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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, thank you for standing by. Welcome to the Cohen & Steers fourth quarter and full year 2018 earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question and answer session. At that time, if you have a question please press the one followed by the four on your telephone. If at any time during the conference you need to reach an operator, please press star, zero. As a reminder, this conference is being recorded Thursday, January 24, 2019.
I would now like to turn the conference over to Brian Heller, Senior Vice President and Corporate Counsel of Cohen & Steers. Please go ahead.
Thank you and welcome to the Cohen & Steers fourth quarter and full year 2018 earnings conference call. Joining me are our Chief Executive Officer, Bob Steers; our President, Joe Harvey; and our Chief Financial Officer, Matt Stadler.
I want to remind you that some of our comments and answers to your questions may include forward-looking statements. We believe these statements are reasonable based on information currently available to us, but actual outcomes could differ materially due to a number of factors, including those described in our most recent annual report on Form 10-K and other SEC filings. We assume no duty to update any forward-looking statement.
Also our presentation contains non-GAAP financial measures that we believe are meaningful in evaluating our performance. These non-GAAP financial measures should be read in conjunction with our GAAP results. A reconciliation of these non-GAAP financial measures is included in the earnings release and presentation. The earnings release and presentation as well as links to our SEC filings are available in the Investor Relations section of our website at www.cohenandsteers.com.
With that, I’ll turn the call over to Matt.
Thank you, Brian. Good morning everyone and thanks for joining us. My remarks this morning will focus on our as-adjusted results. A reconciliation of GAAP to as-adjusted results can be found on Pages 19 and 20 of the earnings release or on Slide 16 and 17 of the earnings presentation.
Yesterday we reported earnings of $0.56 per share compared with $0.55 in the prior year’s quarter and $0.64 sequentially. Revenue was $93.6 million for the quarter compared with $99.3 million in the prior year’s quarter and $98.2 million sequentially. The decrease in revenue from the third quarter was primarily attributable to lower average assets under management. Average assets under management were $57.6 billion compared with $62 billion in the prior year’s quarter and $60.4 billion sequentially.
Operating income was $34.5 million in the quarter compared with $41.2 million in the prior year’s quarter and $39.4 million sequentially. Our operating margin decreased to 36.8% from 40.2% last quarter primarily due to higher compensation and benefits in G&A when compared to revenue.
Expenses increased less than 1% on a sequential basis primarily due to higher compensation and benefits in G&A, partially offset by lower distribution and service fees. The compensation to revenue ratio for the fourth quarter was 36.85%, which is higher than the guidance we previously provided of 33.75%. The increase in the ratio was primarily due to lower than forecasted revenue combined with accrued severance costs. For the year, the compensation to revenue ratio was 34.51%. The increase in G&A was primarily due to higher professional fees, travel and entertainment expenses, and sponsored and hosted conferences.
We did not incur previously anticipated revenue sharing and sub-TA fees on retirement accounts at one of our intermediaries. The decrease in distribution and service fee expense was primarily due to the reversal of these accrued fees during the fourth quarter as well as decreased expenses associated with lower average assets under management in U.S. open-end funds.
Our effective tax rate for the quarter was 25.25%, consistent with our prior guidance.
Page 15 of the earnings presentation displays our cash, corporate investments in U.S. treasuries, and seed investments for the current and trailing four quarters. Our firm liquidity totaled $213 million compared with $291 million last quarter, and stockholders equity was $223 million compared with $324 million at September 30. The amount of firm liquidity and stockholders equity as of December 31 reflects the payment of a special cash dividend in December of approximately $117 million, or $2.50 per share. Over the past nine years, we have paid $11 per share in special dividends. We remain debt-free.
Assets under management totaled $54.8 billion at December 31, a decrease of $5.3 billion or 9% from September 30. The decrease was driven by market depreciation of $3.2 billion, net outflows of $1.2 billion, and distributions of $842 million. Sub-advised portfolios in Japan had net outflows of $304 million in the quarter compared with $314 million in the third quarter. Outflows decelerated in the fourth quarter when compared to August and September, the two months immediately following the last distribution rate cut. Total distributions on these portfolios totaled $363 million compared with $433 million last quarter.
Sub-advised accounts excluding Japan had net outflows of $185 million primarily from client rebalancing out of global real estate, U.S. real estate, and global listed infrastructure portfolios. Advised accounts had net inflows of $300 million during the quarter primarily from inflows into preferred and global real estate portfolios, partially offset by outflows from international real estate portfolios due to client rebalancing. Bob Steers will provide an update on our institutional pipeline and new business activity.
Open-end funds had net outflows of $1 billion during the quarter as the market decline triggered tax loss selling and retail investor redemptions. Distributions, which included the payment of year-end capital gains totaled $351 million, $251 million of which were reinvested.
Looking ahead, although we remain confident in our pipeline positioning and opportunities, we recognize we are in a challenging revenue environment resulting from lower assets under management going into 2019. I will briefly discuss some of the steps we are taking to manage our expense base.
We believe that our current headcount, which includes a number of strategic hires made over the past few years, provides us with meaningful operating leverage, so we are taking a deliberate and measured approach to new and replacement hires. Although we believe this approach will control headcount growth, lower assets under management resulting from the fourth quarter market decline combined with the full-year impact of 2018 new hires will result in an expected compensation to revenue ratio of approximately 35.75% in 2019.
We are actively reviewing all controllable expenses and are committed to reducing our non-client related costs. We are focused on inter-office travel, application licenses, market data services and professional fees, among other items. We believe these efforts will allow us to hold the line on overall costs, if not reduce them. As a result, we project G&A for 2019 will be in line with the $46 million we recorded in 2018 but with a downward bias. Finally, we expect that our effective tax rate will remain at 25.25% in 2019.
Now I’d like to turn the call over to our President, Joe Harvey, who will provide commentary on our investment performance.
Thank you Matt, and good morning everyone. I’m going to discuss our investment performance and then summarize our 2019 priorities for the investment department.
In the fourth quarter our asset classes, with the exception of midstream energy and resource equities, defended much better than the S&P 500, which lost 13.5%. The draw-downs in U.S. and global REITs were half or less of the S&P 500’s decline while global infrastructure experienced even greater resistance, with a decline of just 19% of the S&P 500’s drop. Preferreds returned negative 3.7%, which reflected widening credit spreads which more than offset the decline in treasury yields.
Looking at our relative investment performance, in the quarter six of our 10 core strategies outperformed their benchmarks, and for the full year nine out of 10 core strategies outperformed. Keep in mind that beyond our core strategies, we typically have several versions of portfolios across the spectrum of risk and return as well as portfolios that represent more targeted subsets of the core strategy. For example, within preferreds which is counted as a single core strategy, we have seven composite track records managed by our preferred and fixed income group, including low duration preferreds, REIT preferreds, and contingent capital securities.
Measured by AUM, 93% of our portfolios are outperforming on a one-year basis, 97% are outperforming over three years, and 98% are outperforming over five years. Eight-three percent of our AUM are in open-end funds that are rated four or five star by Morningstar.
Market activity in the fourth quarter indicates that we are late cycle and is likely a harbinger of the next phase in the markets. Over a year ago, we believed the biggest investment risk would be the transition from quantitative easing to quantitative tightening. In late 2018, the market clearly became focused on the potential for a policy mistake by the Fed. Our view is that economic growth and corporate profits have likely peaked, which together with the transition from quantitative easing to quantitative tightening could result in a stretch of higher market volatility and lower negative returns.
Historically in late stages of the economic cycle, real assets have performed well relative to stocks. Looking at late cycle periods going back to 1973, commodities, infrastructure, resource equities and REITs, in that order, have outperformed U.S. stocks by meaningful margins. Looking at the current environment, as growth and return expectations decline, the income provided by our REIT and infrastructure strategies represents a larger proportion of return potential, and together with the relative earnings stability becomes more attractive factors for investors. In addition, we believe these strategies have less risk of multiple compression as growth slows and quantitative tightening takes hold.
Turning to the performance of our asset classes, we outperformed our benchmarks in all of our REIT strategies for both the fourth quarter and the full year 2018. This includes standalone regional strategies in the U.S., Asia and Europe, as well as our global and international portfolios. Real estate was the second-best performing GIC sector in the S&P in the quarter, lifting real estate’s rank for 2018 to five out of 11 sectors after lagging the market significantly in early 2018. In infrastructure, we underperformed in the quarter in part due to our overweight in midstream energy, and outperformed by 160 basis points for the year. The asset class defended well versus stocks in part due to the utilities component of the strategy.
Adding analysts to our infrastructure and midstream teams was a priority in 2018 and we are pleased with the caliber of new additions and our overall team size at this point. We are well positioned to compete for what continues to be an active market for institutional searches in infrastructure.
Midstream energy, which was down 17% in the quarter, was driven by falling oil prices and rising credit spreads. Tax loss selling was a factor driving many markets lower late in ’18, and it hit the midstream sector disproportionately. We were surprised that midstream did not defend better because it had already undergone a fundamental down cycle and now has accelerating fundamentals, attractive valuations, and yield support. We underperformed in the quarter but overall had a strong year with 310 basis points of outperformance. Midstream shares have had a nice bounce so far in 2019, providing some reassurance in our fundamental view.
Resource equities declined 17% on slowing economic expectations, trade wars, and oil price declines. We outperformed in the quarter and by 140 basis points for the year. Our real assets allocation team believes resource equities are statistically cheap.
Our multi-strategy real assets portfolio was down 7% for the quarter, showing its diversification potential versus stocks and reflecting strong relative performance of the defensive sectors of real estate, infrastructure and high-grade credit. We underperformed slightly against our benchmark in the quarter but were in line for 2019.
In preferreds, we outperformed for the full year albeit by a smaller margin than usual. Looking at our full range of strategies in preferreds and in fixed income, we outperformed in six out of seven strategies for both the quarter and year. Considering that treasury yields may have peaked and that credit spreads have widened to more normal and supportive levels, our team is more confident that our core preferred strategy will deliver at least its current yield of 6% this year, if not a bit more, in total return.
In 2018, our best performing strategy was European real estate, which outperformed by 770 basis points. Our European real estate open-end uses fund is rated five stars. Our worst performing strategy was commodities, which underperformed by 260 basis points. As we have discussed on prior calls, our protocol when we underperform is to active performance remediation and improvement plans. In the case of commodities, we have responded by integrating quantitative techniques into our fundamental process, and the initial results are promising.
I’ll conclude my discussion today with an overview of our investment department priorities. Across all teams, we continue to manage and prepare for the late stage environment, and as a result have more balance in our portfolios. I believe it is critical for active managers to outperform in the next down cycle lest the industry lose more market share to index strategies. While our outperformance statistics are strong, we always have strategies that can do better, and as mentioned, commodities are a focus. Another goal is to deliver greater alpha from asset allocation considering that we are seeing more demand for multi-strategy portfolios. Our three-year-old alpha mining project provides the foundation for performance enhancement, and this year as a component of alpha mining, we will dedicate resources in conjunction with our IT department in quantitative techniques and data sources to complement our fundamental processes.
In terms of innovation, we are excited by the opportunity to develop strategies for the endowment, family office, and RIA markets. These investors require strategies that are unique by virtue of having higher concentration, being more targeted, or having unique income or volatility profiles. Examples include our concentrated portfolios in real estate and midstream energy, small cap infrastructure, hedged real estate, and an opportunistic real estate strategy. We have seeded five track record accounts in these areas over the past year and are developing LP and other structures as we engage with prospective investors. Allocating firm resources to those areas where active management is in demand and appreciated will provide growth for our firm, as well as career paths and creative outlets for our investment professionals.
Finally, we will continue to optimize our use of external resources and manage towards lowering these costs. We have made meaningful progress on this front over the past two years, spurred by MiFID regulations and market practices in Europe, and we will transition to the last phase of this initiative as the SEC evaluates commission versus hard dollar arrangements in the United States.
In summary, our investment department is well positioned for 2019. I will now turn the call over to Bob Steers.
Thank you Joe, and good morning everyone. As we all know by now, last quarter and especially December saw capital markets and asset flows that were volatile, complex and influenced by tax considerations. These conditions induced investors across the spectrum to initiate risk reduction, tax loss and rebalancing strategies, with the end result being high levels of money in motion. This market reaction also compressed and illuminated both the cyclical and secular challenges facing the active management industry. Although we were not immune from these market conditions, we remain well positioned and confident that market conditions notwithstanding, we will generate positive organic growth this year.
As reported, we experienced net outflows of $1.2 billion in the quarter, the overwhelming majority of which was derived from our open-end funds. It’s our belief that the retail outflows were predominantly a year-end phenomenon which will be at least partially reversed in the first quarter. Consistent with the trends in recent quarters, the institutional advisory segment enjoyed robust investor demand and continued positive net flows, but our sub-advisory flows in the aggregate remained challenged in the quarter.
Specifically with respect to the wealth channel, tax law selling and concerns regarding the widening of yield spreads had a major impact on our preferred securities open-end fund flows in the quarter. In total, our open-end funds had $1 billion of net outflows with the two preferred securities funds accounting for virtually all of that amount. Flows into our real estate and infrastructure funds were essentially flat; however, our industry-leading midstream energy fund bucked the sector trends and delivered $42 million of net inflows.
Our optimism regarding the wealth channel’s return to positive flows this quarter and year is grounded in a number of relevant fundamental factors. First, we expect a not insignificant portion of the tax loss-motivated redemptions out of our preferred securities funds to return. Secondly, consistent alpha generation across the range of our real asset and alternative income strategies has resulted in seven of our funds being added to 23 recommended lists across 11 distribution partners during 2018, and importantly that positive trend has continued into this year. Third, given the recent market and economic backdrop, defensive dividend paying equity strategies have been upgraded and recommended by some of our biggest distribution partners. Although it’s early, flows thus far this month are validating these expectations.
Similar to the wealth channel, advisory flows were also elevated in the quarter but ended with $300 million of net inflows. As you may recall, we began the fourth quarter with a $1.175 billion pipeline of awarded but unfunded mandates. During the quarter, $255 million of that pipeline backlog was funded. In addition to that amount, $545 million of new mandates, mainly in global real estate and multi-strat real assets, were both awarded and funded in the quarter for an aggregate realized funding of $800 million. In total, we won $785 million of new mandates, leaving the end of quarter unfunded pipeline at approximately $1 billion. Beyond the existing pipeline, we are awaiting the outcome of a record $2.5 billion-plus of undecided final.
Current client net outflows totaled $495 million, of which $133 million were terminations with the remainder attributable to rebalancing or withdrawals for other purposes.
Anecdotally, institutional investors who have historically invested in real assets privately are now inquiring and/or allocating to listed strategies. It appears to us that the private market expected IRRs have declined sufficiently to make listed a more competitive risk-adjusted investment option. In addition, concerns regarding heightened volatility and slowing global growth rates are motivating institutional investors to favor more liquid alternative investments. In any event, search activities remain elevated globally.
There were several significant developments in the sub-advisory ex-Japan channel in addition to the net outflows of $185 million which reflect an evolution in that market and in our assessment and approach to this distribution channel. Fee pressures in combination with an absence of control over sales or marketing strategies makes certain relationships that are not strategic in nature less attractive relative to our proprietary business development opportunities.
In Europe, as you know, we are actively growing our own fund and distribution capabilities aimed at the wealth channel, which has created a conflict over exclusivity with a current global real estate sub-advisory client. Given the choice between delegating our EMEA wealth business to a third party or further developing our own, we have elected to decline to grant exclusivity and to agree to terminate this relationship. Total AUM managed for this client is approximately $800 million, and we anticipate the transition to occur later this year. It’s our hope and expectation that in due course, we will generate sufficient sales in our own funds to replace these assets with competitive fees and greater control of our brand. Separately, as expected, the balance of our $425 million large cap value sub-advisory mandate has been terminated, which constitutes the remainder of our large cap value sub-advisory AUM.
Partially offsetting these future outflows is an expected $320 million inflow into global real estate from a long-term and strategic sub-advisory client, which is also included in our pipeline.
Japanese sub-advisory net outflows showed improvement both before and after distributions versus the third quarter, but remained elevated at $304 million and $667 million respectively.
With REITs recently generating strong absolute and relative returns, and with last year’s top selling funds mainly technology focused now out of favor, there appears to be an opportunity to regain investor interest. This year is off to a good start with positive net inflows into our U.S. REIT funds thus far in January.
In contrast the well documented headwinds facing long-only managers, which were highly visible last quarter, we are as optimistic as ever for this coming year. From a tactical standpoint, our real asset and alternative income track records are strong across the board. Retail allocations to these strategies are rising and we are on more recommended and focus lists than ever before. Institutionally hereto, our performance solidifies a leadership position in our liquid alternative strategies at a point in the economic and capital markets cycles when allocations to our space are rising and listed appears to be as or more attractive than the private market alternatives.
Strategically, we continue to shift and migrate product and personnel towards markets that understand and appreciate our value proposition. Over the last three years, institutional advisory assets under management have grown from $7.6 billion to $12.1 billion, while sub-advisory assets have declined from $18.5 billion to $12.5 billion, inclusive of today’s disclosures. Within the wealth channel, assets under management derived from the rapidly growing independent RIA channel now stand at $7 billion and growing, which now exceeds our broker-dealer assets under management of $6 billion. Not coincidentally, our average fee rate during this three-year period has risen from 54.2 to 57.9 basis points.
To support and accelerate these trends, this year we will be offering, as Joe mentioned, a new series of focused and thematic strategies that will be unique and targeted at the endowment, foundation, OCIO, RIA, single and multi-family office markets. We are confident that we can grow assets in those markets that value performance and diversification along with competitive fees. This initiative in conjunction with our existing business development activity will enhance our ability to generate positive and profitable organic growth for the foreseeable future.
With that, I’ll hand the call back to the operator and open the floor to questions.
[Operator instructions]
Our first question comes from Ari Ghosh of Credit Suisse. Please go ahead.
Hey, good morning everyone. Matt, maybe you can take the first one. Just on the 2019 comp ratio of 35.75 that you mentioned, is that projection based on 4Q AUM levels or are you baking in any market improvement that we’ve seen over the last three weeks? Then just to confirm, the starting point that you mentioned for G&A was $46 million and you expect that to remain flattish for full-year ’19, all else equal?
Yes, so with the comp ratio, we do our own internal forecasts but we are starting off at our year-end AUM levels, and we’re making assumptions like you guys do on flows and markets. Although we are going to have a very tight control on headcount, there’s always going to be one or two that need to be added for strategic and important asset gathering reasons, so our comp ratio is based on that. Obviously it’s January 24, so every early on. It’s our best guess of where are at the moment, and as the year unfolds we’ll react accordingly; but we feel good with that number just based on the $54 billion of where we’re starting.
The G&A, in my points I’ve cited the non-GAAP G&A for the year because there is sometimes a little confusion, since we don’t provide a non-GAAP income statement; but yes, we expect G&A to be flat to 2018 but with a downward bias. Although we don’t have quantified numbers, we’re extremely busy looking at all of our expense base and would be disappointed, honestly, if we wound up flat to 2018.
If I could just add maybe a little color, starting the year with assets that were so depressed and with negative momentum in the marketplace, I think our philosophy, whether considering the inputs to a comp ratio or our approach to managing controllable expenses, has been to plan for the worst and hope for the best, so I would say that our approach to cost management, our approach to assessing or projecting net flows or market are very conservative.
Got it, that’s helpful. Then if you could provide any color on retail trends, maybe, that you’ve seen early in 2019, especially in your preferred funds, and then on the $2.5 billion of mandates in consideration that you called out, are these from new client relationships, existing clients, is it lumpy in nature, and any--you know, if you could provide some information on that, that’d be great as well. Thank you.
Sure. We’ve had positive flows into virtually all of our open-end funds so far this quarter by a wide margin. The greatest inflows are into our preferred securities fund, and so as we anticipated ending the quarter and beginning the year, I think we’re seeing a combination of some of the tax loss selling coming back, but frankly new investors excited about the investment opportunity there. We’re seeing solid flows into real estate funds as well, so so far, so good.
The pipeline or the $2.5 billion-plus that we’re waiting to hear from represents all new clients. It’s a little lumpy in that, as I mentioned in my comments, what we’re seeing is quite a number of very large institutions, both domestically and outside the United States, who have heretofore invested in real assets almost exclusively through private investing, are pursuing the public markets now for the reasons I mentioned. I think the $2.5 billion is a minimum - there’s others in the pipeline that haven’t gotten to the final stage yet, so it’s not just one or two, but it is large and a little bit lumpy.
Very helpful, thank you.
Thank you. Our next question comes from the line of John Dunn, Evercore ISI. Please go ahead.
Good morning. You guys had gross sales go up, I think in the four major categories, up 33% quarter over quarter, so you guys are selling a lot of stuff. Can you talk about that side of net flows, maybe where that aggregate number could go, and maybe what a little bit environment in 2019 would mean for it?
Yes, it’s hard to really get a trend of your gross inflows and outflows. I think it’s encouraging that in the open-end funds, we saw a large increase in our inflows, showing that there’s interest in a lot of our real estate funds where we were seeing the inflows occur. The outflows were distortive, as mentioned, because of the client redemptions and tax loss selling, but we’re encouraged by that trend. I think we’re looking to have lower outflows and maybe stay in the trajectory of the inflows, and that’s where we’re kind of optimistic in the wealth channel for 2019.
John, as we talked about, as you know, the fourth quarter and particularly December was pretty wild and woolly. The volatility was extreme, and so it triggered all sorts of strategies, tax losses being the most obvious, but there were plenty of others. I think it’s hard to extrapolate too much from there. I think it’s more instructive to focus on the fundamental factors that I referred to, so one, top quartile, top decile funds are selling, anything lower than that is not. Asset allocations to defensive dividend paying uncorrelated asset classes like ours are rising, both in the wealth channel which is--I think you’re seeing shifts away from high risk-on, call it technology and related strategies, to more defensive strategies that accrues to our benefit, and real estate infrastructure preferreds as well, and the trends we’re seeing institutionally. So it’s only been three weeks, but with the exception of sub-advisory we have solid positive flows in every channel. I’d like to extrapolate the rest of the year from that, but so far, so good.
Got it. A little more on Japan - it looks to us like flows have improved in January, and if that holds, it would be quicker than other recovery periods in the last couple distribution cut cycles. Are you guys seeing that, and is [indiscernible] doing anything different this time around?
There’s a number of, I think, positive fundamental issues or developments. One is, and some of you have inquired, the regulatory pressure which began two or three years ago on these monthly higher dividend paying funds appears to have waned and is no longer depressing marketing activity. Two, the top selling funds of last year were funds like robotics and AI and what I would call more speculative funds, and they had a very poor end of year. Those funds are not selling any longer. The need for income continues to be extreme and unabated in Japan, and so--and I would also add that one of the two U.S. REIT funds, the larger of the two has actually been in positive flows for several months now. I think the time between the last cuts and now has helped the regulatory pressure dissipating, perhaps gone completely now, and again not unlike domestically, a shift in investor appetite more towards dividend paying, defensive strategies.
I would also point out, as Joe alluded to, we were the number one performing REIT fund in Japan last year, ahead of a fairly large group of decent competitors.
Got you. Thanks very much, guys.
Thank you. Our next question comes from Michael Carrier of Bank of America. Please go ahead.
Thanks guys. Matt, maybe first one just for you, just on the expenses. You mentioned you’re forecasting it based on your outlook, and obviously the tougher start with the December fall-off. As we think about going through the year, maybe just update us on how you think about what portion is variable in case the revenue environment gets a little bit tougher. I think you had some severance in the quarter. I just wanted to make sure we had the right amount, just so we’re thinking about adjusting that out.
ON the comp side, we said that the variation from the third to fourth quarter was primarily severance. It was about $0.025, if you’re just thinking about getting a better run rate. Our ratio of controllable to non-controllable is about 30% being controllable. That said, even in the non-controllable expenses, as we had done a few years back, there’s always opportunity with vendors, with number of users of a system and things of that nature, so we’re looking at everything. That’s why I say that at worse, we would expect it to be flat to ’18, but we would be disappointed if we weren’t able to achieve some saves year over year.
Okay, thanks. Maybe one for Joe or Bob. When I look at--and all your comments are helpful in terms of the outlook, but when you look at the outlook, you have the hardest thing - you have the performance with a lot of active managers, that’s a challenge. When you look at what you’re hearing from some of the clients, both the wins and some of either the reallocations or the redemptions, has some of the headwind been more from a cyclical standpoint and maybe that’s shifting, as Bob, I think you mentioned? Has it been new product competition that’s been coming into some of the categories, or has it just been changes in some of the distribution dynamics, meaning where you’re strong versus maybe where you have more penetration or work to do? I’m just trying to get a sense of some of the drivers, because obviously the performance is there. It sounds like your tone on the outlook is more variable.
Mike, it sounds like your question is focused mainly on retail. Is that right?
I think probably mostly on the retail side, because on the institutional side you gave a lot of color.
Sure. Well look, it’s no secret on the retail side, we compete with passive ETFS consistently, and we’re one of the few managers that is in net inflows in the active long-only REIT space, for example, and passive continues to compete well. We see some other products. We have some private equity firms that have been in the market with non-traded real estate product, and historically the competition is mainly because we’re competing against a brand name. Historically those products do not perform well, so over a full cycle we end up getting those assets back. But you know, it is more competitive.
That said, I think what’s in our favor is, as you know, your firm and others are narrowing their list of managers, and in particular much, much greater emphasis on recommended and, even more importantly, focus lists, and look, we’re the category killer. We’re on the recommended list, we’re on focus lists, and so in many ways we have many fewer competitors. The generic REIT or infrastructure, or even MLP mutual fund which is a two, three or even four stars is not on the focus list, and our partners actually help to elevate our performance and really provide a much stronger platform for us to continue to gain market share.
I would point out, we continue to gain market share in the retail channel in virtually every strategy that we manage versus active managers, so to me the winners are those that can deliver that kind of performance and passive, and the losers are the active managers who cannot deliver five star performance.
I’d just add from a market appetite perspective, from an asset allocation perspective, looking backward for the past two years, a lot of our strategies have been seeing headwinds from the spectre of rising interest rates, whether it’s REIT strategies or preferred strategies, midstream energy not so much - the issues there have been more the fundamental cycle. But when you think about the comments I made on how the macroeconomic environment is turning and if we are in fact seeing a peak in process in bond yields, that headwind could turn to tailwinds. Bob mentioned that we’ve seen several strategies put buy recommendations on defensive equity strategies that have high income components and earnings profiles that are more stable, so it could be that if we get this--if the macro plays out as we suspect, we could have some of those headwinds turn into tailwinds, or maybe to neutral winds.
Mike, if I could also just add a little color on the institutional side, whereas some of those private equity firms are trying to raise retail assets, as Joe and I outlined and consistent with our goal to be able to generate both positive net organic growth and rising fees, not declining fees, we are introducing early this year some strategies that are not in 40 Act wrappers, that are going to be marketed to some of the same, whether it’s family offices, OCIOs, the endowment-foundation market that heretofore have been mainly dominated by private equity firms. We think those investors have the deep knowledge of the value of an asset allocation to real assets and alternative income strategies, they like highly concentrated, focused, thematic, limited capacity strategies, and obviously we’re not competing with passive fees in those channels so we’re very excited about this initiative.
Okay, thanks a lot.
Thank you. Ladies and gentlemen via the phone lines, you may press the one followed the four on your telephone keypad if you would like to register a question or comment. Once again, that is the one followed by the four on your telephone.
Our next question comes from Mac Sykes of G.Research. Please go ahead.
Good morning everyone. You outlined some moving parts in Europe, but I just want to make I have this right. It sounds like fee rates will benefit from a future product mix, so into wealth and away from sub-advisory there at the moment. When I think about that [indiscernible] contribution, will that be additive to the overall fee rate?
Yes, I think the combination of lower fee business sort of being flat and higher fee business showing the greatest organic growth, that is what we hope will be the engine that will keep our fee rates certainly from declining, if not possibly even migrating a little bit higher.
Okay, and then could you just comment a little more on fundraising in Europe in general, just some of the noise around Brexit? Assuming we do get some clarity on those politics in the next couple months, could that be a catalyst for an acceleration in your progress there?
That’s a tough question. Institutionally we’re not--you know, we’re seeing strong investor interest. There’s been no diminution of accelerating demand on the institutional side. The wealth side, as we’ve talked about previously, is coming along more slowly than we originally expected, but it is coming along and part of that issue is there are some significant institutions that are not going to recommend or focus on our funds until they get to a critical mass of $200 million to $300 million, which we expect to achieve in our key funds this year. But I don’t think we’ve really seen any impact from Brexit other than our own contingency planning there.
My last one, a two-parter, the new series funds that you’ve outlined, are they being launched with seeded track records, and then how are you thinking about the margins in that business versus the overall business?
There’s a wide range of approaches to those strategies. There are several strategies that are now very much in demand, our concentrated strategies in global and U.S. real estate that have 15 and 20-year track records, and for one of those we’re looking at an LT structure. When we launch a new fund, we typically need to put in some capital. There are other strategies where we’ve just newly developed them and we don’t have long track records, but for the target markets that we talked about, we don’t think you necessarily have to have a track record, especially if you are managing a spinoff strategy or an extension of the things that we’re well known for. But we’ll have a variety of approaches, there will be some vehicles involved, others will be offered as separate accounts.
In terms of the question of the profitability, we believe we can get attractive fees relative to our current fees. One of the issues, however, is that these investors like strategies that are unique and sometimes have limited capacity, so we may not be able to achieve the scale in some of these strategies that we have historically with broader mainstream strategies.
Great, thanks very much.
If I just could add quickly to that, what those strategies also do is frequently when we offer unique strategies like that, we end up managing two, three, four additional strategies with the same client, so even though a strategy may be capacity constrained, oftentimes we end up adding assets in related strategies - you know, global real estate, infrastructure and so forth.
Thank you. Our next question comes from Robert Lee, KBW. Please go ahead.
Great, thank you. Thanks for taking my questions. Most of them have been answered, but just a couple of minor things, maybe. You had mentioned that in distribution services, expenses in the quarter benefited from some prior reversals. Can you maybe just size that for us so we can get a sense of what the run rate is? Then maybe a follow-on on the expense side, I’m assuming that Q1 will have some--there’s normally some seasonal upward pressure in comp just as you pay FICA taxes and things like that.
Right, thanks Rob. With respect to the frictional costs on the payment of the bonuses and everything, we actually accrue those during 2018, so the comp ratio that we had mentioned would be a good comp ratio to use for the first quarter, inclusive of paying out the bonuses, which all those costs had been previously accrued, so nothing unique for us there.
On the distribution, I would say if you wanted to size it up, it’s about--it’s between $400,000 and $500,000 a quarter. It was one of our larger intermediaries that had indicated towards the end of 2017 that they would be initiating rev-share on certain retirement assets that we have with them, and they didn’t bill us, so whether or not it’s going to get resurrected in 2019 is unclear. But we closed 2018 with a provision that we didn’t need, so we reversed it.
Okay, great. Then maybe just a follow-up question on any advisory. Could you maybe--and I apologize if you mentioned this early on, but give us a sense of some of the geographic breakdown of where you’re having the most success there, and maybe update us again on your view of what’s maybe driving that on a geographic basis.
Well, we’re seeing demand mainly from North America, Europe and the Middle East. We’re not--there’s very little of that, of the pipeline or the pipeline we’re waiting to hear about, very little of that is from Asia, so it’s really North America, Europe, the Middle East. I think what’s driving is the factors that Joe and I touched on already. Importantly, I think a significant part of that is sort of the multi-strat opportunities that we’re seeing, and we’re seeing it from public funds, we’re seeing it from Middle Eastern entities, we’re seeing endowments who are interested in not one of our strategies but three to five of our strategies, and some of the larger pools are interested in essence outsourcing their listed real estate or infrastructure allocation to a single provider.
You know, it’s really not to dissimilar from wealth, where again you’re seeing the intermediaries saying, we’re going to identify the two or three top decile, top quartile managers, and everyone else is going to not have shelf space. I think you’re seeing the same thing institutionally, where large institutions are looking to establish strategic relationships with people, with firms that dominate their asset classes and they’re handing over a wide swath of their portfolios, albeit they have greater negotiating positions. But these are great relationships because they’re large and they’re very long term, they’re strategic, and that’s the key to our thinking today. Whether sub-advisory or elsewhere, we’re focused on developing strategic relationships, not just any.
Maybe as a follow-up to the advisory comment, just curious if you’re seeing any increased interest or maybe demand from some institutional accounts to put in place some type of performance fee structure, maybe a lower ongoing management fee and then having some kind of performance fee on top of that. Are you seeing any of that?
It depends on the strategy. Yes, we’re seeing some of that, but again I think there is--historically in our experience, there’s been two approaches that we’ve seen clients with respect to performance fees. One is a somewhat cynical approach of just cutting fees so that if you deliver massive alpha, you can get back to your base fee, and as you would expect, your ability to negotiate fees that are fair for both parties is a function of how strong your performance is, how unique your strategies are, and I think that’s why if you’re in core style boxes, you have no choice but to acquiesce, whereas the types of strategies that Joe outlined, nobody else is doing and very few can do. That’s one of the reasons that we like the new areas and markets that we’re focusing on.
But yes, for the large cap, more generic strategies, there are clients who are interested in having that discussion.
Great, thanks for taking my questions.
Thank you. There are no further questions at this time. I will turn the call to Chief Executive Officer, Bob Steers for closing remarks. Please go ahead, sir.
Great, well thank you all for calling in this morning, and we look forward to speaking to you after the first quarter. Thank you.
Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Thank you, and have a good day.