Ladies and gentlemen, thank you for standing by and welcome to the Eaton Vance Corp. Third Fiscal Quarter Earnings Conference call and Webcast. At this time, all participants lines are on mute. Please be advised that today's call is being recorded. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]. I would now like to turn the call over to your speaker today, Eric Senay, Treasurer and Director of Investor Relations. Please go ahead.

Thank you. And good morning. And welcome to our fiscal 2020 third quarter 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 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 Investor 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 uncertainties in our business, including, but not limited to, those discussed in our SEC filings. These filings including our 2019 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 today. Since we reported our second quarter earnings results in late May, our business, our employees and the communities in which we live and work have continued to be significantly impacted by the ongoing COVID-19 pandemic. Nearly all of our staff continues to work remotely. And that remains our expectations through at least the balance of this year. Our employees have adapted quite effectively to working from home with minimal disruption to day to day operations and high levels of client service being maintained throughout the pandemic period. The strength and resilience of our business in this difficult environment is testament to the adaptability and commitment of our employees across the company, for which I remain deeply grateful. Since the sharp market sell off in March, the stimulus actions of governments around the globe and visible progress advancing the development of effective COVID-19 vaccines and therapeutics have fueled a recovery in financial markets. Over the course of our third fiscal quarter ending in July, we regained $39.4 billion of the $43.6 billion of managed assets that we lost to market price declines in the previous quarter. While the pandemic is far from over, markets are increasingly willing to bet that the worst is behind us and the economic recovery will continue. Earlier today, we reported adjusted earnings per diluted share of $0.82 for the third quarter of fiscal 2020, up 3% from $0.80 of adjusted earnings per diluted share in the second quarter of fiscal 2020 and down 7% from $0.88 of adjusted earnings per diluted share in the third quarter of fiscal 2019. On a GAAP basis, we reported a loss of $0.01 per diluted share in the third quarter of fiscal 2020, reflecting a $0.90 per diluted share reduction…

Thank you. And good morning. As Tom described, we reported adjusted earnings per diluted share of $0.82 for the third quarter fiscal 2020, up 3% from $0.80 in the second quarter of fiscal 2020 and down 7% from $0.88 in the third quarter of fiscal 2019. As you can see in attachment 2 to our press release, adjusted earnings exceeded earnings under US GAAP by $0.83 per diluted share in the third quarter fiscal 2020, reflecting the reversal of the $100.5 million impairment loss recognized on the company's investment in our 49% owned affiliate, Hexavest, the reversal of $8.5 million of net gains of consolidated investment entities and our other seed capital investments, the add back of $1.6 million of management fees and expenses of consolidated investment entities, and the reversal of $0.2 million of net excess tax benefits related to stock-based compensation awards. Adjusted earnings exceeded earnings under US GAAP by $0.15 per diluted share in the second quarter fiscal 2020, reflecting the reversal of $16.8 million of net losses of consolidated investment entities and other seed capital investments, the add back of $1.8 million management fees and expenses of consolidated investment entities, and the reversal of $1.1 million of net excess tax benefits related to stock-based compensation awards. Earnings under US GAAP exceeded adjusted earnings by $0.02 per diluted share in the third quarter of fiscal 2019, reflecting the reversal of $4.6 million of net gains of consolidated investment entities and other seed capital investments, the add back of $2.3 million of management fees and expenses of consolidated investment entities and the reversal of $0.6 million of net excess tax benefits related to stock-based compensation awards. As Tom discussed in more detail, the outflows driven decline in Hexavest managed assets and management fee revenue over recent months prompted…

Thank you. [Operator Instructions]. Your first question comes from the line of Patrick Davitt with Autonomous Research.

It looks like you had no share repurchase, I think maybe for the first time ever, at least in my model. Could you speak to maybe the thinking around that after the share price decline? Was there some sort of unique restriction this quarter? And how should we think about that going forward?

Hi. It's Laurie. As we were looking at this quarter and last quarter, it really has been top of mind for us to ensure that we've got financial flexibility, particularly in terms of our liquidity. And I think as we mentioned last quarter, given everything that's happening on the global stage, we felt it was prudent to cut back on our share repurchases and we just continue to look at it quarter by quarter. But again, we're really just trying to ensure that we've got the liquidity necessary to continue to grow the business.

And then also, just a quick follow-up. The parametric emerging markets strategy, you called out with some performance-related outflows. I think you said there was $1.5 billion and $2.6 billion left in that bucket. Should we take that to mean that you're worried that that might be AUM at risk given the performance issues?

I think there's a reasonable chance that unless performance improves that it's an active strategy that competes against other attractive strategies in each of our businesses. If you if you can't deliver performance that exceeds benchmarks and peer groups over time, it's reasonable to expect assets to come down. We have seen quite a bit of net outflows from that strategy. We think there's likely to be more stickiness to the assets on the mutual fund side perhaps than the non-mutual fund business. But certainly, for modeling purposes, we would assume that outflows there will continue. Ultimately, we're constrained by the amount of outflows by the assets that we have, which is down to just over $4 billion currently.

Your next question comes from the line of Craig Siegenthaler with Credit Suisse.

I'm interested in an update on what you're seeing on the competitive landscape at Parametric and Custom Core equity. And I'm especially interested in your comments around direct indexing.

So, there's quite a bit of, I guess, you would say noise. There have been announcements of a number of potential competitors that have interest in the space, public comments. In many ways, have been gratifying that people acknowledge that this is an area that provides value added for clients and many people perceive to have growth potential. In terms of what's happening in the marketplace as opposed to what we're hearing in announcements, there really hasn't been a meaningful change in competitive position. There's no new competitor that we're aware of that's taking significant share. We're not losing business being replaced by someone else. So, there's no evidence that any of the announcements are translating so far into changes in the competitive dynamic. This is a business that we and many others expect will grow quite substantially over coming quarters and years. It's not a surprise that others will try and compete in this business, given the growth profile that is there. I would say that our experience which goes back now several decades is that this is a hard business. It's not a business for dabblers, that there's a real commitment required to invest in technology, to invest in service and to invest in distribution to gain access across the markets. So far, there haven't been any competitors that have emerged that we're worried about who check all those boxes in terms of the level of commitment and demonstrated expertise and technology and service and have similar distribution to us. But we think it will be a much bigger market. It's reasonable that there'll be more competitors. But we think that the position that Parametric has there is very solid, very strong and very secure.

And just a follow-up here. If you do see an increase in competition in direct indexing and new entrants offer comparable product at lower price points, can you comment on your ability to reduce pricing below the mid-teens, which is where I think the blended fee rate is today and still generate attractive margins?

Certainly. We have the ability to respond selectively to competitors that compete on price. We will go toe to toe with anyone in terms of the quality and the value proposition that we offer as a leader in customized indexing. Competition in this space is not new. Throughout the time that we've been growing our custom indexing business, there have been other players in the market. The profile of those competitors really hasn't changed. The nature of the competition really hasn't changed. What has happened is that as the market has grown, its visibility has increased and we're seeing more conversation. But in terms of what's happening in the marketplace, we continue to compete as appropriately on price. We see nothing to suggest that we'll see wholesale reductions in average fee rates for this business. But we're certainly making the investments in technology and service and systems that will allow us to support a much bigger business and that ultimately will allow us to lower our operating costs, so that we can achieve attractive margins even at potentially lower average fee rates.

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

Just to follow-up on kind of the flows and the momentum you cited heading into the fourth quarter. If you could just clarify again, I think you said the total number will be similar to the first quarter, I think either including or excluding some of the lower fee stuff, but just want to clarify that. And then also, does that include some of the mandates you talked about or just trying to think about what still has been funded versus what you're saying has happened in August?

Let me clarify, Dan. So, the comment what I was trying to make is that [indiscernible] for our August to date, this would not include any of the pipeline things that I talked about. We're seeing quite strong flows that if you exclude the Parametric overlay service business, puts us, we think, on pace for the same range of flows that we saw in the first quarter. Again, that's based on quarter-to-date results through yesterday and – through the day before yesterday, I guess. That is in the range of about, I think, $1.7 billion for our non-Parametric overlay business. You multiply that by three to account for the fact that we're less than a third of the way through the quarter. And that gets you sort of in the ballpark of the $5 billion of non-overlay net flows that we had in the first quarter. Momentum is good. That includes strong sales with fixed income continuing, positive flows for equity, positive flows for floating rate income, positive custom portfolios. As I mentioned, we're expecting on top of that a quite strong quarter for the overlay services business where we've got meaningful amount – a couple billion dollars plus of net inflows for the quarter-to-date, plus a quite robust pipeline of new business that we're expecting to fund. All these forecasts should be taken with a grain of salt. We're only a third of the way through the quarter. Things can happen as we saw back in March. But, certainly, we're on track for a quite strong fourth quarter in terms of flows, supported by an excellent first month of that quarter and a visible pipeline of new opportunities that we think will likely support continuing flow momentum through the balance of this month and then through September and into the end of October and the end of the fiscal year.

And then, Laurie, just with regards to expenses and kind of the outlook, clearly, with the revenue side looking better based on where markets and AUM sit, as we think about going into next quarter, is margin expansion from here still reasonable, given what's happening with revenue and then still some kind of operational leverage potential on some of the non-discretionary spending side?

I would certainly say there's always the possibility. I hesitate just given the volatility that we see in the markets to put money on anything at this point. But I do think that we're very comfortable in thinking that the year is going to be in this 31% range. I would not necessarily anticipate a significant uptick in the fourth quarter, but I do think we're very comfortable in the range that we're in.

Your next question comes from the line of Ken Worthington with JPMorgan.

I'll combine everything into one. Just following up on the equity outflows this quarter, it seemed to some extent that the weakness this quarter was as much a function of weaker gross sales versus the last couple of quarters as it was for the higher gross outflows. So, can you flesh out, if you agree, the gross sales side of the equation as well? And for the follow-up on the outflows, you mentioned, I believe, it was $1.7 billion of covered calls and the $1.6 billion of the systematic. For the covered call strategy, how do those strategies typically do in this type of market? And maybe how much is left there? And on the systematic side, you said it was performance based. I believe you called out China as the driver. Are there other issues besides exposure to China or was that really all of the issue?

Starting with emerging market equities, systematic strategy, so they don't make market falls. So, think about this in the broad category of things as smart beta or multi-factor strategy. The premise of the fund is value added through diversification and rebalancing. The philosophy is a modified equal weighting approach to country allocation and alpha generation by rebalancing into underperforming countries. That worked for a very long time. It has not worked recently simply because the China market has come to dominate the emerging market indexes both in terms of weighting, but also in terms of contribution to performance. So, a strategy that by design is underweight to the largest markets – in this case, China – is very much hamstrung in trying to perform in market environments which we've been in where you have sustained leadership of those largest countries in the index. So, we've had performance-related outflows. I guess you would say, in addition to the country allocation, given the rebalancing nature of the approach we take, there's an anti-momentum bias to the strategy that also has not helped during this period. But the outflows are, we think, going to abate. I highlighted that we're at $4 billion in assets. I think peak assets in this strategy were in the range of $20 billion. So, it's mostly behind us in terms of the outflows, with only a remaining $4 billion left. How quickly we see that go away I think is anyone's guess. But we're certainly expecting based on performance that we've seen, as of current periods, still underperforming. So, we think it's reasonable to expect that outflows will continue. A second part of the question related to the covered call writing business and what Parametric refers to as volatility, risk premium strategies that is monetizing the alpha that's…

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

Maybe just a two-parter. Maybe for Laurie. Just curious, in terms of capital management, what milestones should we be looking at macro-wise or otherwise, to think about the reengagement of repurchase given your free cash flow? And then, Tom, just a big picture perspective. As you're dialoguing with both the retail and institutional gatekeepers, what are you hearing in terms of allocation decisions, just given the V-shaped recovery of equity and credit markets? Thank you.

We really don't have any markers that I would say to look towards. We don't have a program for share repurchases. It's a discretionary decision. We have a small committee that thinks about this every quarter, and I think that we'll be considering all the possible inputs as we move out of our blackouts. So, more to come on that, but nothing specific to look for in terms of markers.

Bill, in terms of markets and where we're headed, first, I'm generally not too involved in those decisions with gatekeepers about asset allocation. My own market view is that the markets will likely continue to grind their way higher, given what we see as likely to be continuing positive news on the on the pandemic, particularly from a therapeutic and vaccine standpoint, more so than public health, and the likelihood that the economy will continue to be paused. It's certainly one of the things we're watching carefully, is US election and what that might imply for future tax rates, future regulatory and spending initiatives. I think as most of our listeners are aware, we have a large business serving tax paying investors, which represent – some version of tax managed strategies represent over 40% of our assets, including municipal bond funds and tax managed equities. We're not exactly sure what's going to happen, but we certainly think that there's a reasonable prospect that, following the election, we could see an increase in tax rates, which could be a significant positive for that business.

Your next question comes from the line of Brian Bedell with Deutsche Bank.

A lot of good questions and answers on the Parametric. Maybe if I could just add one comment. I guess what do you make of the importance of fractional share accounting in the costume indexing business in terms of the potential competitor responses down the road? And again, going back to – obviously, your business has performed very well and you have a leading position in this business, but going forward, if it's not competing on pricing, what other growth angles within the Parametric business, I guess, would you point to [indiscernible]?

We compete primarily in high net worth markets for Parametric custom portfolios. For Custom Core equities, the account minimum at most places, I believe, is $250,000. So, the impact of fractional shares for someone that's putting to work $250,000 is pretty minimal. There is the opportunity with fractional shares, and you've been reading about these, to do less customized or even non-customized direct indexing based strategies, which to us is not a particularly interesting product or interesting market, our perspective is that the value here is in the customization. And the cost of delivering customization is the service that's required. And to deliver customized accounts and high levels of service at the kinds of fee rates we're talking about and account minimums we're talking about is hard. And we're making investments in technology to put us in a position to continue to be a leader in doing that. But I would say, broadly, the impact of fractional shares, while it will make it easier for us and other competitors potentially to go down market, the real name of the game here is customization. The primary value added for most investors, not all, but most, is tax efficiency, which is a concern primarily at higher tax rates. We do see the business evolving in significant ways. I highlighted the fact that we've introduced Custom Core indexed products on the fixed income side. We certainly see lots of opportunity for product innovation down the road in terms of enhancing the features that we offer, expanding the array of capabilities, so that it's not just index based, but it's index plus active. It's not just equity or not just fixed income, but a combination of both. And then, very interesting applications potentially down the road in terms of target date or target risk, all customized to the individual. So, we think there's lots of room here for lots of different ideas. The value added that we provide, again, is customization and service, primarily for higher net worth investors, primarily with the significant value add being tax. And some of the things that we're hearing about really just not relevant to that market and that market opportunity as we see it.

And then, maybe a follow-up. Just on your perspective on the active ETF industry, now that we've got a number of ETFs live in the industry, I know you filed an amendment for the clear hedge strategy with the SEC, maybe just to comment on, I guess, the status on that and how you think that maybe conversations with potential users of the clear hedge strategy. And then, broadly, the potential for you guys to license active ETFs or create them under a proxy portfolio structure for your own funds.

We remain very interested, very close to the space, as you point out. We did file a second amended application with the SEC for our clear hedge method of what we call portfolio protected ETFs. I'm going to call it less transparent of active ETFs. We filed that last month. You can read that as indicative of positive constructive dialogue with the SEC staff. We certainly can't predict when or ultimately what they will decide, but we certainly feel good about the dialogue that we're engaged in there and are hopeful we'll get a – ultimately get a positive result. The competitive landscape is really just beginning to emerge. I think there's five different concepts that have been approved by the SEC. We hope to be the sixth. Our business model here would include licensing our technology to others. We hope to compete on the basis of offering the highest level of assurance of strong secondary market trading, consistent with not having to disclose portfolio holdings or significant representative proxy portfolio on a daily basis. So, we think we've got a very competitive mousetrap. This market is starting to develop based on the assets and flow numbers that I've seen. And we certainly want to have a place in that. Like the other approved applications, our application, at least initially, is limited to cash and exchange-traded securities that trade during US market hours. So, think of that as US equities and US ETFs and Canadian and perhaps other markets that trade during the same timeframe as the US. So, it would be limited in that respect initially, which we think – frankly, quite reasonably, the SEC says, let's see what how this works for this asset class before we consider other asset classes. But we're very hopeful, very optimistic that, ultimately, this class of products and our application and our technology in particular will see application across all asset classes. And so, we continue to be very much optimistic about the future of actively managed exchange-traded products based on the potential enhancement in operating efficiency, trading convenience and tax efficiency versus ETFs. And so, while we have a long heritage in the mutual fund industry, we are very committed to the development of customized individual separate accounts as an enhanced way for investors to invest in an array of strategies. And then, similarly invested in less transparent ETFs or portfolio protected ETFs as a way to do similar things through a fund vehicle with structural advantages versus a traditional mutual fund concept.

And just for licensing your own funds, would you more likely use a proxy model that's out there already or, let's say, the [indiscernible] model and then apply the clear hedge to the proxy?

No, we would be using our model as an alternative to the – think of clear hedge as a sixth approach, not something that would be an add-on to one of the other approaches.

Our next question comes from the line of Mike Carrier with Bank of America.

Tom, overall, the flow outlook looks promising. I just wanted to get an update on how you're seeing demand shift in the floating rate category and then if there was anything unusual and strange in the fixed income this quarter. And then, just a small clarification as a follow-up, I think you mentioned one or two funds reopening. I caught one was Atlantic Capital, but I wasn't sure if there was another one that you mentioned as well.

The only fund we have that's reopening is the Atlanta Capital S-MID Cap Fund, which is an important milestone for us. It is our largest and, I guess, by that measure, most popular fund and it's got a real strong following. And because it's been closed, we've seen fairly significant net outflows. I think I said $420 million in the quarter. So, once that's reopened, I would hope, at a minimum, we can stop the net outflows and potentially get that fund back into a growth mode again. It's not an open ended opportunity. We're potentially looking at closing it again, if we get significant net inflows. But at a minimum, we're hoping to abate the outflows there. In terms of bank loans, it's an interesting position we're in currently. We are, I just said, modestly to the positive in terms of our bank loan flows for the month of August today through Monday of this week. But it's pretty small, positive, but closer to zero than some meaningful number. That does not include the CLO that I talked about as a big price this week. So, we're thinking that we've kind of bottomed out. We had a very rough quarter in the second quarter in terms of bank loan flows. Yields here are pretty attractive. And I just checked this morning. The yield on our unlevered floating rate fund is about 3.6%. The modestly levered version is at 4.4%. And the version that has allocation to high yield is at 3.8%. Those are pretty attractive yields for a floating rate product in today's marketplace. Obviously, you've got to be comfortable taking credit risk because that's a component of this asset class. These are below investment grade securities. But if people are generally getting comfortable that we've seen the worst…

Your next question comes from line of Robert Lee with KBW.

Hi. This is actually Jeff Drezner on for Rob Lee. Thanks for taking my question. I've got a question. I was curious about the – if you can give us an update on the potential acquisitions, you see things accelerating, where your focus might be on that?

We highlighted in my prepared remarks that we announced an acquisition of a $2 billion wealth manager in Florida called WaterOak Advisors. We announced it, I think, last month, and would hope to close that before the end of the year. You should take that as a signal that we continue to be interested in expanding in wealth management. We're approaching $10 billion in managed assets there, including WaterOak after that transaction is closed, which is a meaningful sized competitor in the wealth management space and think that we have a lot to offer there and we'll look for other ways to grow there. Other things that we find potentially interesting and where we continue to have conversations include private credit, which we view as a potentially highly complementary to our strong industry position and capabilities in the public credit markets through bank loans and high yield bonds. So, those are maybe two areas of focus. We continue to look for opportunities to grow our platform in responsible investing, particularly if we can do that outside the United States. Calvert is today primarily a US brand that, in an ideal world, we could grow our presence in responsible investing outside the United States. So, those are some of the things we're looking at.

And then, just another one on the muni ladder. In terms of the low rate environment, how do you see the demand for those and the outlook?

That is frankly a challenge that, for investment grade muni ladders, there's just not a whole lot of yield available at current interest rates. One of the things we've been looking to do and are in the process of potentially bringing to market is a separate account product that includes a sleeve allocated to high yield muni issuance or corporate issuance for corporate ladders. That brings up the yield and does it in a diversified – an appropriately diversified way. So, it would be owning as a part of a ladder or a separate account structure, a sleeve dedicated to a diversified portfolio of higher yielding assets with the goal to bring up the overall income level for the portfolio in a managed controlled risk way.

Our final question comes from the line of Glenn Schorr with Evercore.

Tom, I wanted to ask a little follow-up on your comments earlier, given tax managed importance to your overall AUM base. And I'm with you between the election and the huge stimulus that it's a good chance tax rates are going up at some point. So, the question is, what can you do to prepare either educating the clients, educating the wealth management channel? And is the post-election tax cut any indication in reverse of what we might see – how big of an opportunity do you see a higher tax rate environment across your platform?

We've gone through this a few times. We've had a focus on tax managed equities and muni bonds for several decades now. And so, we've seen multiple cycles of rates going up and rates going down. So, we have some historical perspective on how this might play out. There is certainly a lot of interest in the topic, and it's been a major focus of our communication efforts to talk about the importance of investment taxes. For a number of years, we used to do surveys of investors, asking about their thoughts on investment in taxes, and the results were always very consistent, which is that many investors appreciate the importance of taxes, but very few of them would say they understand what's involved. And increasingly, they look to their financial advisors as the source of information and guidance on tax efficient investing. And we think a great way for advisors to work with clients and add value, is providing information and solutions to help address concerns about taxes that they're going to be paying. So, we've done a lot of that over the years. If you go to our website and look at our marketing materials, we have a fair bit on there about taxes. We have a calculator which – you enter where you live and what your filing status is and what your taxable income is and you can calculate what your current tax rate is. We're looking at expanding that, so that you can do a pro forma tax rate based on assumptions about where tax rates go. But for us, it's a great way to get in front of advisors to help them educate their clients and demonstrate their expertise on something where clients know they need help on, know they need advice on. Exactly how that plays out for us in terms of what products that is or how our product lineup might change as a result of that, it's still way too early to determine what that might look like. But, certainly, superficially, municipal bonds becoming more attractive at higher interest rates, Parametric custom portfolios, tax managed investing generally becomes more attractive at higher rates. And that's very much a focus of our sales and marketing teams going into the election is to try and help position advisors to provide good advice for their clients in that environment.

This concludes our question-and-answer session. I will now turn the call back over to Eric Senay for closing remarks.

Thank you. I've got to thank you for participating in our earning call today. And we hope everyone will stay safe and healthy. Thank you and have a good day.

This concludes today's conference call. Thank you for your participation. You may now disconnect.