the short term investments. How much of that would you say is free to return versus tied up due to regulatory other needs? And then maybe longer term is there a total payout ratio that you typically target?

Well, we don’t have in our precise number on what cash tied up in regulatory. But we can -- feel like we can comfortably run the business with $200 million in cash. It's probably something close to 100 that would be tied up due to regulatory…

Included within that 200.

Exactly, yes. The second part of your question was?

So I think on the total payout ratio over the long term…

Yes, it's certainly something we look at each year when we review our dividend for the upcoming 12 months, and that typically is done mid-October. So it’s definitely something we consider in addition to cash needs to support the growth of the business.

And I would say that on an overall basis long-term it’s 100%, we have no other reason for being then to earn cash and cash flow for our shareholders, and returning that to shareholders either through dividends or stock repurchases, are certainly long-term goal and strategy and consistent with the history of the Company. The fact that we’ve seen a buildup in cash over the last several quarters doesn't reflect the change in that philosophy.

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

Question for you just in terms of flows, and appreciate the last comments, so seeing across the range of the platform. Could you fill in maybe one level deeper and give us a sense of maybe where you’re seeing the volumes coming from? Is it from other place with lesser performance, or is there any mix shift that you’re seeing in terms of allocations whether it’d be on that retail gatekeeper side or on the institutional consultant side?

Maybe it would be helpful to break that down. It will vary between our active and more passive businesses just starting with the active businesses. And in bank loans, we’re benefiting from two things; one is bank loans have been an asset class that has attracted significant flows, relating to expectations and the reality of rising interest rate; and then second among the bank loan mangers not surprisingly, given our performance, we’ve been gaining market share. So it’s really a combination there of both and expanding category, which reflects cyclical factors maybe some secular growth there as well, plus a relatively strong performance profile for Eaton Vance. I would also highlight absolute return strategies in particular global macro absolute return, which again benefits from the cyclical phenomenon of investors looking to diverse so far away from fixed income and duration risk into a less correlated or non-correlated strategy that invest primarily in emerging market currencies and debt instruments of a short-term duration nature. There I think we’re probably also gaining market share where in Morningstar categorizes us in non-traditional bonds in that strategy. And relative to that category, we’ve noticeably gained market share over the last few quarters. The same generally would apply to other short-term income strategies. We have a short duration government fund that’s in inflows. We have a short duration strategic income fund that’s in net inflows. We have a short duration inflation protected fund that’s in net inflows. In all those cases, we have strong performance. I believe those are all five star rated funds and also these are in categories position to benefit from investors looking for ways to diversify their duration exposure to reduce their duration exposure within fixed income. On the more passive side of our business, this is primarily what we call custom beta. We’re benefiting from a couple of things there. One is on the equity side, this is primarily offering our customized index-based separate accounts as alternatives to index ETFs and indexed mutual funds where the benefit is -- the benefit of a customized exposure, which allows people to reflect responsible investing criteria or other portfolio of tilts that they desire. And also the better tax treatment of holding individual securities as opposed to holding those same investments through a fund. The primary advantages being two; one the ability to fund positions in time without having to sell and realize the taxable gain; and two, the ability to harvest and pass through on a current basis, the value of realized capital losses, which in a fund context are trapped inside the vehicle. On the fixed income side, our laddered, muni and corporate bond separate accounts, these are so primarily into broker dealer channels and there this is a way to feed into and benefit from migration of business from brokerage accounts to advisory relationships, particularly within fixed income and especially within the laddered bond accounts. We have been the market leader in this. We think we have industry leading relationships, industry leading performance characteristics and industry leading service level. So in all of these things, I’d say Bill, it's hard to break it out between market developments and share developments. We have good data on the fund side of our business, not very good data in terms of market share outside of funds. But on overall basis, we feel like we're both gaining market share in key categories for us, but also benefiting from some fairly significant market trends that are pushing business into areas that we care most about, such as short duration or floating rate income and such as things like our custom beta strategies.

And then maybe a follow-up for Laurie, I may ask this question quarter-after-quarters, I do apologize for the repetition of it. Can you give us a sense of how you’re thinking about margins from here? And I am trying to understand interplay now it looks like great comp leverage within the other line little bit sequentially. So you look out into the second half of this year or maybe longer term. Do you still think you can drive some operating leverage? And maybe is the way to think about on the incremental margin, just trying to get a sense of how much incremental room there might be for margins to move higher here quickly given the great growth?

In terms of looking out, I would love to have a crystal ball and tell you that I've got great visibility going out into 2019. But I think that would be an overestimation of our forecasting skills at this point. But I think that as we look ahead to the next couple of quarters, I would anticipate that we will be in this range. I do continue to think that we've got operating leverage opportunity. But I would not anticipate -- obviously, March and February, were both really tough months. From a market perspective, there was lot of volatility and it really hurt us in terms of what we lost to market -- lost to assets due to market. So that create a little bit of a headwind that we're coming out of now. But if we get some really nice market, that's going to be helpful. We could see a little bit more leverage. But otherwise, I would anticipate we're going to be in this range, maybe modestly up another 50 basis points. But I wouldn't anticipate we’re suddenly going to see a screaming run on our operating margin.

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

I guess, just to follow up on that last question. Can you talk maybe about the differences in the profitability or the scalability of certain of your businesses? So if we think about, we know the fee rates but the exposure management how we think about that or this in terms of incremental margin, how you want to characterize it versus say your traditional fund business?

It's important to make sure, we're talking about the same thing, we're talking about margins. So just to be clear, we're talking about operating income as a percentage of revenue not operating income expressed in basis points on assets. So expressed in basis points on assets we make significantly less on exposure management because we clear with 5 basis points not starting with 30 or 50 or 75 on some of our mandates. In terms of margin profitability per dollar of revenue, that's a very good business. It's probably approaching the corporate average. It's not substantially below this is a scale of business very efficiently run. A portfolio manager and implementation business doesn't command the same compensation level as a portfolio manager does in a stock or bond picking business. It is highly scale dependent and we have a large scale there and it's entirely systems dependent. And we have excellent systems to support that business. So it's while though, say it's not particularly the margin, I don't think we would say it's higher than our average margin, but it's in the range of most of our businesses. If you look across our businesses, the key driver of profitability is scale. If you look at things like bank loans, where we've got a very large business. we have higher profitability. And things that we do in limited scale either because we're trying to grow the business or hope brings eternal and we're hanging on. Those kind of businesses have lower margin. So big picture our approach to growing the profits of Eaton Vance is developing and cultivating through scale a range of market leading franchises. And typically the bigger the franchise both the easier it is to sell all else being equal and the more profitable it is from a margin perspective again all else being equal. So the goal is always is to build scale to the extent reasonable and to the extent we still have the ability to manage money flexibly and efficiently at that scale. But the goal is to build scale across franchises and if you want to know relative levels of profitability of our business starting with revenues is probably a good place to look. And things that we have good revenues in, we tend to have good margins in. And things that we're trying to build revenue we don't tend to have attractive margins. This is fundamentally a people business, it takes a certain amount of people to run any kind of investment business, the more assets you manage the more revenues you generate likely the higher the fee is going to be from that business. And that holds pretty true across the board in our business.

Thanks that's helpful. And I guess just another question around M&A you guys have been successful and deploying capital and adding on businesses. I guess at this point of the cycle, how do you think about M&A in terms of that versus repurchasing your own stock or other capital return methods?

We certainly look, there have been some transactions that have happened to our business. We think asset management is right for consolidation. We think Eaton Vance has many of the characteristics of a successful acquire, including as you point out having a record, having done this successfully in the past and a fair bit of financial flexibility to allow us to finance a transaction. We're particular about what we might acquire. While in the past, we've been successful in growing our business and expanding our footprint within asset management through acquisitions. We are also mindful that this is a fairly hazardous business going out and buying someone else's asset management business and inheriting their culture and inheriting there people. So we wanted to do it very carefully. We are price-sensitive, we don't tend to win auctions, because really we're going to put the highest valuation on a business. But we do think that that we bring a lot to offer here and we do devote a fair bit of attention to at least thinking about that. So I think we it's not a large team, its mostly Laurie and myself and other people in the finance group. This is not a significant activity for people in our sales organization or people in our investment or admin group. But in terms of the senior levels of legal and finance and general business we do look a fair bit at things that might be of interest. I would put the kind of things that are possibly of interest to us into three or four categories. One that would be consistent with things that we've done in the past are what I'll call both on acquisitions where we had distribution firepower, we brought on our business mix and helped our business grow to scale, adding more distribution resources than that company could likely afford to do on their own. That's been our traditional growth path. We have also looked at acquisitions that would expand our footprint graphically, only about 6% of our assets today are outside the United States. We think there could be opportunities for us to accelerate the growth of our business outside the United States through transactions that involve cross-border linkups. And then finally there are the scale type transactions that involve both opportunities for revenue synergies, but also cost synergies and those are if done at scale significantly riskier in a financial sense and in a corporate culture sense, but we also certainly kick the tires on those. Again we do believe there should be and there will be consolidation in our business and we want to participate that and that at least at a level of looking and if the fit is right and if we put the highest value on something. It's possible that will be active there as well.

Our next question from the line of Brian Bedell of Deutsche Bank. Your line is now open.

I just want to come back to the fee rates, I think you explained the floating rate is moving towards the institutional from a mix shift and then quickly if I'm wrong I think you mentioned also in the fixed income the [lettered] bond portfolios shift towards that being lower fee rates that impacted that? If you can -- Craig if I am wrong enough and then also if you can comment on the equities bucket and the portfolio implementation in terms of the fee rates declines and that, is that a good run rate start into coming into the second quarter or do you think the mix would go back the other way?

Yeah, I think you're right in your observation. Certainly starting on fixed income, I think we highlighted in the call facts that we had a $1.5 billion of net inflows within fixed income that were ladder separate accounts that's 15-16 basis points business as that grows, that tends to pull down the average fee rate in the fixed income category. So that's the primary driver of that category. So you see, I'm looking in our press release, attachment 10. So the biggest year over year decline was in fixed income where fee rates went down 7% from 38.5% to 35.8% . Again, that primarily reflects the strong growth of our ladder separate account business is that if the rates in the 15 to 16 basis point range. Floating rate income, I think we already talked about that. Alternatives which went the other way. We have a global macro absolute return advantage strategy that is at a higher fee rate, that and its sister fund, call macro absolute return, really dominate that alternatives category, both in terms of assets inflows and because the mix of flows have been skewed towards the higher fee advantage version of that strategy, you've seen that 9% pickup in average fee rates year over year in the alternative category. Equities, that's also primarily mix shift among the fastest growing equity strategies we offer are what we call defensive equity or volatility risk premium strategies, which are Parametric offerings using a derivatives, primarily there's a permanently call selling strategies, fast growth contributing there, there are also other strategies in the equity group and higher fee rates that have been growing but unbalanced, that fee decline reflects primarily mixed with faster growth of these options based -- rules based option strategies offered by parametric. Within portfolio implementation, not exactly sure, that -- some of that might be mix, some of that is also we've grown with the client relationships where they have more pricing power and so fees on some business has been is coming at lower price points where it's a competitive situation, I would say generally, we view our business as, if you take out mix and look at pricing within existing mandates, something like 1% annual declines just based on fee concessions and break points built into fee schedules is part of our business. I've been here 33 years and I can't remember ever raising prices on any of our strategies over that period, I might be missing something. But generally the nature of our business is that fee rates go down within mandates as they grow out to scale. And that trend is certainly present here, still pretty modest, something like 1% of that 4% year-over-year decline in average fee rates is true price declines with the balance representing a mix of faster growth of all three businesses than in higher fee businesses generally.

And then I guess just on the -- I think I heard you say $3 billion and I wasn't sure if that was what you were indicating as the pipeline for through the outlook as you went through that for the quarter that we're currently in. And if you could just verify that? And then also talk about what's going on in the broker dealer channel obviously the platform consolidation? How you are faring in market share there and is portfolio implementation also part of that in terms of when mandates within broker dealer channels?

Yeah, so just to clarify. The number I gave that $3 billion number that's we have a weekly pipeline report of one not funded new business doesn't always happen, but these are as best our sales team can determine. Commitments that clients have made to hire us for new business things that we expect to fund over the coming period. Over the balance of the second quarter, which is going through -- balance of the third quarter which is going through the end of July as I mentioned, it's not only about $3 billion of pending pipeline and that includes about a $1 billion or so of Parametric exposure management and $2 billion of a range of other generally higher fee strategies. So I think that answers that first part. In terms of the impact on platform, broker dealer platform consolidation. We're winning some of [indiscernible]. So we're seeing some of our strategies getting -- taking all availability for current sale in broker dealer channels as they win or down the number of funds they offer. If you have a small fund it's pretty hard to justify the continuing existence of that if flows have not been strong. And we're not immune to that. We're seeing some of our funds being removed from platforms. When that happens I understand that doesn't mean the assets go away, typically those -- the assets stay on the books, though new sales are no longer permitted. There is the possibility for things that have been taken off the platform to come back on if there is advisor demand. We had -- during this quarter, we had and at least wanted to make -- broker dealers we had a case where several smaller Calvert strategies were taken off platform but then added back once they figured out that they have a large corporate initiative to support responsible investing and that these were leading high performing funds in those categories that do have growth potential as those responsible strategies grow. In terms of our non-fund business, our separate accounts including the implementation business the Parametric custom core. I don't think there's has been a lot of impact -- there is not a lot of impact on us of consolidation of offerings. I think that's largely been not fund phenomenon not a separate account phenomenon. And that's a legacy of days going back decades when large broker dealers potentially made all funds available. The separate account business -- the retail manage account business is a newer business and that was never really the way that business operated.

Great, I mean that there are few there potentially gain share in the portfolio implementation process as other funds are cut from the platform?

That's absolutely right, we're positioned to grow our business in portfolio implementation generally as money moves from active to passive and quasi passive. We just picked up a custom core availability in single contract in the last of the major warehouse broker-dealers. So we have got full coverage now for both single contracts into a contract across the landscape of the warehouses that just happened in the last two weeks.

Our next question comes from the line of Glenn Schorr of Evercore ISI. Your line is now open.

Similar to one of the previous questions I'm curious with all this growth and reasonable operating leverage, just thoughts on the share count going forward, I think we're up 7% year-over-year?

I think that we kind of have a very slightly more opportunistic and systematic share repurchase program. We're fairly heavy users or stock based compensation. We recognize that put the pressure on our diluted share count. But we really think about our share repurchase program in terms of our total capital management strategy and address that on a quarterly basis. And this quarter we did mean in, we repurchased what was $73 million worth of stock this quarter, and hopefully that will be helpful as we look at our share count for next quarter. But I don't have guidance to give in terms of what we anticipate we will do throughout the rest of the year outside of saying that we would certainly anticipate that we will be active in the market and that we do view share repurchase as a significant tool in our quiver as we think about ways that we can return value to shareholders.

Okay. And then if I could just get a follow up comment or clarity on the comment you made earlier on exposure management a product of declining client balances not clients leaving, is that just if you can think of it as run off of previous money less that you guys are just going to run this course is that the comment?

Let me again just explain again what this business is. So, imagine your large institutional investor with a couple billion dollars that you have placed with a number of different outside managers. So your pension fund or endowment or foundation. One application of parametric exposure management is to equatize the cash that exists within your different accounts held with different managers. So if you're actual cash in those portfolios is 3.5% and your target cash is 50 basis points you would hire Parametric to take long equity exposure implemented through futures equal to 3% of that billion dollar portfolio. We built on the basis of the amount of exposures outstanding. So if that client moves around. So let's say they either move their actual cash up or down from 3.5% or they move their target cash up or down from half a percent depending on the relationship between those two, the amount of balances on which we earn the management fee will go up or down in a particular quarter. We've tried and pushed down the management of that Parametric business to help us model, does it in some way relate to what's going on in the market, either in terms of market strength or weakness or high volatility or low volatility. And it turns out there aren't great correlations with what we report as flows in this business, to any of those market factors. We have some pretty large clients in there, where a 1% or 2% change in their target cash or how they're using parametric disclosure management can have a meaningful flow impact on us. In this particular quarter, we were in a period where large clients on balance, we're in a position of reducing their exposures. We continue to look at this business long-term as a growing business. We didn't lose clients or at least not any meaningful numbers of clients in the quarter. It's just that for reasons outside of our control and unfortunately outside of our ability to forecast during this particular period we had more clients take off positions then we had a put on positions. So, I have no reason to think that next quarter will be a repeat of this and the vast majority of quarters we've grown this business, both in terms of number of clients and in terms of average exposures with those clients, the best measure of success in our business -- in this business is primarily number of client relationships and that's grown steadily over time. How clients use this and extent to which they use this, is to some degree a function of the range of our services but it's also very much also a function of how they're positioning their portfolios. Do they have a lot of excess cash that they're looking to monetize, are they using futures to add or subtract duration, are they using futures to add or subtract currency exposure? All of these things will impact the extent of our net positions in this business and all of these will impact our revenues and flows from this business. So it's a little messy, it doesn't lend itself to forecasting in quite the same way as the balance of our business. But as I said in my prepared remarks -- despite low fees and despite some volatility of flows, we continue to regard this as an excellent business, nicely profitable, growing and also providing very deep important relationships with major institutions that have been very helpful to us across the Parametric business and thinking about and realizing a growth and other things that Parametric does.

I totally appreciate all that Tom. The only follow up I had is, if the foundation of this is to put idle cash to work and to eliminate cash drag even if it's temporary. As rates rise, does that start to just become a bigger drag or a competitor to the product in and of itself?

Maybe, I would guess that, really it's -- so it's -- how do you think about cash in your target allocations. Most institutions that I'm close to aren't targeting the allocations to cash because even though cash returns have come up, they're still significantly below longer term either equity or fixed income assets. And most institutions take the view that they can't afford to have a lot of assets sitting around earning very little. I think you're right in that, with rates around 1% there is a little less pressure than there was at rates at zero. But whether that's enough to impact institutions and how they think about cash I don't really know. I think if rates were 8% or cash rates were 8% and people were despondent about the return potential of longer term financial assets, we wouldn't be equitizing cash, but we might also be synthetically taking off equity or income exposure because this doesn't only work one way. One of the beauties of derivatives is it gives the flexibility to not only equitize cash but also to change equity exposures up or down or from emerging markets to developed markets and vice versa and but also to add and subtract duration currency exposure commodity exposure, et cetera. These are very powerful tools that can be used for lots of portfolio reasons. And we're optimistic certainly that as the push for return grows, that people will look to manage their portfolios more efficiently and these are ultimately tools for enhancing portfolio efficiency by allowing managers to more precisely target their asset allocations on a very tactical basis if that's what demands they want to do, without disturbing relationships with underlying managers. So we think this business is here to stay. Whether it's marginally less attractive at higher interest rates, I think there is a case can be made for that, but I would say that there are I would guess bigger factors likely that overwhelm that just in terms of the other flexibility of this service offering what we can do for clients beyond just equitizing cash.

And at this time, I would like to turn the call over to Ms. Hylton for any closing remarks.

We just want to thank you for joining us this afternoon. And we look forward to catching up with everybody again when we release our third quarter results in August. Thank you.