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Edited Transcript of WHG earnings conference call or presentation 31-Jul-19 8:30pm GMT

Q2 2019 Westwood Holdings Group Inc Earnings Call

DALLAS Aug 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Westwood Holdings Group Inc earnings conference call or presentation Wednesday, July 31, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian O'Connor Casey

Westwood Holdings Group, Inc. - President, CEO & Director

* Julie Kramer Gerron

Westwood Holdings Group, Inc. - Senior VP, General Counsel, Chief Compliance Officer & Corporate Secretary

* Murray Forbes

Westwood Holdings Group, Inc. - Senior VP, CFO & Treasurer

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Conference Call Participants

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* Macrae Sykes

Gabelli Funds, LLC - Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Q2 2019 Westwood Holdings Group, Inc. Earnings Conference Call. (Operator Instructions) As a reminder, this call is being recorded.

I would now like to turn the conference over to your host, Ms. Julie Gerron, General Counsel, Chief Compliance Officer. Ma'am, you may begin.

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Julie Kramer Gerron, Westwood Holdings Group, Inc. - Senior VP, General Counsel, Chief Compliance Officer & Corporate Secretary [2]

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Thank you, and good afternoon. Welcome to our second quarter 2019 earnings conference call.

The following discussion will include forward-looking statements, which are subject to known and unknown risks, uncertainties and other factors which may cause actual results to be materially different from those contemplated by the forward-looking statements. Additional information concerning the factors that could cause such a difference is included in our press release issued earlier today as well as our Form 10-Q for the quarter ended June 30, 2019, filed with the Securities and Exchange Commission. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. You are cautioned not to place undue reliance on forward-looking statements.

In addition, in accordance with the SEC rules concerning non-GAAP financial measures, the reconciliation of our economic earnings and economic earnings per share to the most comparable GAAP measures is included at the end of our press release issued earlier today.

On the call today, we have Brian Casey, our President and Chief Executive Officer; and Terry Forbes, our Chief Financial Officer. I will now turn the call over to our CEO, Brian Casey.

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Brian O'Connor Casey, Westwood Holdings Group, Inc. - President, CEO & Director [3]

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Good afternoon and thank you for taking the time to listen to our quarterly earnings call. As always, I'll start with comments on the investment teams and market environment and finish with comments on our business.

Second quarter was volatile as markets generally rallied in April, fell sharply in May and rallied once more in June. First quarter GDP was better than expected, which helped markets early in the quarter before concerns of an escalating trade war with China sent markets lower. Fed pivot earlier in the year, which now has markets expecting multiple rate cuts, has provided some additional support for equity markets while concerns over fading growth and weakening manufacturing has pushed bond yields lower.

Positive corporate earnings growth remains the most likely outcome for the full year, but it will be increasingly dependent on an acceleration at the end of the year. Volatility has continued to moderate, but the risk of a spike in volatility remains high as we move into the later stages of the business cycle. Investors will be focused on company outlooks as tight labor markets and a rebound in housing buoy consumers and begin to have a positive impact on earnings and cash flows.

As the economic cycle progresses, the preference for high-quality, cash-generating businesses is likely to grow. The market's focus on the underlying quality of each business will cause further dispersion in returns as it discriminates between companies with strong fundamental strength or weakness, providing a key driver of investor returns. Ultimately, we believe that the investing landscape will continue to move towards one that allows active managers to more clearly identify winners and losers. We remain vigilant in assessing absolute risk in the securities we invest in and are striving to protect client capital during these times of potential volatility and uncertainty.

Our U.S. Value Equity products fared well during the rocky second quarter with notable outperformance during May selloff. SmallCap delivered another strong quarter with over 450 basis points of outperformance against the Russell 2000 value and now stands over 800 basis points ahead in 2019.

Our SmallCap mutual fund, WHGSX, was also raised to 5 stars by Morningstar. The fund's second quarter performance places it in the top decile among peers on a year-to-date, 3-year and 10-year basis. And our institutional strategy is also on the top decile over year-to-date, 3, 5, 10 and since inception time periods. This is a great accomplishment for our portfolio management team and our entire team of research analysts who provide investment ideas for the SmallCap strategy. Interest in this strategy remains high, and we're excited about its opportunities in 2019.

Our SMidCap strategy finished better than its Russell 2500 value benchmark in the quarter and is now over 300 basis points ahead for the year. This is an important step in the rebuilding of our intermediate track record. And we continue to believe that in this inefficient part of the market, we can grow this strategy in the years ahead.

LargeCap Value performance bounced back in the quarter. It outperformed the Russell 1000 Value Index, highlighted its good downside protection during the intra-quarter selloff and was ranked in the top 20% of funds for the quarter. LargeCap Select also outperformed. Its track record places it in the top quartile on a trailing 1-year basis and top decile over the last 3 and 5 years.

Within our Multi-Asset class strategies, we've built on our product lineup, which now holds an array of products aligned across the risk and return spectrum that are tailored for a client's specific risk profile and investment objective. The integration of our Boston team into our overall Multi-Asset group has progressed well. Formalization of the entire Multi-Asset class team with its leader, Adrian Helfert, along with enhanced portfolio management processes, has enriched the team's communication and idea contribution process.

Our newest mutual fund in the space, Flexible Income, WFLEX, began building its track record with another good quarter of performance and a top quartile ranking in Morningstar amongst its peer group. Its institutional track record remains highly ranked as well with the top percentile rank among peers over the last 1 and 3 years. The Flexible Income strategy will complete its fifth year in December. Since inception, Flexible Income has produced nearly 250 basis points of annualized outperformance and a top decile peer ranking.

Income Opportunity, which is managed by Adrian Helfert and David Clott, produced a quarter of strong absolute and relative returns. The mutual fund, WHGIX, is ranked in the top 30% in the Morningstar 30% to 50% equity universe for the quarter and top 20% for the trailing 1 year. The return stream of the fund is reflective of our analysts' expertise at finding good, underappreciated companies, and the increasingly dynamic asset allocation process has again served clients well as a defensive position with strong downside protection against falling equity markets.

Our Global Convertibles strategies, both global long-only and U.S. long-only strategies, were positive in the quarter and ahead of their respective benchmarks, while our market neutral strategy continued to build on its excellent start to the year. The Market Neutral Mutual Fund, WMNIX, is ranked in the top 20% of peers for the quarter and year-to-date 2019 among the Morningstar market neutral universe.

Our institutional strategy is also ranked in the top quartile over the last quarter, year-to-date and trailing 1-year time periods. Our market neutral strategy has maintained low correlation, low volatility and low equity beta characteristics despite a rather volatile market backdrop in the quarter. And importantly, our market neutral strategy has shown steady returns during nearly any market backdrop.

With uncertainty in global markets likely to persist, the asymmetric nature of convertible bonds gives investors a lower risk equity proxy that should perform well relative to stocks. Global markets also experienced volatility in the quarter with a strong June recovery driven by developed market regions. Within Emerging Markets, Europe and Middle East outperformed due to interest rate cuts and oil strength in Russia, while Latin America rose on positive political developments in Argentina and policy reforms in Brazil. Asian markets lagged as they continue to be overshadowed by trade war concerns between the U.S. and China.

Our Emerging Markets, EM Plus and EM SMid strategies, all outperformed their respective benchmarks in the quarter, are strongly ahead on a trailing 1-year basis and performed well versus peers over the trailing 1-year period. We expect that markets will continue to be volatile and react swiftly and often irrationally to global and regional developments. We will focus on allocating our portfolios in a well-diversified manner among high-quality emerging market opportunities and taking advantage of overreactions by the market.

As long-term, bottom-up investors, our team is focused on the fundamental attributes of companies that lead to a competitive advantage and an ability to thrive and generate economic profits throughout the market cycle.

Before we discuss sales and service, I wanted to mention that as a signatory to the United Nations Principles of Responsible Investing, we completed our first reporting of responsible investment practices to the UN PRI on April 1. We were pleased to learn in early May that we received an ESG ratings upgrade to BBB based largely on our commitment to responsible investing, our privacy and data security and corporate governance. I want to thank our many employees who worked hard on this effort and all our employees who strive to improve our rating each day.

Shifting now to institutional and intermediary sales. For the second quarter, institutional and retail businesses had inflows of $211 million that were offset by outflows of $2.1 billion, producing net outflows of $1.8 billion. Outflows were primarily in the Income Opportunity and LargeCap Value strategies. Outflows in Income Opportunity are expected to bottom in the third quarter, and the large outflow in LargeCap was a surprise given the great performance we've achieved for the client over the past decade.

However, we are truly optimistic about our ability to grow the business going forward. This time last year, our total pipeline of institutional new business opportunities was $686 million across 4 strategies. And today, it is filled with multiple opportunities worth $2.4 billion across 8 strategies. More importantly, the level of activity is higher than it's ever been. When we combine our institutional pipeline with the pipeline that is being built on the intermediary side of our business, we feel confident that we can convert much of this activity into new clients going forward.

Our reorganization within institutional sales and intermediary sales and service has been completed with our final new hires in intermediary joining us in July. We are pleased to have recruited 5 high-quality sales professionals who can drive sales and client relationship management in both channels.

Under unified distribution and marketing leadership, we are bringing an expanded team of sales, service and support personnel together and providing them well-defined coverage and direct sales responsibilities with technology support and a centralized marketing infrastructure.

In institutional, early results of this effort are positive with sales activity having more than doubled from last year. For the quarter, the team logged over 200 meetings, increased new business-focused meetings fivefold and grew our new business pipeline across multiple strategies.

We're pleased with the progress the team has made in a short amount of time, creating a pipeline that is diversified across multiple strategies and at various stages of advancement, including several large SmallCap Value opportunities that have advanced to the final stage.

Our expanded intermediary group of experienced sales professionals joined Westwood last month, and I'd like to take a second to welcome [Mike Descal], [David Friedman], Bill Hunter, Tim Gordon and [Charlie Colleen]. This team has hit the ground running and has already begun to bring in new intermediary sales this month. More importantly, the pipeline of meeting activity on the calendar for the next several months is the highest we've ever seen. We've spent the last 6 months preparing for their arrival by developing integrated dashboards and new technology initiatives to help us better target our audiences and measure our group's performance.

The intermediary team has advanced several key platform approvals in the key partner home offices for SmallCap and LargeCap Select with Sensible Fees, which we feel will continue to accelerate interest and sales activity. In fact, we've had 6 meetings with one of the most prestigious platforms regarding Sensible Fees. They are excited to take on the strategy but need to solve some of the operational and billing challenges of our unique fee structure.

Our product management and investment teams are working closely together to ensure that our product offerings are aligned to be commercially successful and focused in areas where we can add value and grow assets under management. We have begun the process of rationalizing product offerings with poor performance or limited potential, which will involve restructuring or closing some mutual funds.

From an innovation standpoint, we also plan to make announcements on the investments we're making in new product development to grow our Multi-Asset franchise, which outline a product continuum across absolute return, total return and income-oriented solutions. We'll have more to share with you in the coming quarters on that front.

As part of our marketing and innovation initiatives, Sensible Fees has been well received by the academic community and has increased Westwood's visibility in the marketplace. The innovative Sensible Fees structure is an exciting development, and it was nominated by wealthmanagement.com for a 2019 industry award in asset managers new product development category.

We are committed to ongoing product innovation to improve alignment between asset owners and asset managers and improve the probability of winning for active investors. We plan to expand Sensible Fees for institutional and intermediary investors across multiple asset classes during the balance of the year.

We have several speaking engagements planned in the second half of 2019 at industry conferences including the CFA Institute, Investment Institute and Cutter Associates to discuss the alignment of fees with active management. In the coming quarter, we plan to release a new thought leadership paper to build on our initial introduction. While this fee structure was initially offered with LargeCap Select, we plan to introduce this across other strategies soon.

Breaking down activity on the strategy level, SmallCap and LargeCap Select continue to be key areas of focus in 2019. During the quarter, SmallCap maintained net positive flows and is our best product in terms of net flows this year. New business opportunities in the pipeline are increasing with several opportunities advancing to the final stage.

With the transition of portfolio managers and Income Opportunity fully complete, our sales and service teams continue to work to ensure all parties clearly understand the path forward for Income Opportunity and the Multi-Asset team. However, not all consultants have embraced our expanded approach and investment team changes and outflows continued in Income Opportunity, which at $1 billion in net outflows were more than half our overall total for the quarter.

We do anticipate net outflows to continue in the quarter as clients connected to this consultant complete their moves to other strategies. Meanwhile, the performance is strong, and we believe our sales teams will have great success in building flows and momentum.

Our sales and service teams are focused on higher activity, strategic targeting and client engagement in 2019. We've increased sales activity, expanded the new business pipeline and taken steps to strengthen relationships with intermediaries, clients and consultants.

Sensible Fees has accelerated interest in LargeCap Select and some of our other strategies, which bodes well for 2019 growth. We also believe SmallCap is positioned well to grow AUM in 2019.

SMidCap performance has been improving and Income Opportunity performance is excellent. We expect that later this year and into next year, we will be commercially competitive again for both strategies.

Emerging Markets strategies remain in demand. And with their recent performance improvements, these strategies can be additive in the future as well with continued performance improvements.

On the Wealth Management front, our team has continued its great start to the year. Client retention remained at 98%, while our Houston group posted new business flows, up 156% in the first half of the year.

Our taxable Select Equity strategy, managed out of the Houston office, outperformed the Russel 3000 Index for the quarter and continues to gain assets in both our Houston and Dallas offices as an attractive offering for clients seeking overall market exposure and a tax-efficient product.

We introduced our third private equity fund by partnering with Blackstone to offer unique and diversified private equity strategy to our clients and prospects that has been very well received.

We continue to benefit from a trend away from big banks towards the smaller, more flexible firms with trustee services and superior personalized service. Westwood Private Bank was approved by regulators last month and opened a few weeks ago.

Our partners at Charis Bank in conjunction with our Westwood Wealth Management team have officially opened the bank, which is located adjacent to our Dallas headquarters and offers white-glove, private banking services.

Our clients have already taken advantage of the services and have been pleased with the fast, local response time, friction-free account setup, fair rates and personalized service. We've been disappointed by recent outflows, but we continue to build products and services that serve our clients' needs and meet industry challenges head-on.

Many firms had been complacent with the decade-long bull market, and our industry is plagued by inefficient operating models with redundant processes and legacy technology, often referred to as a technology debt by today's digital players. We have been proactive in our journey to retire our technology debt and move to a digital state-of-the-art environment.

We are pleased to announce that we have just implemented the InvestCloud middle-office platform known as Green in the InvestCloud universe. We are the first client on InvestCloud Green going live at the end of the second quarter. The platform has been a huge success and has meaningfully reduced human-error potential by increasing automation of account reconciliation to 98%.

In addition, we've reduced reconciliation times for all accounts by up to 80% and have improved the time lag for reporting to clients. It has also produced an immediate cost savings of almost 50% from our previous platform, which is combined with the potential future cost savings through opportunities to streamline workflows, limit headcount and implement future enhancements at a fraction of the effort in cost required of typical legacy technology architectures.

We have invested heavily in technology and have retired our technology debt at a faster pace than our peers. Our investment in operations teams and Westwood as a whole are now better positioned to take on the industry disruption and, more importantly, support our clients' needs. We are excited to be in this position and are seeing a number of talented people interested in joining our firm.

In addition, we're seeing opportunities for acquisitions of firms that have not made the investments in technology and want to join someone who has already built the foundation. We remain disciplined with our shareholder capital but excited to see many opportunities in the pipeline.

I'll now turn the call over to Terry Forbes, our CFO.

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Murray Forbes, Westwood Holdings Group, Inc. - Senior VP, CFO & Treasurer [4]

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Thanks, Brian, and good afternoon, everyone. Today, we reported total revenues of $21.7 million for the second quarter of 2019 compared to $23.9 million in the first quarter and $32.8 million in the prior year second quarter. The decrease from the first quarter was primarily due to lower average assets under management resulting from net outflows. The decrease from the prior year second quarter was primarily due to lower average assets under management resulting from net outflows and lower performance-based fees.

Second quarter net income of $1.9 million or $0.22 per share compared to $0.4 million or $0.05 per share in the first quarter. The increase was due to higher seasonal payroll taxes and benefit matching on bonuses paid in the first quarter. Economic earnings, a non-GAAP metric, was $4.8 million or $0.56 per share in the current quarter versus $4.1 million or $0.49 per share in the first quarter.

Second quarter net income of $1.9 million or $0.22 per share compared to $8 million or $0.94 per share in the prior year second quarter. The decrease primarily related to lower total revenues and a $0.6 million foreign currency loss net of tax, partially offset by lower compensation expenses for reductions in incentive compensation.

Economic earnings was $4.8 million for the current quarter or $0.56 per share compared to $12.2 million or $1.43 per share in the second quarter of 2018.

Firm-wide assets under management totaled $15.4 billion at quarter end and consisted of institutional assets of $8.4 billion or 54% of the total, wealth management assets of $4.4 billion or 29% of the total and mutual fund assets of $2.6 billion or 17% of the total.

Over the year, we had experienced net outflows of $3.3 billion and market appreciation of $2 billion. Our financial position continues to be very solid with cash and short-term investments at quarter end totaling $103.9 million and a debt-free balance sheet.

I'm happy to announce that our Board of Directors approved a quarterly cash dividend of $0.72 per share payable on October 1, 2019, to stockholders of record on September 6, 2019. This represents an annualized dividend yield of 9.2% as of the closing price on July 30.

That brings our prepared comments to a close. We encourage you to review our investor presentation we have posted on our website, reflecting second quarter highlights as well as a discussion of our business, product development and longer-term trends in revenues, earnings and dividends.

We thank you for your interest in our company, and we'll open the line to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Mac Sykes of Gabelli.

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Macrae Sykes, Gabelli Funds, LLC - Research Analyst [2]

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Brian, on the ESG rating, maybe you could talk a little bit more about the importance of the BBB for engagement with clients in driving growth.

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Brian O'Connor Casey, Westwood Holdings Group, Inc. - President, CEO & Director [3]

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Sure. Well, thanks for your question, Mac. So really it's become an important part of not only how you're viewed as a company but whether or not you incorporate it into your investment process. So we started a few years ago and really building out what we hope to be a sustainable ESG footprint that will improve over the years. There's about 4 things that really matter. We're working hard on all 4 of those, and what we expect to see in the years ahead is continued improvement as we work on it. It's particularly popular in Europe and is becoming a criteria that you must be a signatory of the UN PRI in order to really compete effectively in Europe.

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Macrae Sykes, Gabelli Funds, LLC - Research Analyst [4]

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And congratulations on the pipeline. Could you provide some more color though on that expected timing of the fundings potentially average fee rates? Any more color around that would be very helpful.

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Brian O'Connor Casey, Westwood Holdings Group, Inc. - President, CEO & Director [5]

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Sure. Well, the pipeline is pretty broad-based. Our SmallCap is seeing a lot of interest. And as you know, the SmallCap product carries probably the highest fee rate of any of the products that we have. The 5-star upgrade in Morningstar was helpful this quarter, and we already have a number of new prospects in the pipeline. But it's been really good to see that the breadth of prospect activity has increased such that we're seeing looks in AllCap for the first time in a long time. We're seeing maybe our first ever opportunity in Market Neutral Income. It's been more broad-based, and it's been primarily from our institutional team.

I'm super excited to see what our intermediary team is going to do. As you know, those guys have only been on board for less than 30 days, but when you look at their pipeline of activity over the next few months, I think we have over 600 meetings booked for the month of August and early September. So it will be exciting to see what they are able to produce.

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Macrae Sykes, Gabelli Funds, LLC - Research Analyst [6]

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And then my last question on the Income Opportunity, it does seem like a decent space, I understand the management turnover there. But any more color kind of on -- I now the performance has been good and it's fairly consistent, but just a little more color on sort of the churn there?

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Brian O'Connor Casey, Westwood Holdings Group, Inc. - President, CEO & Director [7]

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Sure. Well, it's -- we think it's a great product. It's a product we started really about 17 years ago. Susan Byrne, our founder, and I sat down to really solve a problem for an existing client who felt like interest rates couldn't go any lower. But we came up with a product construct that had 8 different asset classes that was designed to provide a level of income with high quality and low volatility, and it's never wavered from that. All of the ideas come up through our research department that are well vetted by each of our analysts, make it to the buy list and then a team puts together the portfolio.

One of the things that we did to improve the product is we enhanced the duration of the fixed income portion to be more in line with the benchmark and that helped out a lot as interest rates came down. It added about 40 or 50 basis points to the performance, and we're excited to continue to build out our Multi-Asset franchise. As I've said in the past, I believe Multi-Asset is an area where clients and consultants value skill and judgment and they will pay for it. And so you'll see additional versions of income opportunity in the years ahead and as we continue to enhance and refine that process.

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Operator [8]

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(Operator Instructions) I'm showing no further questions at this time. I'd like to turn the conference back over to Mr. Brian Casey for any closing remarks.

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Brian O'Connor Casey, Westwood Holdings Group, Inc. - President, CEO & Director [9]

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Okay. Well, thank you very much. Well, in closing, I'd just like to reiterate that it's sometimes tough to see improvement when you are measuring in short, quarterly time periods. And we've been working for nearly 4 years to build a firm that can withstand the industry disruption and thrive in the new world of asset management. We've invested millions in technology. We've streamlined our work processes from top to bottom. We're the very first customer on the InvestCloud portfolio accounting platform, and we are already seeing immediate improvements in time and efficiency and we believe we'll see significant cost savings in the years ahead.

We've built a highly experienced distribution team for both institutional and intermediary. We're using data and analytics to improve our prospecting, and our pipeline of new business opportunity is nearly 4x where it was this time last year. The UN PRI treaty we signed, we've incorporated responsible investing into our investment practices, and we've improved our ESG rating in each of the past 2 years.

We're aligning our pricing on some products with customer outcomes with an innovative fees construct known as Sensible Fees, and we've opened Westwood Private Bank to better serve our private wealth clients. Our Dallas and Houston private wealth offices are well ahead of plan, both in terms of new clients and retention for 2019.

And finally, I'd just remind everybody that this is a stair-step business where you have to stand against the wind and make investments ahead of what you hope will be sustainable growth. We've done it before and we intend to do it again.

Thanks for taking time to listen to the call. Please visit our website or give us a call if you have further questions.

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Operator [10]

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Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you for your participation, and have wonderful day. You may all disconnect.