Westwood Holdings Group, Inc. (WHG) Q3 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Westwood Holdings Group’s Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] As a reminder, today's program may be recorded. And now, I'd like to introduce your host for today's program Julie Gerron, General Counsel and Chief Compliance Officer. Please go ahead.

Thank you and good afternoon. Welcome to our third quarter earnings conference call. The following discussion will include forward-looking statements, which are subject to known and unknown risks, uncertainties and other factors, which may cause actual results to be materially different from those contemplated by the forward-looking statements. Additional information concerning the factors that could cause such a difference is included in our press release issued earlier today as well as in our Form 10-Q for the quarter ended September 30, 2020 filed with the Securities and Exchange Commission. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. You are cautioned not to place undue reliance on forward-looking statements. In addition, in accordance with SEC rules concerning non-GAAP financial measures, the reconciliation of our economic earnings and economic earnings per share to the most comparable GAAP measures is included at the end of our press release issued earlier today. On the call today we have Brian Casey, our President and Chief Executive Officer; and Terry Forbes, our Chief Financial Officer. I will now turn the call over to Brian Casey.

Good afternoon. Thank you for taking the time to listen to our quarterly earnings call today. I hope you all are healthy and persevering in these challenging times. As we announced last quarter, we have now ceased operations of Westwood International Advisors in Toronto, and almost all of its remaining cash, over $37 million, has been repatriated to the United States, adding to our financial flexibility. We also wrote off some historical goodwill. The accounting effects of our actions were primarily noncash and nonrecurring. While the investment performance produced by Westwood International Advisors proved disappointing, it ultimately led to its demise. The financial impact of owning WIA for Westwood shareholders was positive for most of its eight years of operation. We still believe that emerging market equities is an asset class with high-potential for alpha generation, lower pressure from passive indexing and attractive fees. Institutional and retail investors are attracted to its growth profile and accordingly, search activity is robust. Westwood has the operational expertise to manage emerging markets equities with a new team, and we continue to research available opportunities. Despite September's market drop, equity markets climbed again, even as we head into the final stages of the presidential election. The divergence in performance between the indices remains wide. Mega caps are dominating the LargeCaps, which are outperforming SmallCaps and growth is outperforming value across all market caps. While the SmallCap space remained challenged and is down for the year, the larger cap dominated S&P 500 is in positive territory year-to-date after posting its best quarter since 2010. For sure, the path forward is uncertain, and volatility has begun to pick up in tandem with the election rhetoric we're hearing from both sides of the aisle. Incidences of COVID are proving equally volatile, with some parts of the country experiencing declines, while others are seeing spikes. Overall, recovery and reopening efforts continue to progress and along with them, earnings estimates are rising from their troughs. Our U.S. equity value products once again turned in a mix performance. Our SmidCap strategy kept pace with the markets move higher, while our LargeCap and LargeCap Select products were more challenged by the rotation as lower quality stocks rallied along with growth during the third quarter. These stiff headwinds caused some weaker relative performance, but our year-to-date performance remains strong, thanks to our downside risk focus, which helped shelter our clients from the full brunt of the March sell off. Despite falling behind in an up quarter, LargeCap Value remains ahead of the benchmark Russell 1000 Value index on a year-to-date basis and over most trailing year periods. Amongst its eVestment database institutional peers, LargeCap Value remains in the top quartile for the trailing three and seven-year time periods. LargeCap Select fell behind in the quarter but is ahead year-to-date and overall trailing time period since inception in 2014. LargeCap Select commands a top quartile ranking in the eVestment LargeCap Value Manager universe over the trailing three-year time period and boasts a top decile ranking since inception in 2014. Our SmidCap strategy strongly outperformed the Russell 2500 Value index, and our portfolio managers continue to build a terrific record with solid stock selection. SmidCap is one of our best-performing strategies year-to-date and over 500 basis points ahead of the index, which puts it in the 29th percentile among small and mid-cap value managers in the eVestment database and in the 23rd percentile over trailing three years. Our SmallCap strategy underperformed the Russell 2000 Value index by less than 100 basis points as non-earning, low-quality securities rallied, but it remains ahead year-to-date and over multiple trailing time periods. Among its institutional peers, SmallCap is in the top half year-to-date and ranks in the top quartile over trailing five years and top decile over the last 10 years. The curious headwind of companies rallying despite being nonearning may begin to fade as levels of financial stress have risen and as the economic stimulus measures introduced earlier this year begin to phase out. This scenario is likely to create additional headwinds for these companies. And once again, the market should recognize the higher quality nature of our portfolio. Let's turn now to our multi-asset group, which manages an array of strategies across the risk and return spectrum. Our suite of multi-asset products remains uniquely positioned to benefit from the crosscurrents affecting asset classes while taking advantage of market inefficiencies by finding mispriced securities. With heightened volatility, not just for equities, but within credit asset classes too, having more targeted ownership of securities within a multi-asset vehicle can help clients preserve their return potential while lowering volatility and limiting exposure to key macro risks. We're convinced that dispersion returns as asset classes, industries, and companies react to unfolding economic, social, and political developments will provide ample investment opportunities for our skilled investment teams in the period ahead. Our largest multi-asset strategy, income opportunity outperformed its benchmark by 61 basis point of 40% S&P 500, 60% Bloomberg Barclays aggregate index this quarter. Our process is based on asset allocation and stock selection using fundamental analysis to achieve the twin objectives of attractive returns and lower volatility. Absolute performance was strong for our income opportunity mutual fund, ticker symbol WHGIX, which finished the quarter in the 21st percentile in Morningstar's 30% to 50% equity category and in the top half year-to-date. Longer term, income opportunities Morningstar rankings are also strong, and the top 20% over trailing 3, 5 and 10-year time periods, and it places it in the top 30% amongst its institutional peers year-to-date. Our other multi-asset products similarly added to their solid track records with strong absolute and relative results. Liquidity in the convertibles market has improved over the last couple of quarters, and returns have improved substantially from their lows last March. In this environment, our global convertibles and alternative income strategies have performed exceptionally well. Our mutual fund, WMNIX, finished the quarter in the 25th percentile year-to-date in the Morningstar market neutral group. It's top quartile for the trailing one-year period and 27th percentile for the trailing five-year period. Total return outperformed its benchmark, 60% S&P 500, 40% Bloomberg Barclays government corporate aggregate index by nearly 200 basis points this quarter. High income also outperformed its benchmark, 20% S&P 500, 80% Bloomberg Barclays government corporate aggregate index by over 300 basis points. Our newest strategy, credit opportunities, is posting strong returns as the team identifies mispricings in various asset classes and leverages Westwood's strong fundamental research. A washout event may well occur as some businesses fail to weather the consumer storm, and this often leads to periods of dislocation and illiquidity, which our investment team can profitably mine to discover mispriced quality candidates to add to the fund's portfolio. Shifting to wealth management. Our teams in Dallas and Houston continue to actively engage with clients to assist them through the market's uncertainties. I'm constantly impressed by the ability of our distribution team to conduct virtual and physical meetings, despite the constraints of COVID. Our new colleagues are integrating well, and last quarter's launch of our online portal has expanded beyond the initial beta test group with a new release planned for rollout over the next several weeks. A stronger online portal will allow us to enhance our digital client engagements even more by supplementing our traditional hands-on advice and support. Despite current uncertainties, our clients trust us to remain focused on a goals-based approach to achieve their long-term goals. Deploying an increasingly holistic approach to interacting with our clients, assets have remained sticky and client retention is stable. This past quarter, our teams brought in new business of about $88 million, offset by client withdrawals to make delayed tax payments. We also experienced some outflows from closed strategies and pension distributions. Client referrals are on the rise, and we've seen a definite uptick since Labor Day, with a particular focus from folks wanting estate-planning advice. Client conversations like these typically take several months to result in fund conversion, and we're looking forward to new business inflows later this year and into early 2021. Our select equity strategies with over $700 million in assets posted strong returns for the quarter. The select equity strategy posted an absolute return of nearly 9%. Downside capture at below 80%, measured on a daily returns basis for both strategies was strong and the additional alpha gain from tax loss harvesting helped the tax sensitive version outperform the Russell 3000 index on a year-to-date basis. The new strategies we created for our high net worth clients to exploit market dislocations, dividend select, and high alpha, have each performed very well in picking up assets. There have certainly been challenges to meeting clients and prospects in this environment, but we continue to find new and better ways to connect. We recently held an online event to discuss the upcoming election with more than 150 participants, and we are pushing that recording via YouTube to over 2,300 clients, prospects, and third-party advisers. We're excited about the future of our wealth business and the prospects for growth in the years ahead. In institutional and intermediary sales, we had inflows of approximately $326 million and about $847 million in outflows, which are mostly the result of closing our emerging markets and MLP strategies, along with client rebalancing in global converts and LargeCap. SmallCap was our most successful strategy for the quarter and year-to-date. LargeCap, while negative for the quarter, has positive inflows from selected clients and income opportunities stabilized with net outflows below $5 million for the quarter. Income opportunity flows appear to have stabilized and are gaining momentum across the RIA channel. Intermediary sales improved after suffering industry-wide from the pandemic, and sales for the third quarter rose versus the second quarter and are now running ahead of 2019 and pre-pandemic levels. We're pleased to see our mutual funds moved into net positive territory with strength coming from our SmallCap and income opportunity strategies. We discussed a key new platform approval for SmallCap on last quarter's call and details have now been finalized, and we are on track to launch as a focused manager with the platform advisers next month. As we look forward, we believe that continued strong performance in our U.S. value and multi-asset strategies should lead to an increase in consultant searches and additional wins in the mutual fund and model delivery space. Our pipeline is growing with attractive opportunities in our SmallCaps, SmidCap, and income opportunity strategies. Our investment teams have remained disciplined in their process and execution, which has allowed our distribution teams to focus their talents on presenting our strategies to the marketplace. We are focused on managing the expense side of our business, and we're pleased to report that our first full quarter of outsourced trading was very successful. Our clients are getting better execution and more competitive transaction costs, while our portfolio managers have access to a bigger trading desk to obtain market data and more frequent updates. We have initiated many internal efficiencies in our front and middle office areas, which are expected to generate over $1 million a year in reduced expenses. Well before the pandemic upended the status quo, the asset management industry was undergoing significant disruptions, and its impact is exerting even more pressure on companies to evolve to meet the challenge. These extraordinary circumstances have tested organizations, and ours is no exception, and they will result in a lasting change. We truly believe that the steps we started taking well before the pandemic have placed us in a strong position, not just to survive, but to thrive and grow. Success in the asset management industry requires a well thought out plan, followed by focused execution in four key areas. Number one, alpha generation is critical to all buyers, institutional and retail. Westwood value strategies have delivered excess return in every one of our strategies over multiple time periods. Our multi-asset strategies have developed the outcomes our clients want and our flagship fund, Income Opportunity, has recently been upgraded to Morningstar's highest category of 5 stars. Number two, distribution is a team sport. Gone are the days of salespeople randomly knocking on doors and sending newsletters to stale contact lists. Sales alpha is delivered via a combination of excellence in brand awareness, thought leadership, digital engagement, and product management delivered by experienced sales professionals using technology to optimize productivity. We now have the largest and most experienced distribution team in our history. Number three, wealth management has evolved from simply being about products to comprehensive solutions. For decades, all that was required was a competitive financial product, a client meeting once or twice a year and a paper statement in the mail at the end of the month. While many firms still operate this way, winners are pivoting to a solutions-based model delivered digitally. Westwood has been working for several years to build a broader platform of solutions. We have grown our financial planning resources, added depth and estate planning, built tax sensitive investment strategies, and added private equity and private banking to our array of solutions. These services are quickly moving to table stakes for wealth management. And in our view, firms that haven't made the shift will not survive. Number four, financial technology will accelerate growth for firms that embrace its transformative powers. We are using technology to improve our efficiency and screening investment ideas, building company models, and populating our sales team with data to help them better target potential buyers. We are rolling out our enhanced digital portal to wealth clients, and we're building additional platforms with InvestCloud that will be announced in the coming months. Industry disruptions have been building for some time, and the added shock of the pandemic presents a perfect storm of challenges. Fortunately, Westwood has been making major investments in technology to reduce costs, gain efficiencies, and prepare for industry disruptions. We have been careful to nurture a strong balance sheet, which allows us the flexibility to pursue an array of future growth initiatives. Frankly, the disruptions confronting our industry will present rewarding opportunities for firms like ours that have kept their powder dry. In the months and years ahead, we're planning to capitalize on the infrastructure we've been building to support a much larger business. We remain committed to supporting our employees and clients as they navigate the challenges presented by the spread of the virus. Our team members continue to make extraordinary efforts each and every day, and I'm very grateful for all they do on behalf of our clients. I'll now turn the call over to Terry Forbes, our CFO.

Thank you, Brian, and good afternoon, everyone. Today, we reported total revenues of $15.5 million for the third quarter of 2020 compared to $15.9 million in the second quarter of 2020 and $19.9 million in the third quarter of the prior year. Revenues were somewhat lower than the second quarter due to closing emerging markets strategies, which slightly reduced our average fee rate. Revenues were lower than last year's third quarter, principally as a result of lower average assets under management. The third quarter net loss of $10.3 million or $1.31 per share exceeded the net loss of $2.6 million or $0.33 per share in the second quarter. The loss primarily related to several onetime items, including a $4.2 million noncash reclassification of foreign currency translation adjustments from accumulated other comprehensive loss to net loss with no impact on stockholders' equity, following the closure of Westwood International Advisors, as well as $1.1 million in incremental Canadian withholding taxes net of federal tax deduction, paid to repatriate more than $37 million from Westwood International Advisors to the U.S., as well as a $3.4 million noncash write-off of historical advisory goodwill to reflect lower market capitalization and advisory net outflows. These onetime items were partially offset by lower operating expenses and lower foreign currency transaction losses. Non-GAAP economic loss was $1.7 million or $0.22 per share in the current quarter versus economic earnings of $0.2 million or $0.03 per share in the second quarter. Third quarter net loss of $10.3 million or $1.31 per share compared unfavorably to net income of $1.1 million or $0.13 per share in the prior year's third quarter, primarily due to the onetime items previously noted, partially offset by lower operating expenses, particularly employee compensation and benefits. Economic loss for the quarter was $1.7 million or $0.22 per share compared with economic earnings of $3.9 million or $0.46 per share in the third quarter of 2019. Firm-wide assets under management totaled $12 billion at quarter-end and consisted of institutional assets of $6 billion or 51% of the total, wealth management assets of $4.1 billion or 34% of the total, and mutual fund assets of $1.8 billion or 15% of the total. Over the year, we experienced market depreciation of $0.9 billion and net outflows of $2.4 billion. Our financial position continues to be very solid with cash and short-term investments at quarter-end totaling $77.6 million and a debt-free balance sheet. That brings our prepared comments to a close. We encourage you to review our investor presentation we have posted on our website reflecting third quarter highlights as well as a discussion of our business, product development, and longer term trends in revenues and earnings. We thank you for your interest in our Company. And we'll open the line to questions.

[Operator Instructions] And we have a question from Mac Sykes from Gabelli. Your question, please?

Brian, I saw in your comments, you talked about finals for several large mandates, so obviously, showing some continued good business momentum there. Maybe you could just put some more color around those opportunities. What's driving them in terms of strategies that are in demand? And perhaps, where are you seeing the opportunities? Is that institutional, RIAs consult driven? Just a little more color on what you are seeing in terms of distribution.

Sure. Well, thanks for your question, Mac. As I've talked about for the last several quarters, we have worked really hard to build a robust distribution team and the work that they've been doing is starting to really pay off, both in terms of institutional consultant approvals that are happening at two of the largest consulting firms in the world, where we are buy rated in a couple of strategies. We complemented that with a couple of initiatives that we have done. One was reviewing all of our products to make sure that our fees were positioned in a way that they were attractive, and so that anybody doing a search, looking for our products will find our -- not only our performance to be attractive, but our fees to be attractive. In addition, we have added share classes to some of our funds that are designed for smaller to medium-sized institutional customers. So, we have a share class that has essentially no other fees that is for $10 million or above, and then we have another share class that is designed for defined contribution plans. As I noted in my comments, the intermediary distribution team was really gaining a lot of momentum through the first quarter. And then, COVID hit and all of the wire houses shut their offices, and it was difficult for our guys to make contact and to get into see people. And they have worked really hard to be creative about how to make new touch points with folks and do meetings outside the office. And some of that momentum has begun to pick up. September was particularly promising. And we have a number of searches on the horizon that we're excited about. And one of the things that is really appealing to us is the income opportunity fund where we lost a lot of clients a year and half, two years ago. A number of those clients put money with other managers that have underperformed, and some of those are starting to come back. The performance has been exceptional. As I noted, income opportunity is now a 5-star fund and we think going to be very attractive in this type of environment, where we have lots of volatility. This is a fund that's designed to produce some income, a nice total return with low volatility.

Okay. And then, your balance sheet continues to be a source of strength. Maybe you could just update us on how you think about using that in the next year around repurchases or potential nonorganic M&A? I think, you've talked about in the past potentially looking at wealth managers.

Yes. Well, thanks for your question there. I can't even begin to understand how our stock is trading where it is today when we have $77.6 million in short-term investments and $11.5 million, in long-term investments, which includes our investment in InvestCloud and our investment in a bank, Westwood private bank, which are both doing exceptionally well and growing, and our stock is actually trading below those levels today. As I indicated in my comments, the asset management industry has been under significant pressure. And so, we are seeing more opportunities than we've ever seen in our entire history as a public company, both proactively looking for opportunities, but also having opportunities presented to us. So, we want to make a really good decision with our capital, and we think there's an opportunity to buy a firm if it makes sense to do so and it's the right thing to do. But we talk about it every quarter at our directors meeting. We talked about it today. And one of the things that you see when you have markets like today and the last couple of days, is you're really glad that you've been conservative over the years that you have a fortress-like balance sheet and no debt. The other thing I would mention too from investors that I've noticed recently is that there is a lot of cash on the sidelines. There is a lot of cash in banks. Some of our clients are starting to tiptoe back in during this pullback. In fact, just before I got on this call, one of our clients indicated they're going to send another $100 million on Monday to add to their account, and we have some of our wealth customers who are also taking advantage of this pullback to add to the market. With all told, to answer the top of your question, some of the opportunities we're seeing, there's roughly $300 million to $350 million of accounts that we've won that have not yet funded that will fund between now and the end of the year or into the first quarter.

Our next question comes from the line of Daphne Armstrong from UNC.

Hello. My question is, how has the recent influx of retail investors due to COVID-19 affected your Company and the asset management industry as a whole?

Okay. The recent influx of retail investors, for us, when we think about retail investors, we're typically trying to reach retail investors through advisors. And we spend about half of our time calling on advisors who would have the retail customers, and then, the other half of our time are spent calling on the wire houses where we're trying to get our products approved. So, as far as -- if you were to think about private wealth as retail, I guess, you could think of it that way, but that tends to be higher average assets under management.

Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Brian Casey for any further remarks.

Well, thanks, and we appreciate you listening to our call today. If you have any further questions, please feel free to call. If you'd like to set up a shareholder call, we'd be happy to do that. Terry and I can make ourselves available and address your questions. So, have a great day. Stay safe. Stay healthy.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.