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

Q3 2019 Westwood Holdings Group Inc Earnings Call

DALLAS Nov 10, 2019 (Thomson StreetEvents) -- Edited Transcript of Westwood Holdings Group Inc earnings conference call or presentation Wednesday, October 30, 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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Ladies and gentlemen, thank you for standing by, and welcome to the Third Quarter 2019 Westwood Holdings Group Earnings Conference Call. (Operator Instructions) As a reminder, today's call may be recorded.

And now I'd like to introduce your host for today's program, Julie Gerron, General Counsel and Chief Compliance Officer. Please go ahead.

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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 third 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 in our Form 10-Q for the quarter ended September 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 SEC rules concerning non-GAAP financial measures, the reconciliation of our economic earnings and our 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 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 market environment and investment teams and finish with comments on our business.

Volatility continued in the third quarter as markets worldwide fell in August only to rally once more in September. In the U.S., the fed pivot officially became a 180 as expectations were realized and the fed cut rates twice, citing muted inflation, slowing business investments and international uncertainties as rationale for their decision to cut rates. At the aggregate global level, concerns persisted over the direction of the economic cycle, thanks to declines in leading economic indicators in key markets and uncertainty from the U.S.-China trade dispute. The U.S. added to investor apprehension at the end of the quarter with the launch of the presidential impeachment inquiry. Increased volatility and an inverted yield curve in the U.S. created a favorable environment for high-quality investments as investors turn to companies’ position to weather an economic slowdown.

Companies with strong cash generation and solid balance sheets performed better during the quarter. History has shown that post a yield curve inversion, such high-quality factors can deliver alpha for several more quarters. As a result of the third quarter's volatility, the U.S. markets were positive, while global equity markets ended with a slight decline for the quarter.

With election rhetoric set to heat up approaching the 2020 presidential election, we anticipate further uncertainty as markets assess each candidate's potential impact to the financial markets. The fed continues its shift towards easing monetary policy constraints to further support the economy, and our expectations are for global interest rate policy to remain supportive of equity markets. We will remain vigilant in assessing absolute risk in client portfolios and protecting client capital as market volatility shows no sign of abatement. Our first goal is to protect our clients' capital, particularly as we move later and later into the business cycle. We do this by investing in high-quality businesses, which we believe have limited downside risk, principles that have served our clients well and continue to resonate with prospective clients.

Our U.S. value equity products emphasized an approach of high quality and value, which fared well during a volatile quarter and once again showed notable outperformance during August sell-off. SmallCap delivered another strong quarter, particularly during the sell-off in August and is over 800 basis points ahead of the Russell 2000 value through the third quarter of 2019. Our SmallCap mutual fund, WHGSX, 5-star-rated at Morningstar, is in the top decile on a trailing 10-year and year-to-date basis and in the top quartile on a trailing 1-, 3- and 5-year basis through September 30, 2019. 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 are excited about its opportunity in the years ahead.

Our SMidCap strategy also finished better than its Russell 2500 value benchmark this quarter and, for the first 3 quarters through September 30, is over 500 basis points ahead for the year. The trailing 3-year returns through September 30 are ahead of the benchmark and have begun to improve relative to peer rankings. We look forward to growing this strategy in the years ahead.

LargeCap Value added a quarter of outperformance against the Russell 1000 value with strong downside protection during the intra-quarter sell-off. The LargeCap mutual fund, WHGLX, has a top-quartile ranking on a trailing 1-year basis in Morningstar's large blend category and is in the top third through the third quarter. Our institutional strategy also has strong rankings in the investment manager universe with top-quartile rankings year-to-date and for the trailing 1-, 3- and 5-year periods.

LargeCap Select, also managed by the LargeCap Value team, outperformed, adding further alpha to its more than 5-year track record. This product has maintained its top ranking in the eVestment universe among LargeCap Value peers over the 5-year period ended September 30 and is in the second percentile over the last 3 years.

Within our Multi-Asset strategies, our product lineup now holds an array of strategies aligned across the risk-and-return spectrum that are tailored for a client-specific risk profile and investment objectives. Income opportunity produced a quarter of strong absolute and relative returns. Good selection and active allocation into longer maturity fixed income securities helped provide very strong downside while delivering strong performance.

The mutual fund, WHGIX, 5-star-rated at Morningstar, is ranked in the top decile in the Morningstar 30% to 50% equity universe for the quarter and year-to-date through September 30. It is also ranked in the top 12% for the trailing 1 and 3 years, top quartile over a 5-year basis and top decile over the trailing 10 years as of September 30. We expect this strategy to deliver an active allocation at a point in the cycle where managing both fixed income and equities can help provide higher income with less volatility than either an investment in fixed income or equity alone would provide.

Our convertible strategies, both global long-only and U.S. long-only strategies, were ahead of their respective benchmarks for the quarter, while our market-neutral income strategy continued to build on its excellent start to the year. The Market Neutral Income Mutual Fund, WMNIX, is ranked at the top 30% of peers for the quarter and year-to-date through September. It is in the 11th percentile and 6th percentile on a trailing 1-year basis among the Morningstar U.S. market-neutral universe.

With the volatility 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. Their low-correlation equity markets, coupled with low volatility and steady returns, positions convertibles well in this environment. Our confidence that the uncertain future will create more volatility in markets has us extremely excited for the prospects of our convertible strategies.

In Emerging Markets, the Asia Pacific region performed best with strong performance in Korea, Taiwan and India. China posted yet another unimpressive quarter with a loss as the deepening domestic slowdown was met with only a tepid response from policymakers. Although still down in the quarter, India saw a strong rally in September, following a massive fiscal stimulus in the form of corporate tax rate cuts. Latin America fell as central banks in the largest 3 markets: Brazil, Mexico and Chile, implemented further monetary easing in the form of rate cuts.

Our Emerging Market strategies all outperformed in the quarter and remain well ahead of their benchmarks year-to-date. Emerging Markets outperformed the MSCI Emerging Markets Index by over 100 basis points in the third quarter and is over 350 basis points ahead for the first 3 quarters. EM Plus also outperformed the index in the quarter and year-to-date through September, while EM SMidCap beat the MSCI EM SMidCap Index by over 250 basis points in the third quarter and is over 600 basis points ahead year-to-date through September 30.

Markets remain volatile and react swiftly and often irrationally to global and regional developments. We continue to be very focused on constantly evaluating the impact of developments around our holdings and taking advantage of the irrational overreactions by the markets where appropriate.

Shifting now to wealth management. Our teams in Dallas and Houston continue to produce great results. Client retention remains high at over 97%, and our Houston group again posted strong new business flows that were up nearly 100% year-over-year. In fact, Houston has set a new high watermark in new assets gained. We held several client events that have been effective towards maintaining close relationships with existing clients and building trust with our prospective clients. Business in Texas is booming, with job creation and significant wealth creation providing a nice tailwind for our private wealth pipeline.

Our tax-efficient Select Equity strategy, managed out of the Houston office, outperformed the Russell 3000 Index for the quarter. Select Equity is designed to provide a high-quality, low-turnover, tax-efficient portfolio with strong risk controls for downside protection. We saw our risk management metrics in full action in August when markets fell nearly 2% on tariff concerns, and the strategy outperformed its benchmark. Year-to-date through September, our downside capture in this strategy has remained below 80% on days when the market was down more than 1%. Select Equity gained assets in both our Houston and Dallas offices with assets under management surpassing $700 million. This is an impressive start for a product that began in 2017, and we look forward to completing a 3-year record at year-end.

Westwood Private Bank held its grand opening last week, and we had over 60 clients and prospective clients in attendance. The concept of having everything in one place with the ability to lend against an existing portfolio, combined with bill paying and concierge private banking services, is resonating extremely well with our clients. As we perfect the model in Dallas, we intend to work with Westwood Private Bank to extend the brand to Houston, pending regulatory approval.

In institutional and intermediary sales, our institutional and retail businesses had third quarter inflows of approximately $260 million that were offset by outflows of $700 million, producing net outflows of $440 million. Outflows were primarily in the income opportunity strategy. However, other strategies, including Emerging Markets, LargeCap and SMidCap also had outflows.

Breaking down activity on the strategy level. Our SmallCap franchise continues to gain momentum with searches and inbound inquiries on both the institutional and retail front. SmallCap is our most successful strategy year-to-date in terms of net flows. Our expanded and reorganized institutional and intermediary sales and service groups are fully in place. Both groups are generating significant meeting activity and growing our new business opportunity pipeline with key platform approvals advancing our SmallCap strategy in the intermediary space. Our portfolio managers have done several interviews recently in an attempt to increase visibility in tandem with our 5-star rating, attracting greater interest. We have recently been approved at 1 of the top 3 consulting firms, and we are beginning to see search activity.

In SMidCap, we lost a client due to manager consolidation. But with improved performance, we are now able to move into offense and are participating in several new searches.

Market-neutral income was our largest gainer of net new assets during the quarter as our partner, Aviva Investors, allocated additional assets to the strategy.

In Income Opportunity, our sales and service teams are working to ensure all parties clearly understand our path forward, and our portfolio managers continue to work on producing the quality results that our clients expect. However, as we've discussed in the past, not all consultants have embraced our expanded approach and investment team changes. As a result, there were some consultant recommendations earlier this year to clients recommending a move away from Income Opportunity. However, some of those clients have been slow to act, and outflows in Income Opportunity were less than expected in the third quarter. We are capitalizing on Income Opportunity's 5-star rating and top decile Morningstar investment performance and peer rankings year-to-date with a new sales campaign in the retail space and a roadshow across all territories in the fourth quarter.

Sales in our LargeCap strategy remained challenging due to lack of demand for active management despite the strategy's strong performance. Recent outperformance has resulted in some clients overweighted in the LargeCap asset class, necessitating a rebalance, which gave rise to outflows in the third quarter for the strategy.

We have taken and continue to take steps to strengthen our relationship with intermediaries, clients and consultants. Performance has strengthened across many of our strategies, and we are optimistic in our ability to grow. Our sales and service teams are focused on targeted activity and client engagement. Our on-the-ground wholesaling is lifting sales, particularly in the previously uncovered territories, with over 900 meetings held during the quarter. We are pursuing more platform approvals to make our funds more widely available to investors, and we hope to see positive flows into our mutual funds in 2020. With increased sales activity, our pipeline is healthy and spread across several different strategies. We expect some of the active opportunities to approach decisions later this year or early in 2020.

Our product management and investment teams continue to work closely together to ensure that our product offerings are aligned properly for commercial success and focused in areas where we can add value and grow assets under management. We spent most of this year completing our investment in distribution and getting the right talent on the field. We have spent considerable time on product evolution and assessing the commercial viability of our product line. We have closed 4 noncore products and evolved others along the Multi-Asset continuum with an eye towards a clearer vision and focus on our core competencies. We are now positioned to serve investors across absolute return, income-oriented and total return outcomes, which will be formally announced early in November.

Also, conditional on the SEC's approval, we expect to announce a new sensible fee structure in 3 mutual funds as part of our mission to better align fees with client outcomes. As we invest in building retail intermediary distribution, it is critical for the positioning of our brand in the marketplace that we emphasize high-quality value equity and expanded Multi-Asset franchise in emerging markets expertise. We have invested heavily to get the right technology and people in place, so that we are positioned to take on new opportunities, support our clients' needs and return Westwood to a growth trajectory.

Our sales resources and activity levels are at the highest point in our history, but building new relationships, reinvigorating long-standing relationships, introducing new strategies, teams and capabilities takes time. Westwood strategies are well positioned in areas where active management can take advantage of mispriced securities and deliver excess return and specific outcomes. Clients are looking for differentiated results, and we have demonstrated an ability to deliver a differentiated client experience as evidenced by our high, active share equity strategies with strong track records.

The asset management industry has reached a point of overcapacity and appears ripe for consolidation in the years ahead. With passive taking more than a 50% market share, there is less active management opportunity, which is driving price cutting, while at the same time, all firms are experiencing rising data and technology costs. We are seeing a number of opportunities to acquire stranded teams or small firms looking for enhanced distribution. Our ideal candidate would be a firm of fixed income expertise, differentiated equity manufacturing and a private wealth business with an attractive demographic profile. We continue to look for accretive opportunities and will always be disciplined with our shareholder capital.

While near-term results are clearly disappointing, we've been building and transforming ourselves over the last few years in the face of adversity and industry headwinds. While many in the industry are simply waiting for the active management come back, we have made major investments and are taking bold steps to reinvent ourselves to become less of a product-focused firm and more of a solutions-oriented firm. We have reduced headcount, cut underperforming or commercially unviable funds, built the largest sales force in our history, added transformative technology, including a private wealth platform dedicated to connecting digitally with younger generations, added financial planning and estate planning, private equity and partnered with Charis to create Westwood Private Bank.

In the years ahead, the industry is likely to consolidate. Pricing and compensation will adjust to new levels, and only the strong will survive. We believe the investments we've made will not only allow us to survive but to be a leader, a place that teams or firms want to join. We are excited to see the array of solutions we have created gain traction in the years ahead while regaining sales momentum with our traditional institutional and retail products. We appreciate our shareholders' patience and firmly believe that the future is bright for Westwood and all our stakeholders.

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 $19.9 million for the third quarter of 2019 compared to $21.7 million in the second quarter and $29.9 million in the prior year's third quarter. The decrease from the second quarter was primarily due to lower average assets under management resulting from net outflows. The decrease from the prior year's third quarter was primarily due to lower average assets under management resulting from net outflows, partially offset by higher performance-based fees.

Third quarter net income of $1.1 million or $0.13 per share compared to $1.9 million or $0.22 per share in the second quarter. The decrease primarily related to lower total revenues, partially offset by a $0.3 million foreign currency gain net of tax in the current quarter. Economic earnings, a non-GAAP metric, was $3.9 million or $0.46 per share in the current quarter versus $4.8 million or $0.56 per share in the second quarter.

Third quarter net income of $1.1 million or $0.13 per share compared to $5.4 million or $0.62 per share in the prior year's third quarter. The decrease primarily related to lower total revenues, partially offset by lower incentive compensation expense and a $0.3 million foreign currency gain net of tax in the current quarter. Economic earnings for the quarter was $3.9 million or $0.46 per share compared to $9.5 million or $1.11 per share in the third quarter of 2018.

Firm-wide assets under management totaled $15 billion at quarter end and consisted of institutional assets of $8.3 billion or 56% of the total, wealth management assets of $4.3 billion or 29% of the total and mutual fund assets of $2.3 billion or 15% of the total. Over the year, we have experienced net outflows of $3.8 billion and market appreciation of $2.2 billion.

Our financial position continues to be very solid with cash and short-term investments at quarter end totaling $101.2 million and a debt-free balance sheet.

Our Board of Directors approved a quarterly cash dividend of $0.72 per share payable on January 2, 2020, to stockholders of record on December 6, 2019. This represents an annualized dividend yield of 10% as of the closing price on October 29.

That brings our prepared comments to a close. We encourage you to review our investor presentation we have posted on our website, reflecting third 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) And our first question comes from the line of Mac Sykes from Gabelli.

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

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Could you comment about the outlook for fundraising for EM strategies? Now that the performance has improved this year, what are you seeing in terms of end-market demand for those products?

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

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Well, the EM asset class is certainly one that has windows back. I think when investors look around the world and they look at the various asset classes that are known for being likely to produce alpha, EM is certainly one of them. We've had some good activity recently with the improved performance. We hope to have something to announce next quarter with one of the larger firms that we are in chats with on the EM strategy. So we're excited to talk to you about that at a future date.

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

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Great. And my follow up is in terms of capital management, how should we think about your strong balance sheet, high payout ratio now increased feedback about potentially growing organically?

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

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Well, I think as far as our balance sheet goes, we've always valued having a strong balance sheet. We've never had any debt. And we find that it's something that's important for us as a long-term shareholder.

As far as the second part of your question with respect to organic growth, I would say that we have worked really hard to build a sales team like we've never had before. And that sales team, if we add in the platform meetings that they had, in addition to the meetings that our wholesalers had with advisers around the country, we had over 1,000 meetings during the quarter. That's unprecedented. And most of these meetings with the advisers were the first time that they had ever met anybody from Westwood. So we have a lot of greenfield opportunity. We have a lot of territories that we've never sold in, and we feel really good about our profile going into 2020.

In addition, we have had a number of conversations with platforms. And as you know, platforms are shrinking their product shelf. And it's very difficult to get on to a platform these days, but we have made a lot of progress and really have 3 live opportunities and hope to have something announced when I talked to you next quarter.

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

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Okay. Just to clarify. In terms of like the last question, it was more about inorganic growth and your desire to potentially add fixed income, perhaps wealth management. I just wanted to understand a little bit more about your capacity for using cash investments to fund those against desirability to keep the payout high and also to keep your balance sheet?

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

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I see. Okay. I'm sorry, I misunderstood your question. I thought it was around organic growth. Well, certainly, having a strong balance sheet with over $100 million in cash allows us the flexibility to talk to very high-quality firms that would have an interest in joining Westwood. As far as the dividend goes, that's something we talk about every quarter, and we'll talk about it again next quarter.

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Operator [8]

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(Operator Instructions) And I'm not showing any further questions in the queue. At this time, I'd like to hand the program back to management for any further remarks.

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

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Great. Well, thank you. I appreciate everybody's time and listen in today's call. If you have -- like further information, please visit our website at westwoodgroup.com. If you have any specific questions, feel free to call myself or Terry Forbes, our CFO. Have a great afternoon. Thank you.

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Operator [10]

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Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.