Invesco Ltd
NYSE:IVZ
Earnings Call Analysis
Q3-2023 Analysis
Invesco Ltd
Invesco has strengthened its relationship with MassMutual, a critical partner that significantly contributes to Invesco's growth, particularly in the private markets business. MassMutual has increased its commitments, effectively boosting Invesco's growth institutionally and within wealth management channels. The partnership encompasses Invesco managing $9 billion of MassMutual's assets, with Invesco ranking as the largest sub-advised and defined contribution investment-only manager on MassMutual's platform.
Invesco showed resilience, with 67% of actively managed funds topping half of their peers and beating benchmarks over three-year and five-year periods. The company witnessed a dip of $51 billion in assets under management (AUM) to close the third quarter at $1.49 trillion, primarily due to market declines and foreign exchange movements. The firm still managed to achieve $2.6 billion in net long-term flows and is performing well in ETFs with $11.8 billion of inflows, which indicates competitiveness in a challenging environment for asset growth.
Invesco is actively managing its expense base with identified annual run-rate savings of $50 million, expected to be realized by the beginning of 2024. This cost discipline is a strategic move to position the firm for scalability and profitability amid anticipated AUM growth, despite expected short-term expenses related to restructuring and technological investments.
ETFs have transitioned from being margin-neutral to margin-accretive for the company, contributing positively to overall profitability as the firm focuses on growing this business segment. Given the firm's total AUM of $1.5 trillion, further scale in the ETF business and stemming outflows in fundamental equities are seen as the primary drivers for margin improvement.
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Welcome to Invesco's Third Quarter Earnings Conference Call. [Operator Instructions] As a reminder, today's call is being recorded. Now I'd like to turn the call over to Greg Ketron, Invesco's Head of Investor Relations. Thank you. You may begin.
Thanks, operator, and to all of you joining us today. In addition to the press release, we have provided a presentation that covers the topics we plan to address. The press release and presentation are available on our website, invesco.com. This information can be found by going to the Investor Relations section of the website. Our presentation today includes forward-looking statements and certain non-GAAP financial measures. Please review the disclosures on Slide 2 of the presentation regarding these statements and measures as well as the appendix for the appropriate reconciliations to GAAP.
Finally, Invesco is not responsible for and does not edit nor guarantee the accuracy of our earnings teleconference transcripts provided by third parties. The only authorized webcasts are located on our website. Andrew Schlossberg, President and CEO; and Allison Dukes, Chief Financial Officer, will present our results this morning, and then we'll open up the call for questions. I'll now turn the call over to Andrew.
Thanks, Greg, and good morning to everyone. I'm pleased to be speaking with you today. But before I begin my commentary on the quarter, I did want to take a moment to acknowledge the humanitarian crisis in the Middle East. We are deeply saddened by the loss of life and devastation and the impact it's had on civilians across the region. We're on the safety and the well-being of our colleagues and their families, and our thoughts are with everyone who has been impacted by the heartbreaking recent events.
But now turning to the topic of the third quarter earnings. I'll start today's presentation on Slide 3. Volatility and uncertainty continue to define global financial markets with interest rates rising and investors awaiting more clarity from central bankers, there's an extraordinary amount of cash that's been moved to the sidelines where investors can earn acceptable returns while they await more certainty. The slowing and narrowing investor activity has been a near-term challenge for our industry, but it also sets the course for an eventual reallocation and money moving back into higher risk-based assets.
Our results, which are highlighted on Slide 3, in many ways, reflect these dynamics. However, our unique positioning with deep client relationships, a strong geographic mix and a broad suite of investment solutions helped us deliver positive net long-term inflows in the third quarter. One of the primary contributors to our relative net flow strength is our robust EPF and SMA platforms. Our ETF [ business ] delivered record flows in the third quarter, which were concentrated in our leading factor-based capabilities. It was one of the strongest ETF quarters we have experienced as we continue to gain market share. We captured nearly 3x our industry share of net asset lows to our market share of AUM and importantly, over 3x of our industry share on a revenue flow basis as well.
Additionally, we continue to enhance the commercialization of our SMA platform and are seeing strong momentum in flows, particularly within fixed income, where we have posted 12 consecutive quarters of positive net flows despite the challenging market environment. Within these vehicles, we are well positioned to meet the increasing interest around personalization and tax optimization that we're seeing by wealth management clients in both the U.S. and around the world. While areas of growth like ETFs, SMAs and fixed income have been strong for us this year, we continue to see flow pressure in active equities. While headwinds have persisted in this asset class industry-wide, we are beginning to see marked improvement in Invesco, in particular in the global, international and emerging market equity segments.
In aggregate, our net outflows in these strategies are significantly lower than what we experienced in 2022 and have stabilized at around $1 billion in outflows each of the last 2 quarters. We continue to put considerable effort into further improving investment quality, product differentiation and client engagement in these capabilities to ensure we are well situated ahead of the eventual renewed demand in these important and higher fee-yielding asset classes. We're going to spend some time on the call today highlighting how we're positioning the firm against shifting investor demand, its impact on our asset mix, net revenue and our net revenue yield and how we're organizing to meet the evolving client demand in both the near and the longer term. As we've outlined previously, we are undertaking a multi-quarter plan to simplify and streamline the organization to position the firm around rapidly evolving client demands.
Our aim is to operate with more agility, improve our consistency of investment quality, create a more seamless client experience and more efficiently leverage our size and our global scale to enable better outcomes for our clients and drive even greater profitability. We have already made meaningful progress in these areas, and we will continue to execute pace in the coming quarters. Some of the key highlights on the evolved investment platform that we have achieved to date include the following: we've established a unified globally integrated fixed income platform, we're creating a single, highly focused multi-asset group from 3 distinct teams. We're bringing together leadership across our fundamental active equity teams and we're further strengthening our private market platform that spans both real estate and private credit capabilities. Notably, all of these simplification efforts will enable us to more fully take advantage of the benefits of our State Street Alpha platform, as a single global investment operation engine across asset classes.
On the product and distribution side of our business, we've also made considerable progress in repositioning growth and efficiency. We've combined our ETF SMA and model portfolios efforts into a single strategy and group. Going forward, we believe that these capabilities will be the leading vehicles of choice for our clients. Our established infrastructure, brand and innovation will enable us to continue to lead and bring both active and passive capabilities to investors in an even more personalized and efficient way. We're also continuing to prune our product line, and we've reduced it by over 150 products in the past year. Further, by globalizing many aspects of our marketing and digital delivery, we're finding opportunities to leverage our scale, simplify our applications, unify our data and use technology to strengthen these capabilities while lowering costs.
There are efficiencies to be gained from all of these simplification efforts, which we are beginning to realize, and we will continue to do so over time. However, these efforts are much more or more about -- much more than just expense savings. We view these as drivers of revenue acceleration, which will allow us to improve our investment quality, reallocate our expenses and capital base much more effectively and deliver sustainable profit growth and margin expansion and time.
Moving ahead to Slide 4. As investors gain greater clarity on inflation and Central Bank interest rate policy, we expect clients to move out of cash and extend their duration profiles of their FICAM allocations into a wider range of strategies. Fixed income is a clear area of strength for Invesco, and we're focused on ensuring we are well positioned to capture what we believe will be an outsized share of this reallocation. As you can see on this slide, our $500 billion plus fixed income platform has strong investment performance, requisite scale, diversity across asset classes and client geography, it spans public and private investments and it has a robust offering of both active and passive products. The globally integrated institutional quality platform has been a consistently strong grower for Invesco, having posted long-term net flows over the previous 18 quarters and its very strong top-tier investment returns across a wide range of fixed income capabilities.
A few highlights to note on our favorable position that are on the page include our global liquidity capabilities, which have grown AUM by over 150% over the past 5 years, and we're now squarely in the top 10 of institutional money fund managers in the top 5 amongst nonbank-owned providers. Our stable value capability is well placed in DC platforms and ranks as a top manager in the U.S. institutional marketplace. Our municipal capabilities rank in the top 5 largest among mutual fund managers in the U.S. and #2 amongst high-yield muni fund managers. Within our investment-grade capabilities, our relative performance has been improving since the recent mini banking crisis and our long-term performance strength has helped us nearly double our AUM in the past 5 years. Furthermore, our global and emerging markets fixed income capabilities of stellar performance and are very well placed for growth in the U.K., European and Asian institutional and retail markets.
And finally, we believe that significant opportunity exists for even greater expansion of our fixed income ETFs and bank loan capabilities which are too notable strengths of Invesco. So against the backdrop where clients are seeking to work with fewer asset managers to meet the breadth of investment requirements, fixed income is clearly an area of our business that is poised to continue to gain market share and drive even greater profitability as the eventual rotation beyond cash unfolds.
Finally, and before I turn the call over to Allison, I want to take a moment to highlight on Slide 5, another important piece of the Invesco investment thesis, our strategic relationship with MassMutual. Our engagement with MassMutual has many facets that create a meaningful, mutually beneficial strategic relationship. First, MassMutual is one of our largest investors as both a common equity and preferred shareholder. So we're mutually aligned to delivering profitable growth and long-term success against the backdrop of an evolving industry. MassMutual is also a significant investor over the past years and supporting many of our newly launched private market and other key strategies with a total of $3.5 billion of commitments.
Notably, this is 3 to 4x the multiple of seating of our own products on our own balance sheet. MassMutual has significantly increased their commitments since the inception of our relationship, and this is meaningfully bolstering our growth trajectory in our private markets business both institutionally and in our wealth management channels where early access to capital is paramount to setting the course for growth.
Finally, we work closely with MassMutual on behalf of their clients and we are pleased to be a third party manager of $9 billion of assets through their insurance and broker-dealer channels, where we ranked the largest sub-advised and defined contribution investment-only manager on the MassMutual platform.
To summarize, this is a powerful and important relationship for Invesco with significant potential ahead. We continue to explore avenues with MassMutual to make this relationship even more meaningful in the future. With that, let me turn the call over to Allison for a closer look at our results, and I look forward to your questions.
Thank you, Andrew, and good morning, everyone. I'll begin on Slide 6 with investment performance. Overall, our investment performance was solid in the third quarter with 67% and 65% of actively managed funds in the top half of peers are beating benchmark on both a 3-year and a 5-year basis, respectively. This is in line with those time frames in the second quarter. We did see investment permits improved considerably on a 1-year basis, going from 67% in the second quarter to 70% in the third quarter, reflective of the improved investment performance we are seeing across several categories, including global and international equities and alternatives. As Andrew noted, we have excellent performance in fixed income across nearly all capabilities and time horizons, an important fact given our strong conviction and our ability to attract flows as investors deploy money into these strategies.
Turning to Slide 7. AUM was $1.49 trillion at the end of the third quarter, $51 billion lower than last quarter. The quarter began with what appeared to be a continuation of a recovery in markets, albeit uneven that we saw in the second quarter. However, that quickly shifted to a risk of posture again as the quarter progressed and uncertainty grew, marking another volatile quarter for markets worldwide. Market declines, coupled with foreign exchange movements, drove the decline in AUM. Despite the market volatility, we did generate $2.6 billion in net long-term flows, and we expect we will outperform peers in what has been a very difficult environment for organic asset growth. Client demand for passive capabilities remain strong as we garnered $13.5 billion of net long-term inflows during the quarter. ETF inflows were $11.8 billion, marking one of our best quarters for ETFs. Our SMB 500 Equal Weight Index funds led the quarter with $3.6 billion of net long-term input.
This ETF is also our leading flow driver year-to-date, with our newer QQQM, drawing the second highest flows in our ETF suite year-to-date. The QQQM was launched 3 years ago and has attracted $14 billion of AUM since inception, now making it our fourth largest ETF. We've demonstrated the ability to sustain growth in ETFs throughout the full market cycle with organic growth in 12 of the past 13 quarters. We also saw solid growth in our index strategies with $2.3 billion in net long-term flows for the quarter. Offsetting some of the growth in passive was $10.9 billion of net outflows in active strategies. Contributing to the outflows was a single sizable redemption in our global targeted return strategy. This strategy has been in significant outflows for several years and now has less than $1 billion remaining in the fund.
In September, we announced plans to close the fund and focus on other capabilities within our multi-asset franchise where we are seeing stronger client demand. Our global active equities, which includes the developing market funds were also drivers of net outflows in this quarter. The level of outflows from this investment class has moderated after significantly elevated redemptions in the second half of 2022. Looking at flows by channel. The retail channel generated $4.3 billion of net long-term inflows while the institutional channel had $1.7 billion of net long-term outflows. This was driven by the global target of returns redemption. Outside of this redemption, we would have had $800 million in institutional inflows for the quarter.
Moving to Slide 8 and closed by geography. Asia Pacific delivered net long-term inflows of $2.8 billion due to growth in Japan, which offset outflows in Greater China during the quarter. In Japan, we experienced another quarter of strong growth with our Henley Global Equity and income funds, guarding $1.8 billion of net inflows from Japanese clients making it a top-selling retail fund for the industry in Japan on both a quarterly and a year-to-date basis. We are well positioned in Japanese -- as Japanese markets are experiencing some of the most constructive conditions for risk on assets in many years, including favorable new regulations.
After resuming organic growth in the second quarter, our business in Greater China experienced net long-term outflows of $1.9 billion for the quarter. The outflows in our China JV were $1.7 billion. Outflows were concentrated in fixed income, where continued weak market sentiment and interest rate tightening has led to diminished growth across the industry this year. However, as China's economy recovers, Invesco is extremely well positioned to capture additional share in the world's fastest-growing market.
Turning to flows by asset class. Equities generated $7.4 billion in net long-term inflows, mainly driven by the strong growth in EPS. The $2.4 billion in outflows in alternatives was largely driven by the previously mentioned single client global targeted returns [ redemption ]. Excluding this redemption, alternatives were in flight inflows of $100 million. We have a good track record in our private markets platform within alternatives and are well positioned to capture long-term flows in this asset class as client demand shifts to these strategies. We have over $6 billion of dry powder to capitalize on opportunities emerging from the market dislocation of the last several quarters, but greater market clarity will be required for this opportunity to meaningfully materialize.
Fixed income net long-term flows turned modestly negative with $1.3 billion of net outflows with growth in investment grade, SMAs and global debt, offset by the outflows experienced in China. As Andrew outlined, we like our position in this space and believe we are well positioned to capture flows as investors put more money to work in fixed income products. We have the track record to support our conviction with 18 straight quarters of net inflows prior to this quarter.
Moving to Slide 9. We've provided additional insight into our portfolio and the trends driving our revenue profile. Secular shifts in client demand across the asset management industry, coupled with more recent market dynamics, have significantly altered our asset mix since the acquisition of Oppenheimer Funds. As you'll note, ETF and index AUM, and this excludes the QQQ, have grown from $171 million or 14% of our overall $1.2 trillion in AUM in 2019 to $318 million or 21% of our nearly $1.5 trillion of AUM in the third quarter. We've also seen very strong growth in Asia Pacific, driven primarily by our success in China. During the same time frame, we've seen weaker demand for fundamental equities, driven in part by the risk off sentiment that was sparked in early 2022, coupled with the pressure we experienced in developing markets and global equity as well as the closure of our GTR capabilities.
Our fundamental equity portfolio in 2019 was $348 billion or 29% of our AUM. At the end of the third quarter, that portfolio was $242 million or $0.16 of our AUM. The result of revenue headwinds created by these dynamics has weighed on our results over the last 2 years. While we have experienced excellent organic growth and lower fee capabilities like ETFs and liquidity, it was not enough to offset the revenue loss from higher fee fundamental equity outflows and market depreciation. Our overall net revenue yield has declined significantly during this time frame, but that decrease has been driven by the shift in our asset mix, not degradation in the yields of our investment strategies. Net revenue yields by investment strategy have been relatively stable within the ranges provided on the slides.
The other point I want to emphasize is that this multiyear secular shift in client preferences have been increasingly captured in our results. Our portfolio is better diversified today than 4 years ago, and our concentration risk and higher fee fundamental equity has been reduced. These dynamics though challenging to manage through as they occur, should portend well for future revenue trends and marginal profitability improvement, independent of market improvement. Further, we now have a more diversified business mix, which better positions the firm to navigate various market cycles events and shifting client demand.
Turning to Slide 10. Net revenues of $1.1 billion in the third quarter was $12 million lower than the third quarter of 2022 and $7 million or 1% higher than the second quarter. The decline from the third quarter of last year was due largely shift in our asset mix that was just discussed. Total adjusted operating expenses in the third quarter were $789 million, $48 million higher than the third quarter of 2022 and unchanged from the prior quarter. Included in our third quarter operating expenses were $39 million of compensation expenses related to the organizational changes we are making to position the firm for greater scale and profitability as we grow our revenue base. In the second quarter, we had $27 million of compensation expenses related mainly to executive retirements. The full benefits from our simplification efforts will be seen over time as we generate revenue growth and margin recovery.
To this point, we have identified $50 million of annual run rate expense savings that will be realized by the beginning of 2024. The restructuring costs associated with these efforts were $39 million in the third quarter as we accelerated several of the reorganization activities that we were undertaking into the quarter. Next quarter, fourth quarter, we expect an incremental $15 million to $20 million of expense associated with these efforts, bringing the total expense associated with the efforts to $55 million to $60 million. As we've discussed, we managed variable compensation to a full year outcome in line with company performance and competitive industry practices. Historically, our compensation to net revenue ratio has been in the 38% to 42% range, trending towards the upper end of that range and periods of revenue decline.
At current AUM levels, we would expect the ratio to be slightly above the high end of the range for 2023 when excluding the cost pertaining to executive retirements and other organizational changes. Marketing expenses of $27 million were $6 million lower than the prior quarter and $3 million lower than the third quarter of last year as we continue to tightly manage discretionary spend given the ongoing challenging revenue environment. Property, office and technology expenses were relatively unchanged as compared to last quarter and the third quarter of last year. Another area in which we are diligently managing expenses as G&A. G&A expenses of $108 million in the quarter were down $6 million from the prior quarter. Compared to the third quarter last year, G&A expenses increased $2 million.
However, the third quarter of this year includes $8 million in spending on our Alpha platform, which prior to the second quarter of this year was included in transaction integration and restructuring expenses. We expect quarterly average spending on our Alpha platform to remain near this level for the next few quarters.
Moving to Slide 11. Adjusted operating income was $309 million in the third quarter which included the costs related to organizational changes. Adjusted operating margin was 28.2% for the third quarter. But excluding the costs related to the organizational changes, third quarter operating margin would have been 350 basis points higher. Earnings per share was $0.35 in the third quarter. Excluding the expenses related to the org changes, third quarter earnings per share would have been $0.07 higher. The effective tax rate was 23.6% in the third quarter. We estimate our non-GAAP effective tax rate to be between 23% and 25% for the fourth quarter of 2023. The actual effective rate can vary due to the impact of nonrecurring items on pretax income and discrete tax items.
I'll finish up on Slide 12. Stated priority, where I'm pleased to say that we've made significant progress in building balance sheet strength. This quarter, our cash balance exceeded $1.2 billion. We've lowered our net debt significantly, and it now stands at less than $250 million. I'm pleased with the improvement we've made on the balance sheet as we continue to work to bring net debt excluding the preferred shares down to 0 by the second half of next year. Our leverage ratio, as defined under our credit facility agreement was 0.7x at the end of the third quarter. We have an opportunity to further address outstanding debt with the maturity of the $600 million in senior notes at the end of this January. We ended the third quarter with 0 drawn on the credit facility.
To conclude, the resiliency of our firm's net flow performance in a difficult environment for organic growth is evident again this quarter, and I'm pleased with the progress we're making to simplify the organization and build a stronger balance sheet while continuing to invest in key capability areas. We're committed to driving profitable growth and a high level of financial performance. We have the right strategic positioning to do so. And with that, I'll ask the operator to go ahead and open it up to Q&A.
[Operator Instructions] And our first question comes from Glenn Schorr with Evercore.
So I appreciate all the commentary you made around fixed income. I'm still, I guess, a little surprised for everybody that flows haven't been stronger. Can you talk about what signed post you think clients are looking for? Is it literally just the end of rate hikes and economic outlook? And are you seeing that in dialogue with in solutions, through RFPs, things like that? And then maybe just the same comment on with -- in your words, an extraordinary amount of casing on the sideline money market or money markets were in outflow.
Glenn, thanks. It's Andrew. I'll start and Allison will chip in as well. The cash on the sidelines a bit, but whether it's from wealth managers or from institutions, it's something like 25% to 35% portfolios are allocated to that from best we can tell from lots of conversations with clients. And I think it's exactly what you described, waiting for clarity from central banks, waiting for a reason to move off the sidelines and get paid to do so. Conversations have been very active whether it's through our solutions efforts or just through direct conversations. And it's -- I think it's really those things and that's straightforward and simple. On the money market side, Allison, why don't you pick up?
What I would say about our money market portfolio is about 85% of our portfolio is positioned with an institutional client base. So think about that is being managed by corporate treasurers and those funds are going to stay and save for assets. So I think what we saw in this quarter was a repositioning in the treasuries just given the opportunity that those presented and just the yield that the treasurers are seeking. That will also, in many respects, prevent those funds from being deployed into more risk on strategies like equity. So the composition of our money market client base, I think, is important as you think about it being 85% institutionally owned.
I appreciate. One just quick follow-up is as you noted, the fee rate on fixed income is obviously lower than overall. But I would imagine there's some pretty high incremental margins. If flows do happen in the way you think into fixed income as people start extending duration, how should we think about that interplay between fee rate and margins kind of like the same conversation we've had for years?
No, your assumption is correct and that you've got a relatively fixed cost base underpinning that fixed income portfolio. So you should think about flows into fixed income as being accretive to the overall firm operating margin. So -- and I think that's look, that's a lot of what we want to draw out in providing some of this additional color is where we are seeking to grow through scale and where that will be accretive to margins, overall fixed income is certainly an area where that is true.
And Glenn, we -- some of the things we talked about last quarter and this quarter, we further brought together elements -- disparate elements of our fixed income platform, and we wanted to call up a scale in that platform for just the reasons Allison described.
The next question comes from Craig Siegenthaler with Bank of America.
So maybe just starting where you left off, with 25% of portfolios sitting in cash and waiting for rates to stop going higher, which bond verticals are you the most positive on in 2024 and also, do you think active fixed income can garner significant share? Or do you expect most of the flows to come from passive, which you'd also benefit through the ETF platform?
It's Andrew. Just maybe I'll pick up on the second part first. We think it will come in both active and passive. And as you said, the diverse range that we have in both, in some ways, we're a bit indifferent, but the conversations are happening on both sides of the equation. In terms of areas that are particularly of focus and things that we're having conversations about it, we're well positioned, the municipal portfolio, whether that's investment grade or high yield, the performance is stellar. The funds are highly rated, they're well known, and that's probably the first protocol we would point to.
On the investment-grade side, European corporate bonds had been of interest and have been an area where we're positioned well. And then really just anything across as people move a little further on the curve, even elements of our short-term fixed income portfolio. So it's pretty wide ranging, but I'd sort of point out those areas, in particular, especially because we're just well -- we're well placed there to take share.
And just for my follow-up on Investor of [ Great Wall ] in China. Flows are negative in 3Q. I just wanted your perspective on if you thought they would snap back on a near-term basis. Or if you think we'd go through a longer term time period here where you'd see net outflows from China?
Craig, I'll start. I think the most important component of the flows in IGW was really that it was driven by fixed income. And I think we're just seeing with the interest rate tightening that's happening inside of China, a diminished appetite for fixed income overall. We actually saw inflows in equities over the quarter. So we do think it's hard to gauge exactly the timing as to when economic sentiment will recover there. I think we're confident the government is doing quite a bit to try to stimulate some stabilization there and improvement in the sentiment overall. Hard to say exactly which quarter that will be and when things will snap back, we do -- we are very confident -- very well positioned when that does occur.
Our next question comes from Daniel Fannon with Jefferies.
A question on expenses. First, a clarification. I believe Allison, you mentioned that the savings from some of the charges won't be in until next year. So curious as to why you're not seeing some of the savings here in 4Q. And then there's a lot of changes or kind of streamlining, I think, that was talked about. Could you maybe summarize like what [ year ] is the most impactful in some of these changes that you raised?
So on the expenses, let me clarify that, we expect that, that $50 million will be fully realized by the first half of 2024. And so that -- I expect we will actually start to see some of those savings materialize here in the fourth quarter. I'm expecting somewhere around like $10 million improvement in compensation expense in the fourth quarter. So that run rate is out to almost probably $40 million. So I actually think we'll start to see the majority of those savings materialize in the fourth quarter and then continue into next year. That, of course, is all things being equal and dependent of AUM and where markets go in variable compensation.
A part of the increase in the severance and reorganizational expenses in the third quarter is because we did pull forward some of those savings, so we would start to realize the benefits of them in the fourth quarter. And so again, I know there were some expectations because we provided an expectation that severance is expended to be closer to $20 million in the third quarter. It was $39 million as we seek to pull forward some of those savings. Where do we expect to see them. Honestly, it's quite broad-based as we are looking at just making thoughtful streamlining decisions across our entire organization. It's everywhere from areas of operations to streamlining some of our investment teams. As Andrew noted in his remarks, to just pocket the simplification where we can globalize some of our teams and seek to do things one way across the globe instead of multiple ways. I couldn't point to any one particular area. I will tell you the majority of the savings you will see are in compensation expense, and that is, of course, excluding any first quarter seasonality that you see in payroll and taxes and the like.
That's helpful. And then just on the institutional outlook, the overall pipeline, I think the numbers you didn't disclose. You talked about the slide is 35% still solutions, which has been in the range it's been. So maybe just some context around the institutional activities you see it in building into fourth quarter and obviously into next year.
Sure. The institutional pipeline, the one not funded pipeline, so the same as we typically provide some color to, it was about $20 billion in the third quarter so a little bit lower than the prior quarter, although the fee rate was a little bit better, the composition pretty consistent. So it still looks pretty good. I would say, if I look at our inflows, excluding the GTR, very sizable redemption that we pointed to. If I look at our gross inflows in the quarter, it was about $17.5 billion in gross inflows from the institutional channel and that was about 43% of that was from our pipeline. So our pipeline continues to be healthy, strong. It does not really reflect the full breadth of the activity in the institutional channel. But it's certainly a good health measure. And it's kind of consistent in that $20 billion to $30 billion range.
The next question comes from Ken Worthington with JPMorgan.
To follow up on the pipeline question, what was the backlog for alternatives? If solutions increased to 35%, I guess, what sort of shrunk relative [ to ] in the pipeline? And where does alternative stand? And well, to start there.
Sure. What shrunk would have been equity. Alternatives actually held pretty consistent to the prior quarter. And I think we mentioned we've got about $6 billion in dry powder and that's been pretty consistent. So it's actually been one of the challenges is it's been difficult to deploy just because the transaction activity, particularly in private real estate is relatively low, just given some of the financing dynamics that are going on. But what we saw was a little bit of diminishment in the pipeline for equities overall.
Okay. Great. And then in private markets, so on the $6 billion of dry powder, where -- what represents the bulk of that dry powder? Is it real estate? Is it credit? Is it sort of split between the 2? And are there any big funds in private markets that you expect to come to market in the next 12 months or so?
The bulk of the $6 billion would be more real estate oriented than it would be private credit. We've got several things that are -- we are working on, I would say, in terms of what we're trying to bring to market in both the real estate space and the private credit space as we look to capture some of the opportunities there out there right now particularly from an opportunistic standpoint and a stress standpoint.
Yes. And Ken, in particular, real estate debt for both institutions, but mostly in the wealth management channels is probably the area where we're seeing the greatest amount of demand and we're in market with strategies there. And then as Allison said, on the private credit side, just traditional direct lending, both in Europe and the U.S.
Our next question comes from Brennan Hawken with UBS.
I wanted to start on fee rate. So the actual investment advisory fee was a lot of pressure, but distribution offset kind of allowed the net revenue yield to be only down modestly. So was there any noise in that net distribution line? Or is that the right way to think about that going forward?
I'll take that. The net distribution line, it tends to -- in that third-party line, it runs about 41% to 42% of management fees on an annual basis. I think last year it was about 41.5%. Year-to-date, it's about 42%. Third quarter was a touch lower, though. So I mean, there's just some noise and it fluctuates quarter-to-quarter. But I would say in line, it's pretty in line with history right now.
So are you saying that we should look at it more on a year-to-date basis than this quarter specific?
I would. Absolutely. I would think about it in that 41% to 42% range, and this quarter kind of brings up 42%, starts to bring it down a bit. I would look at it in the range. That's how we think about it. It's hard to manage to it quarter-to-quarter.
Excellent. That's great. And not that I want to give Greg more work, but it definitely would be great to see like fee rate or like revenue by asset class along with the flow disclosure that might help to given -- particularly given the dynamics at play for your business, just a recommendation. On -- for my follow-up, you said that there was a big loss of a single account with GTR. Was the fee rate given that, that was a single large investor, was that fee rate sort of below the average for your alts business for the firm broadly just given the size?
Yes. Thanks, Brennan. Okay. First, I'm going to point you to Page 9 because Greg did do the extra work, and we've got some of the fee rates disclosed from an AUM standpoint there to try to provide exactly that and give a little bit more color. And then on GTR, no, that fee rate, that capability was priced significantly above the firm average. And so that has been, as you think about some of the challenges and the remixing and some of what we are trying to draw out on Slide 9. GTR would have been one of the challenges we've been experiencing along with the pressure from developing markets and global equities. Those would have all had fee rates quite north of the firm average, consistent with what you would see in that fundamental equities fee rate range on Slide 9.
Yes. Okay. Great. And thanks for pointing out that on page -- on Slide 9, of course, I just more meant in a way that we could actually embed within the financial models, right? So we could have it in greater detail. Does Slide 9 tie to the AUM disclosures you guys have in your pressor?
Not exactly. And I think that's part of the challenge, and we hear you on that one, and I know that is a desire you have expressed, and we will continue to work through our data in a way that we can make it as digestible as possible. Although I do think this gives you quite a bit of color as to what's been going on over the last 4 years and a lot of the challenge in the results that we've experienced being increasingly captured.
The next question comes from Michael Cyprys with Morgan Stanley.
Just one on regulation, Basel III end game rules for the banks are slated to potentially raise capital requirements. Just curious how you see that trickling down to the asset management industry and your business whether it's availability and cost to warehouse spoke derivatives, accessing leverage? Just what areas you think might be impacted from the new capital rules? And then can you speak to the opportunity set just in terms of where you guys might be a beneficiary where you might be able to press to innovate, to create new products to be able to take some share from the banking system?
I'll take that one. I'd say, honestly, the Basel III capital requirements have little to no impact on us at all. There's very little that we do that has have any relationship to the areas that are impacted by Basel III. So I would say, in terms of where might we have some opportunities, we could take advantage of. Certainly, we're all seeing the opportunity to continue to think about capturing some private credit share as we continue to see that be a challenge for the banking system and a lot of that getting pushed out of the banking system. We've certainly already seen the impact of that over the last 5 years, and I expect that those trends will continue. I think it also creates opportunity on the real estate debt financing side, and I think consistent with Andrew's prior comments and where we see some opportunities in our positioning our capabilities there to take advantage of that as well.
I'd just add bank loans where we've been an innovator as well as different things on the liquidity side of the business. But I'd echo Allison's comment it's just not Basel has not been a focus of ours.
Sure. I get it doesn't apply to you, but just curious how you see that impacting the banks, which then may reprice or pull back capacity, which is to the question I was getting at. But maybe we'll move on. Just a question here on efficiencies. That's an area of focus for you guys in streamlining the organization. I was just hoping you might be able to speak to some of the potential from generative AI, how you guys are experimenting with that today? How do you see the opportunity set from that? How might be able to quantify the benefit there over time?
Yes, it's a great question. Early days, of course, data and organizing our data and making it strategic asset is one of our priorities and how we apply artificial intelligence and generative artificial intelligence to it is high on the order. We're early days in experimenting with traditional applications that we think will and could lower costs and drive efficiency going forward. But also [ speed ] to market and friction that exists inside the client experience. So things like marketing material and content legal and regulatory procedures and filings, onboarding of accounts, things like that, that are pretty operationally intensive at the moment. We haven't started to experiment yet, but how we'd apply that on the investment side. But on the sales side, we're applying it internally with finding ways to get ourselves to products and get ourselves to attributes that we can express to clients rapidly. So we're going to continue to invest in the area, explore it and seek to make it a part of our efficiency going forward. But it's a little too early to quantify.
Our next question comes from Brian Bedell with Deutsche Bank.
Maybe just back to Slide 9, maybe on the fundamental equities franchise. Obviously, given industry pressures, that's -- that shrunk as a proportion of your overall asset base, but it is the highest revenue yielding area. So can you talk about maybe what types of investments you're making in the overall fundamental equities franchise that might help the organic growth prospects of that? And then also maybe just to what extent are you viewing active ETFs as a potential vehicle enhancement for that platform?
Great. Thanks for the question. It's -- let me start with how we're seeking to improve fundamental equities, both from an investment standpoint and from a client standpoint. On the investment side, clearly, our investment leadership, we put new investment leadership in place. That leadership is focused on not just improving performance over time, but risk and tools and analytics and controls around it. Performance will be the biggest driver in addition to where market demand is and getting strong investment quality across the piece is a high priority. And you're seeing some of those investment performance returns sort of play through into the results. And I think that's what's mitigating some of the redemptions in particular, on the international emerging and global equity side of things.
From a distribution standpoint, given our history in both the U.S. and in the U.K. and Europe, where a lot of those assets are placed on retail platforms, we're very well placed. We have strong distribution in place. We have high education there as well. So it's really about just being in front of clients more actively where when demand comes and when we have quality. The one thing I'd really want to point out as you kind of decompose that fundamental equities is really around the places in international, global and emerging markets, which are the relatively high field and component parts. They are the component parts that are less susceptible to passive and there are places where we think we can differentiate on product, et cetera. And those are the areas where I was pointing out in my earlier comments as well, where we're seeing the most improvement in terms of net flows.
In fact, for the quarter, those categories globally were just $1 billion of net outflows compared to many multiples of that in 2022. So I think that's our first port of call in terms of where we could see growth in time. And then I think it's a little more challenging on the domestic equity side, but the same comments I made would apply. Allison, I don't know if you want to add anything there. On the shift from mutual funds to ETFs, we're well placed in the ETF platform. We've brought active strategies to market over many years. We're going to continue to look for ways to take active strategies from the mutual fund vehicle to other vehicles in time and not just ETFs, I'd say SMAs are going to be another place, custom SMAs, both on the fundamental and index side, but on the fundamental side, in particular. So we're going to look for ways to bring that forward. I think the development of active ETFs is going to take some time. But as it develops, we'll definitely be a frontrunner there.
That's great color. And then maybe just on the expense side, Allison, just a clarification, the $10 million in the fourth quarter improvement in the compensation line. Does that exclude or include the dynamic of the charges between the 2 quarters, 3Q and 4Q?
That would be run rate improvement. So that is independent of the $39 million of this quarter and the $15 million to $20 million that we anticipate in severance reorganizational costs in the fourth quarter, that would be true underlying run rate improvement. And we'll [ begin ] to give you more transparency to that as we realize those savings.
Yes. No, that makes sense. And just I don't know if you're able to comment on other 4Q expenses in EMEA marketing is typically seasonally high but anything else on the property line and the G&A line, other than the -- you made the State Street output commentary, obviously, but anything else on those 2 lines for 4Q?
Yes. I would say we do often see a little bit of seasonality in both marketing and G&A in the fourth quarter as there are just professional services fees and the like that's usually true up there in the fourth quarter. So there might be a touch of seasonality marketing those 2 line items higher. We are thoughtfully and very aggressively managing our discretionary expenses though.
Our next question comes from Alex Blostein with Goldman Sachs.
Lots of noise and expenses, obviously, for you guys this year. So maybe you can kind of help us level set and as you go through all these changes provide some color on how you're thinking about margins for 2024. Obviously, the revenue backdrop could be volatile as we know, but assuming more stable markets. It looks like you guys are doing sort of low 30s percent kind of clean operating margin. Assuming there's no additional charges in '24. Is there room to build off of that into 2024 versus '23? So any color you provide on that would be helpful.
Sure. Alex, our expenses this year a little bit noisy for 2 reasons. One, a lot of the executive retirement, the reorganization efforts and the severance associated with that and then the fact that we no longer have TIR after the first quarter. So I will say when you back that out, it's actually quite consistent. They've been quite flat. And Alpha has been running in our expense base to the tune of $7 million or $8 million a quarter since the second quarter when it moved out of TIR and fully into our expenses. So there's sort of that -- it's a fully loaded expense base, and we are trying to call out where there are some one-timers associated with that. We will continue our simplification efforts well into next year. We aren't going to let up and continuing to find efficiencies. I don't know that they will be to the tune of the materiality we've seen in these last couple of quarters as we've sought to bring a lot of that forward. But we will continue with those efforts, and we'll call it out when it is material.
As I think about next year and what could help us improve operating margin above that 30%-ish range, it absolutely becomes -- it's largely a revenue story, and we are very, very focused on revenue and just the impact, again, that we have experienced with the remixing of our asset base and the market depreciation that has impacted us quite significantly starting late last year, again, in developing markets and global equities, especially as Andrew noted earlier. I think independent of where revenue goes, we are highly focused on really managing that expense base next year. We will provide more guidance as we get into January. Alpha is a huge focus for us next year. And now it's going to be [ full did ] in our expense base. We'll be giving more color to that as the quarters unfold. But that will impact our ability to really drive our expense base down in 2024 because we'll be working on fully going live and running parallel on several systems at the same time.
So again, we'll create transparency, but all of this is with an eye towards simplifying and streamlining our end-to-end delivery so that we can create positive operating leverage coming out of '24 and anticipating further growth in our AUM. I just want to underscore, I mean, a lot of the flows that we're seeing, we're very pleased with what we saw in the third quarter. We recognized it was quite a bit better than what the rest of the industry is seeing. And I think it really speaks to the diversification of our platform and how aligned it is with client demand. It's giving us the opportunity to make really thoughtful decisions as we continue to simplify our organization and really invest in the capabilities and the technology that's going to be necessary to create that positive operating leverage going forward.
Also, we're going to continue to have the expense discipline that Allison has been talking about in addition to these streamlining efforts playing through over time and helping us grow our revenue base but also be much more efficient with our expenses and be able to reallocate additionally to these growth areas in time as well. So you should expect to see both of those sides of the expense equation in the coming quarter.
Got it. All right. That's helpful. And just a quick clarification question for you guys on the net revenue yield. So I appreciate the comments around diversification of the business improving and that should provide some stability to the net revenue yield. Just a quick reminder on China. I think there are some decreases in pricing that either already occurred or yet to occur. So just remind us maybe the magnitude of that and whether it's already fully in the run rate and what you expect that to...
Sure. So in China, that we do expect with some of the changes that happened there and the impact to fee rates that it will have an impact of about $10 million on our revenue overall, given the AUM that's impacted there. The impact to operating income will be quite a bit less than that, just given there will be some comp expense takeout that's associated with that reduction in the fee rate. And that's a 100% so keep in mind how we reflect 100% and then back out the 51%, excuse me, that we don't own below the line.
So the one thing I would say to that is while that is an impact to revenue upfront, we actually think this portends very well for our business in China as regulation seeks to just further strengthen the capital markets there. We know as the 12th largest asset manager, we are well positioned to be a net winner, and we think we will benefit from some of these fee rate changes and the impact to some of the smaller players.
The next question comes from Patrick Davitt with Autonomous Research.
So it sounds like you're changing your tone a bit on the path to future fee rate declines. But at the same time, it sounds like you expect much more bonds, fund flows and ETF demand from here, which are among the lowest fee buckets. So what changed to kind of change your tone on the potential for fee cuts if the lowest fee buckets end up being the biggest inflow contributors?
Sure. Thanks, Patrick. A couple of things. I don't I would say we're changing our tone. I mean, I do expect you'll continue to see some modest downward pressure in our fee rate as we just continue to see some of this mix shift. We're not calling it into mix shift. And we know we all are quite aware of the secular trends that are out there. The demand for passive and the weaker demand for active and we're certainly benefiting from one side of that trend. But increasingly, those -- the impact of that is captured in our results. And so if you look at our net revenue yield, ex performance fees and ex QQQ, it's $32.9 million basis points this quarter. So it was actually 4x basis points higher than last quarter. That's in some respects due to one additional day in the quarter.
But I will say we have that seasonality occurs every year. And this is one of the first third quarters in a long time where you saw it be flat or positive. Typically, the pressure is downward. I still think we'll have some downward pressure, but it's going to start to moderate and $32.9 million is a lot closer to an average passive fee rate of 18-ish basis points than 40 was. And so at some point, you start to see where we get closer to that average and that remixing starts to have less of an impact on fee rate.
I would also say, keep in mind, while we're focusing on fundamental equity and passive and the difference in that net revenue yield, important to look at APAC managed, again, largely China and Japan under there with a 40 to 50 basis point fee range and the growth we're seeing over -- through the cycle in those 2 areas, very accretive to the overall fee rate and also the growth that we expect to continue to see in private markets and multi-asset accretive. So while the biggest drivers and the biggest change in terms of outflows and inflows have been passive and outflows in fundamental equity, there are other aspects of our portfolio that are very accretive. And our objective is to take that $1.5 trillion in average AUM that's been relatively flat over the last couple of years, given the market depreciation and grow that. And as we grow that and these pieces of the pie grow, you start to see the impact of the last couple of years really better realized in our average fee rate, and you start to see some stabilization in the decline.
Yes. Patrick, I'd just add to what Allison said, the APAC multi-asset private markets that you see on Page 9, volume would increase that in time. relative to where we are. And then on the fundamental equity side, we've -- we sort of underperformed on our market share capture and our redemptions. And so as you see redemptions start to mitigate and get into positive flows eventually, that's going to be through market share gains. And so I think on both sides of that. And I think Allison covered it well.
Great. That's helpful. And then one quick follow-up on margins. I think many years ago, you used to say the ETF business was a drag on margin as it hasn't scaled yet. So similar to Glenn's point on bonds, I'm not getting to a point where we start to see a lot more incremental margin from the CTF growth, given how big some of the funds are getting. So do you think we're at a point where we could see kind of a step-up on change in the margin contribution from the ETF growth you're seeing?
Yes. I would say going back to when I joined the firm a few years ago, we were saying the ETF business was neutral to the firm margin. It's been quite some time since it would have been dilutive. We are certainly in a position now where it is accretive to the firm's margin overall. And we're very focused on continuing to grow that business because it is accretive to the firm's margin. And I think as you think about what could -- one of the 2 biggest things that could really improve margin for this firm overall, it is rapidly growing the size of that business, stemming the redemptions and fundamental equities and again, growing that pie overall from $1.5 trillion in AUM, so something quite a bit larger than that. Scale is what is going to add contribution from a margin perspective.
We do have time for one final question. And our last question comes from Finian O'Shea with Wells Fargo Securities.
A question on the MassMutual partnership commentary in the beginning. Are you working toward a broader, say, private markets, organic product build-out with hopeful seating through master -- or is this more a focus on executing what's in the ground already for those areas of partnership?
Yes. Thanks for the question. Much of the private market seeding for the strategies we talked about earlier has happened already. And so the comments we made around the $3.5 billion are largely inclusive of all of that. As we move forward and bring additional private market strategies, MassMutual will hopefully will continue to be that kind of partner, but much of it's happened already, which leads us to executing on the ground, as you said with growing third-party assets from institutions and wealth managers, which is what we've been doing the last several years and getting ourselves situated for that demand to continue to come. So that's that. What was the other piece on the MassMutual -- do you have another piece of MassMutual?
That was pretty much it. Thank you.
Okay. Well, thanks, everybody, for joining the call today, and we continue to believe that we have great opportunities at Invesco as we discuss today and that we have momentum from which to build. We're very well positioned as investors gain better visibility on rates and [ more direction ] and put their money back to work. Hopefully, you've seen that we have the breadth of products, scale, performance and competitive strength to meet the spectrum of client needs and we are simplifying and streamlining the organization to better position for greater scale, performance and improve profitability. So thank you for your interest in Invesco and we look forward to speaking again soon and next quarter.
Thank you, and that concludes today's conference. You may all disconnect at this time.