Morgan Stanley (MS) Q4 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Eaton Vance Corp. Fourth Quarter and Fiscal Year Earnings Conference Call and Webcast. At this time, all participants are in a listen-only mode. After the speakers’ presentations, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today. Eric Senay, Treasurer and Director of Investor Relations. Thank you Please go ahead, sir.

Thank you, Lisa. Good morning and welcome to our fourth quarter and fiscal 2019 earnings call and webcast. With me this morning are Tom Faust, Chairman and CEO of Eaton Vance; as well as our CFO, Laurie Hylton. In today’s call, we will first comment on the quarter and fiscal year and then take your questions. As always, 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. 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 uncertainty 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, everyone, for joining us. Earlier today, Eaton Vance reported $3.45 of adjusted earnings per diluted share for the fiscal year ended October 31, which is an increase of 7% from $3.21 per diluted share in fiscal 2018. For the fourth quarter of fiscal 2019, we reported $0.95 of adjusted earnings per diluted share, up 12% from $0.85 per diluted share in the fourth quarter of fiscal 2018, and up 6% from $0.90 in this year’s third fiscal quarter. Both the annual and quarterly results represent new record highs for the company. We ended fiscal 2019 with $497.4 billion of consolidated assets under management also a new record high, and up 13% from the end of last year. By mandate reporting category, changes in consolidated assets under management versus the prior fiscal year end ranged from growth of 22% for exposure management, 21% for fixed income, 20% for portfolio implementation, and 14% for equity, to declines of 22% for floating rate income and 31% for alternatives. Fiscal 2019 marked Eaton Vance’s 24th consecutive year of positive net flows. For the fiscal year, we generated $23.9 billion of consolidated net inflows, or $12.9 billion, excluding exposure management mandates, which have more volatile flows and lower average fee rates than our other mandate reporting categories. Fiscal 2019 net flows represent 5% internal growth in managed assets. Consolidated net inflows for the fourth quarter were $9.8 billion, or $2.8 billion, excluding exposure management, making the fourth quarter of fiscal 2019 our 21st consecutive quarter of positive net flows. Fourth quarter net flows represent 8% annualized internal growth in managed assets. Internal growth in consolidated management fee revenue was a modest 0.1% for fiscal 2019 as a whole, as growth achieved in the second, third and fourth fiscal quarters was substantially offset by first quarter declines. Annualized internal growth in consolidated management fee revenue was 2% in the fourth quarter, which compares to 2% in the prior quarter and 1% in the fourth quarter of last year. To calculate, internal growth in consolidated management fee revenue, 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. While other public asset managers generally do not disclose similar growth metrics, we believe Eaton Vance continues to rank among the industry leaders by this measure. Looking at our annual flows by mandate reporting category, equity net inflows for the year totaled $4.8 billion from $1 billion of equity category net inflows in fiscal 2018. Each of our principal investment affiliates contributed positively to equity net inflows in fiscal 2019. Eaton Vance management’s 2019 equity net inflows of $2.3 billion included a corresponding amount of net inflows into privately offered wealth management funds and $1.3 billion into wealth management separate accounts under Eaton Vance Investment Counsel, partially offset by aggregate net outflows from other EVM equity strategies. Atlanta Capital’s $350 million of equity net inflows for the fiscal year were driven by nearly $700 million into the Calvert equity fund, for which Atlanta Capital serves as sub advisor, $250 million into other large-cap growth mandates, and nearly $500 million into the select equity mid large cap strategy, all partially offset by net outflows from Atlanta Capital’s small cap and SMID-cap franchises, which are generally closed to new investors. Excluding the Atlanta Capital managed Calvert equity fund, Calvert generated $2.0 billion of net – of equity net inflows in fiscal 2019 led by emerging market small cap and responsible index strategies. Parametric’s equity strategies had approximately $250 million of net inflows for the fiscal year, as growth in defensive equity and other volatility risk management mandates more than offset net outflows from Parametric’s emerging market equities. Eaton Vance’s fixed income strategies had $11.9 billion of net inflows in fiscal 2019, up 24% from $9.5 billion of net inflows in fiscal 2018. As in fiscal 2018, our fixed income net inflows was added by laddered bond separate accounts, which contributed $6.5 billion across municipal and corporate mandates. Net inflows in the Eaton Vance and Calvert brand in the U.S. fixed income mutual funds totaled $6.1 billion in the fiscal year, including $4.3 billion into taxable fixed income mutual funds and $1.8 billion into national and state specific municipal bond funds. Full leaders among fixed income funds included Eaton Vance short duration government income, with net inflows of $2.65 billion and Eaton Vance core plus bond fund with net inflows of $575 million. Calvert fixed income mutual funds saw net inflows of $1.1 billion for the fiscal year. In our portfolio implementation reporting category, net inflows of $8.4 billion in fiscal 2019 were substantially unchanged from the prior fiscal year and reflect $8.7 billion of net contributions to Parametric custom core equity individual separate accounts and $1.4 billion of net contributions to custom core equity institutional accounts, partially offset by net withdrawals from centralized portfolio management and multi-asset implementation mandates. Combining the $8.7 billion of custom core equity individual separate account net inflows, with the $6.5 billion of laddered bond individual separate account in inflows, what we refer to sometimes as custom beta, contributed nearly $15.3 billion to Eaton Vance’s net inflows for the fiscal year. As shown on Slide 12 of our presentation, managed assets in custom beta individual separate accounts increased 33% year-over-year to end fiscal 2019 at almost a $112 billion. Parametric’s exposure management mandates generated $11 billion of net inflows for the fiscal year versus net outflows of $8.3 billion in fiscal 2018. The positive change year-over-year in exposure management net flows, primarily reflects continuing clients on balance adding to their overlay positions in fiscal 2019 versus net reductions in outstanding positions of continuing clients in fiscal 2018. Net flows from entering and leaving clients were positive in both fiscal 2018 and 2019, as they have been throughout Parametric’s ownership of this business dating back to 2012. In our alternatives reporting category, net outflows of $3.9 billion for the fiscal year, compared to net inflows of $700 million in fiscal 2018 and were driven by $2.7 billion of outflows from our two global macro absolute return mutual funds offered in the U.S. and nearly $1 billion of outflows from global macro institutional sub-advisory mandates. These strategies, which hold the long and short positions in currency and short duration sovereign debt instruments of emerging and frontier market countries generated disappointing returns in calendar 2018, but have rebounded to solid performance in 2019. For the year-to-date through yesterday, total return net of expenses of the Class I Shares of the Eaton Vance global macro absolute return and global macro absolute return advantage funds were plus 7.9% and plus 11.7%, respectively, far outpacing their benchmark in peer groups and restoring these funds long-term performance to competitive levels. Our floating rate bank loan strategies faced similar forward pressure in fiscal 2019, although not driven by performance. On an overall basis, our floating rate category flows moved from net inflows of $5.9 billion in fiscal 2018 to net outflows of $8.3 billion in fiscal 2019. Retail bank-owned funds we offer in the U.S. and internationally had net outflows of $5.8 billion and institutional bank-owned funds in separate accounts contributed another $2.5 billion to fiscal 2019 net outflows. Demand for floating rate loan strategies contracted in fiscal 2019, as investors responded to changing expectations for short-term interest rates. While the outflows we experienced are disappointing, we’re pleased that we have been able to increase our market share among U.S. bank loan mutual funds, reflecting our loan team’s position as an industry leaders and the strong track record the team has developed over time. In the fourth quarter of fiscal 2019, flow trends across mandate reporting categories generally mirrored results for the fiscal year as a whole with continuing net inflows into equity fixed income, portfolio implementation and exposure management mandates and continuing net outflows from floating rate income and alternative mandates. Compared to the preceding quarter, notable swings in net flow results were $4.3 billion increase in exposure management net inflows, a $1.1 billion decline in fixed income net inflows, and a $1.4 billion increase in floating rate income net outflows. Consistent with the year-over-year improvement in exposure management flows, the growth in fourth quarter net inflows for this category was driven primarily by existing clients adding to their overall overlay exposures during the period. In fixed income, the quarterly decline in net inflows reflects reduced flows into Eaton Vance short duration government income fund and somewhat lower net sales of laddered bond separate accounts. In floating rate income, the quarterly increase in net outflows was attributable primarily to higher mutual fund redemptions, as retail investors responded to the Fed’s rate cuts of 25 basis points each instituted on July 31, September 18, and October 30. With the Fed now officially in pause mode with no more rate cuts anticipated and the loan funds offering quite attractive relative yields, we anticipate improvement in our floating rate flows over coming quarters. While flows in and out of our floating rate loan strategies have always cycled up and down with movements in short-term rates and changing economic conditions, we see no reason to believe this business won’t resume its long-term growth trajectory when external conditions are right. A notable positive development over fiscal 2019 was Calvert’s strong overall flow growth. Including the Atlantic Capital managed Calvert equity fund, Calvert generated net inflows of $3.7 billion in fiscal 2019, which corresponds to 25% internal growth in managed assets and growth accelerated as the year progressed. Calvert’s fourth quarter net inflows of $1.3 billion equate to an annualized organic revenue growth of 29%. Since becoming part of Eaton Vance in December 2016, Calvert’s managed assets, including Calvert equity fund, have grown from $11.9 billion to $19.8 billion at the end of fiscal 2019, an increase of 66%. With strong investment performance across Calvert’s diversified lineup of equity income and multi-asset strategies and accelerating market demand for investment strategies that achieved both positive returns and positive social impact, we continue to believe that Calvert represents a significant growth opportunity for Eaton Vance. On an overall basis, fiscal 2019 was a period of continuing strong investment performance across our principal investment affiliates. As of October 31, we sponsored 76 U.S. mutual funds with an overall Morningstar rating of four or five stars for at least one class of shares, including 32 five-star rated funds. As measured by total return, at fiscal year-end, 46% of our U.S. mutual fund assets ranked in the top quartile of their Morningstar peer groups over three years, 62% in the top quartile over five-years, and 58% in the top quartile over 10 years. Amid continuing skepticism about the value of active management, our teams are delivering market beating performance across a broad array of investment mandates. I would next like to provide an update on the strategic initiative involving our Parametric and Eaton Vance management investment affiliates that we announced in late June. As described in August on our third quarter call, the initiative has three principal components. First, 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 platform supporting the individual separate – separately managed account businesses at Parametric and EVM; and third, integrating the distribution teams serving Parametric and EVM clients and business partners in the register and investment advisor and multi-family office market. The internal change process supporting this initiative is now well underway with completion targeted for the first quarter of fiscal 2020. As we move closer to finalizing implementation, we’re increasingly convinced that these changes will meaningfully enhance Parametric’s position as a market leader in the rapidly growing customized individual separate account business and position the company overall for faster growth. As we enter fiscal 2020, Eaton Vance is focused on four strategic priorities. First, capitalizing on the near-term growth opportunities presented by our market-leading positions in customized individual separate accounts, responsible investing and specialty wealth management strategies and services, as well as the array of high-performing active strategies we offer across asset classes and investment styles. Second, defending our franchise businesses now experiencing declines, most notably floating rate bank loans and global macro absolute return strategies. Third, evolving the company to enhance our competitive position by developing new value-added investment offerings, achieving greater operating efficiencies and opportunistically pursuing acquisition opportunities. And fourth, investing in the company’s future, both in terms of our infrastructure and our people. As the investment industry continues to weather challenging times, we remain confident in the strength of Eaton Vance’s competitive position and our ability to thrive amid industry adversity. Few peer companies have realistic prospects for near-term and long-term business growth on the same scale as afforded by our leading positions and customized individual separate accounts, responsible investing, especially wealth management strategies and services and high-performing active investment strategies. And few peers are blessed with similar strengths in corporate culture, financial resources, business focus, and marketplace reputation and relationships. We entered fiscal 2020 with confidence in our strengths and optimism about our future. That concludes my prepared remarks. I will now turn the call over to Laurie.

Thank you, and good morning. Tom described, we are reporting reported adjusted earnings per diluted share of $3.45 for fiscal 2019, up 7% from $3.21 in the prior fiscal year. As you can see in attachment two to our press release, earnings under U.S. GAAP exceeded adjusted earnings by $0.05 per diluted share in fiscal 2019, reflecting the reversal of $5.4 million of net excess tax benefits related to stock-based compensation awards. Adjusted earnings exceeded GAAP earnings by $0.10 per diluted share in fiscal 2018, reflecting the add-back of $24 million income tax expense recognized in relation to the non-recurring impact of the U.S. tax law changes enacted in December 2017, and a $6.5 million charge recognized upon the expiration of the company’s option to acquire an additional 26% ownership interest in our 49% owned affiliate, Hexavest, partially offset by the reversal of net excess tax benefits related to stock-based awards a $17.5 million. In fiscal 2019, operating income decreased by 6% year-over-year, reflecting substantially flat management fee revenue, a 6% decline in non-management fee revenue and 2% growth in operating expenses. Our operating margin was 30.9% in fiscal 2019 and 32.8% in fiscal 2018. The difference between our reported 7% increase in adjusted earnings per diluted share and the 6% decline in operating income is explained principally by a $50 million positive change year-over-year in non-operating income and expense, a decline in the company’s adjusted effective tax rate from 27.6% in fiscal 2018 to 25.2% in fiscal 2019 and a 7% reduction in weighted average diluted shares outstanding. The improvement in non-operating income and expense was driven principally by higher net gains and other investment income from the company’s investments in sponsored strategies and an increase in income contribution from consolidated CLO entities. As Tom described, we are reporting record adjusted earnings per diluted share of $0.95 for the fourth quarter fiscal 2019, up 12% from $0.85 in the fourth quarter fiscal 2018, and up 6% from $0.90 in the third quarter fiscal 2019. Our adjusted earnings per diluted share this quarter include $0.08 of combined contribution from seed capital and consolidated CLO entity investments, compared to the $0.01 contributed in the fourth quarter of last year and $0.04 of contribution in the third quarter fiscal 2019. Earnings under U.S. GAAP exceeded adjusted earnings by a $0.01 per diluted share in the fourth quarter of fiscal 2019 and $0.02 per diluted share in the fourth quarter fiscal 2018, reflecting the reversal of net excess tax benefits related to stock-based awards during those periods of $1.5 million and $2.4 million, respectively. Adjusted earnings per diluted share in the third quarter of fiscal 2019 equaled GAAP earnings per diluted share with no material adjustments. As Tom noted, ending in consolidated managed assets reached a new record high of $497.4 billion at October 31, 2019, up 13% year-over-year and 3% sequentially, driven by strong net flows and positive market returns. Average managed assets in fiscal 2019 were up 5% from the prior fiscal year. Management fee revenue was substantially unchanged year-over-year, as growth in average managed assets was offset by decline in our average management fee rate from 33 basis points in fiscal 2018 to 31.6 basis points in fiscal 2019. Changes in our average management fee raised year-over-year, primarily reflect shifts in business mix. Performance-based fees, which are excluded from the calculation of our average management fees, contributed $1.7 million to revenue in fiscal 2019 versus a negative $1.7 million in fiscal 2018. Comparing fourth quarter results to the same quarter last year. 8% growth in average managed assets drove 2% growth in management fee revenue. Sequentially, average managed assets increased 4% driving management fee revenue growth of 1%. Management fee revenue growth trailed growth in average managed assets for each of the comparative quarterly periods, primarily due to declines in our average annualized management fee rates of 6% year-over-year and 3% sequentially. Performance fees were a positive $0.1 million in the fourth quarter fiscal 2019 and negative $0.3 million in the fourth quarter of fiscal 2018 and a positive $0.1 million in the third quarter fiscal 2019. Fiscal 2019 operating income decreased by 6%, or $34.3 million, primarily reflecting a 1%, or $9.2 million decrease in revenue and a 4%, or $21.9 million increase in compensation expense. Fiscal 2019 revenue was adversely affected by the market declines experienced in November and December 2018. While approximately $8.7 million of the increase in compensation expense year-over-year is attributable to higher severance expense, $6.2 million of which was recognized in the fourth quarter. Operating income increased by 6% in the fourth quarter fiscal 2019 from the same period a year ago, reflecting a 2% increase in management fees, offset by a 5% decline in non-management fee revenue and a 4% growth in operating expenses. Operating income was down 1% sequentially, reflecting a 1% increase in both management fees and operating expenses compared to the prior quarter. Our operating margin of 31.2% in the fourth quarter fiscal 2019, compared to 33.5% in the fourth quarter of fiscal 2018 and 31.8% in the third quarter of fiscal 2019. Turning to expenses. Compensation costs increased 4% in fiscal 2019, primarily driven by higher salaries and benefits associated with increases in headcount, salary increases instituted for rank and file employees, higher stock-based compensation and the $8.7 million increase in severance, partially offset by lower sales-based incentive compensation operating income-based bonus accruals. One-time severance costs associated with employee terminations totaled $10.2 million in fiscal 2019 versus $1.5 million in fiscal 2018. Based on what we know today, we do not expect to incur meaningful amounts of employee termination costs in the first quarter fiscal 2020. Compensation expense as a percentage of revenue increased to 37.2% in fiscal 2019 from 35.7% in fiscal 2018. We anticipate the compensation as a percentage of revenue in the first quarter of fiscal 2020 will likely be modestly higher than the 37% we experienced in the fourth quarter fiscal 2019, given seasonal pressures associated with payroll tax clock reset 401(k) funding, the acceleration of stock-based compensation expense associated with first quarter retirements and year-end base salary increases. Controlling our compensation costs and other discretionary spending remains top of mind as we move into the new fiscal year. Non-compensation distribution-related costs, including distribution and service fee expenses and the amortization of deferred sales commissions decreased 3% in fiscal 2019, 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. Fund-related expenses increased 7% in fiscal 2019, reflecting higher sub-advisory fees due to an increase in average managed assets to sub-advised funds. Other operating expenses increased 5% in fiscal 2019, primarily reflecting increase in information technology spending, facilities expenses and travel expenses, partially offset by decrease in amortization expense related to certain intangible assets that were fully amortized during our first fiscal quarter of 2019, and 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 related to seed capital investments contributed $0.13 and $0.03 to earnings per diluted share in fiscal 2019 and fiscal 2018, respectively. On a quarterly basis, net gains and other investment income on seed capital investments contributed $0.04 to earnings per diluted share in the fourth quarter fiscal 2019, a $0.01 in the fourth quarter of fiscal 2018 and $0.06 in the third quarter of fiscal 2019. When quantifying the impact of our seed capital investments on earnings, 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 impact of 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. Although we hedge the majority of our seed capital portfolio, gains on the unhedged portion drove with the positive contribution to earnings in the fourth quarter and the fiscal year. Other income and expense amounts related to consolidated CLO entities contributed $0.07 and a $0.01 to earnings per diluted share in fiscal 2019 and fiscal 2018, respectively. On a quarterly basis, amounts related to consolidated CLO entities contributed $0.04 to earnings per diluted share in the fourth quarter fiscal 2019 were negligible in the fourth quarter fiscal 2018 and reduced earnings by $0.02 per diluted share in the third quarter of fiscal 2019. Other income and expense amounts related to consolidated CLOs reflect changes in our economic interest in these entities, including the fair market value of our investments, distributions received and management fees earned. Our strategy for CLO equity remains to commit prudent amounts of EV capital to support growth of 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 24.2% in fiscal 2019 and 28.8% in fiscal 2018. The company’s income tax provision for fiscal 2019 included $3.2 million of costs 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 of $5.4 million in fiscal 2019 and $17.5 million in fiscal 2018. The company’s income tax provision for fiscal 2018 further included a non-recurring charge of $24 million related to the enactment of the 2017 Tax Act. 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 rewards and the non-recurring impact of the tax law changes. On this basis, our adjusted effective tax rate was 25.2% in fiscal 2019 and 27.6% in fiscal 2018. On the same adjusted basis, we estimate that our effective tax rate will range between 26.5% and 27% for fiscal 2020. During the fourth quarter of fiscal 2019, we use $38 million of corporate cash to pay the $0.35 per share quarterly dividend declared at the end of our previous quarter and repurchased 1.2 million shares of nonvoting common stock for approximately $55.1 million. Our weighted average diluted shares outstanding were $114.4 million in fiscal 2019, down 7% from $122.9 million in fiscal 2018, reflecting share repurchases in excess of new shares issued upon vesting of restricted stock awards and exercise employee stock options, and a decrease in the dilutive effect of in-the-money options and unvested restricted stock awards. We finished our fourth fiscal quarter holding $855.5 million of cash, cash equivalents and short-term debt securities, and approximately $323.8 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 markets and significant corporate initiatives. As Tom noted, the strategic initiative we announced in June includes investments in technology to support a consolidated individual separate account platform geared towards enhancing scalability and achieving higher levels of operating efficiency. We anticipate that the operation efficient – operational efficiencies gained with this initiative will enable us to grow our customized individual separate account business without making significant additions to our headcount. 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. At this point, we’d like to take any questions you may have.

Thank you. [Operator Instructions] And our first question comes from the line of Dan Fannon from Jefferies. Your line is open.

Thanks. Just a clarification on some of the comments, Laurie, around severance. So did I hear right that it was $6.2 million here in the fourth quarter and you don’t expect much in the first quarter? And I guess, it sounds like in the aggregate number for the year was a little high, can you talk about where the changes are coming from a headcount perspective, and if there are any other one-time kind of expenses in this fourth quarter number?

Sure, Dan. The severance is largely focused around the initiatives that we announced in June associated with the separate account project with Parametric and Eaton Vance management. So I think, we had announced we have made some significant – we’ve made a very significant hire at Parametric in terms of the Chief Technology Officer and some of the severance related to some employee changes around that initiative. And in terms of other significant fourth quarter impact items, there really was nothing else that would identify as being significant in the quarter.

Okay. And then, so I guess just now that you’re a little bit further along in terms of that restructuring and some of those changes. As you think about next year, I get the comments that you’re focused on efficiency, but is there increased savings or operational leverage as a result of some of these changes that you maybe have greater clarity on today than you did when you first announced this?

Dan, we’re still in very early days. Obviously, we’re working through a lot of the internal changes. I think that we had identified that we’re going to be consolidating sales professionals into a one single channel to cover RIA and multi-family offices, and we’re well underway in actually making those changes. We’re also, as we identified, consolidating under the Parametric brands, our tabs laddered in our corporate laddered businesses, so all those changes internally are well underway. We do anticipate that we will have, as we identified previously, incremental technology spends that we will be – and we will be making those investments throughout fiscal 2020. I would anticipate that we’ll see a modest uptick in our technology spend related to those efforts. We do firmly believe, however, that those efforts over time will result in a significantly more efficient platform, and therefore, we will not be seeing significant increases in headcount associated with that.

Okay. Thank you.

And our next question comes from the line of Ken Worthington from JPMorgan. Your line is open.

Hi, good morning. Thank you for taking my question and really just to kind of follow-up on Dan’s question at first. As we think about 2020, if we’re in normal markets, if sales are sort of similar to the pace that you guys see this year, are margins expected to kind of rise/fall, or do they see the same based on your outlook for these investments?

I would not anticipate that we would see a significant change in margins. I think it’s important to keep in mind that roughly 55% of our costs at this point are fixed, 45% are variable. As I mentioned, we would anticipate seeing a modest uptick in the technology spend. But given the parameters that you outlined in terms of the forecast for next year, I would not anticipate seeing a significant change in margin.

Okay.

And I would just add, that’s assuming that market levels…

…right.

…stay in the range at where we are today.

Okay. Okay, thank you. And I know you’ve been at a couple of conferences and probably addressed this question a bunch. But just on UBS, the changing of pricing for SMAs beginning in, I think, January of next year, so a couple of questions around that. Is Eaton Vance going to opt into the UBS Access or UBS Strategic Wealth Portfolio offerings that have the new pricing? And if so, what might the impact be of that? UBS is calling SMA strategies this month, was Eaton Vance impacted by the calling? And then, ultimately what is the move by UBS mean for Eaton Vance, particularly if UBS becomes sort of the industry standard in how they’re treating the SMAs?

So a few things in there, I can respond to. So as far as I know, we were not impacted by any calling of products to use your words, so I don’t – we haven’t seen any changes yet. My understanding of the timing of the UBS initiative in separate accounts is that, they’re offering some, what I’ll say, internally or maybe technically managed by not UBS Wealth Management, but UBS Asset Management, but affiliate company offerings will begin entering the market in January 2020, and that they’re looking to add third-party managers to this new program that they announced, I believe starting in July. So we’re still some months away and we certainly have not committed to being a part of that program. Whether or not or to what degree it affects this business, I think, will largely be based on participation levels and I mean, that in two different respects. First, how active are UBS Financial Advisors in introducing these programs to their clients or converting their client business into these new programs. So is there a significant opt-in to these internal programs that will take effect in January? And then second, when the program becomes available to third-party managers, such as ourselves in the second-half of next year, what’s the participation rate among asset managers? And also, again, what’s the participation rate among UBS Financial Advisors? So it’s pretty early days. My impression is that some of the pricing and terms of these offerings are still at least somewhat in flux. One of the things we do like about this is importantly, that it recognizes the distinctive value of tax management and responsible investing with the – I believe under their proposal, this would – there would be a extra client charge, extra payment that would be passed through to the investment advisor associated with assets that are tax managed and assets that offer responsible investing as a component of that, and we are – we believe the market leader in both tax advantage and responsibly managed individual separate accounts. So in some ways, that’s an endorsement of our position in this business. They have described this as a move to bring institutional pricing to the individual separate account business. But from what we understand, the pricing levels that we’re proposing are generally quite a bit lower than our understanding of where institutional prices are. So I think it’ll be a challenge for advisors to embrace the UBS pricing without potentially adversing pricing of other business, where, in many cases, that most favored nation provisions will limit the ability to offer better prices to UBS clients, for example, than are offered to compliance of other broker dealers or other institutional clients. So I think, it’s pretty early days in terms of trying to anticipate what the impact of this will be, but maybe I’ll stop there on that topic.

Okay. Well, that was helpful. I really appreciate it. Thank you very much.

Thank you.

And our next question comes from the line of Patrick Davitt from Autonomous. Your line is open.

Good morning. Thank you. You mentioned, the Fed – the change in Fed stance on rates potentially helping flows in the bank loan business, but there has been a lot of increasing chatter about credit weakness in leveraged loans. So could you kind of parse out that view through the lens of potential concerns about credit weakness? In other words like, how could we expect that much better flow picture, people are worried about credit in that product?

Yes. And that’s the – you’re right. That’s – why do people buy or sell bank loan strategies? These are below investment-grade strategies. So in addition to being floating rate, there is a credit component, that’s what you get paid for as a loan investor as to take credit risk during periods when credit risk is perceived as widening prices of loans typically fall. We have not seen a lot of price action. Bank loan prices have actually been quite stable. Overall moves in terms of the stock market and other sort of broad measures of economic expectations have generally been positive over the last couple of months. There’s certainly nothing in our portfolio of loan exposures, at least to the extent I’m aware, that suggests there are major concerns about credit emerging in the bank loan asset class. At some point, there will be a turn in the economic cycle. We certainly don’t believe that economic cycles have been in some way repealed, but there’s nothing in our crystal ball that suggests that a downward trend is imminent. And from the perspective of our team, the spreads offered and – the spreads and rates offered by floating rate bank loans are quite low today, are quite – sorry, quite attractive today and that the risk of a near-term downturn is seemingly quite low. I would also observe that the history of this asset class through market downturn has been generally quite attractive rates of recovery on loans that default reflecting the senior secured status of these assets. So we don’t see a cycle turning down anytime soon. We know at some point it will turn down, but the history of this asset class is that based on spreads in the market today and in the market over time that investors are being well compensated for the credit risk they’re taking by investing in floating rate bank loans.

That’s all I have. Thanks.

Thank you.

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

Okay. Thank you very much for taking the question. Maybe just, Tom, sticking with maybe your thinking a little bit more, you had mentioned in some of your prepared comments some of the three or four things you want to focus on for this year. Could you expand a little bit on maybe two of those points just in terms of “the spending” some of the franchise, parts of the business, the bank loan and global macro? And then, just sort of how you sort of see the industry from a consolidation perspective and how you might think about capital deployment?

Sure. So let’s first talk about bank loans and global macro. So our bank loans have been in this pretty significant outflow. I’m really focused on U.S. retail, where the flow numbers are quite visible. Remarkable outflows over the last 12 months after a period of inflows and, yes, it pretty well attracts changes in interest rate expectations, though it feels like this cycle of inflows and outflows has been rather amplified relative to the changes in short-term rates that we’ve seen and certainly what we expect from here. As I mentioned in my prepared remarks, we’re pleased that we’ve gained market share in that environment. We are the flow leader in the category in terms of market share and are gratified that through the downturn, we’ve seen smaller shrinkage in our business than the retail market as a whole, so that’s good. So we feel like we’re entering this – we’re going through this down period by strengthening our position. And I would say broadly that one of the benefits of being an industry leader, and certainly this is a category where we are an industry leader, is that that’s often the case is that opportunities to hold and build market share, capitalizing on leadership positions tend to be the greatest during periods of market weakness and that’s what we’re going through, and that’s what we’re experiencing. And while we don’t like to see the shrinkage in our business, we’re pleased that we are seemingly adding to our position based on industry statistics. In terms of our global macro, this is a business that we’ve grown over the last maybe 10 or so years pretty significantly. Here, too, there’s a certain cyclicality of performance and flows. What tends to happen is that, during periods of general equity market strength and strong returns in bond markets, the value of this asset class as a diversifier is maybe somewhat underrepresented, underappreciated in the marketplace. But during periods when people are concerned about equity risks or concerned about interest rate risk or concerned about certain types of credit risk, the diversifying impact of this asset class and these two funds, in particular, has caused these to be significant flow winners in those environments. So they play an important role in diversifying our book of business in the same way that they play an important role in diversifying the asset class exposures of investors in these strategies. They are – just as a reminder, we have a country picking approach taking long and short positions in emerging market and frontier market debt and sovereign currency – currency and sovereign debt instruments of emerging and frontier market countries. So a quite distinctive return profile. It’s been good this year, approaching 8% for our lower risk, less volatile core offering and close to 12% for our somewhat more aggressive offering in that business. This has been a business, where historically flows have tracked returns. The fact that we’ve got good returns this year to us suggest that we will see improvement next year in the flow picture there. In terms of our overall – just the – maybe with the broader question of our competitive position, as I mentioned, I feel really good about where we are that there are in addition to the two sort of businesses that are in defend mode, that is bank loans and global macro, both of which – it feels to me they either are or should be nearing a point of bottoming in terms of the trajectory of down flows. But also we’ve got a nice group, a very strong group of growth vectors that we think put us in very strong position, starting with the leading position of Parametric in customized individual separate accounts, sometime referred to as direct indexing or custom indexing, where we do see significant opportunities for incremental growth likely to develop out of this initiative to combine our municipal and corporate laddered business under Parametric, which gives us the ability to offer, among other things, multi-asset class structures, all tax managed and managed and reported in a single coherent way. Overall, I think that’s likely to be a tremendous growth driver for us. As I mentioned, our business in wealth management strategies and services is growing our, what we call, Eaton Vance Investment Counsel, had a very strong year of inflows, which we’re certainly hopeful we can build on next year. Clearly, there has been an explosion in interest and responsible investing. Calvert is one of the leading brands in that marketplace. In the U.S. retail space, we see significant opportunities in the next fiscal year to grow not only in U.S. retail, but to start to move beyond that into institutional markets in the U.S. and also growing internationally. We are one of the most recognized brands in responsible investing, and that’s an area where people still struggle for definition and clarity, where our role as an industry leader positions us to really help define and help drive the growth of this business segment going forward. So I really think we’re in the early days of what can be very strong – many years of strong growth for Calvert and more broadly for Eaton Vance in responsible investing. As I look at the industry landscape, sort of trends that we see are likely to be increasing pressures on many parts of the business, I think, we’re likely to see more pressure on top line, driven by continuing price competition in the business. At some point, we’ll see an equity downturn that will put more pressure on companies, where we think we enter that environment from a position of clear strength with not only a number of market-leading franchises, but also strong balance sheet, strong culture, strong leadership, continuity of approach focused on this business, great relationships in the market, history of innovation. We think all of those things will be rewarded in the hard times that we expect our industry to be going through certainly compared to the periods of strong growth that we’ve experienced over most of my 30-plus-years in the business. So we’re not all that optimistic at the moment about near-term trends in our industry, but are quite optimistic about our relative position within asset management.

Okay. And just as a follow-up, and thanks for taking these questions. Maybe a two-part or one, can you just – Tom, I lost you a little bit when you were talking about some of the pricing complexities with the UBS in terms of the most favored nations. Just wondering if you could sort of flush that out? And then, stepping back, there has been a bunch of sea chain events on the retail broker/dealer models just in terms of combination of moving to the zero pricing on certain trading, as well as some potential M&A. How full would those events impact Eaton Vance’s pro or con?

Yes. I guess to be determined, but let me start with the UBS question just to clarify. So maybe I use the term most favored nation provision, which I assume most people would know means that we have arrangements with broker dealers who offer retail managed account platforms. And also in some cases with institutional clients that that say broadly, that we want to offer the same strategy at a better price to a competitor. That is put in there typically at the insistence of the customer. But it also has a somewhat protective effect by enforcing an element of price discipline. So if somebody says within our organization, jeez, this is a great opportunity. We ought to offer this at a discounted fee level. It’s somewhat helpful to our business discipline, if we can say, no, we can’t offer that at that discounted fee level, because that means we have to reprice that same strategy to everyone, but to everywhere where we have a most favored nation provision in place. So that’s the – I think that’s the general idea. I’m not going to get into the specifics on contracts with individual organizations. But I think it’s fair to understand that there are most favored nations provisions employees covering these managed account programs of the type that UBS is – that we participate in a UBS. The other question was about, I guess, specifically the Schwab, TD Ameritrade merger proposal or announcement. And back a few weeks earlier, the elimination of trading commissions in certain retail brokerage transactions initiated also by Schwab. In the short run, I would say those changes, at least, the second, but the first one hasn’t happened yet. The merger of the two companies hasn’t happened yet. But what has happened is the elimination of trading commissions in both the direct business of Schwab and its competitors and they’re serving a registered investment advisors. So far, the short-term impact of that on our business has been positive. The effect is, on our individual customized separate account business is, clients aren’t paying commissions on trades and those accounts, which makes at the margin, owning separate accounts more attractive than owning similar exposures through a fund. And broadly speaking, when we sell customized individual separate accounts, in some cases, we’re competing against fund costs – fund structures, and to the extent, there’s a lower cost for implementing our strategies. That’s a benefit to our growth in those businesses and we have seen that. We have seen benefits from that and a few specific cases. I would say more broadly, as these changes take place with distribution partners and we are partners with all of these firms, increasingly, they will be looking for opportunities to either replace revenues in the case of the loss commissions or to build on existing relationships to otherwise drive revenue growth, that creates opportunities for us. So, I’d say, it cuts both ways. There’s a – there’s business growth opportunity. No doubt, as that industry consolidates, there will be some pressure to also consolidate the number or types of vendor relationships they have, including with asset management firms. And the imperative for our relationship management teams and sales teams is to make sure that if there is a reduction in relationships to include only the stronger relationships that were on the winning side of that, not the losing side.

Thanks, Tom.

Thank you.

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

Great, thanks. Good morning. Thanks for taking my questions. Maybe, Tom, could you just update us – I think it was back in the spring or so exactly when you had kind of filed for your clear hedge non-transparent ETF technology and, obviously, we’ve seen some others get approvals on their submission. So could you kind of update us kind of what you’re thinking about timing with getting some – getting through the SEC, I mean, more optimistic less? And then I guess, I have a follow-up to that.

Yes. Thanks, Rob. So we are in discussion with the SEC. They control the timing of that, not us. So we can’t really speculate on timing. But I can confirm that we did submit a proposal. We’ve gotten comments back. We’ve been in dialogue with the SEC. We view the approval or the – I don’t think it was the final approval, but notice of intent to approve something to that effect, and being a positive for their openness to innovation in the space. We looked carefully at the terms of those approvals. One thing we would note is that, none of the approaches approved so far permit investments in asset classes other than cash and things that trade on exchanges during U.S. market hours. So generally, U.S. stocks and a few other categories of things, but it does not include traditional fixed income investments, which don’t trade on U.S. exchanges. It doesn’t trade – it doesn’t include foreign stocks. And we certainly believe that there is an advantage to the clear hedge method that should enable it, if approved, to provide funds that follow this method to invest across asset classes with greater confidence of maintaining tight trading markets and also greater confidence that they can maintain tight trading markets across all types of market conditions. So we think the window is open. We don’t know the timing. We’re up – we’re a newer submission than any of those that were approved. So nobody – nobody has jumped us in line in terms of the applications that got a favorable nod last week. But we feel good about the opportunity that’s here. Clearly, it’s going to be a very competitive landscape assuming some version of these now five approved ideas will make their way to the marketplace and time. In some ways, who wins or who loses will be defined by product features, relationships also will come into play, also, pricing will certainly come into play. But we want to continue to be active in this space and think that we have a differentiated technology that potentially, if we can persuade the SEC of this positions us to facilitate the offering of less transparent ETFs across all markets – across all asset classes.

Okay, great. And this is my follow-up. Tom, you mentioned kind of, obviously, continuing to look at strategic initiatives, including acquisitions, and I guess, really, maybe it’s a two-part question. Can you maybe update us on some of your non-U.S. ambitions three, four years ago or so, you – obviously, you spent time and money kind of building out London. And that kind of almost feels like it’s been, I don’t want to say back-burnered a bit, but there was so much to do in the U.S. kind of hasn’t been front of mind and update us on that? And then if you are thinking about incremental M&A, could you maybe kind of refresh our memories on what some of your priorities would be?

Sure. Just talking about our initiative in London, it certainly has not been a back burnered. We’ve continued to maintain and grow staff in our London office. We recently opened a small satellite office in Dublin as well. So we are committed to and expect to maintain a presence in the UK and Europe. And what maybe has been back burnered a bit is our ambitions and hopes to do a significant acquisition that would bring us broader non-U.S. distribution and investment capabilities outside of the United States. And it’s not for a lack of wanting, it’s for a lack of confidence that there’s a partner out there that makes sense for us. We kick the tires on a number of potential opportunities. And after, as you said, a few years of trying to do this in a significant way, I know that we’ve concluded that there’s no good partner for us. But we certainly are a bit frustrated that we haven’t found the right partner that in a transaction structure that would make sense for us. So that part of it has been has been back burnered. But certainly, our ambition to grow our business outside the United States organically or through strategic partnerships remains. In terms of things that we are looking for in potential acquisitions, I guess, I would highlight a couple. I’ve talked about our ambitions and our strong platform and responsible investing, if there’s a way to grow that, incrementally, we would be certainly open to that. In the past, I’ve talked about our strong position in credit markets, primarily through bank loans and high yield bonds. But the idea that that can provide a natural springboard for us into the private credit space is also something that we have looked at and continue to pursue. But as always we’ll be price-sensitive as we look at potential opportunities there. A third thing we’ve talked about, I think, I’ve been in this on a call earlier this year is the growth of our private client business or wealth management business, where we’ve seen a good organic growth and where we think there could be opportunities to benefit by participating in industry consolidation among wealth management firms, increasing our global – increasing our footprint across the U.S. and creating avenues for selling our wealth management strategy. So those are the three areas I would focus on. I would identify as focus areas responsible investing private credit in various forms and then wealth management businesses.

Great. And if I could maybe squeeze one last one in the the exchange fund business, which has been around a while. I mean, we’re pretty far into a decade or so bull market. Just kind of curious if you’re seeing how that business is doing? Is it still kind of resonating as much with investors as it used to and kind of status on that?

Yes, that remains a good business for us. Those are private offerings. So we don’t provide a lot of detail on how that business is progressing. But it’s a – these are strategies offering diversification out of concentrated stock positions into broadly-based equity portfolios. And you would imagine, as the market cycle matures and people have large gains that those strategies continue to have broad appeal.

Okay, great. Thanks for taking my questions. Have a great Thanksgiving.

Thank you. I think, we have time for one more question on our call today.

Okay. Your last question comes from Brian Bedell with Deutsche Bank. Your line is open.

Great. Thanks very much for getting me in. Most of my questions have been asked and answered. But maybe, Tom, if we could just maybe one more on the active ETF approvals. Just in terms of the two different models that have been approved the Precidian model versus the T. Rowe model, maybe just your perspective on what investment managers might do if they’re keeping that information proprietary in – which appears to be the structure of the T. Rowe model. And then how your clear hedge model would fit in into that and whether you see the demand not to pick a winner or loser, anything like that. But whether – to what extent you see demand in future demand in what your clear hedge model would you for that type of structure?

Sure. So, I guess, maybe first to say that what I think people here know, but just to clarify, none of these things are actually approved in the marketplace and there are still some significant steps involved. With our next year’s initiative, we got a – we got an exemptive order issued, I think, in December of 2014, and we launched our first product in February of 2016. So I can’t say what the time window will be for these other strategies, but that was our experience. And we also got a listing and trading approval in the November, December 2014 timeframe. And I don’t believe any of these concepts have listing and trading approval. And I think for many of them, there’s not even an application that’s been filed. So I think it’ll be a while before these still come to market. I think, there have been some speculation that these might be in the market before the end of 2019. I think that’s not going to happen. In terms of clear hedge and where clear hedge – where funds utilizing the clear hedge method might fit into this. We are broadly in the camp of disclosing our proxy portfolio. So in that sense, similar to what you’re calling, the T. Rowe Price proposals, these four different ideas that got preliminary approval last week. What’s different about our approach is that, we include a second step, not only disclosing a proxy portfolio, but adding a second step whereby market makers can lay off the basis risk, that is the relative performance risk between the disclosed proxy portfolio and the funds are underlying assets by transacting with the fund itself through a swap type arrangement. The – so based on this sort of belt-and-suspender approach to achieving better trading efficiency, our case that we’re making to the SEC is that, funds relying on the clear hedge method because of this two step or belt-and-suspender approach to ensuring tight trading can be comfortably applied in places, where the SEC has not to date has been comfortably applying these other concepts, which would be funds that own things other than U.S. equities and cash or things that trade on U.S. exchanges, plus cash, which is the way the market is currently limited. So that’s our case. And also, our case is going to be that, because of this belt-and-suspenders two-stage approach that even in U.S. equity, where these other ideas are approved, our approach can be expected to trade better during periods of market stress, because we’re not in effect asking market makers to place blind bets on the relative performance of the known proxy portfolio versus the unknown portfolio that they are also going long and short in. So it’s a – think about it as a two-step process, one of which is very similar to this recent round of approval. But the other with this ability that we’re providing, where market makers could lay off the relative risk between the unknown fund holdings and the known proxy portfolio, which none of these other ideas incorporate, and that is subject to a patent that was issued to us about a year ago. So we’ll see how it goes. We’ve been in this game for quite a long time. I think we’ve learned a lot and are optimistic that we can put that learning to good use and hopefully see that translate into an approval and market success for funds utilizing the clear hedge method.

That’s great color. And then, just I guess in terms of the investment managers going down this path in the future, do you think they would prefer to have proxy portfolios with if they could develop those and thereby keep the – their information private or proprietary to their shops?

Well, I think, the underlying premise of all these ideas is that disclosing your holdings every day, which is the current fully transparent ETF model, is not consistent with proprietary active management. So if I’m telling the world what my holdings are every day, I don’t consider that proprietary. And if I do that, they’re at least a couple of adverse effects on me that’s the investment advisor or my clients. One is other people can by seeing my changes in daily holdings can learn to anticipate my trades and potentially front run my trades and drive up my trading costs and then drive down returns. The other one is to the extent that on disclosing what is in effect my intellectual property, that is my model portfolio, giving that away to the market for free, I’m inviting other people to take advantage of that by offering the same or similar strategies at a lower price point similar to a generic drug. You don’t want to give away the $4 million and put it out in an unprotected form, which is what fully transparent ETFs do. But also, you’re providing significant information about if it’s a bond portfolio, how you’re feeling about the world in terms of how you’re shifting your duration exposure, how you’re shifting your credit exposure in a way that could give you insights in – give insights to your competitors to take or potentially use to improve their performance potentially and harm your performance. So it’s – do you believe in proprietary management and do you believe there’s something that’s worth protecting about that? If you do, the fully transparent structure, we think falls short. All of these ideas, including our own, are seeking to provide the benefits of truly proprietary active management to end customers in an ETF form, which is not heretofore been available.

Okay, great. Thanks for the color.

Yes. Thank you.

Okay. Well, this concludes today’s earnings call. I want to thank everybody who participated in the call today and we look forward to speaking with you next quarter. Thank you very much.

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.