Morgan Stanley (MS) Q3 2019 Earnings Report, Transcript and Summary

Good morning. My name is Julian, and I will be your conference operator today. At this time I would like to welcome everyone to the Eaton Vance Corp Third Fiscal Quarter Earnings Conference Call. 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] Thank you. Eric Senay, Treasurer and Director of Investor Relations, you may begin your conference.

Thank you, Julian, and good morning and welcome to our fiscal 2019 third quarter earnings call and webcast. With me today this morning are Tom Faust, Chairman and CEO of Eaton Vance; and Laurie Hylton, our CFO. In today’s call, we 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 website eatonvance.com under the heading Investors Relations. I will remind you 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 2018 Annual Report and Form 10-K are available on our website or upon request at no charge. I will now turn the call over to Tom.

Good morning and thank you for joining us. Earlier today, we reported $0.90 of adjusted earnings per diluted share for the third quarter of fiscal 2019, an increase of 10% from $0.82 in the third quarter of fiscal 2018 and up 1% from $0.89 in the second quarter of fiscal 2019. Our adjusted earnings per diluted share this quarter include $0.04 of combined contribution from seed capital and consolidated CLO entity investments. By comparison, seed capital and consolidated CLO entity investments contributed a combined $0.10 to adjusted earnings per diluted share in the second quarter of fiscal 2019 and had negligible impact in the third quarter of last year. We ended the third quarter of fiscal 2019 with a record $482.8 billion of consolidated assets under management, up 3% over the prior quarter and up 7% from 12 months earlier, and up 10% for the fiscal year to date. By mandate, reporting category changes in consolidated assets under management versus the prior quarter end ranged from growth of 5% for fixed income, 4% for exposure management, 3% for portfolio implementation, and 2% for equities to declines of 4% for alternatives and floating rate bank loans. In the third quarter of fiscal 2019, we had $8 billion of consolidated net inflows or $5.3 billion, excluding exposure management mandates, which have lower average fee rates and more variable flows than our other reporting categories. This represents our 20th consecutive quarter of positive net flows. For the first nine months of fiscal 2019, we had $14.1 billion of consolidated net inflows or $10.1 billion excluding exposure management. Barring unforeseen fourth quarter reversals, we're poised for fiscal 2019 to become our 24th consecutive year of positive net flows. The consistency of our organic growth over the long term speaks to the diversity of our leading investment strategies, the strength of our distribution organization, the performance excellence our investment teams have delivered, and the compelling value proposition offered by the distinctive wealth strategies and services we provide. Our third quarter net flows represent 7% internal growth in consolidated managed assets on an annualized basis or 5% excluding exposure management. Annualized internal growth in consolidated management fee revenue was 2% in the third quarter, which compares to 5% in the third quarter of last year and 1% in the prior quarter. To calculate this measure of internal growth, we subtract management fees attributable to consolidated outflows for the period from management fees attributable to consolidated inflows, and then measure the difference as a percent of beginning of period consolidated management fee revenue taking into account the fee rate applicable to each dollar in and out. This quarter's $1.6 billion of net -- equity net inflows were led by $1.2 billion into Parametric volatility risk management mandates, which include defensive equity, covered call writing, dynamic hedged equity, and other strategies incorporating equity options. Calvert emerging markets, large-cap growth, and responsible index strategies, EVM large cap growth and Atlanta Capital large-cap core and growth strategies also contributed to the quarter's positive equity flows, offsetting net outflows from Parametric emerging markets and the Atlanta Capital SMID-cap and small-cap strategies, which are closed to new investors. Across a broad range of investment categories, active equity strategies managed by EVM, Calvert, and Atlanta Capital have delivered strong return versus benchmarks and peers over recent periods. As of July 31, actively managed mutual funds whose iShares total returns ranked in the top quintile of their Morningstar category over each of the year-to-date 1-year and 3-year periods, included the Eaton Vance large-cap value, balanced tax managed equity allocation, global income builder, and Atlanta Capital focused growth funds as well as the Calvert equity mid-cap, small-cap, international equity, and balanced funds. In fixed income, approximately half of the $3.4 billion of net inflows in the third quarter of fiscal 2019 were attributable to laddered corporate and municipal bonds, separate accounts, which had $1.7 billion of net flows. Among our taxable fixed income funds, the quarter's flow leaders included Eaton Vance short duration government income fund with more than $400 million of net inflows, core plus bonds with $200 million of net inflows, and emerging markets local income with nearly $200 million of combined net inflows into the U.S mutual fund and offshore versions of the strategy. Having recently surpassed $1 billion in net assets, our top-performing emerging markets local income strategy is an increasing focus of our institutional sales efforts, particularly in offshore markets. Across our family of municipal income mutual funds, net flows totaled just over $500 million led by the Eaton Vance National Municipal income, short duration muni opportunities, muni opportunities, and high yield muni income funds. As of July 31, we offered 24 municipal income funds with one or more share classes currently rated 4 or 5 stars by Morningstar, including a 11, 5-star-rated municipal income funds. Our floating rate bank loan strategies had net outflows of $1.2 billion in the third quarter, improving from $1.6 billion of net outflows in the second quarter and $2.9 billion of net outflows in the first quarter of fiscal 2019. Third quarter net outflows reflect approximately $800 million of net redemptions from U.S retail bank loan funds, $500 million of institutional separate account withdrawals, and a $200 million reduction in bank loan fund leverage amounts, offset in part by $400 million of new collateralized loan obligation assets under management added during the quarter. Although positioning floating rate investments for sales success during periods of falling interest rates can be a challenge, we continue to be pleased with the resilience of our bank loan business, particularly in U.S retail. As the bank loan mutual fund category has experienced unprecedented net outflows this year, our managed assets and flows have held better than most competitors, enabling us to expand our industry leading-market share. Although we can't predict when the market’s appetite for high-yielding floating rate investments will improve, we know that it will. With distribution rates now in the 6% range for the iShare classes of each of the three Eaton Vance bank loan[ph] mutual funds we offer, not a lot of change in sentiment may be required for each retail interest in bank loan investing to pick up. Our funds and separate accounts classified as alternative had net outflows of approximately $650 million in the third quarter, a deterioration from approximately $475 million of net outflows in the quarter ended April, but a sharp improvement from $2.2 billion in net outflows in the quarter end of January. Managed assets in this flow -- inflows in this category are dominated by our two global macro absolute return mutual funds offered in the U.S., which ended the quarter with a combined $7.1 billion under management. Flows into these funds tend to rise and fall with their returns. When returns of our global macro funds are well in excess of U.S risk-free rates, as they have been this year, net inflows normally follow. While not insulated from event risk, our global macro funds offer the potential for attractive levels of absolute returns that are substantially uncorrelated to U.S equity and bond market returns, which could be especially appealing an environment of low bond yields and high economic uncertainty. In our portfolio implementation reporting category, third quarter net inflows of $2.1 billion, reflect $2.5 billion of net contributions to Parametric custom core equity individual separate accounts, $250 million of net contributions to custom core institutional accounts and $650 million of net withdrawals from centralized portfolio management mandates. As mentioned previously, our municipal and corporate laddered bond individual separate accounts contributed $1.7 billion to net inflows in the third quarter. When combined with the $2.5 billion of net inflows into custom core equity individual separate accounts, inflows into our industry leading suite of custom beta strategies offered as individual separate accounts totaled approximately $4.2 billion in the third quarter. As shown on Slide 12 of our presentation, our custom beta individual separate accounts crossed the $100 billion AUM mark this quarter with nearly $105 billion of managed assets as of July 31. For the fiscal year-to-date, net inflows into our custom beta individual separate accounts have totaled approximately $12 billion, representing annualized internal growth of 19%. In late June, we announced the key strategic initiative involving our Parametric and Eaton Vance Management investment affiliates. The initiative has three principal components, rebranding EVM's rules based systematic investment grade fixed income strategies as Parametric and aligning internal reporting consistent with this revised branding. Second, combining the technology and operating platforms supporting the individual separately managed account businesses, as Parametric and EVM; and third, integrating the distribution teams serving parametric and EVM clients and business partners and a registered investment advisor and multifamily office market. As announced in June, the initiative will bring to Parametric industry-leading expertise and systematically managed investment-grade municipal taxable and crossover tax-free taxable fixed income strategies. Based on assets under management as of July 31, approximately $42.5 billion of systematically managed fixed income assets will transfer from EVM to Parametric, representing approximately 9% of Eaton Vance's consolidated assets under management. Along our driver of Eaton Vance's above industry growth trajectory, Parametric becomes even more of a differentiator going forward. As a result of this strategic initiative, Parametric's custom core benchmarked based separate account offerings will expand to encompass fixed income securities and maturity base and liability driven portfolio benchmarks. Customized benchmark separate accounts, which are for sometimes referred to as custom indexing, compete against index ETS and index mutual funds on the basis of enhanced tax efficiency, increased client control over portfolio construction and management and the avoidance of pass-through fund operating and trading costs. Industry observers have identified custom indexing as one of the most promising trends in investment management. This is a market we lead today and are committed to growing aggressively. By expanding Parametric solutions set and customized benchmark based separate accounts and investing in technology to enhance client service and realize operating efficiencies and scale economies, our goal is to further solidify Parametric's position as market leader and position this business for accelerated growth. In late June, we announced that Ranjit Kapila will join Parametric as Chief Technology Officer and Head of Operations. And the promotion of Desmond Gallacher to become Chief Technology Officer of Eaton Vance Management and Calvert. Ranjit formally served as Global Head of Portfolio Management Investment Systems for BlackRock, where he was responsible for leading strategy and development for portfolio management applications across equity, fixed income and multi-asset portfolios for BlackRock and Aladdin clients. Des, joined Eaton Vance in 2014 and served most recently as EVM's Division Head of Investment Technology. This appointment support the Parametric strategic initiative of continue to advance the technologies underpinning the EVM fundamental active and Calvert responsible investment offerings and related services. Although Ranjit does not arrive at Parametric until next month, the change process supporting our strategic initiative is now well underway. Dedicated teams have been established to execute on each of the major components, turning go live dates principally in the first quarter of our fiscal 2020. While we anticipate a period of elevated investment to support the newly combined SMA platform, spending will be less than if we had continued to maintain separate platforms for Parametric and EVM. We expect these investments to be offset by increased revenue growth and cost savings realized from greater operating efficiencies. As we consider our strategic position in the evolving asset management industry, we feel very good about where Eaton Vance sits. Through the expanded Parametric, we are the leader across asset classes and customized benchmark based separate accounts, a market with strong current momentum and limitless growth potential. In Calvert, we hold one of the foremost brands and deepest research and engagement capabilities and responsible investing with a track record of significant sales success over the two and two-thirds years Calvert has been part of Eaton Vance. Eaton Vance Management is a market leader across a range of specialty income investment areas: bank loans, high yield bonds, mortgage-backed securities, emerging market debt and municipal bonds were active strategies continue to compete effectively against passive alternatives. EVM equities focus primarily on distinctive growing niches, focused on risk control and after tax income and returns. Atlanta Capital now offers an array of exceptionally well performing active equity strategies, their poise for accelerated growth. The strength of our investment offerings is supported by one of the top sales and marketing organizations in the business, a culture of innovation and excellence in client service and a capital structure and leadership team, we believe are supportive of long-term success. While these continued to be challenging times for the asset management industry, we remain optimistic about the future of Eaton Vance, both near-term and long-term. That concludes my prepared remarks. I will now turn the call over to Laurie.

Thank you and good morning. As Tom described, reporting adjusted earnings per diluted share of $0.90 for the third quarter of fiscal 2019, up 10% from the $0.82 in the third quarter of fiscal 2018 and up 1% from $0.89 in the second quarter of fiscal 2019. As you can see in attachment two to our press release, adjusted earnings per diluted share in the third and second quarters of fiscal 2019 equaled earnings per diluted share under US GAAP with no material adjustments. GAAP earnings exceeded adjusted earnings by a penny per diluted share in the third quarter of fiscal 2018, reflecting the reversal of $1.3 million of net excess tax benefits related to stock-based compensation awards. In the third quarter fiscal 2019, operating income decreased by 4% year-over-year, reflecting a 2% increase in management fee, a 7% decline in non-management fee revenue and 3% growth in operating expenses. Operating income was up 8% sequentially, reflecting a 5% increase in management fees, 6% growth in non-management fee revenue and 3% higher operating expenses compared to the prior quarter. Our operating margin was 31.8% in the third quarter of fiscal 2019, 33.2% in the third quarter of fiscal 2018 and 30.9% in the second quarter of fiscal 2019. Ending consolidated managed assets reached a new record high of $482.8 billion at July 31, up 7% year-over-year and 3% sequentially, driven by strong net flows and positive market returns. Average managed assets this quarter were up 6% from the same period last year. Management fee revenue growth trailed growth in average managed assets year-over-year, primarily due to decline in our average annualized management fee rate from 33 basis points in the third quarter of fiscal 2018 to 31.8 basis points in the third quarter of fiscal 2019. Versus the prior quarter, average managed assets were up 3%. On a sequential basis, management fee revenue growth exceeded growth in average managed assets, primarily due to the impact of three more fee days in the third quarter. This quarter's average annualized management fee rate of 31.8 basis points was flat in comparison to the second quarter of fiscal 2019. Changes in our average annualized management fee rates over the comparative period primarily reflects shifts in our business mix and variations in fund subsidies. Included in management fees is a contra-revenue item, fund subsidies were down the $1.8 million year-over-year and $3.2 million sequentially, primarily due to a reduction in fund custody expenses resulting from the renegotiation of a service provider contract. Performance based fees, which are excluded from the calculation of our average management fee rate were a positive $0.1 million in the third quarter of fiscal 2019, a negative $0.4 million in the third quarter of fiscal 2018 and a positive $1.8 million in the second quarter of fiscal 2019. In the third quarter of fiscal 2019, our annualized internal growth and management fee revenue of 2% trailed annualized internal growth in managed assets of 7%, primarily due to a mix of higher fee and lower fee strategies within our inflows and outflows during the quarter. This compares to 5% annualized internal growth in management fee revenue and 3% annualized internal growth in managed assets in the third quarter of fiscal 2018 and 1% annualized internal growth in management fee revenue and 4% annualized internal growth in managed assets in the second quarter of fiscal 2019. Turning to expenses. Compensation costs increased 4% year-over-year, primarily driven by higher salaries and benefits associated with increases in headcount and higher stock-based compensation, partially offset by lower operating income based bonus accruals and lower sales based incentive compensation. Sequentially, compensation expense increased 3%, primarily reflecting higher salaries driven by increases in headcount and the impact of three more payable days in the third fiscal quarter, higher stock-based compensation, higher operating income based bonus accruals and higher sales based incentive compensation, all partially offset by decreases in payroll taxes, benefits and performance based bonus accruals. Non-compensation distribution related costs, including distribution service fee expenses and the amortization of deferred sales commissions decreased 2% from the same quarter a year-ago, primarily reflecting lower Class C distribution and service fee expenses, driven by a decrease in average managed assets of Class C mutual fund shares. This decrease was partially offset by higher service fee expense and commission amortization for private funds driven by higher average managed assets in these funds. Sequentially, non-compensation distribution related costs increased 6%, primarily reflecting higher marketing and promotion costs, an increase in Class A and private fund service fee expenses, driven by higher average managed assets and Class A mutual fund shares and private funds. Funds related expenses increased 5% year-over-year, reflecting higher sub-advisory fees due to an increase in average managed assets in sub-advised funds. Sequentially, funds related expenses decreased 2%, reflecting a decline in other fund expenses paid for by the company, partially offset by an increase in sub-advisory fees due to higher average managed assets in sub-advised funds. Other operating expenses increased 6% from the third quarter of fiscal 2018, primarily reflecting higher information technology, facilities in travel expenses, partially offset by a decrease in amortization expense related to certain intangible assets that were fully amortized during the first quarter of fiscal 2019. Other operating expenses were flat sequentially, reflecting increases in information technology, facilities and travel expenses offset by a decrease in professional services expenses. We continue to focus on overall expense management and identifying ways to gain operational leverage. Net gains and other investment income on seed capital investments contributed $0.06 to earnings per diluted share in the third quarter of fiscal 2019. A penny to earnings per diluted share in the third quarter of fiscal 2018 and $0.03 to earnings per diluted share in the second quarter of fiscal 2019. When quantifying the impact of our 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 and sponsored strategies, whether accounted for as consolidated funds, separate accounts or equity investments as well as the gains and losses recognized on derivatives used to hedge these investments. We then report the per share impacts net of income taxes and net income attributable to non-controlling interest. Looking through the hedge to the market exposures of our seed capital portfolio to the extent practicable to minimize the associated earnings volatility. Although we hedged majority of our seed capital portfolio, gains on the unhedged portion drove deposit contribution to earnings this quarter. Non-operating income expense includes net expenses from consolidated CLO entities of $3.5 million in the third quarter of fiscal 2019. This compares to net expenses of $1.2 million in the third quarter of fiscal 2018 and net income of $11 million in the second quarter of fiscal 2019. Other income and expense amounts related to consolidated CLO entities reduced earnings per diluted share by $0.02 in the current quarter, a penny in the third quarter of last year and contributed $0.07 per diluted share in our second fiscal quarter of 2019. Other income expense amounts related to consolidated CLOs reflect changes in our economic interest in these entities, including the fair market value of our investment, distributions received and management fees earned. Our strategy for CLO equity remains to commit prudent amounts of EV capital to support growth in this business, taking advantage of opportunities to recycle equity in existing CLOS to help fund new CLOS in the future. Turning to taxes. Our effective tax rate was 25.5% in the third quarter of fiscal 2019, 26.2% in the third quarter of fiscal 2018 and 25.1% in the second quarter of fiscal 2019. The company's income tax provision for the third and second quarters of fiscal 2019 includes $1.1 million and $0.7 million respectively of charges associated with certain provisions of the 2017 Tax Act relating to limitations on the deductibility of executive compensation that began taking effect for the company in fiscal 2019. The company's income tax provision was reduced by net excess tax benefits related to stock based awards, totaling $0.6 million in the third quarter of fiscal 2019, $1.3 million in the third quarter of fiscal 2018, and $0.3 million in the second quarter of fiscal 2019. As shown in attachment two to our press release, our calculations of adjusted net income and adjusted earnings per diluted share remove the net excess tax benefits related to stock based awards and the nonrecurring impact of the tax law changes. On this basis, our adjusted effective tax rate was 25.9% in the third quarter of fiscal 2019, 27.1% in the third quarter of fiscal 2018 and 25.3% in the second quarter of fiscal 2019. On the same adjusted basis, we estimate that our quarterly effective tax rate for the balance of fiscal 2019 and for the fiscal year as a whole will range between 25.9% and 26.4%. During the third quarter of fiscal 2019, we used $38.6 million of corporate cash to pay the $0.35 per share quarterly dividend declared at the end of our previous quarter and repurchased 1.5 million shares of nonvoting common stock for approximately $61.3 million. Our weighted average diluted shares outstanding were 113.5 million in the third quarter of fiscal 2019, down 8% year-over-year, reflecting share repurchases in excess of new shares issued upon investing a restricted stock awards and exercise on employee stock options and a decrease in the dilutive effect of in-the-money options and unvested restricted stock awards. Sequentially, weighted average diluted shares outstanding were down 1%. We finished our third fiscal quarter holding $777.8 million of cash, cash equivalents and short-term debt securities and approximately $368.6 million in seed capital investments. We continue to place high priority on using the company's cash flow to benefit shareholders. Fiscal discipline around discretionary spending remains top of mind as we contemplate both volatile market and significant corporate initiatives. As Tom noted, the strategic initiative we announced in June will include investments in technology to support a consolidated individual separate accounts platform geared towards enhancing scalability and achieving higher levels of operating efficiency. We do not currently anticipate that there will be significant adds to staff associates with these investments. We can provide additional color on related headcount and spending when we report our earnings for the fiscal year. Based on our strong liquidity and overall financial condition, we believe we are well positioned to continue to invest in our business to support long-term growth, while returning capital to shareholders. This concludes our prepared comments. And at this point, we would like to take any questions you may have.

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

Hi. Good morning. Thank you. I might be splitting hairs here, but I feel like when you announced the repositioning in June, you kind of pushed back on the view that it could drive more incremental efficiency on the cost side. But Tom's comments this morning highlighted cost savings and efficiency. Just curious if you maybe identified a bigger operating leverage opportunity on the cost side as you’ve gone through the process just over the last couple of months.

Yes, I would put it -- maybe I would agree with your assessment that it's maybe splitting hairs here. I don't think we're far enough into this to have a really very different view on kind of what the spin levels will be and what the resulting impact on operating efficiencies and scale economies would be. We are working on, we put a lot of effort into this. We made some real progress. As I noted, Ranjit, who will be joining Parametric towards the end of next month, isn't here yet, so we can lay a little bit of this uncertainty on the fact that the person that’s going to be driving this isn't here yet. It's not like we haven't done anything. In fact, we’ve done quite a bit to prepare for the launch of this new platform. But in terms of quantifying the margin impact of how this is going to impact our overall business or even impact the profitability of that particular part of our business, I think it's quite premature to say that. I will say that this is a business where continuous investment in technology are just par for the course. We’ve scaled this thing up to something like 80,000 separate accounts, and we are looking for ways to continue growing that business to a multiple of its current size. We know if we do this right, there will be significant CL economies. It does not take twice as many people to run 160,000 accounts as it does 80,000 accounts, particularly if we invest in technology the right way. So, a little bit vague in the answer. Sorry, I can't be more helpful. Directionally, we know we are going to be spending a bit more money in the near-term, but we're highly confident that’s going to pay off with operating efficiencies and scale economies down the road as we grow that business.

Thank you. And as a follow-up, there has been some chatter about some larger asset management properties in Europe becoming available. As we think about M&A as a piece of the capital return story, could you update us your thinking around your appetite for deals like that and within that any detail on what kind of asset classes, wrappers, or distribution pipes would be most attractive to you?

I certainly can't comment on anything specific. We're not aware of -- there aren't major opportunities that we're looking at in Europe that we are at a point where we could comment on, not that we would. I would say areas of interest to us relate primarily to rounding out our business in ways that are -- that we view as complementary to what we're doing now. I would put on that list extending our credit capabilities into private assets. We’ve also looked at things recently expanding our small wealth management business to leverage our capabilities in wealth management solutions. Beyond that, I would say we’re opportunistic. We'd like to grow in responsible investing. We have a -- we think very strong platform, really a couple of platforms there with Calvert and what Parametric does in customized separate account solutions with responsible investing being one of the key value adds there. Those are probably the areas I would highlight for us. We are -- our business continues to be approximately 95% in the U.S and 5% outside. We’ve stated our long-term goal to become more diversified internationally. But we are only going to do an acquisition that we think makes sense to us and we are highly confident it's going to bring value to our shareholders.

Thank you.

Your next question comes from Brian Bedell from Deutsche Bank. Your line is open.

Hi. This is actually Melinda Roy filling in for Brian Bedell. Maybe just a couple more on the retail SMA business. Can you talk about what portion of the business is concentrated in Parametric strategies and where you see most growth coming from an intermediate term? And then on the culmination of the EVM and Parametric's platforms, how specifically do you think that could improve organic growth once the combination is kind of complete?

Yes. So, I think I scaled the business at about $105 billion of what we call custom beta. So that's the Parametric custom core business as well as the municipal and corporate bond laddered offer -- laddered products offered at individual separate accounts. We have additional individual separate account businesses. There are actively managed muni pieces, there are active managed equity businesses as well.

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What do you have for the total there?

It’s [audio disturbance].

The -- but the biggest growth opportunities we see are in what we call custom beta, which is I believe slide 12 of the handout had the growth trajectory. We’ve been on there. Year-to-date, 19% annualized internal growth. We think we're positioned to see -- we hope, we bet we don't know this, but we hope an acceleration of that growth as we move the muni and corporate capabilities there under Parametric. We think there will be new product strategies that will emerge out of that, that will give us the potential to do things that we don't do today. We think the investments that we're making in technology to enhance service levels and drive scale economies will position us more attractively versus competitors where our goal would be that to gain market share over time. We think there is a -- there is room in this market for multiple competitors, but we intend to maintain our position as the market leader.

All right. Thank you.

Your next question comes from Mike Carrier from Bank of America. Your line is open.

Good morning and thanks for taking the question. Maybe first just on the operating leverage. So, Laurie, you guys had positive operating leverage quarter-over-quarter. I’m assuming that’s the days in the markets. But it sounds like, you guys are focused on that, in terms of the expense discipline. You also mentioned just some of the investments with the Parametric initiative. So just wanted to get your thoughts on how we should be thinking about expenses, maybe operating leverage, particularly just given the strength that you guys are seeing on the flow side?

Yes, we are not prepared to provide any guidance at this point. But in terms of the way that we’re thinking about we recognize that we got a significant investment that we are looking to make in this project. And I think what we are very much aware of is that we are going to have to stay very, very tight on all of our other spending in order to ensure that we can focus our attention and our resources on this initiative and be as efficient as we can in terms of deployment of capital. Now recognizing that when you are talking about technology projects, obviously they’re going to be -- there's a portion of this that will be operating a portion of this will be capital. And as we finalize our thoughts around our longer term strategic vision for the platform, we are going to figure those components out and we certainly will hope to be able to provide more guidance as we move into the fourth quarter. But I would say that overall, we are looking to really keep our spent tight as we are moving into the fourth quarter on all of our other general corporate spending recognized and that we want to be able to put as much as we can into this project and -- because we do believe that there's tremendous long-term leverage to be gained by building a scalable platform that’s going to be highly efficient and it's going to have a solid operational foundation for us to do the types of product initiative as Tom mentioned earlier.

Okay. That's helpful. And then maybe just on the overall like investment performance inflows. Things have been very strong, particularly relative to the industry. The shorter term performance, it's probably a little bit weaker that we’ve seen. Just any color on maybe what’s driving that? Any concerns, the 3, 5, 10 is still very solid, but just any concerns on the shorter term side?

I guess it depends where you're looking. We’ve got pretty broad business. If you look at our equity performance to starting there, we're really having a quite strong year where Calvert strategies, Eaton Vance managed equities and particularly the Atlanta Capital strategies, which in many ways are our purest for compete on performance equity mandates, really exceptional, high performance there. That group as you may know also runs the Calvert equity fund, which also has had strong performance. So we are seeing flows into -- positive flows into active equity strategies that are not completely, but we would assume are being driven largely by that -- the strong performance numbers that we’ve been putting up over the last, let's say, year and 3-year periods. On income side, I think generally a good story. Our -- because our bank loan assets are fairly large percentage of our total. We have seen a -- maybe somewhat of a falling off in performance there, nothing that we're worried about. But we had a significant boost to performance last year that came as some loans that we had held through restructuring process, paid off in a major way as -- to us is equity holders as they came to a restructuring. We haven't had that same effect this year, so our bank loan performance has been more muted across fixed income. The primary driver of relative performance year-to-date and particularly over the last three months has been duration exposure. So if you're long relative to your peers, you’ve had the wind at your back. If your shorter duration relative to peers, you had the wind a bit in-your-face. We have an array of short duration income strategies. The biggest being our short duration government income fund which really had a exceptional performance run. It's been facing a bit of a performance headwind this year, primarily because relative to its peers it is shorter duration than its peers. And in the government category duration is going to be a primary driver of short-term periods, particularly during months like we've seen recently when we’ve had sharp movements. Sharp movements in this case down in treasury yields. So it's really nothing that from a competitive point of view we're fighting against. We continue to see good flows into that short duration Government Income Fund, despite a fall off in relative performance versus other funds in that government category. Same with bank loans, a relative performance versus peers over the year-to-date period has fallen a bit. The longer-term track record there is exceptional and as I mentioned our market share there based on the numbers we see continues to grow. So there's certainly -- we don't see a performance problem for Eaton Vance over all or for any of our major strategies. In fact, I would point to performance of our active equity strategies, Calvert branded and Atlanta Capital managed in particular, as creating opportunities for us to sell places that we wouldn’t if we had more pedestrian returns.

Okay. That’s helpful. Thanks.

Your next question comes from Ken Worthington from JP Morgan. Your line is open.

Hi. Good morning. First on the leverage loan market. We've seen some leverage loan deals slip in recent weeks. Talk about the CLO market, the floating rate market more broadly, any implications for Eaton Vance including any balance sheet exposure you might have here?

So we have a relatively small CLO business. I think they’re 4 or 5 active CLOs that we managed. It is a pretty small balance sheet exposure. Overall, bank loans are important business for us. We have been in net outflows there as described. There is nothing systemic there that we're particularly worried about. We believe the outflows have been primarily driven by the fact that these are floating rate assets and people are expecting short-term rates to come down, that's a strong market consensus probably will prove right. But we don't see significant issues on the credit side. Nothing is showing up in our portfolios to date. We're very aware that these are below investment grade loans and that these are subject to credit risk. We maintain broadly diversified portfolios. To date, we have not had issues with liquidity or -- so we generally feel that things are okay. On balance, we think that the stimulative moves that are starting to happen in the U.S and in other Western economies are broadly supportive of good credit performance and bank loans. So on the one hand, shorter rates make -- can make floating rate assets less appealing from a yield perspective. They also have the effect generally of reducing economic risk of significant credit losses. But we're mindful that we're at -- we are -- we're long into the current economic cycle. We are mindful of the fact that flat or inverted yield curves are sometimes viewed and have been markers of coming prudence of economic weakness. But to date, we are not seeing that in our bank loan portfolios.

Okay. Okay. Thank you. In terms of the $42.5 billion transferred to Parametric, do your clients need to affirm the transfers in any way, or their new contracts that result with this transfer? Trying to get a sense if there's any risk to either the fee agreements that you have, or even the assets. Is there any chance that assets may slip here.

No. That the key is that it is not deemed an assignment for purposes of the contracts. And we have a legal opinion to that effect, which we’re making available through our business partners, primarily this is the separate managed account business where this is -- potentially an issue. But we've gotten -- I would say, no pushback from clients or intermediaries about the change. There is no change in control. We control these businesses through Eaton Vance Management today. We will control them in the future through Parametric, which is a control subsidiary. The same people will be running the strategies, the same investment style. It's a change in branding and ultimately organizational reporting responsibilities. But nothing that we think clients should be concerned about and nothing that we think based on evidence that clients are concerned about performance records will carry over. No change from a client's point of view other than a different name associated with the brand.

Okay, great. Thank you.

Your next question comes from Bill Katz from Citi. Your line is open.

Hi. Good morning. Its Ben Herbert on for Bill. Thanks for taking the question. Just wanted to follow-up on Mike's question regarding operating leverage. And Laurie, last quarter you mentioned the comp ratio should trend down going forward. And then recently you said -- today you said no headcount change with the strategic initiatives announced at the end of June. So can we still think that comp ratio should kind of move down over time here into 2020?

Into what?

2020.

Oh, into 2020. I wouldn’t be making any prognostication at this point about 2020. I would anticipate that the comp ratio in the fourth quarter is probably not going to look dramatically different from the comp ratio in the third quarter. So I think that’s probably a fair assessment. But I wouldn’t be making any prognostications beyond that.

Okay. And then a follow-up would just be on the ALPS [ph] fee rate. There was a significant tick up quarter-over-quarter. Just wanted to understand kind of the underlying dynamics behind that.

Yes. We talked about how we benefited during the quarter of a renegotiation of a custody fee agreement where -- because the custody fees are highest for emerging markets, non-U.S markets, which are -- were those assets tend to be concentrated in alternative strategies. The impact of that on our effective fee rates was positive during the quarter which reflect that -- reflects the fact that a fair bit of the subsidy activity that we’ve been had in our funds is connected to those strategies and where the relief in terms of lower custody fees fell in part to benefit of the fund, then also fell in part to us to the extent we're providing subsidies to keep fund fee levels at a flat level.

Thank you.

Your next question comes from Robert Lee from KBW. Your line is open.

Great. Thanks for taking -- excuse me, thanks for taking my questions. Can you maybe just talk a little bit, Tom, you had mentioned early on some pretty good success and what I would call more defensive equity strategy. So could you maybe break that down a little bit kind of how that's compares in a retail versus institutional and then maybe any color you may have on any institutional pipeline, whether it's through those strategies, Calvert or otherwise?

Yes, we don't have much of a pipeline in active equity institutional accounts. Most of the sale success we are seeing for active equity is retail either funds or in some cases individual separate accounts. Most of that active business is through model programs. But the places where we're seeing sales success are primarily high-performing equity strategies, branded Calvert, sorry. So it's the one-two punch of strong performance, which is a distinctive factor and also the strong brand of Calvert and responsible investing. So we're benefiting, I would say, across the board. Almost without exception across. Calvert active strategies from strong performance and this wind at the back in terms of marketing, because although there are a lot of players that have come into the responsible investing space, few of them have the credibility and reputation that Calvert has, you marry that with strong performance and we’ve been able to grow Calvert's business in active equities pretty meaningfully. The other brand manager I would point to is our Atlanta Capital affiliate, which although Atlanta Capital in total has been a net redemptions in the last couple of quarters, primarily because their largest strategies which are the SMID-cap and small-cap strategies are at capacity. They've had very strong across the board performance, small-cap, SMID-cap, large cap in their active equities. Atlanta Capital's mantra is high quality investing, which they’ve practiced for decades. We are in a market cycle where high-quality is performing very well. They have not just top quartile, but top decile performance across most of their equity strategies. And they’re seeing growing interest in that as you would expect. This is a group of funds and separate accounts that are distinguished not only by strong performance over time, but also a consistent investment approach, low turnover investing in high-quality companies that resonates with a lot of investors that are looking at alternatives to passive investing. So beyond that I would say, a small cap generally as a place where we're seeing positive flows both branded Calvert and branded Eaton Vance, both U.S and international. So you don't think about active equities as a place where there's a lot of growth opportunity, but we're seeing some potential for our business to grow there based on performance and based on the distinctiveness of the Calvert brand.

Great. And maybe as a follow-up. Could you maybe talk a little bit about the competitive environment within custom beta and the ladders? And specifically, look any time I guess you’ve good growth opportunities, people try to come into the markets, often try to compete on price. Can you talk a little bit about what you're seeing and to what extent do you feel like you have there's maybe a barrier to entry, so to speak, given that it is a technology-heavy kind of business. I mean, kind of talk about how you see that?

Yes, this is a -- it's a lot harder business than managing funds. 80,000 separate accounts gives us a scale that's hard for anyone to come close to, we think we are based on industry data, the largest player in this market. We compete on service more than anything. And when I say we, this is both Parametric and what are today Eaton Vance Management branded strategies that would be -- in some cases moving over to Parametric. We have over the last, I would say, two years seen a number of new competitors coming to the market both in terms of laddered bond separate accounts, but also on the custom core equities. So competing against us on both the income side as well as the equity side. You’ve seen our numbers. We continue to grow that business. 19% organic growth for the year-to-date on a combined basis. We will see no doubt more competitors into this. Other people, we think will be attracted to the same opportunity to grow in the space, but we think we have today a differentiated position based on our reputation for service. And so far we've been able to hold off competitors and keep that business growing. Some of our competitors have not surprisingly try to compete largely on the basis of price. For the most part, we’ve held the line on price, but have the flexibility to be competitive when necessary. This is a value proposition. If we can deliver value relative to cost, which we think we can, we think this business will continue to grow. For the most part, our competition here is more about competing against on the equity side index funds and ETS as opposed to other managers of customized individual separate accounts. And in the case of munis and taxable bond portfolios, it's primarily competing against unmanaged portfolios. So, yes, there are more competitors into the space, but at $100 billion we are by far the largest player in this business, but tiny compared to the size of the addressable market, which we view as consisting of most of the index ETF and index mutual fund market held outside of qualified retirement plans. And maybe away from institutions that are using ETFs as a short-term market exposure vehicles. But we think this is you sketch it out. This is -- these are potentially trillion dollar plus markets. You look at the number of municipal bonds, the value of municipal bonds that are owned by individuals, how much of that is managed versus how much is unmanaged. We think there's a huge potential for that market to convert to from unmanaged to managed. You look at the growth of index investing. How much of that is held through funds, where there's not the advantages of customization, not the advantages of pass-through tax -- pass-through treatment of realized tax losses that you can achieve with customized separate accounts. We think there's enormous growth potential here. Our objective is to grow our market share over time as this market continues to grow, maybe that's a challenge because we will see new entrants into this market. But there aren't many people that are in a position like we are to make the kind of investment in technology to drive service levels that other people I think are going to look at this and say I don't want to do that. That looks really hard. I don't think I can compete with Parametric and Eaton Vance on the basis of service excellence. I think I will do something else.

Great. That was helpful. Thank you.

I think we have time for two more participants before we wrap up the call today.

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

Thanks. My question is on fee rate. If we look on a year-over-year, you’ve seen compression across the longer-term categories. I guess as you think about the mix of business today and where you’re seeing strength in the ins and outs, do you see that stabilizing, improving, or kind of continuing kind of the rate of decline we’ve seen?

I don't see any improvement. The last I checked fee rates aren't going up across any parts of asset management that we participate in. Our primary driver of those fee rates that will continues to be mix, even both across categories and inside categories. The biggest changes in average fee rate has been within fixed income. That really reflects the growth of this business that we call custom beta, the muni and corporate ladder business which is fundamentally quite different than managing high yield bond portfolios or mortgage-backed securities portfolio. We are seeing some price competition, some level of fee concessions in existing businesses. I don't think it's accelerating. It feels like it's more on a steady modest decline in average fee rates across most of our businesses if you look at true apples to apples comparison. We think we can manage through that. I’ve been in the investment business well over 30 years and there has never been a time when fee rates have been going up, how you grow and how you achieve attractive margins in this business tends to be based on scale. The ability to offset reductions in a fee rates tied to per dollar of assets by growing up the base of assets you managed and leveraging the spending in support of that asset management. So no real change in our business mix. We expect continued modest declines in our average fee rates.

Okay. And then as a follow-up, the global macro product seemed improved performance. You mentioned historically that's dovetailed with, or correlated with improved flows. Can you talk about just the positioning of the fund and kind of historically it's had a fair amount of currency exposures and other things to it. But any kind of near-term dynamics in terms of shift in terms of flow outlook for that segment as well would be helpful.

Yes. So this is -- these strategies are a little hard to pigeonhole in terms of what -- where they’re positioned relative to broad market trends. We describe ourselves as country pickers, investing both long and short in emerging and frontier markets using primarily currency and short duration sovereign credit instruments. We -- returns, you can look this up, I think are like 6% or so in the range of 6% year-to-date through yesterday, for the iShares of these funds. So we think that's pretty good. Some years 6% returns are nothing to get too excited about in other years. If you can deliver something like that, in a way that is less volatile than long-duration fixed income or less volatile than most equity strategies, that can be quite appealing, particularly given the very low correlation of the performance of these strategies to the major asset classes that most U.S investors are heavily weighted in, namely developed market equities and U.S. duration assets. There have been some upsets in the world recently, maybe putting that thing modestly. So far we're weathering the storm quite well. And those performance numbers are current numbers for the year-to-date.

Okay. Thank you.

Your last question comes from Craig Siegenthaler from Credit Suisse. Your line is open.

Thanks. Good morning, everyone.

Good morning.

I just have a follow-up to Rob's last question, on the competitive landscape and custom beta. I wanted to see if you saw a pickup in product launches SMA wins, fund registrations from some of your competitors just given the success of Parametric?

There have been absolutely -- so let me answer the question in two parts. One is on the equity side, which is the Parametric business and the other is the -- is on the fixed-income side, which is the Eaton Vance Management business that is going to become part of Parametric. So on the equity side, the traditional player in this market that we’ve competed with is a firm focused on this business called Aperio that I think continues to grow in our business, but is an established competitor. No particular change that I’m aware of in the Parametric versus Aperio competitive dynamics. There are other players who have been in this market and put more of a focus on that. Goldman Sachs has an investment offering here. Natixis has a subsidiary that has an offering here. The competitive landscape is first about getting access to platform. So are you offered at major broker-dealers or are you available through a particular registered investment advisor and what kind of strategies are you offered though? So is it tied to a single index, is it across a range of indexes? What’s the expectation in terms of product features? Are you -- what kind -- what approach are you taking to tax loss harvesting? What kind of your business is funding -- funded in kind? Do you do after tax performance reporting? Is that performance reporting appropriately tranched by the age of the account? These are all things that that differentiate players in this market. It is a very customized business. If your level of customization is not as good as the next guys, you’re going to struggle to be successful here. An element of customization is that service is often challenging. So what kind of turnaround is there for whatever customization that a particular advisor or client is looking for. So far we’ve been able to withstand the competitive challenge and continue to grow that business, despite no secret that this is a growing market. People look at the success we've achieved and said, yes, that doesn't look all that hard. But one of the things we're trying to do with this strategic initiative is to make it less attractive and make it harder for other asset managers to try and get into this space by doing a better job for clients. On the fixed-income side, the story is probably similar. The names are different. Aperio, I don't believe has a fixed-income offering. Names here are Nuveen, Lord Abbett. I think BlackRock has an offering in this market. There might be a couple of other players there. By and large, we’ve -- we continue to be successful in that market. One of the things that’s notable about our competitive offering is that earlier this year we launched a systematic year-round tax law -- tax loss harvesting service as part of our core offering, no upcharge in price, something we make available. We’ve been in the process of rolling that out, getting approval at various platforms to offer that for clients. We view that as a bit of a raising of the bar to differentiate us from competitors, not everyone. Most people don't offer something similar. Again, beyond the service, beyond the features that we offer, a lot of this comes down to service, how good are we at responding to requests to evaluate a particular hypothetical transaction? What's our turnaround relative to somebody else's? What kind of service do we provide to advisors? In general, fee rate differentials in this market are small and that these are not viewed as commodity products because of the intensity of the service experience and the high-level of satisfaction we deliver on the service side has allowed us to in many cases when business we're not a low-cost provider, but we're at or near the top end of the fee range for people bidding on the business. But we think it's a business that has the potential to grow to accommodate a number of competitors. We expect fairly soon the competitive landscape to shake out where this won't be a competitive market -- this won't be an interesting market for new people to get into simply because we and perhaps some others will set such a high bar in terms of scale in technology and service levels that people look at this and say, I don't think I can be successful here.

Thanks, Tom. Very comprehensive. I just had one follow-up on your retail SMA strategy, which I know you’re in the process of upgrading here. What do you see as the key qualities of asset managers that have succeeded in the RA market? Because this has been a very challenging segment for traditionals to crack.

Sorry, so you said RIA market?

Yes. So I believe most of your strategic positioning that you are going through now is a big chunk of that is targeting the RIA channel. So I wanted to see what qualities you think will make Eaton Vance successful? And maybe what are some qualities that you’ve seen at peers that have been successful in those channel, because very few happen.

Yes, I got it. So, one of the -- you’re referring to the strategic -- part of the strategic initiative is that we're combining our sales organization covering the RIA channel here heretofore. Parametric has had a dedicated sales team covering an array of their strategies, but primarily custom core in that channel and then Eaton Vance's separately offered mutual funds and separate account offering there. And as you've said, like most asset managers, it's been a bit of a struggle for us from the Eaton Vance side to be successful there, whereas by contrast Parametric has built quite a business with dominant market share in that custom core product offered into the RIA channel. What we’re hoping to do is not surprisingly leverage the success that Parametric has achieved there across a broader array of asset classes. And so if we’re leader today in custom equity index separate accounts, we want to be the leader in custom bond separate accounts, both indexed and laddered and otherwise. But it's really leveraging the strength of the Parametric brand, the relationships that they built up over the last 25 years to allow us to successfully introduce fixed income strategies into that channel beyond the small success that we've had to date there. I think as your question implied, most of the assets that we have today on the fixed-income side are in the wirehouse and independent side. Through this reorganization and rebranding and changing in this -- in the sales coverage for the RIA channel, it is very much our objective to extend that success into RIA for fixed-income separate accounts.

Got it. Thank you, Tom.

Yes. Thanks, Craig.

All right. I think this concludes our call. Thank you very much for everybody participating into this call and we will speak with you in fourth quarter earnings webcast. Thank you very much.

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