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Welcome to Invesco's Fourth Quarter Results Conference Call. All participants will be in a listen-only mode until the question-and-answer session. [Operator Instructions] Today's conference is being recorded, if you have any objections you may disconnect at this time.
Now, I would like to turn the call over to your speakers for today, Martin Flanagan, President and CEO of Invesco; Loren Starr, Chief Financial Officer; and Greg McGreevey, Senior Managing Director of investments. Mr. Flanagan, you may begin.
Thank you very much and thank you everybody for joining us. Again, if you're so inclined that presentation that we'll be addressing is on the website. So please feel free to follow if you'd like to.
So we'll cover the business results for the fourth quarter today. Greg is going to go through the investment highlights, but also talk about the environment and also what the combined investment firm will look - the investment potential also look like. And Loren will go in greater details on our financials. And then finally, I'll give an update on where we are with the Oppenheimer combination.
So turning to highlights on page five, there's no question that the fourth quarter is very challenging for the industry and for us. Eight out of ten asset classes were negative territory 2018. It's the worst on record in decades, and 74% of all listed companies were in their market territories. So again, much more difficult than I'd say that we've generally understood in the marketplace. And if you look at our fourth quarter results, we were not immune to the impact of these market dynamics.
The good news was gross sales were up, that's a nice health indicator, but absolutely, we had net flows during the quarter, driven by these market dynamics and a big risk off move by many investors around the world. It was further impacted by a number of our key investment capabilities have relative under performance with those with a value bias during that period of time. We did purchased $300 million of stock during the quarter. That's from the $1.2 billion stock buyback program we announced last October. And again I mentioned, Loren will get into the financials in just a minute.
As we have previous talked about, over the past few years, we've been actively repositioning the company to what we think are the opportunities in the market. There's no question that Oppenheimer is an important part of this work and will greatly accelerate our activities. And we'll talk about that more specifically in a few minutes. I do want to make the point we are on track to hit our $475 million of synergies and we're making meaningful progress towards hitting the close in the second quarter of this year with Oppenheimer. And we will revisit the financial returns with a combination, because of the fourth quarter being so difficult and you'll see they're very, very compelling still.
And so with that Loren, you want to.
Yes. Thank you very much, Marty. So on slide six, you're going to see a summary of the results for the fourth quarter. 54% and 63% of actively managed assets were in the top half of peers over the three and five year periods, while the one year numbers dropped a bit to 41%. We did see significant performance improvement in December and into 2019. And Greg is going to talk about that a little bit later in the presentation.
While gross sales are up nearly 27% versus the prior quarter, the market dynamics that Martin talked about, and some near-term performance challenges continue to set redemptions at a higher than normal level. Total long-term net outflows were $20.1 billion for the quarter, significantly contributing to this results were just a small number of larger institutional client redemptions.
Adjusted net operating income was $300 million for the quarter, down from $358 million in the prior quarter. The lower revenue environment also impacted our adjusted operating margin, which decreased to 32.6% from 37% in the prior quarter. We did returned $422 million of capital to shareholders during the quarter through $122 million of dividends and $300 million of buybacks.
So now let's look at the long-term flows found on page seven. For actively managed strategies outflows remained elevated in Q4. This was particularly true for our U.S. and UK retail equity products, which faced some investment performance headwinds. Active flows were also impacted by a handful of institutional outflows, for example in October we experienced a $5.5 billion low fee mandate redemption associated with a single client.
Our passive flows were also somewhat mixed in the quarter, we saw good sales into our European S&P 500 bullet shares, low volatility and ultra-short duration ETFs. However this was more than offset from outflow due to $1.2 billion of naturally maturing bullet shares at year end and $1.7 billion in negative flows from our senior loan ETF.
The strength of our pipeline was reflected in our institutional results as gross sales were up more than 80% versus Q3. The single account $5.5 billion low fee outflow that I mentioned previously drove us into negative net flow territory. The strength of our gross sales was well diversified and led by real estate stable value, fixed income and quantitative equity products.
I'd also like to note that while you don't see it on these charts we benefited from strong flows into our great wall JV money market products, which added nearly $3 billion in inflows in the quarter.
Next, turning to slide eight, our assets under management decreased by $927 billion or 9.5 percentage points, which reflects the impact of negative market returns and long-term outflows. Our net revenue yield excluding performances fees was down 0.3 basis points to 38.6 basis points. This decline was driven primarily by the negative impact of FX end market on our AUM mix, which was partially offset by an increase in the day count and higher real estate transaction fees and other revenues.
Let's move to slide nine, where we provide our U.S. GAAP operating results by quarter. My comments today will focus on the variances related to our non-GAAP adjusted measures, which can be found on slide 10. But before turning to those results, one item I want to highlight on our U.S. GAAP financials for the quarter is a new expense line item named transaction integration and restructuring expenses.
This line item includes transaction related costs for acquisitions, as well as integration and restructuring related costs. You might remember in fact that we use the same line annual approach when we did the Van Kampen acquisition given the size of that deal and given the size of the Oppenheimer deal.
The presentation to prior period business combinations and optimization amounts has been also reclassified to be consistent with the current period presentation. And finally, I would like to note that this reclassification has absolutely no impact on total operating revenues, total operating expenses or net income on a GAAP or on a non-GAAP adjusted basis.
So now let me just turn to page 10 for our non-GAAP results and you'll see that our net revenues decreased by $47.7 million or 4.9% quarter-over-quarter to $19.2 million. This decrease primarily reflects a lower average AUM for the quarter, partially offset by higher performances primarily earned from our European real estate investment teams.
Our adjusted operating expenses at $619.2 million increased by $10.1 million or 1.7% relative to the third quarter. The expense increase quarter-over-quarter was driven by about $10 million of seasonally higher marketing expenses, which were focused on new fund launches in the UK, ETF offerings in Europe and our U.S. efforts including a focus on our bullet share ETF products.
We also saw a $5 million of higher run rate outsource administrative costs - administration costs that's associated with our digital platforms and outsourcing of our back office services. And then finally about $6 million in non-recurring G&A expense from professional services in Q4 as well as there was a large VAT credit that we recognized in the third quarter. These expense increases were partially offset by about $15 million less in variable compensation expense.
Our adjusted non-operating income decreased $32.6 million compared to the third quarter largely reflecting the negative mark to market on our seed investments during the quarter. In terms of the firm's effective tax rate increased to 25%, primarily resulting from the impact of these unrealized mark to market losses. And that brings us to our adjusted EPS of $0.44 and our adjusted net operating margin of 32.6 percentage points for the quarter.
Next, just turning to slide 11. So let me say that when Oppenheimer joins Invesco in Q2 of this year, as you know we plan on reducing the total expense base of the combined firms by roughly 15%. Clearly that will represent a significant spending reduction. However, given the challenging revenue environment that we're currently experiencing, we're implementing a number of immediate cost control measures that should help to limit the negative impact to our operating results, while we continue to focus on the integration efforts.
These efforts are consistent with our historical approach when we manage through extreme volatility like we've been seeing. Some of these actions include deferring new hiring, canceling open requisitions when possible, limiting discretionary non-client travel conferences, training and the slew of other professional service expenses, as well as assessing all other areas of spend for additional opportunities.
So in addition to the mentioned activities, we are also working hard to accelerate many of the Oppenheimer synergies and the combined synergies of the firms that we plan on delivering upon close. This is the topic that will be covered in greater detail in a few minutes.
And with that, I'm going to turn it over to Greg.
Thank you very much, Loren. There's a couple of key topics that I'd like to cover today just to set the stage. First, I want to cover investment performance for Invesco as a standalone firm and provide some color on our long-term investment performance. And within that context, we'll look at some early signs of improvement.
Second, I want to highlight the significant benefits that we believe we'll achieve through our combination with OppenheimerFunds. And finally, I'll highlight how the expansion of our capabilities with the addition of OppenheimerFunds will enable us to provide better outcomes to clients and that's something we're very excited about.
So if you can turn to slide 13, we'll just take a quick look at performance overall. And as Loren referenced earlier in his remarks, on this slide, this chart shows our one, three and five year peer relative performance on a relative basis to peers for our assets under management for the entire firm.
And as you can see, our long-term performance remained strong with 63% of our overall actively managed assets in the top half of our peer group. In total, our five year performance has remained strong despite challenging market conditions that Marty referenced, to which you're all aware of over the past 18 months.
Favorably and what's not on the slide, we had 40% of our total actively managed assets in the top quartile of our peers on a five year basis, which speaks to our long-term capabilities and a reflection of our quality investment teams.
So let's turn to the next slide to look at early signs of improvement in our investment performance. If you look at slide 14, the market for much of 2017 and 2018 was one fueled by growth and momentum, which should not benefit active management. Our investment team stayed the course, reflecting our strong belief that discipline is critical to producing repeatable alpha through market cycles.
As you look at recent investment results, while it's still early days, we're seeing significant performance improvement in a number of areas. So let me provide a couple of touch points. On the upper left hand portion of this slide, we show our total U.S. mutual fund assets. On a one year trailing basis, performance in the top half of peer groups improved from 11% to 42%, that's the end of November of last year to the middle of January of this year. We've also seen significant improvements in the performance of our largest mutual funds in the U.S.
As important, we're seeing material improvement in the one year peer relative rankings for several strategies that have experienced the greatest flow challenge, as highlighted on the right hand portion of this slide. Specifically, diversified income moving from 88 percentile to 18 percentile on a one year basis; international growth moving from 66 percentile to 46 percentile; developing markets moving from 74 percentile to 46 percentile and UK income moving from 88 percentile to 37 percentile. Again, this improvement was achieved by investment teams staying true to their philosophy and approach.
Now, while six weeks is not necessarily a trend that we recognize the short-term nature of that, we're encouraged by this early improvement in our performance, a continuation of which we believe would set us up for better flow experience in the coming months.
Let me now turn on the next slide to the combination with OppenheimerFunds from an investment perspective. And on slide 15, upon closing the transaction, Invesco will be better situated than it's ever been to serve clients with a more complete comprehensive array of world class investment teams and capabilities that can produce strong relative performance over a market cycle.
Specifically, we believe we'll be better positioned to provide the following benefits to clients post-closing. One, have a stronger deeper investment organization; two, have complimentary investment capabilities that will drive enhanced and more stable long-term investment results; and three, have greater sources of alpha to better align with client needs across the globe and in different channels. So now I wanted to cover these points in more detail given their importance.
Touching on the first of these three points on slide 16. It's very clear that will be better off together that we would as a separate organization. Oppenheimer brings world class investment teams and high demand and high alpha potential asset categories like global equity, emerging markets and international equities. As can be seen from the right hand portion of this slide.
The combination significantly enhances our scale within the U.S. mutual fund market, which will afford us greater platform access and relevance to clients. And we think this is critical in the retail channel as intermediaries are looking to partner with fewer firms. This increased size and scale will also provide greater access to capital markets, which we believe is important and obtaining greater access to deal flow, research and firm exposure.
So if we can now turn to slide 17. As mentioned earlier, Oppenheimer brings very strong performance track records, which improves our combined position in the marketplace. Moreover history suggests our complimentary investment styles and capabilities will produce stronger and more stable investment performance on a combined basis. And the chart on this page supports that assertion. So I wanted just to give you a little bit of backdrop on it.
If you look at rolling three year performance since 2010, the batting average for having 60% or more of our U.S. retail assets under management in the top half of the peer group would have been 66% of the time for Invesco standalone, 83% of the time for Oppenheimer standalone and 89% of the time for the combined firm. And this improved performance for the combined firm over the standalone firms would have shown similar results even if the threshold were made higher.
So driving home this point, Oppenheimer's performance is often Z when Invesco's performance is A and vice versa. Indicated by the fact that the performance between the two firms has been inversely correlated for the vast majority of time since 2010. And what this means from our perspective is the transaction better positions us to promote products and solutions with stronger combined performance through the full investment cycle.
So let me now turn to the final slide in my section on 18. And as we discussed, the expansion of our investment capabilities will provide us with an all-weather product suite to better meet the needs of our clients across the globe. And specifically, having a more diverse set of strategies will improve our ability to meet the unique and varied needs of clients on a product-by-product basis. And in addition to that having greater sources of uncorrelated alpha will enable us to better customize outcome oriented portfolios and deepen our partnership with clients.
We think this represents a massive opportunity for us to increase our relevance to clients by leveraging this enhanced product suite with our leading solutions capabilities across our global distribution network within both retail and institutional channels. So with all this, we could not be more excited about the opportunities created, because of this combination and the positive impact it will have on our clients globally.
So I'm now going to turn the call back over to Marty.
Thanks, Greg. So if you turn to page 20, I'll pick up there and just spend a minute talking about an update on Oppenheimer and to level set, let me put in a context of what I talked about earlier. We have been aggressively repositioning the business over the last number of years, where we think clients are going and where the industry is going. And we've done this by focusing on strengthening our leadership positions in core markets, while at the same time investing in areas where we see rapid growth and client need, ETFs, China, digital platforms, factors, et cetera. You all know that quite well.
But let's put Oppenheimer in the context of that. And it's really the combination of Oppenheimer and the relationship with MassMutual that will accelerate this work. Clearly, we get an expanded leadership position in the U.S. wealth management channel with Oppenheimer, it is actually very important, it is the largest pool of assets in the world and most competitive and being relevant to those client matters enormously. It will strengthen our ability to execute in a number of these high growth areas that we've talked about in the past.
And also and I think very importantly, in particular, in light of this market where we talked about it before you can actually see the unique opportunity for us to create greater operating leverage and scale throughout combining the two organizations.
We're going to do this by using the framework that we used in the past, it served very, very well I'll get in the greater detail about in a minute, but it does the obvious, it's eliminating complexity, location optimization, focusing on rationalization platforms and the like. Yes you save money, but quite frankly we generate greater resources and build a better business and that's the point that I want to drive home as we talked about this.
So let me give you an update on where we are during the quarter, an awful lot got done during the quarter and I want to thank everybody in both organizations it's been quite exciting and a lot of good things have been happening. So I do want to start by making a point that confirming the synergy target that we talked about initially $475 million we feel very confident about that and we also feel very confident that we're going to be a stronger business coming out of it.
Greg's comments highlight some of that in particular, there is no question we'll be a stronger more talented organization post the close, which is what we have been focused on from day one. I also want to reiterate a key element of the value of the transaction is really the highly complementary initiative investment team, which Greg artfully described in a very clear way.
The Oppenheimer investment teams are really excited to be the part of the combine firm. They do have a strong retention program in place, which is important now. But the reality is it's the culture in the combine firm and feeling impart of something important and special that matters and collectively I think we are making that happen as an organization.
A very important milestone happened during the quarter and that was the OppenheimerFunds Board of Trustees approved the transaction. And this is foundational and a real catalyst for us to achieve the synergy targets that we've talked about initially. The mutual fund proxies have been filed with the SEC that will be in the market soon as you know that becomes another gating factor to close. And then finally, we are actively engaged with MassMutual future partnership opportunities. So again, very good progress during the quarter.
Let's turn back to the financials. We wanted to come back and sort of recap the financials in light of that very, very difficult fourth quarter. I think what you'll see is they remained stunningly compelling still, so if you - EPS accretion remains very strong if you look on a pro forma basis, it'll add $0.10 in 2019 and that's assuming the close, so for Q3 and Q4 so half of the year.
When you look at 2020, we expect the accretion to be $0.52 per share and if you look at assets under management at 12/31/2018, the IRR 16% it is down three percentage points from time of announcement, but again extremely strong returns in light of the market that we've just been through. And as a result of the combination and inclusive of the expected run rate synergies of $475 million if you looked at 2020 we'll add more than $800 million EBITDA we have an operating margin in excess of 40% and the combined annual EBITDA will be $2.5 billion.
So again, in light of a very, very difficult fourth quarter the financial returns are very compelling to shareholders to say nothing of a firm just being dramatically stronger than prior to the transaction.
So let's spend a little more time go in a greater detail on the synergies. And on page 23 we've laid out the various categories for the opportunities that are emerging. We have robust plans in place heading towards closing and through execution many of which are in execution, consolidating key platforms, addressing overlap in areas such as distribution, consolidating the product support functions and moving to common technology and infrastructure plan. So well underway right now and these are the areas where we see the emerging synergies coming from.
Some of this will be done by day one and other activities will accelerate post close due to regulatory reasons not permitting us to get start ahead of time or frankly a very important part of mitigating our client experiences. All of these activities continue to drive further decisions helping us further refine our location strategy, reduce complexity in the organization, identifying a stronger talented group of people with the organization and the reduced cost and benefits for clients and shareholders ultimately.
And I do want to reiterate, we're taking advantage of this very unique opportunity to materially strengthen the combined organization, while gaining operational scale. Those opportunities don't come along very often and this is one of them and our heads are down on it. We are using a framework and approach that has serviced very well in the past and I just want to make the point again I have a high degree of confidence our ability to get the synergy target and the fact that we will be a much stronger organization post close.
So let me sort of recap before up we open up to questions. As you all know, prior to 2018, we had nine straight years of positive net inflows and as we've talked about last year that that was not the case with the negative market dynamics and the various styles of our approaches. We are disappointed to be in net outflows, but it comes with the territory. Greg made the point, we have a high degree of confidence in our investment teams and the performance and yes, we'll continue to strengthen those the market continues to evolve.
That said, we've made great progress in continuing to invest and repositioning our firm ahead of where we think client demand is and where the opportunities are. And I want to reiterate the combination with Oppenheimer will accelerate these efforts, driving further growth in trading scale and client relevance for us as an organization.
Post close, we'll have approximately $1.1 trillion in assets under management, putting Invesco in a very strong position to serve clients grow our business and provide compelling financial returns for our shareholders.
So with that, I will stop and Loren, Greg and I are happy to answer any questions anybody may have. Operator?
[Operator Instructions] Our first question is from Ken Worthington with JPMorgan. Mr. Worthington, your line is open.
Hi. Good morning and thank you for taking my questions. First on expenses, there is clearly seasonality in 4Q for your non-comp expenses, but maybe why weren't you better able to pivot given market conditions when the market started sort of weak earlier in the quarter? And then Loren, were there any pull forwards in expenses from 1Q 2019 or 2019 in general into 4Q, such as the prepaying of marketing or other expenses? And then, I guess maybe lastly, how much cost cutting from your efficiency program was realized in 4Q both actual and the run rate of savings as we go into 1Q?
So Ken, let's say in terms of expenses, a lot of the expenses related to marketing were planned probably well in advance of being in the fourth quarter. So these are product launches, these are events that have been sort of scheduled and committed to. So there isn't as much sort of near-term flexibility around marketing expense management as you might think.
Obviously, as we got into the more challenging parts of Q4, what we could pull back we did, but it was really not enough time to really move the dial on the market expense. But I would say that generally there's about $10 million of what I would call sort of unusually high run rate levels of marketing expense that should be taken into consideration.
In terms of any pull forward, no, there was nothing pulled forward from Q1 into Q4. Again, I think the Q4 numbers as I've mentioned were punctuated by some higher expenses, particularly around G&A as well, which was about $6 million of probably one-time cost that should be considered in terms of what a true run rate would look like for us.
In terms of the cost cutting, we feel like we're absolutely on track in terms of the optimization. And so in terms of achieving the total goal of run rate expense savings, I think we are at that level, maybe a little bit still going to happen in Q1.
Okay, thank you. And just on the balance sheet post Oppenheimer, it seems like some of the feedback that you're getting suggests that investors characterize the preferred as dead and thus see Invesco as a highly levered asset manager. With this in mind, are your thoughts - what are your thoughts about the priorities for cash post Oppenheimer? And does deleveraging take priority over buybacks once the $1.2 billion commitment is complete?
Great question. So I do believe we're sensitive to the leverage clearly, but we do feel that the $1.2 billion is something that we need to do as part of this transaction, as part of I think the economics. And clearly we may delay some of it a little bit further into 2020 as opposed to accelerating more in the upfront part of it, but we are still intending to complete the $1.2 billion within the two year timeframe that we originally discussed. We are going to be - clearly looking at the leverage ratio, I don't want to say we're blind to it. Markets will have some impact, it's still I don't want to say it's sort of immutable true that we're going to deliver $1.2 billion. If markets really took another downturn, we might think about it again. But right now where we are, we feel very comfortable completing the $1.2 billion per schedule.
Thank you.
Thank you, Mr. Worthington for your question. Our next question comes from Craig Siegenthaler with Credit Suisse. Sir, your line is open.
Good morning, Marty. Loren. I just wanted to come back to slide 16, can you provide us an update on the potential to merge the Invesco and OppenheimerFunds that are in the same categories? And I know you didn't include this in the $475 million of expense redundancies, which is mostly focused on back office. But there is a lot of product overlap between the two businesses. So just wanted an update here.
Yes. So that is one of areas that we will not turn our attention to until after close for various regulatory reasons. There's probably going to be less overlap than you imagine in that. But I will say there is opportunity, I'm sure there's opportunity for rationalization. And again, after close, we will come back to you and give you some insights. And again, I wouldn't look at it as just unique to the Oppenheimer transaction. Again, it's a normal practice that we just look at our product shelf and make those decisions.
So, I wish I could give you a more clear update, but we're just not in a position where we can do that.
And then my follow up is on the ETF business. You build a large ETF business both organically and through M&A. But the business really didn't participate in the migration to ETFs last year or in the fourth quarter. And I know some of that was the bank loan ETF, but can you give us your view on sort of what happened in 2018 in terms of share loss? And also, how you're positioned for growth in the future?
Yes, look we think this has been a very important undertaking for us. And I think if you just look at where we started and where we are, we think we're very well placed. We do make some important points of - if you look at where the dollars were moving us last year where our lineup was. And as what we said, on the back of Guggenheim we had a lot to build from utilizing
the self-indexing unit and some of the things like bullet shares. The final launches where we think we will be done will be by the end of Q1 of this year. And we feel that we'll be in a very good position to continue to grow. And again I think you're right. So, [indiscernible] other bank loans in life, those are - that's part of what comes with that market.
Thank you, Marty.
Thank you for your question Mr. Siegenthaler. Our next question is from Michael Carrier with Bank of America. Your line is open.
Thanks, guys. Loren, maybe first one for you. Just given your commentary around expenses and more environmental separating it from say the Oppenheimer like synergies throughout the year. Just wanted to get maybe a little bit more granularity on how you're thinking about maybe Invesco like the core expense base going forward relative to say like the fourth quarter run rate?
Yes, absolutely, Mike. So, I think, I was giving you some points around sort of run rate versus one-time. So let's say there's in my mind, sort of roughly $16 million of expense in Q4 that, I'd say were elevated and more onetime in nature related to specific events that won't recur on a regular basis. So if you were to take that out of the Q4 numbers, I would say our go forward into Q1 will be certainly down, flat to down to that number. So we feel very confident that that number into Q1 is going to be at a lower level run rate wise versus where we are in Q4 ex-those one-time things.
Okay, thanks. And maybe one…
Wait, Michael, I think, Marty just want to add…
Yes, I understand, and again, we're being very responsible going through Q1. But I do want to - the organization is going full forced to get this combination done. And I think turning your attention to that is really what matters. There are very, very few opportunities where you can literally create a stronger organization and take out 15% of the operating costs around the world. One in fact this is largely is coming from the U.S. And if you put that side by side, very, very few organizations able to pivot like this in an environment.
So again, it's really the capabilities that attracted us Oppenheimer. But when you look at the scale benefits they are material and real. And I think as we said Q4 really sort of highlight that for everybody is beyond the conversation it's actual fact.
Okay, that's helpful. And then, Marty, just on the organic growth or the flow outlook. So clearly fourth quarter was tough for everyone. I think in the third quarter you guys had some elevated outflows. Just want to kind of get your maybe perspective on what were some of the more unusual things or things that were more surprising versus when you're looking at 2019 with markets stabilizing you guys pointed to some of the investment performance rebound. Where you're seeing some of the sales traction where you're maybe most hopeful that redemptions could slow to start to turn the trajectory around.
Yes. So let me put in context, and again, we feel that we've built a very diversified business by asset class and by geography. But if you look at last year and if you line up the organization you almost couldn't make it up thing didn't serve us well because of the value capabilities we had. You saw that quite clearly what happened that largely impacted the U.S. mutual fund business. Brexit is a real topic for us and you just saw sterling dropped from I think a peak a 1.44 to 1.24. But if you literally look at EMEA and use mutual funds flows as a proxy in the year they dropped by 87% there.
So, I mean - and then you look at the trade wars and people will point so well there's nothing really happened in there. I can tell you our clients went risk off. We had some very good capabilities Asian equity capabilities that got terminated during that. So the notion that you could have trade for as Brexit. And saying disproportionately impacting an organization like Invesco.
I would not have thought that's possible. It's not an excuse, it's just a reality. And again, I think, importantly, Greg, was talking about the depth and breadth of the investment capabilities, the performances these markets are actually good for active management and we're seeing that.
I don't know if Greg, if you'd add to that.
The only thing I'd add to, when you kind of look at our pipeline overall I think there's maybe a couple of areas where that pipeline is starting to see a pretty significant increase in fixed income as kind of one factor we kind of talked about that before is too. And then pockets of the alternative business overall where clients out there need income when they need returns. So specifically within real estate and we're starting to see after a very troubled kind of fourth quarter within bank loans overall we're starting to see an increase in the interest within kind of bank loans.
So in our solutions businesses really being ramped up given the investment that we've made there. And so we're starting to see a number of things come out of that engagement that we're having with clients. So those would be I think if you just look at our pipeline the kind of areas we've seen an increase.
Okay, thanks a lot.
Thank you for your question Mr. Carrier. Our next question is from Dan Fannon with Jefferies. Your line is open, sir.
Thanks. Good morning. I guess, Marty, just kind of building upon your comments about the last quarter and kind of the integration of - and how excited you are about the deal. Can you talk about I guess what you're hearing from intermediaries, consultants, your clients about the transaction? And I know you guys have an outflow assumption based on what you gave us last quarter based on the transaction, maybe update us on if there's any changes to that or how you think that may or may not be conservative?
Yes, look I can speak to my very specific conversation if not every single one of them was incredibly positive. So if you just start with the fundamental strength of where Oppenheimer is in the U.S. wealth management platform the notion of those two firms together that we've had nothing, but very, very strong positive feedback for all the reasons that Greg talked about, right. It's depth of capability, type of capabilities it's beyond investment capabilities what can you serve the clients beyond the investment capabilities. So very, very positive.
There is also institutional clients in different parts of the world that are actually very attracted already to a number of the Oppenheimer capabilities emerging markets, global equities to name two of them. So again, we're just getting very good client feedback of Oppenheimer joining us, but also what we can do together. So again from our perspective the next few months can go fast if we want to get those closed.
The redemption assumption on the - because of the deal.
So I think nothing changed in terms of those assumptions, we're still looking at sort of a $10 billion assumption outflow in 2019 after the deal is completed again that's a degree of conservatism. I think in some ways I mean you're seeing a little bit of the overhang on Oppenheimer flows right now as people are waiting for the deal to close.
And so - but again the good news is it seems to be manageable number, it's nothing that is sort of excessive. We are feeling very confident that once we bring the firms together that we're going to be able to improve the redemption experience for both firms quite honesty.
Okay. So just to clarify a couple of things on your change in accretion, can you just give us the specific factor of the change, I think the timing closed and I think obviously markets. But also, could you just update us since the announcement what Oppenheimer's outflows have been?
So again, I think in terms of the biggest change will be the timing so we only have two quarters of accretion versus sort of roughly the three quarters that we had in the prior assumption. Obviously, we're starting at a lower AUM base for the business, which also has impact on both the first year and the second year accretion numbers. Beyond that all the other assumptions are essentially the same in terms of market and so forth.
The outflow for Oppenheimer, I think is roughly a 4% decay annualized. So again, it picked up a little bit as we've entered the fourth quarter and not to be surprised about that one just generally because of the market environment. So we continue to watch it, but as I said there's nothing extreme or alarming at all in terms of the flow pattern that we're seeing so far.
Great, thank you.
Thank you for your question Mr. Fannon. Our next question comes from Bill Katz with Citigroup. Your line is open sir.
Okay, thank you very much. I think in your press release you had mentioned and a little bit in your prepared remarks that you're still pursuing some cost containment work as well. I was wondering, if you could maybe potentially quantify that? And then, how sticky is that, in other words if the revenue backdrop were to improve would you relax some of that with maybe some delayed spending on the other side of that?
So, I mean, in terms of stopping hiring and freezing it that makes a lot of sense for us in the context of a large transaction that is going occur in the second quarter. We are obviously bringing on a fair number of folks to the combined company.
But I would say that, we are really asking people between now and the time of the close to curtail any hires that they otherwise might want to bring in if they are able to without affecting clients or investment performance really the discretionary elements of what we do. And then, sort of services around training, development, really sort of internal thing that can be delayed.
So some of it is just the time based, can we sort of reduce our spend until we get to the point where the biggest event will be sort of reducing 15% of the combined cost of the firms coming together that is by far in a way the bigger impact. We are looking at - I mean, with that said are there sort of longer term opportunities to reduce cost on a permanent basis as opposed to some of the things that we just talked about.
So that is still happening, but those things take longer and again it is going to be impacted by bringing the two firms together, we see a lot of opportunity to do that.
Okay. Just as a follow up two part question, so thanks for taking both of them. In your guidance you also mentioned the pro forma EBITDA being $2.5 billion versus previously $3 billion. So I was wondering, if you could unpack that and I guess you gave some of that around the Oppenheimer assumptions. But how much of that comes from sort of the legacy footprint if you will? And then, as we look into the new part of the year any qualitative or quantitative update on how the flows are both at Invesco standalone as well as Oppenheimer?
So the reduction in EBITDA is really a function of lower AUM for both firms that is just quantitatively what is driving our EBITDA numbers down. Nothing more in terms of sort of unpacking, it's really just lower earnings. I think in terms of sort of the preview into the quarter I think we feel that there's a lot of variability right now. And so, we're sort of hesitant to sort of provide glimpses into the quarter. We think it will be a better result if we can sort of talk about that when we see all three months' completed as we - and you will see the monthly releases as they come through.
Okay, thank you very much.
Yes, thanks, Will.
Thank you for your question, Mr. Katz. Your next question is from Alex Blostein with Goldman Sachs. Your line is open.
Hey, good morning, guys. So maybe just a couple of specific questions, I know we're kind of go through some of these numbers already. But could you guys give us just the Oppenheimer ending AUM revenue run rate and expense run rate where things done today?
I don't have that detail for you, Alex. Obviously, we have the AUM of 213 to 214, I think is the number that we provided. So, again, I think it will scale down, revenue will scale down, you should expect kind of literally with the AUM.
Got you. And in terms of the purchase price. So, understand, obviously, the market conditions got a lot worse. But, the $0.52 accretion in 2020 or 30% below the $0.80 that you provided in the last call. Can you talk a little bit about it, there's any room to negotiate the purchase price I think there was something there as it relates to flows, but was wondered if you could flash that out a little bit.
Yes, I mean in terms of the flow, there are some contractual sort of adjustments related to outflows between now the close - or the type of close if we aren't successful bringing over client assets as well there's an adjustment there. So it's a pretty significant hurdle for that to kick in.
I think it has to be at least 7.5 percentage points and it's done on a revenue run rate. So - and at that point and below is when the adjustment happens. So anything between 0 to 7.5 there would be no adjustment made on the purchase price. And Marty, I don't know if you want to talk about sort of concept of renegotiating that's not even a thought.
I think we're contractually bound and happy to continue.
Look, I turn your attention to the financial returns that you just put in front of you after a very, very difficult market are quite compelling. And again, we're going to be dramatically stronger firm coming out of it. So…
I would say, I mean, obviously markets have improved off that point. I think, sort of 3.5 and above percentage points rose where we are. So all those numbers are going to look better in light of just a few weeks of January coming through.
Okay, fair enough. Thanks.
Thank you for your question, Mr. Blostein. Our next question is from Brennan Hawken with UBS. Your line is open, sir.
Good morning. Thanks for taking the question. So just to clarify on the triggers that Alex just asked about. I think you said 7.5% decay rate, is that annualized in the period from announcement to close? And while I appreciate that is at a 4% decay rate, a lot of that seem to come in the fourth quarter post the announcement.
It's hard to unpack exactly how - what attributed to that decline, the announcement of the deal versus a very difficult market period. But when you update us on the $10 billion number or did not update the $10 billion number, that's post to close. So it would anticipate potentially some of those outflows happening ahead of close. Can you just sort of flush that out a little bit for us, please? Thanks.
So, I mean, what we're doing this is taking the 214 assuming flat markets through the close and then $10 billion out, right. So it's not a not a refined sort of when it happens. But if it happens before 214 sort of becomes 200 before the close, it's essentially getting the same place, right.
So it's not a - that we assumed that outflow was almost immediate when it kind of happened - when the deal happen. So I don't think it would affect the deal economics in terms of when the flow happens it's really just the fact that is $10 billion less off of the 214 numbers, right? So that's the assumption that you should be looking at for those deal economics that still work.
Okay. And then the 7.5% decay that you required is that annualized?
So there is two things, so one there's so that you can look at the filed documents in terms of the contract just all the details there and it's probably a little more complicated I'm making. But that's our run rate, that's a 7.5% revenue run rate decline off of what was originally put in place due - purely due to clients not coming over through the deal. So, I think it's just important to note that, again, there's details around that, I don't know if it makes…
It's a common practice, we have these transactions.
Okay. And then, when you guys had announced it initially, you had indicated that you had a repurchase that you're going to be executing in between announcement and close. Can you give us an update on your expectations for those repurchases and the timing, et cetera around those?
So I think we had said originally $400 million to $600 million prior to the close, obviously we've done $300 million of that already and then the rest being done after that. We're still looking at the market; we're looking at what happens to stock price. So, I mean there's all sorts of elements are coming to our repurchase decisions. We're sort of exiting the blackout period, so we're going to be able to begin to transact again in our stock. And again, also just mindful of the leverage ratios and so forth. So we're going to be sort of reasonably conservative around the pace of buyback prior to the close as you would expect.
Thanks for taking my questions.
Yes, thank you.
Thank you for your question, Mr. Hawken. Our next question is from Brian Bedell with Deutsche Bank. Your line is open, sir.
Great. Thanks very much. Maybe just coming back to the one more in the cost saves of the $475 million. Just to get it clarified, I think I may have missed this, I think you think the deal is now closing closer to the later part of the second quarter. And then, on the expense synergy on that timing through 2020, can you just give us - just reaffirm sort of that trajectory? And then whether you can - whether you think you can actually accelerate those back office saves given the environment? And then, the walk down of the margin from over 45% to 40% post synergy is that all due to the lower AUM and market conditions?
Yes. So, Marty you can jump in if you want.
Why don't you start, I'll hop on.
Okay. So, I mean on - so in terms of the $475 million, you should expect that because the close has been delayed effectively a quarter that our timing around capturing synergies is going to be more pushed into the first quarter of 2020, getting that sort of numbers that we were talking about, 75%, 80% of synergies just because of share timing. So that's kind of one point.
I think in terms of the margin, being 40 - around 40, greater than 40, that's all just due to AUM levels. And so the associated impact. Again, that would be better today just because of the lift that we've seen in the markets with respect to both firms. So again, we'll obviously continue to look at those deal economics very sensitive to where markets are, but again hopefully we've sort of hit a bottom and we'll see more upside in these deal economic numbers.
Yes. And I would just add, the platforms and the like. Look, these are big undertakings. Now we do know how to do it, we have a history of doing them well, we'll do them as quickly as possible. But also very importantly, we got to meet - you got to serve your clients, you need to do a good job. So again, I would come back to the big picture. We will hit $475 million, we will hit the margin target as we talked about markets and it's a very unique opportunity for us to frankly build some very important scale into the organization, which we will do.
Great. Okay. And then, as you think about the growth - the revenue synergy and growth opportunity, this is going back to your comments about being able to launch new product structures using Oppenheimer investment management talent on those products and also expanding them geographically into Europe where they don't have a big presence.
Is - I guess the spending around those growth initiatives - how do you think about that like the timing of that? Is that something that you would prefer to get a handle first on whether you're going to combine any investment teams and then go about that process or would you rather try to get that product into these new structures and geographies sooner rather than later and maybe sacrifice some of - have some additional expense against that?
Yes, I think the beauty of the combination is the incremental spend is not very much. The quality of the investment teams are there. We have an institutional distributional capability. There is demand for it. So pace will be determined by the clients and their appetite. And as you know institutionally it takes time to go through those processes. Oppenheimer already has a non-U.S. range, a SECOP [ph] range that frankly it's getting it into our distribution capability.
So again, those are things that will come pretty rapidly. I do want to come back to there is no revenue synergies in these numbers from going to the institutional business or the non-U.S. business or anything between MassMutual and ourselves. And that's just fine, but there's none of that in that as we move forward.
And just the timing on that, on the expectation of doing those. Is it synergizing that Oppenheimer product? Would you wait for product teams to be combined first or would you kind of just go right out those synergies?
Look, there are already conversations with what the teams and what the opportunities are. And also we're in deep conversation with MassMutual about what we can do. But again, I don't want to set an expectation other than we will execute and what's in front of us. But the combined firm together and a relationship with MassMutual is going to be an important one.
Okay, great. Thanks very much.
Thank you for your question Mr. Bedell. Our next question is from Kenneth Lee with RBC Capital Markets. Your line is open, sir.
Hi. Thanks for taking my question. In terms of the - just a question on the OppenheimerFunds.
I think on the last call you mentioned that fee rates have been trending upwards over the last few years. Just wondering what's the expectation over the near-term? What factors or mix shift could push that fee rate either up or down? Wonder if you could just give us a little bit more color there. Thanks.
Yes. I'll maybe start and Loren can add. Look it's no different than us. Our effective fee rate what you see trending down it's really - it is a mix shift topic for us. And you would imagine in risk off environments, people putting money and money funds, et cetera that you see that happen.
Oppenheimer during the period had the exact opposite. There was an aggressive or I shouldn't say aggressive quite successful in emerging markets and international equities and those are higher fee capabilities. And again that is sort of the natural flow of things within an organization. So client demand will drive those mix shifts. There's very little we can do about it.
Yes, and I'd say, I mean from what we can see, their fee rate is very stable. So nothing is really - even though the market has been sort of negative, I think they've continued to offset that through growth in the alternative platform. And so, overall I'd say it's pretty stable.
Got you. And just one a bit of a housekeeping. Some details behind that $5.5 billion LOP mandate redemption you mentioned, which asset categories were those located? Thanks.
So that was mostly fixed income. There was a little bit of equity component all single-digit basis points.
Got you. Very helpful, thanks.
Thank you for your question. Mr. Lee. Our next question comes from Patrick Davitt with Autonomous Research. Your line is open, sir.
Good morning, guys. Thank you. Earlier last year before you announce the Oppenheimer deal, there was a lot of focus and chatter from you guys around 2019 optimism on flows from newer initiatives, in particular, Gem Step [ph] getting ramped up with some new distribution pipes. Could you walk through your expectations on that now?
Has the ability for that to generate a little bit more incremental flow changed, or has been pushed out or pulled forward? Now you're really focused on Oppenheimer, but it'd be helpful to get an update on some of that stuff as well.
Yes. So we're still on track second quarter of 2019 is when are the largest client that we've sort of one business from is going to start using and putting into production the Gem Step capability along with our models. So we will begin to see flows in revenues coming from that immediately into the second quarter. Again, I think it is one of these things that we said is going to build, it's not going to be sort of a flood of revenues and AUM immediately.
But given the size of this client and the breadth and scope of the advisors they're using and how the model they are going to play out, I think it will built into a material number as we get into end of 2019 and into 2020.
The pipeline for Gem Step is still very strong, continues to win business. And so that is, again progressing, but it is as we said slower than anybody would have possibly had originally imagined in terms of the actual going from the design, to production, to execution just takes time.
I'd say the other thing just in terms of the thing that we are excited about around ETFs and institutional business, China factor-based investing, I mean all of these capabilities is growth engines that we so called characterized have just been growing as a percentage of our overall sales every quarter. So we do see that as being an increasingly important factor in terms of our success. And so the investments that we've made, which we've talked about I believe are paying off for us and will even more so into 2019.
I've got a quick follow up. You mentioned Brexit earlier and I think everybody has kind of decided to trying to handicap what happens there, will be vital at this point. But as that plays out through March and April, have you done any work to kind of gauge how much worse the outflows in the UK business could be if it goes bad? And conversely how much better they could be if it goes good?
Yes. So it's a good question. Everybody is doing those types of calculations, but what I would say and I mentioned this earlier, Brexit for our business really didn't become real until this past year in the second half of the year. And as I've - it's just not the UK it's on the continent too. And I mentioned if you look at flows across, it's literally down 87% year-over-year that - it has been risk off environment like you really can't imagine.
So I don't know what's going to happen with Brexit, there are a lot smarter people than me on it. We spend a lot of time on it, it's important to us. But Loren was talking about this quarter if my perspective and the organization's perspective, if you take a no deal Brexit off the table and it looks like there will be some different outcome, I think that would be very positive for investor sentiment, client sentiment and I would imagine we would be in a better position when you look at clients getting back to making investment decisions. That's how we're looking at it.
The other one that is a headwind that we'll see what happens is the trade negotiations between U.S. and China that is a headwind for us. So anything that moves into positive manner is again I think about positive development for us.
Yes. And maybe just a bit of information. So one, in the quarter, Q4, the UK equity outflow was under $1 billion. Still a big number, but again in terms of overall size of AUM, it's sort of manageable number. And the other point is, we did just because of the uncertainty around the Brexit outcome, we did hedge through the full 2019 using similar strategy that we've used in the past around hedging the operating income for struck at 1.25 as sort of insurance policy.
So if the pound were to drop below 1.25, I would say this insurance policy would protect us on the down side at worst case scenario. So anyway just so people know, we have it through 2019.
Thank you for your question Mr. Davitt. Our question comes from Robert Lee with KBW. Sir, your line is open.
Great, thank you. And guys thanks for your patience in taking all the questions this morning.
Yes.
And again sorry to maybe go back to the expense saves, but I just want to make sure I understand everything correctly. So, I guess, what I'm trying to square is - I mean still the expectation of ultimately an 800-ish EBITDA contribution if I have that number correctly with the lower kind of accretion. So should I was simply be thinking that how you're going to still targeting that, but really maybe some of that benefit because of the later close and timing kind of leads it into 2021, so that's why 2020 is kind of coming down. Am I thinking of that correctly?
No. So I just want to be really clear on this. So the accretion numbers that - for 2019 and 2020 that we laid out, it is based on I mean our expectation of getting to close having the two quarters this year full next year. Then the run rate impact of a $475 million through the programs that we outlined that are in place right now. We know how to do this, we've done it in the past. And the only change that drove the EBITDA from $3 billion to $2.5 billion was the market.
And so, there is - we don't expect or believe the reason why the quarter went back was you really have to get - getting through mutual fund approval is just critical. And that happened at the end of the year into January and other than that we're on track. So again, we have a high degree of confidence that we'll get this done.
Great. And maybe just to confirm the guidance from a share count perspective, basically where you finished post the share repurchase you've done already plus what you're going to issue and that fit kind of no incremental that filling in the rest of the $900 million every purchase between now through call 2020?
Yes, so I mean again I think let me just specifically your question is, timing of the 1.2 or…
Well, no more like if I think of 50-ish cents accretion in 2020 you're not - is there additional share repurchase kind of baked into that from this point forward or you just kind of pro forma we are today plus what you're going to issue?
Yes it's - I mean it's the exact same pro forma where we are today, what we're going to issue and then buyback as just previously described. The 400 to 600 prior to the close and the rest on was in the year after the close.
Okay, great. That was it, guys. Thank you.
Thank you very much.
Thank you for your question Mr. Lee. Our next question is from Chris Harris with Wells Fargo. Your line is open.
Thank you. Hey, guys. So on the improved investment performance you're highlighting here, I wonder if you can talk about that a little bit more. Is that mainly attributable to the value style investing coming back or is there something else going on? And if it is kind of an improvement in value should we be assuming that potentially about saying then for the Oppenheimer business?
Yes, so Chris thanks a lot for the question. I think there's a couple of things that are going on I think one of which I mentioned in my comments when we're kind of going through the prepared remarks, a lot of it is just the change in momentum driven stocks that were really a big driver of the market. That really changed or started to change when we moved into December and kind of into January. And so it's become over that time period and hopefully that will continue much more conducive environment for active management.
So it's just the stock selection was really the big driver there. And specifically momentum it was driving a lot of stock performance kind of changed if you will there was a component of that that could be a little bit of kind of value in growth, but that really wasn't the biggest component if you will that would contribute to that performance if you will.
In terms of the second part of your question I mean, I think as we kind of highlighted that we're going to zig and they're going to zag, which we think is a really good thing when you look at stock selection and uncorrelated sources about if you will.
So some of their strategies in the very short run they have fallen off a little bit not necessarily specifically related to the fact that value has come more back into it, I think the headline for what we're really trying to point out is when you look historically at our performance and their performance it's very uncorrelated sources of alpha we think that's very important for our clients kind of over the long on.
Got it, thank you.
Thank you for your question Mr. Harris. Our next question is from Michael Cyprys with Morgan Stanley. Sir, your line is open.
Hey, good morning. Thanks for your patience and taking the question. I just wanted to circle back to the strategic partnership that you have with MassMutual. Can you just talk about what that will entail, how formalized it is and how does Invesco - how do you ensure you get what you need from it in say three or five years' time? Just in terms of the level of commitment and alignment. Thank you.
Yes, Michael, this is Marty. So look, we've a very good relationship with them. They have a material interest Invesco and the alignment of interest starts right there and that's not going to move. Roger is very clear about the long-term nature of wanting to be in the asset management business and that's how they view this transaction it was just broadening their exposure to the sector. And what we are right now assuming a big broad range of conversations of what are the things that we could do together that it could make a difference in the marketplace.
And again, I'd rather come back with facts then to get ahead of it and right now we are assuming zero revenue synergies from anything other than the core Oppenheimer business.
Got it. Okay. And then, just if I could ask a follow up just quickly here, on liquidity in the market and the credit cycle just be curious to hear your perspectives on any sort of implication of a turn in the credit cycle just given the buildup in leverage by corporate to cycle with a larger portion going into daily liquidity funds such as high yield bond funds and loan funds many of which you guys manage? So I guess what sort of risk does that present to the industry? And what's being done to mitigate such risk and how do you see this playing out?
So we're looking pretty closely and I think it's probably a very long winded answer to probably address the heart of your question. So we are - we certainly are seeing those things that you kind of referenced play out if you will. I think the main part that we're dealing with is really looking at from a client fiduciary standpoint, the liquidity within our funds, the ability to be able to respond to that liquidity if you will.
I think the size and scale and a comment that I kind of referenced from a capital markets perspective I think is kind of helpful in our ability to get access to the capital markets and be able to hopefully get improved liquidity in areas like that.
So, the implications I think are multifaceted, when you kind of talk about the industry. So maybe in the second time I'll kind of - just kind of stop there in raising your question.
I would say though in terms of like our bank loan product we saw absolutely no issues in terms of managing through volatile markets and sort of addressing the redemptions. So it was all done really with no issues. Given the way that we manage that product. So again one data point, but probably one that's relevant certainly for Invesco.
Okay, thank you.
Thank you for your question, Mr. Cyprys. Our last question is a follow up from Alex Blostein with Goldman Sachs. Your line is open, sir.
Good morning. This is actually Ryan Bailey on behalf of Alex. I guess a question for Loren on the standalone Invesco expense base for 2019. So if we look at expenses for 2018 ex distribution looks like it's about $2.4 billion. Can you help us think about where we should be resetting for standalone Invesco given current AUM levels? And then some of the cost initiatives that you outlined excluding what was happening with the deal synergies.
Yes. So I think I touched on it a little bit when we're sort of looking into the first quarter versus where we are fourth quarter we are - if you look at the $619 million, which was quarterly expenses in Q4 you subtract out the $9 million kind of one-time expenses that I was talking about I mean you're sort of in a $603 million kind of run rate. And we said we're going to be down from that number.
So again - and that first quarter also includes payroll taxes and so forth, which tend to go away. So again it is a little hard to sort of talk about the full year because we're obviously doing this large transaction and that's the plan. And so, we're planning on taking out 15% of the combined business and post close there is no standalone Invesco anymore. So it's really the combined company.
But I would say in terms of thinking about us the run rate guidance that I just provided should give you the right standalone view if you want to just extrapolate that assuming flat markets across the year.
Got it. And maybe just if I can sneak one more in. What's the minimum amount of cash we should be thinking about that you'd need on the balance sheet just given the seasonal expenses you just mentioned for kind of the first half and then any integration costs?
So again we - again our capital policy has not changed. We are targeting and continue to target $1 billion of cash in excess of what is required from a regulatory capital perspective largely driven by the rules in Europe that requirement in Europe is somewhere between $600 million and $700 million of capital that needs to sort of stay on the balance sheet. And so we'd have roughly $1.7 billion would be kind of the target on a go forward basis.
Got it, thank you very much.
No problem.
That does conclude our Q&A session of today's call, I'll not turn our conference back over to Martin Flanagan.
Again I just want to thank everybody for participation in the questions and look forward to speak with everybody soon. Have a good rest of the day.
That does conclude today's conference call. We thank you all for participating. You may now disconnect. And have a great rest of your day.