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Edited Transcript of WHG earnings conference call or presentation 24-Oct-18 8:30pm GMT

Q3 2018 Westwood Holdings Group Inc Earnings Call

DALLAS Oct 31, 2018 (Thomson StreetEvents) -- Edited Transcript of Westwood Holdings Group Inc earnings conference call or presentation Wednesday, October 24, 2018 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. - VP of Finance

* Tiffany B. Kice

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 Third Quarter 2018 Westwood Holdings Group, Inc. Earnings Conference Call. (Operator Instructions)

As a reminder, today's conference may be recorded. I would now like to turn the call over to Ms. Julie Gerron, General Counsel and 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. Good afternoon, and welcome to our third quarter 2018 earnings conference call. The following discussion will include forward-looking statements. These forward-looking statements 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 difference is included in our press release issued earlier today as well as in our Form 10-Q for the quarter ended September 30, 2018, that is 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're 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.

I will now turn the call over to our President and Chief Executive Officer, 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 thanks for taking time to listen to our third quarter earnings call. I'll start with some comments on investment environment and then dive deeper into our investment performance and business.

In the U.S., economic data continued to be strong, and despite the news on trade wars, we saw some nice top line revenue growth for many of the companies we follow. Tariff relief for large multinationals came in the form of a newly renegotiated NAFTA agreement, now called USMCA, or the U.S.-Mexico-Canada Agreement, and helped large caps outperform small caps by nearly a 2:1 margin in the third quarter.

The Fed continued down the path of increasing interest rates, which will continue shifting the investing landscape for the past 8 years from a monetary policy that created a rising tide lifting all boats scenario towards one with both winners and losers. This landscape benefits active managers as does higher volatility, which provides more mispriced securities and asymmetric reward/risk outcomes to invest in and lines up well with the way we've managed money for 35 years.

Our U.S. Value products performed well, with solid security selection driving outperformance in many of our strategies as high-quality companies were rewarded this quarter.

Our LargeCap Value product outperformed against its primary benchmark, the Russell 1000 Value, for the seventh straight quarter and remained solidly ahead for the year with top quartile peer rankings year-to-date as well as over the last 1- and 5-year time periods.

Concentrated LargeCap, nearing completion of its fifth year, extended its lead year-to-date with another strong quarter and is now up more than 4% over the Russell 1000 Value. Concentrated LargeCap peer rankings remained strong with a 12th percentile ranking year-to-date, fourth percentile for the trailing 1 year and first percentile since inception among its large cap value peers. We're excited about the prospects for new business growth, and our marketing and product development team is developing new presentation materials for a big push in 2019.

Our SMidCap strategy improved this quarter and outpaced the Russell 2500 Value Index, with nice improvement in both returns and peer group rankings this year. SMidCap peer rankings have improved, and we are currently approaching top quartile year-to-date and nearly in the top third for the trailing 1 year. Our long-term rankings since inception are strong, but we recognize the midterm rankings need improvement.

Our SmallCap Value product, which has produced strong returns for several years remained solidly ahead year-to-date. It modestly outperformed this quarter and ranks in the 26th percentile year-to-date and top decile over the trailing 5, 7 and since-inception time periods.

Our income-oriented products had a solid quarter, where equities were the largest contributor, though most asset classes have -- had a positive contribution to performance.

The performance dispersion between value and growth style was again notable during the third quarter as growth maintained leadership. Income Opportunity beat its benchmark and Worldwide Income Opportunity performance rebounded with global equity markets.

Emerging Markets presented a challenging environment for investors as news of possible escalation in the U.S.-China trade war, pressure on EM currencies and concerns around possible contagion risk due to country-specific events in Turkey and Argentina weighed on the Emerging Markets. Overall, we are pleased to report that our EM strategies have made good progress this year, and our EM, EM Plus and EM SMid were all top quartile for the third quarter and moving into the top half year-to-date.

Our avoidance of heavily crowded trades, such as the benchmark-heavy Chinese technology companies, has been an important source of alpha this past quarter.

With key themes from the third quarter expected to continue into the end of the year, we expect the portfolios to continue to benefit from their positioning, long-term perspective and focus on quality.

As in our other strategies, volatility in the markets will continue to unearth new investment opportunities as quality companies become mispriced by exogenous events. It is during times of uncertainty where quality companies come to the surface and shine. Across all our mandates, as long-term investors who have invested through past crises, we remain disciplined to our investment process.

In Global Convertibles, we continue to believe the current economic backdrop for convertible bonds remain supportive of better returns for the asset class. Increased volatility is good for convertibles as the asset class provides investors with equity sensitivity and lower volatility than typical equity products, thus providing a measure of defensiveness.

Our long-only convertible bond strategy has benefited from the upward movement in equity prices and outperformed the benchmark Thomson Reuters Global Focus Index year-to-date. The funds have been aided by their equity sensitivity and an overweight in strong-performing U.S. markets.

Market Neutral Income also benefited this quarter from its equity sensitivity this quarter and posted a slight gain. This product typically has short duration, low equity beta and is not closely correlated to the other asset classes. As the performance track record grows, we are seeing investors consider Market Neutral Income as an attractive alternative to fixed income products.

We remain of the view that volatility will continue to move higher over the next few years and that the Market Neutral Income product is positioned well for this move. Additionally, the recent selloff in Emerging Markets has produced some good opportunities for the short duration yield book, and the team has been taking advantage of this opportunity.

Turning now to sales and service. We welcomed our new Head of Institutional Sales last quarter, and Steve Paddon has been a great addition to our team. He's evaluated our business and support infrastructure and instituted several changes, including a reorganization of our sales and service roles and support infrastructure that we hope will bear fruit in the near future.

Income Opportunity beat its custom benchmark this quarter, what was behind year-to-date at the end of the third quarter. Performance versus the custom benchmark has improved in October, but we've underperformed our peers in the Morningstar and eVestment universes over the past few years, resulting in outflows.

Our SMidCap performance has improved recently, but faced performance challenges over the past few years. While many clients have remained with us, we've experienced outflows this quarter and throughout the year. We also just learned that one of our largest SMid clients hired a new consultant, then promptly fired 25 managers, including Westwood, to allocate more money to passive and alternatives. This will result in outflow before the end of the year of approximately $268 million as of market close yesterday.

Our largest EM client employs over a dozen EM managers and they made a decision to reduce EM exposure across-the-board, which resulted in approximate $300 million outflow for us. The good news is that we met with them last week, and they said they do not anticipate any additional EM reallocations.

As mentioned last quarter, in our Emerging Market strategy, we've been proactively visiting clients to reinforce the importance of owning sustainable, high-quality companies and avoiding the speculative, crowded trades that have become so popular in Emerging Markets investing. We have asked our European marketing partner, Cardinal Partners, to shift focus to our Emerging Markets franchise and begin to spread the word to their best global prospects.

We continue to build our research department in Dallas with the addition of 2 analysts and 2 research associates. In Toronto, we hired an experienced analyst to strengthen and broaden our Emerging Markets coverage.

As for good news, our SmallCap strategy experienced net positive inflows year-to-date, and we have several opportunities in the pipeline for SmallCap, Income Opportunity and Emerging Markets. We won a nice public fund award in our SmallCap product, which is not yet funded, and we are waiting on the new Morningstar subadvisory mandate to launch later this year. In the subadvisory space, our team saw net positive flows in the quarter. Cash flows were largest into our Emerging Markets and SMidCap strategies.

While we're pleased that we've had net inflows in the subadvisory group from current clients this quarter, we are aware that a large subadvisory client will be leaving us in the fourth quarter. Our client sold their fund complex to a large financial services firm, and all the funds will be merged into the acquiring firm's fund later this year. While the fees on this relationship are subadvisory fees and well below our average fee level, the assets leaving are approximately $333 million as of market close yesterday.

In our mutual funds business, we saw net outflows in our Income Opportunity Fund and SMidCap Plus fund of approximately $300 million, while our LargeCap and SmallCap Funds had net inflows for the quarter of approximately $46 million.

We're excited to launch a new fund before the end of the year that is designed to provide higher income than our traditional income-oriented strategies. We believe that demand for income is only growing as more baby boomers retire and look for ways to live on their savings.

On the Private Wealth front, our Houston team is building momentum and gaining market share with over 2/3 of new business coming from new relationships. Despite this momentum, the team did experience outflows as clients made regular tax payments. Outside of this, net flows were minimal and the team has done a great job of retaining existing clients and finding new ones. Our Select Equity strategy is performing well and seeing especially strong sales into the RIA channel with assets now exceeding $650 million in assets under management.

We have several events planned for fourth quarter 2018 and 2019, including exclusive naming rights to The Society of Performing Arts talk series, which will be called The Westwood Talk Art Series; a professional open house; an advanced estate planning conference series; and several smaller events targeted toward high net worth investors in the Houston area.

In the Dallas Private Wealth business, we believe that our expanded array of services to clients will have a positive impact on our Private Wealth business. Our Dallas team has solid traction with several new leads and client relationships, and there were no significant outflows.

Westwood sponsored the Psychedelic Robot, a pop-up art exhibit held at the Crescent Hotel in Dallas last month. We sponsored the event as part of our effort to provide clients with information and advice regarding art as an asset class for acquisition, wealth transfer or charitable giving purposes. We received great interest from the event from clients and prospects who never attended a prior Westwood event and have booked many prospect meetings in our follow-up calls.

As we build our digital platform, we strive to be viewed as an indispensable, holistic and trusted financial adviser for institutions and families by providing personalized investment solutions and services. We intend to increase the quality, frequency and value of interactions between Westwood and our clients by utilizing a combination of human judgment and automated digital engagement techniques. Our platform will be friction free and easy to use. Clients can use all or any of our services, which will include asset management, banking services through a partner bank, complex financial planning, estate planning and private equity wrapped in a state-of-the-art digital platform using technology from our partner, InvestCloud. Adding these capabilities and focusing on solutions that truly create a unique experience, we hope will result in a Westwood client for life.

We have certainly been disappointed with our outflows this year, but we are not standing still. We have made significant investments in transformational technology that will drive deeper client engagement as well as operational, regulatory and reporting efficiency. As we've stated in the past, we believe that clients are looking for differentiated performance and that starts with being different than a passive index. Volatility seems to be on the upswing, and that will be a more positive environment for active managers and for Westwood.

As we look forward, we have several strategies in high demand areas, and we are pleased to see improved performance in EM and SMid. Our focus in 2019 will be on sales execution across our high-conviction and outcome-oriented investment strategies.

As markets become more volatile and equity returns more challenging, we expect to see more opportunities for acquisitions in the private wealth area. It is likely to become more difficult for smaller firms to make the investments in technology, compliance, human capital and infrastructure to compete in a more competitive and volatile world. We offer a great platform, a public stock and the talented people necessary to complete and successfully integrate a private wealth business.

I'll now turn the call over to Tiffany Kice, our CFO, and will be available later for your questions.

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Tiffany B. Kice, 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 $29.9 million for the third quarter of 2018 compared to $33.5 million in the prior year's third quarter and $32.8 million in the second quarter of 2018. The decrease from the prior year was primarily due to net outflows and the sale of the Omaha-based component of our Private Wealth business. The decrease from the immediately preceding quarter was primarily due to net outflows and performance-based fees earned in the second quarter.

Third quarter net income of $5.4 million or $0.62 per share compared to $4.1 million or $0.49 per share in the prior year's third quarter. The current quarter benefited from reductions in compensation following the sale of the Omaha-based component of our Private Wealth business and reductions in short- and long-term incentive compensation, offset by lower asset-based fees and higher information technology implementation costs as we continue to invest in our technology infrastructure. Additionally, the prior year quarter was negatively impacted by a $2.5 million legal settlement charge, net of insurance recoveries and taxes.

Third quarter net income of $5.4 million or $0.62 per share compared to $8 million or $0.94 per share in the second quarter of 2018. The second quarter benefited from higher asset-based and performance-based fees in addition to foreign currency transaction gains.

Economic earnings, a non-GAAP metric, was $9.5 million or $1.11 per share compared to $9 million or $1.07 in the prior year's third quarter and $12.2 million or $1.43 per share in the second quarter 2018.

Firm-wide assets under management totaled $20.8 billion at quarter end and consisted of institutional assets of $12 billion or 58% of the total, Private Wealth assets of $4.8 billion or 23% of the total and mutual fund assets of $4 billion or 19% of the total. We experienced net outflows related to our ongoing business of $1.2 billion, with the remaining net outflows related to the sale of our Omaha-based Private Wealth operations and market appreciation of $690 million.

Our financial position continues to be very solid, with cash and short-term investments at quarter end totaling $119.1 million and a debt-free balance sheet. We have no significant updates on the impact of tax legislation since our last earnings call, and we continue to expect our fiscal 2018 effective tax rate to be in the range of 26% to 28%.

I will now turn the call back over to Brian.

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

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Thank you, Tiffany. And as you probably saw in our 8-K filed earlier this month, this will be Tiffany's last quarterly call for Westwood as she resigned as CFO effective October 31. I'd like to thank Tiffany for her hard work and dedication at Westwood over the past 4 years and wish her well in her next endeavor.

And I'd now like to introduce you to Terry Forbes, who we've promoted to CFO.

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Murray Forbes, Westwood Holdings Group, Inc. - VP of Finance [6]

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Thanks, Brian. I'm excited for the opportunity to lead the accounting and finance team, and I look forward to building relationships with our investors and our stakeholders over the coming months.

I'm happy to announce that our Board of Directors approved a quarterly cash dividend of $0.72 per share, which represents an increase of 6% from the previous quarterly dividend rate. The dividend will be payable on January 2, 2019, to stockholders of record on December 7, 2018. This represents an annualized dividend yield of 6.5% as of yesterday's closing price.

That brings our prepared remarks to a close. We encourage you to review our investor presentation we have posted on our website, reflecting third quarter 2018 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 will open up the lines for 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 with Gabelli.

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

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Actually, first, a nice statement to Tiffany. Best wishes. I appreciate all the help over the last couple of years.

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Tiffany B. Kice, Westwood Holdings Group, Inc. - Senior VP, CFO & Treasurer [3]

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Thank you, Mac. I appreciate that.

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

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Brian, you talked a little bit about your Select Equity and your success with the RIA channel and that's been a bigger focus of distribution for the industry, just given that it's growing faster. I was wondering if you could dig in a little bit, just talk a little more about why that specific product is being successful with the channel there? And what other products could you be more successful with in terms of sell-through?

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

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Sure. Well, thanks Mac. And I echo your sentiments on Tiffany. We'll miss her, and we wish her well in her next career. As far as Select Equity, as you know, we started that fund about 3 years ago, and the idea behind it was to have a high-quality, low-turnover, tax-efficient portfolio. It's basically the kind of portfolio that I would want as an individual investor. And it's resonated really well with those that we've spoken to about it. The performance has been really good. And as we complete our third year this year, we hope to have even greater success in the future. I mentioned a couple of other products during my remarks. One of them is EM. EM has had a remarkable improvement in the third quarter. As you know, our team tends to own companies for a long period of time. When they invest in a company, they like to own it for 5 or 6 years. Their annualized turnover is about 12% or 13%. And they have always underwritten the companies like they want to own them for a long time. And the index has really gotten crazy over the last several years as China has become a bigger and bigger part of that index. They've had a cap relative to that, so they've underperformed when China has run up. They've made a lot of that back here recently, and they feel really good about how they're positioned going forward. So the performance has improved quite a bit, and we're excited about the prospects for the EM franchise. In addition to that, our SMid performance has improved recently. That's been a sticking point for us the last several years. So we're good to see -- or we're glad to see some continued improvement there.

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Operator [6]

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(Operator Instructions) And I'm showing no further questions at this time. I would now like to turn the call back to Mr. Brian Casey for closing remarks.

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

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Great. Thank you, and we appreciate everybody taking the time to listen to our call. It's a very character building day on Wall Street with the market down big, so we know you've got lots of other companies to listen to.

So thank you, again, and please visit our website, westwoodgroup.com, for more information on our firm and any of our public filings. Feel free to call me or Terry, if you have any questions as a follow-up. Thanks for your time.

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Operator [8]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.