Artisan Partners Asset Management Inc. (NYSE:APAM) Q4 2023 Earnings Call Transcript
Artisan Partners Asset Management Inc. (NYSE:APAM) Q4 2023 Earnings Call Transcript January 31, 2024
Artisan Partners Asset Management Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good afternoon and welcome to the Artisan Partners Fourth Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator instructions] Please note, this event is being recorded. I'd now like to turn the conference over to Eric Colson, Chief Executive Officer. Please go ahead.
Unidentified Company Representative: Welcome to the Artisan Partners Asset Management business update and earnings call. Today's call will include remarks from Eric Colson, CEO; Jason Gottlieb, President and C.J. Daley, CFO. Following these remarks, we'll open the line for questions. Our latest results and investor presentation are available on the Investor Relations section of our website. Before we begin, I would like to remind you that comments made during today's call, including responses to questions, may include forward-looking statements. They are subject to known and unknown risks and uncertainties, including but not limited to the factors set forth in our earnings release and detailed in our SEC filings. Risks and uncertainties may cause actual results to differ materially from those discussed in the statements, and we have no obligation to update or revise any of these statements following the presentation.
In addition, some of our remarks today will include references to non-GAAP financial measures. You can find reconciliations of those measures to the most comparable GAAP measures in the earnings release and the supplemental materials, which can also be found on our Investor Relations website. Also, please note that nothing on this call constitutes an offer or solicitation to purchase or sell an interest in any Artisan Investment product or a recommendation for any investment service. I'll turn it over to Eric Colson.
Eric Colson: Thank you for joining the call or reading the transcript. For us, these calls are an opportunity to repeatedly communicate who we are, what we seek to accomplish, and the time horizons that matter to us. We intentionally de-emphasize quarterly and annual outcomes. Instead, we focus on what we are doing to create and maintain an environment and culture that maximizes the probability of long-term performance for clients, talent and shareholders. Artisan Partners is a high-value-added investment firm designed for talent to thrive in a thoughtful growth environment. Our purpose is to compound wealth for clients over long time periods. We do this through our talent-driven business model. We attract, recruit and partner with exceptional and differentiated investment leaders, and we give them autonomy, resources and time to generate investment returns over long time periods.
As Jason will discuss, we have been doing this for nearly 30 years in public equities, for a decade in fixed income and are in the early innings in alternatives. Time is a crucial ingredient in what we do. We protect the time of our investment teams so they can maximize time spent on research, investing and adding value for clients. We work to earn time to extend duration. We do this by being true to who we are, by maintaining a culture focused on long term, by avoiding the temptation to engineer short term results, by remaining disciplined through difficult periods, by constantly communicating our time horizon to clients and shareholders, setting the right expectations and doing business with individuals, allocators and institutions that are aligned with our long term approach.
The chart on Slide two reinforces why we focus on the long term. Short time periods are noisy. Skill and luck are indistinguishable. Over longer periods, the value of process and discipline become apparent. As we extend time, the value of what we do becomes evident. Of our five strategies with 20-year track records, all five have added value over the period after fees. With enough time, alpha can compound into meaningfully more wealth for clients and investors, a simple example of which is on the right side of the slide. We take a similar long term approach to developing our business. We look for opportunities that are consistent with who we are and where we have an edge. We are methodical. We don't chase fads. We remain focused on high value added investing.
If we do these things with patience, we are confident that quality long term outcomes will follow. I've asked Jason to elaborate on this approach as it applies to our investment platform.
Jason Gottlieb: Thank you, Eric. As Eric mentioned, we have been building equity franchises for nearly three decades. We are a decade in with fixed income and are in the early innings with alternatives. I want to start with our equity businesses. Today we have eight equity investment teams and 16 strategies accounting for $137 billion in AUM and approximately $900 million of annual revenue. Several of our equity teams are well established franchises with recognized leadership, depth of resources, disciplined investment processes, unique cultures and long term track records. These characteristics result in powerful and durable investment and business engines, but it takes time. The path is not linear and there are periods of decline as well as growth.
Slide three features our international value franchise. Lead portfolio manager David Samra joined Artisan 22 years ago and launched the international value strategy. David has a well-articulated value investing philosophy and process that the international value team has applied with discipline through market cycles. The result is outstanding investment performance over long time periods. The international value strategy has generated 466 basis points of average annual alpha net of fees since inception. The Artisan international value fund is ranked number one in its Lipper category. You can see the business outcome on the page. The team laid the foundation in the early years, establishing themselves and their track record. They have steadily grown their business by compounding client capital and net new flows.
Today the team manages $41 billion across a diversified book of institutional and wealth channel clients. In 2020, Beini Zhou and Anand Vasagiri joined the international value franchise and partnered with David to launch the International Explorer strategy. The International Explorer now has a three year record. It has generated 549 basis points of average annual alpha net of fees since inception, is managing nearly $250 million in AUM, and is poised for future growth. The international value franchise demonstrates the demand for high value added investing in public equities. The result is a highly valuable business asset that can compound long into the future. We have multiple examples of this throughout our equity business. Turning to Slide four, we expanded into fixed income 10 years ago with the addition of Bryan Krug and the credit team.
The fixed income opportunity set is compelling. The asset class is large and growing. It is complex with tremendous opportunity for skilled talent to add value for clients, and there is asset allocation demand, with aging populations creating the need for income and yield. We believed 10 years ago that the success of our talent-driven business model and long-term approach would translate to fixed income, provided we partnered with the right talent, focused on high-value-added areas, fully resourced the effort, and took the time necessary to build a solid foundation. We are beginning to see the long-term outcomes. The Artisan high income strategy is nearing its 10-year mark. Since inception, it has generated an average annual return of 6.18% after fees, compared to 4.31% for the index.
Over that time period, the Artisan high income fund is ranked number one out of 324 funds in its Lipper category. As a result, the high income strategy has generated $1.5 billion in net flows in 2023. In 2022, we launched our second fixed-income-oriented team, the EMsights Capital Group, which focuses on emerging markets. We are proving that our platform, philosophy and approach can work in fixed income, evidenced by steady growth in fixed-income AUM. We believe we are establishing two world-class fixed-income franchises with significant investment capacity. It will take time, but we believe these franchises will be every bit as successful and sustainable as our equity franchises. Turning to Slide five, in the same way that we have methodically built our equity and fixed-income businesses, we continue to build our alternatives capabilities.
We remain in the early innings. We are focused on setting the right foundation, adding investment degrees of freedom, designing and launching strategies where we have an edge with talent and an opportunity to grow over time. We believe that fixed income provides a natural avenue to continue expanding in this direction. Our credit opportunity strategy now has a six-year track record and has generated an average annual return of 9.84% since inception net of fees. The more recently launched global unconstrained strategy has generated an average annual return of 8.92% since inception net of fees and during the fourth quarter, we closed $130 million of commitments for our first closed-end fund designed to capture opportunities in dislocated credit markets.
While we remain in the early innings, we are confident that our model and philosophy will work in alternatives like it has worked in equities and fixed income.
Eric Colson: Thank you, Jason. We remain extremely excited about the long-term investments we are making across equities, fixed income and alternatives. Our excitement stems from a proven approach across asset classes and time periods, successful long-term outcomes for clients, shareholders and key investment talent and the limited supply of homes for investment talent providing our combination of autonomy, resources and time. We will continue to think in decades versus years or quarters, and we will continue to focus on those things that we can directly influence day in and day out in pursuit of long-term success. Thank you for your time, and I will now turn it over to CJ.
C.J. Daley: Thanks, Eric. Our 2023 results reflect the impact of a rising market and strong investment performance. Market volatility experienced in 2022 and 2023 highlights the importance of our financial model. We maintain a highly variable expense structure to minimize the distractions of short-term market volatility. As we've shown in the past, our financial model is able to deliver stable and predictable results through market cycles. An overview of our financial results begins on Slide eight. Assets under management ended the fourth quarter at $150 billion, up 10% from the September 2023 quarter, and up 17% from the prior December year-end. Investment returns contributed $14.6 billion to the increase in AUM in the quarter.
Net client cash outflows during the quarter were $400 million, and there was $500 million of Artisan funds distributions that were not reinvested. Average AUM for the quarter was down 1% sequentially, and up 10% compared to the December 2022 quarter. The full year, investment returns contributed $27 billion to the increase in AUM. $3.9 billion of those returns were attributed to investment performance in excess of benchmark returns. Net client cash outflows were $4.1 billion for the year. Net outflows continue to be impacted by industry trends in favor of low-fee passive index products, and more recently, the move of have funds into fixed income. Gross inflows remain muted and well below our historical levels. Average AUM for 2023 was down 2% year-over-year.
Our complete GAAP and adjusted results are presented in our earnings release. Revenues in the quarter increased less than 1% compared to last quarter, as performance fees more than offset the impact of lower average AUM. Total performance fees were $6.1 million in the quarter. However, as a result of the required consolidation of our credit opportunity strategy, $2 million of the performance fees are recorded on our P&L below the operating line, has a reduction to net income attributable to consolidated investment products. Compared to fourth quarter of 2022, revenues were up 10% on higher average AUM. Adjusted operating expenses for the quarter increased 1% sequentially and 9% compared to the same quarter last year, primarily driven by an increase in incentive compensation expense on higher revenues.
For the full year, revenues were down 2% from 2022 on lower average AUM. Our recurring average fee rate remained at 70 basis points. Adjusted operating expenses were up 2% in 2023 compared to 2022. The decrease in variable expenses due to lower revenues was more than offset by higher fixed costs. Fixed compensation costs were up $10 million in 2023 on a 4% increase in the number of full-time employees and inflationary salary and benefit increases. Travel expenses were also up $3 million during the year. The higher expense was driven by an increased travel by investment research and distribution professionals. Adjusted operating income decreased 9% in 2023 compared to 2022, and adjusted EPS was 7% lower. Adjusted EPS includes over $6 million of interest income earned on excess cash in 2023 compared to the negligible amount in 2022.
The balance sheet remained strong. We currently have about $150 million of seed capital invested in sponsored investment products with significant amounts of realizable capacity. As those products begin to scale, we will redeem the seed capital to either deploy into new products, otherwise reinvest in the business, or return to shareholders. In addition, our $100 million revolving credit facility remains unused. We continue to return capital to shareholders on a consistent and predictable basis through quarterly cash dividend payments and a year-end special dividend. Consistent with our dividend policy, our Board of Directors declared a quarterly dividend of $0.68 per share with respect to the December 2023 quarter, which represents approximately 80% for the cash generated in the quarter.
Our Board of Directors also declared a special annual dividend of $0.34 per share. Similar to prior years, we retained a portion of the cash generated in 2023 to fund future growth initiatives, primarily to make seed capital investments in new investment strategies and vehicles. A total of $2.78 per share will be paid out with respect to 2023 cash generation. That results in an annual trailing dividend yield of almost 7% and is in line with our historical average annual yield of 8% since our IPO in 2013. Each year, our Board of Directors approves a grant of long-term incentive awards. In the first quarter of 2024, the Board approved an award of approximately $60 million, consisting of $39 million of cash-based franchise capital awards and $21 million of restricted stock awards.
Generally, 50% of the award vests pro-rata over five years and the remaining 50% vests on or 18 months after a qualified retirement. Starting with this 2024 grant, the majority of our incentive awards will include a traditional retirement acceleration feature. This new provision eliminates the five-year vesting requirement when career award recipients have a qualified retirement after having met an age plus years of service threshold of 70. All other vesting conditions, including notice periods and clawbacks, will remain in effect. The goal of the traditional retirement acceleration feature is to maintain our best-in-class compensation structure for top talent. From a financial statement perspective, the added feature results in front-loaded expense for awards granted to employees who already meet the age plus years of service requirement.
The overall amount of expense to be accorded will remain the same. We're estimating $69 million of long-term incentive amortization expense for 2024. Approximately $8 million to $9 million of that expense is a result of the new retirement provision. We expect to have elevated LTI expense for the next several years due to this change and then expect the expense will reduce and level off. Including long-term incentive compensation, fixed expenses are expected to increase mid-single digits in 2024. The majority of the increase reflects 2024 merit increases, the absorption of a full year of expense for full-time employees hired in 2023, and an expected low single-digit increase in employees in 2024. The additions will primarily be related to investment and distribution roles to capitalize on our growth strategy.
Travel may also increase slightly in 2024 as we execute on our growth initiatives. Occupancy, technology and other fixed operating expenses are expected to be relatively flat compared to 2023. As a reminder, our compensation and benefits expenses are generally higher in the first quarter of each year due to seasonal expenses. We estimate these expenses will be approximately $6 million higher in the first quarter of 2024 compared to the fourth quarter of 2023. That concludes my prepared remarks. I will turn the call back to the operator.
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