Q3 2023 Artisan Partners Asset Management Inc Earnings Call
Participants
Charles James Daley; Executive VP, CFO & Treasurer; Artisan Partners Asset Management Inc.
Eric Richard Colson; CEO & Director; Artisan Partners Asset Management Inc.
Jason A. Gottlieb; President; Artisan Partners Asset Management Inc.
Unidentified Company Representative
Alexander Blostein; Lead Capital Markets Analyst; Goldman Sachs Group, Inc., Research Division
John Joseph Dunn; Associate; Evercore ISI Institutional Equities, Research Division
Michael C. Brown; MD; Keefe, Bruyette, & Woods, Inc., Research Division
Presentation
Operator
Hello, and thank you for standing by. My name is Jason, and I will be your conference operator today. (Operator Instructions) As a reminder, this conference call is being recorded. At this time, I will turn the call over to Artisan Partners Asset Management.
Unidentified Company Representative
Welcome to the Artisan Partners Asset Management business update and earnings call. Before we begin today, I would like to remind you that comments made during today's call, including responses to questions, may include forward-looking statements. These 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. These risks and uncertainties may cause actual results to differ materially from those discussed in the statements, and we assume no obligation to update or revise any of these statements following the presentation.
During today's call, we will be discussing our Investor Day, which took place on September 27 in New York and online. Materials from the Investor Day and a replay of the presentation are available on our Investor Relations website. The Investor Day presentation also included forward-looking statements that were current as of the time they were made, but have not been updated to reflect any changes in circumstances.
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 could 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 will now turn it over to Eric Colson, our CEO.
Eric Richard Colson
Thank you for joining the call or reading the transcript. On September 27, we held our first Investor Day. After more than 10 years as a public company, we wanted to review who we are as an investment firm, describe how we have evolved our business and compounded wealth for clients and highlight the team and platform we have in place for future growth. The title of the Investor Day was The Power of Quality Compounding. We wanted to reinforce the power of compounding, the eighth wonder of the world and reinforce the power and potential of Artisan Partners, a firm designed and operated the compound wealth, careers and outcomes over long periods of time.
As an illustration, a hypothetical portfolio of $1 million invested at inception of each of Artisan's 28 strategies launched to clients would have grown to nearly $117 million net of fees as of September 30, 2023. This amount is nearly $43 million or 58% more than if the same amounts had been invested in the passive benchmarks most often used to assess our strategy's performance. That's a good example of the power of compounding and the long-term performance of Artisan Partners. Another goal of our Investor Day was to introduce more members of our business management team. We have a group of senior leaders who know the investment industry and are aligned with who we are as a high value-added investment firm. This group gives us the breadth and depth to continue our repeatable franchise development process, further expand our investment and business capabilities and keep the compounding process going long into the future. At the Investor Day, Jason Gottlieb, our President, led a detailed discussion of our franchise development process, the positioning and potential of our existing investment strategies and areas where we may expand in the future. Today, Jason is joining C.J. and me, and I have asked him to update you on the status of our credit-oriented business as well as opportunities we see in Emerging Markets.
Jason A. Gottlieb
Thank you, Eric. Our expansion into credit is a case study in our repeatable franchise development process. Slide 2 should look familiar. It shows the spaces we are focused on and our methodical build-out in these areas. As we discussed at the Investor Day, we pursue asset classes where we see the overlap of exceptional talent, large investment opportunity sets for differentiation and alpha generation, large addressable markets with long-term allocators and good fit with or strategic expansion of our business model and operating platform. 10 years ago, we did not have any of these capabilities shown on this slide. Today, we have an investment offering in each of these areas except private credit.
Earlier this week, we completed the first close of the Artisan Dislocation Opportunities fund. The fund is a closed-end drawdown vehicle managed by Bryan Krug and the Credit team. Throughout his career, Bryan has exploited opportunities in dislocated markets. Dislocation Opportunities fund is designed to provide clients with targeted access to this core competency of the team. When I think about the lineup on this slide, what is most notable to me is that we have demonstrated that our philosophy and process works for clients and talent beyond public equities. In short, these strategies have performed. Since inception and after fees, the high-income strategy has delivered 193 basis points of average annual alpha. credit opportunities, 751 basis points; floating rate, 50 basis points; Global Unconstrained, 603 basis points; Emerging Market debt opportunities, 939 basis points; and Emerging Market local opportunities, 255 basis points.
During the third quarter, we continued to capitalize on this success and grow these businesses. We onboarded a $425 million institutional account in Emerging Market local opportunities. We onboarded a $250 million institutional account in Global Unconstrained, and the high-income strategy had another strong quarter of flows, bringing year-to-date net inflows to over $1 billion for that strategy. Looking ahead at the near term, we are particularly focused on credit opportunities and Global Unconstrained strategies. Both have outstanding track records with differentiated portfolios. We will also continue to round out and further diversify the high-income business and execute on early opportunities for the EMsights Capital Group.
While we have made significant progress in expanding our credit capabilities, we are still in the early innings. We have a tremendous opportunity with our 2 existing teams, and there is great potential to leverage our operational platform with additional fixed income talent. As we move forward, we expect to do more in high value-added credit, but we will remain patient for the right opportunities that are consistent with our repeatable process.
Turning to Slide 3. With the addition of the EMsights Capital Group, we now offer 5 Emerging Markets investment strategies, 3 refocused on equities and 2 focused on credit. We don't include Global Unconstrained as an EM strategy given its broad mandate to seek return and manage risk across developed and developing markets. It is no secret that Emerging Markets investing has been rough. Over the last decade, the MSCI EM equity index has returned 2.07% annually compared to 7.55% for the ACWI index and 11.91% for the S&P 500. Flows haven't been good either. In 2022, $90 billion flowed out of the EM debt strategies, and $4 billion flowed out of EM equity strategies. 2023 has seen a continuation of these trends in EM debt with EM equities seeing modest inflows.
We take a long-term approach. Emerging Markets accounts for over 40% of global GDP and even greater share of global growth. Emerging Markets offers a large and growing investment opportunity set. There is ample opportunity for differentiation and alpha and clients want and need active risk management. Yes, allocators are dialing down EM allocations right now, especially to China. But long term, we believe that Emerging Markets will be an important source of return and diversification for our sophisticated allocators. While others are retrenching from Emerging Markets, we continue to move forward carefully and with discipline. We have long experience in Emerging Markets. We launched the Artisan Sustainable Emerging Markets strategy in 2006 and Artisan Developing World strategy in 2015. More recently, in addition to launching the EMsights Capital Group, we have built out our China Post venture team with 7 individuals operating out of Hong Kong office. Our Developing World team now has talent in Hong Kong as well, and we recently obtained regulatory approval to execute trades from Hong Kong and placed our first trades from there in October. We have no illusions about the challenges presented by geopolitics and China, in particular. These take judgment and patience to navigate, but we have never tried to time markets or short-term demand. We look for the overlap of talent, opportunity and business fit. When we find it, we move forward, we build, and we remain patient. Over the long term, we continue to believe that Emerging Markets will present opportunities that allocators want and need to access. We have today and will have in the future a compelling lineup of talent and strategies to fit those needs.
Eric Richard Colson
Thank you, Jason. Slide 4 summarizes our growth since 1995. Our growth has been a function of compounding wealth for existing clients, adding new capabilities and assets over time and patience. As we've added investment capabilities and assets, we've invested in the distribution capabilities that support them. At the Investor Day, listeners heard from our Head of Global Distribution, Chris Krein. Our distribution model is a hybrid approach. Traditionally, our investment team specific business leaders have marketed and serviced institutional clients and consultants, while our centralized sales teams have marketed and serviced their own channels or geographies.
We have hired excellent people, provided compelling incentives and sold and serviced across multiple channels and geographies with modest headcount and total spend. Over time, though, the number and complexity of our investment strategies has grown considerably. And historical distribution channels are converging, making distinctions like institutional and intermediary less relevant. But it takes to sell and service as a sophisticated asset allocator is increasingly similar whether it's a pension fund, institutional consultant, broker-dealer research department or family office. We are involving to increase intentionality and focus by improving alignment between our distribution professionals, content and marketing and data. We will continue to have high-caliber talent and compelling incentives, but we are creating more structure and coordination, more clearly delineating sales and service responsibilities. We are clarifying sales priorities, and we're producing more investment content and better coordinating that content with sales and service efforts. And we are collecting, generating and using more data to improve the effectiveness and efficiency of our sales and service groups.
Let me give you 2 examples to illustrate this evolution. First, we recently hired our first individual to focus exclusively on marketing our alternative strategies. His near-term focus is on marketing the credit opportunity strategy as well as related co-investment style opportunities that are a derivative of what the Credit team does such as dislocation opportunities. Second, we are identifying specific strategies where we have compelling near and medium-term opportunities and aligning people, resources, content and data to increase our focus and improve our feedback loops. These more structured marketing efforts increased the probability of near and medium-term success and serve as a model for the future.
All of this evolution is consistent with who we are and how we have historically evolved. We have always sought to align people, resources, incentives and opportunities. At the Investor Day, we also described why we are confident, we will continue to compound wealth for clients, scale our newer strategies, add additional capabilities and continue to generate high-quality outcomes for our clients, employees and shareholders. We have expanded across more investment teams, asset classes and geographies. We have a repeatable process for identifying, recruiting, onboarding and partnering with investment talent. Our operational platform has more capabilities than ever. We are evolving our distribution model, and we have in place a business management team with deep industry and Artisan-specific experience that is extremely well positioned to move us forward.
I will now turn it over to C.J. to discuss our recent financial results.
Charles James Daley
Thanks, Eric. The decline in equity markets during the quarter drove our assets under management down to $136.5 billion as of September 30. That's a 5% decrease from the June 30 AUM and 7% higher than our AUM at the start of 2023. Declines in global market indices contributed meaningfully to the decline in our AUM. Net client outflows primarily in global equity mandates also contributed to the AUM declines. Average AUM was $142.2 billion for the quarter, up 2% compared to last quarter and up 7% compared to the prior year September quarter. Year-to-date average AUM was $139 billion, down 5% from last year.
Our complete GAAP and adjusted results are presented in our earnings release. Revenues in the quarter increased 2% compared to last quarter on higher average AUM. Compared to the third quarter of 2022, revenues were up 6% on higher average AUM. Performance fee revenue has been insignificant since 2021. We are on track to earn some performance fees in the fourth quarter although the amount remains relatively small as only 3% of our AUM have performance fee billing arrangements.
Adjusted operating expenses for the quarter increased 1% sequentially due to an increase in incentive compensation expenses in line with higher revenues. Adjusted operating income increased 4% in comparison to the previous quarter and increased 5% compared to last year's third quarter. On a year-to-date basis, revenues were down 5% compared to 2022 on lower average AUM. Adjusted operating expenses were generally flat compared to the 2022 9-month period. The decrease in incentive compensation expenses on lower revenues was offset by an increase in fixed compensation costs related to annual merit increases and a 6% increase in our number of employees compared to September 2022. Our headcount increases continue to be in line with our strategic growth plans and were primarily targeted to investment, distribution and marketing teams to support our growth initiatives.
Travel expenses remain around 35% higher than last year, driven by increased travel related to our global investment strategies and client activity and firm events such as the Investor Day we held in late September. As a result of lower revenues, year-to-date adjusted operating income and adjusted net income per adjusted share were both down 15% compared to the 2022 year-to-date period. Full year expense projections remain consistent with the guidance I provided on the February earnings call.
Turning to Slide 10. Our balance sheet continues to support our operations and seed capital needs and provides a healthy cash dividend. We currently have approximately $140 million of seed capital invested in sponsored investment products with significant amounts of realizable capacity. The ability to support all of these objectives is only possible because of the strong cash flows generated by our business. In addition, the $100 million revolving credit facility remains unused. Given the rise in interest rates, our excess working capital cash contributed an additional $3.5 million of interest income in 2023 compared to the 2022 year-to-date period. Consistent with our dividend policy, our Board of Directors declared a quarterly dividend of $0.65 per share with respect to the September 2023 quarter, which represents approximately 80% of the cash generated in the quarter and an 8% annual dividend yield based on our recent stock price before factoring in the special annual dividend, we intend to declare in January. Our Board will consider the declaration of an annual special dividend at our January 2024 Board meeting. We expect we will retain some cash from the special dividend as we have in the past several years to support our growth initiatives.
In the fourth quarter, we expect the Artisan funds to complete their annual income and capital gains distributions. Based on our current estimates and assumptions, we expect fourth quarter distributions to result in approximately $400 million of net client cash outflows from investors who choose not to reinvest their distribution. As highlighted in our recent Investor Day, growth is not linear and takes time in patience, and we continue to demonstrate the patience and discipline to grow our business over time to produce durable and high-quality results.
Slide 12 illustrates the results of our business model and philosophy. We have delivered quality outcomes for our shareholders since our IPO 10 years ago. We are confident that our commitment to investing in our business will drive future growth, and we remain focused on returning capital to shareholders to generate quality outcomes over long time periods.
With that, I will turn the call back to the operator.
Question and Answer Session
Operator
(Operator Instructions) And our first question comes from John Dunn from Evercore ISI.
John Joseph Dunn
Could you maybe spend a little time just kind of framing for us the puts and takes of the institutional side of the business right at this moment? And then maybe just a flavor of like the kind of consultant and institutional mindset and how conversations are going right now?
Eric Richard Colson
Yes, sure, John. It's Eric. The -- just back and away even above the institutional marketplace, we've come off of a pretty big drawdown in '22 and then a lot of uncertainty here in '23. So we've seen, in general, muted flows compared to '20 and '21. So the bigger flows that are happening in the institutional side are sticking out a little bit more. Primarily, they've been non-U.S. clients in our larger global equity strategies that have been rebalancing or derisking or acknowledging that there's been regulatory change, which has occurred more in Australia. So you've seen more activity there. And as we look at the put and the take, the flip side is looking forward, and there's quite a bit of cash buildup that we've seen in money market funds. We're starting to see more people look at their targeted asset allocation and where to put that to work. So one of the areas we're looking at on a go forward is people rebalancing back to Emerging Markets and rebalancing into areas of interest, which is fixed income and alternatives. And more recently, you've seen a pickup in the dispersion of -- in individual securities within indexes showing an interest leaning towards active management. So I think the muted year so far with an expectation of money getting put to work next year back to targeted asset allocation.
John Joseph Dunn
Got you. And then maybe just on the 3 new mandates that you got recently. Maybe just because it seems like they came together pretty quickly, like could you give us a flavor of how those came to be? And then also, is there more -- might we expect some more activity in those 3 areas in the medium term?
Eric Richard Colson
Yes, certainly. We -- as everybody is aware, we brought on the EMsights Capital Group and focused on the EM debt as well as the Global Unconstrained, the type of investments in Emerging Market debt either requires a larger scale separate account or a pooled vehicle. The earlier investments have been in the larger separately mandated. We have a good interest in the institutional marketplace around these mandates. And we're starting to build a nice track record in the pooled vehicles and expect that we would have a forward lean in smaller allocations into the pooled vehicle is our expectation there. So we think it's -- the EMsights' team is going as expected. We spent the early months building out the foundation, bringing in the team and allowing the team to put the proper foundation to build a strong track record. The track record is looking as we expected, which was a high value-added Emerging Market debt and Global Unconstrained strategies. And now we're out in the marketplace seeking early investors, which we found in the separate accounts and now continuing to sell with the pooled vehicles.
Operator
Our next question comes from Alex Blostein from Goldman Sachs.
Alexander Blostein
I was hoping we could build on the discussion around Emerging Markets, both in equities and debt. And the point you made around allocated is pulling back from Emerging Markets in the last year or so is, I guess, perhaps not too surprising. But when you talk to consultants and institutional allocators and distribution platforms, what do you see as the catalyst to perhaps reignite some of the interest in the asset class? And how are you positioning Artisan to ultimately capitalize if that trend reverses?
Eric Richard Colson
Alex, it's Eric. What really interests us in this discussion is that change is going to occur here. Either people are going to pull back from Emerging Markets and reduce their allocation. They're -- or they're going to look at their target allocation and have to re-up to that target and put money to work. So there -- in our mind, there's going to be money in motion. And when there's money in motion, it gives us an incredible opportunity given the array of strategies we have. So we're not sure if there's going to be an uptick or a downtick. But we definitely know people are going to have to rethink about their Emerging Market allocation, look at how they're structuring it, using equity debt active, passive. And the marketplace is going through that right now, and it's a great time for us to get out and showcase the breadth of Emerging Market strategies we've built inside the firm. And on top of that, if they do reduce Emerging Markets, they're going to go to higher value-added international or global strategies that have a higher allocation to Emerging Markets to pick up that exposure, which you wouldn't see in a passive strategy. So again, it actually benefits, active international or global equity mandates, which we are very well positioned for. So we're just excited about that the topic is coming to market, and we're starting to see that topic come out with institutional clients and consultants.
Alexander Blostein
Interesting. C.J., a question for you maybe just around margins and expenses. A bit of a 2-parter. But I guess, one, I know it's -- you guys are probably going through the budgeting processes. But any early thoughts on 2024 expense outlook, particularly around the nonvariable portion of the expense base? But also bigger picture at the Investor Day, and I think in the slides today, you sort of alluded to the idea that over time, the margin of the business was much higher than what you guys have currently kind of in the mid-30s versus low 30s right now. In the last decade, we've all been operating in a much more favorable market backdrop with probably higher market beta maybe than what's on the come. But how do you think about ability to get back to that mid-30s percent margin if market tailwinds are less sort of robust than what we've seen in the past?
Charles James Daley
Yes. Sure, Alex. So first off, we've invested pretty heavily in sort of our new capabilities over the last couple of years. So I think we've seen a good amount of expense investment, which has obviously impacted our margin. And we shouldn't underscore the effects of inflation as well and just the increase of cost of doing business where employee costs are higher as a result of inflation. Many of our vendors, including mostly data, technology vendors are increasing prices to offset those inflationary pressures they have. Our fee rates remain stable. And so the offset then is margin. We do -- we are early in a budgeting process. I would expect us to continue to invest in distribution and marketing. I think a fair amount of the lift has been done, but there will be some more, and I can give you better clarity in January. But I would assume normal inflationary plus 1% or 2 expectations for cost increases next year. And then getting back to the margin, we're built to handle a much larger amount of AUM, and we have the capacity and the products to do it. The performance is there. And now it's just about giving ourselves the time and being patient to capture that growth opportunity. And if we do, our margins will respond accordingly.
Operator
(Operator Instructions) And our next question comes from Michael Brown from KBW.
Michael C. Brown
Okay. Great. So I was just looking at Slide 2, and I guess the private credit bubble that's up at the top right there. Just it stands out. It's obviously a very hot asset class today in asset management land. So I just wanted to expand on maybe where you can lean in more? It sounds like you are certainly leaning in with Bryan Krug and the Credit team. And I wanted to hear a little bit more about what that opportunity looks like and how that could grow? And maybe if you could size it a little bit for me? And then is there any desire to be larger there? Would you consider bringing on a team to have a more true bigger capability in the private credit space and what kind of goes into that decision today given it is, of course, a pretty hot asset class?
Eric Richard Colson
Yes, certainly. It's Eric. The private credit space is built up substantially over the last few years. In our minds, it's clearly solidified a space and long-term asset allocation. So it then becomes an area of interest for us. And so with that category, we'll keep an eye on it and patiently wait for an opportunity to think about our existing teams or new teams to provide strategies and opportunities to invest. With regards to chasing a hot asset class and space, we have certainly not been well positioned to chase hot asset classes. Typically, it's very hard to find talent during this peak excitement, and you have to have a strong almost retail distribution to tap that in a very short-term period. So with regards to something happened in the near term around private credit. It would happen in our existing team as one-off investments in the high degree of freedom oriented strategies where we would see opportunities come. And we've been broadening out with Bryan Krug that you mentioned. And we have a fairly broad and robust credit platform. The credit opportunities and now the dislocation fund, both of those are really taking advantage of the smaller public credit markets that, I guess, have been somewhat forgotten and ignored in capturing an illiquid premium in that, which we think is an incredible opportunity. We also are expanding out with the EMsights and the Global Unconstrained, which is a macro aware go-anywhere strategy that is long short in design. So those are the areas that we're leaning into the alternative credit. I think we just list the private credit to keep an eye over the long term and which is no different than how we looked at Emerging Markets over the last 10 years. And it took us quite a while to find the right team, and we brought the EMsights site team in. So that's our thought on the upper end of the credit spectrum.
Michael C. Brown
Okay. Great. You've been making some shifts in your distribution capability and making investments there. You referenced the recent hire dedicated to the [alt] space. I guess what's next in terms of investing in that distribution channel, where would you be kind of focused either by channel, region or asset class?
Eric Richard Colson
Yes. The -- I think the important thing is we believe we have a very strong distribution team that's focused on who we are. And the highlights are less about increasing expenses to get more scale and broaden out and more about prioritizing and aligning resources to who we are today. And given the number of strategies and the complexity of those strategies, it's very hard for channels or geographies to sell and service. So most of the change we're talking about is how we're managing the business to align to who we are today. So there's a shift going on to get that focus and create more accountability into our sales effort and our service effort. And that's the big change that we're talking about.
Operator
There are no more questions in the queue. This concludes our question-and-answer session, and the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
