Q4 2023 Virtus Investment Partners Inc Earnings Call
Participants
Sean Rourke; VP, IR; Virtus Investment Partners, Inc.
George Aylward; President & CEO; Virtus Investment Partners, Inc.
Mike Angerthal; CFO; Virtus Investment Partners, Inc.
Crispin Love; Analyst; Piper Sandler
Bradley Hayes; Analyst; TD Cowen
Michael Cyprys; Analyst; Morgan Stanley
Presentation
Operator
Good morning. My name is Steve and I will be your conference operator today, and I would like to welcome everyone to the Vertis Investment Partners quarterly conference call. The slide presentation for this call is available in the Investor Relations section of the Virtis website, www.virtus.com. This call is being recorded and will be available for replay on the Virtus website. At this time, all participants are in a listen-only mode. After the speakers' remarks, there will be a question-and-answer period and instructions will follow at that time. I will now turn the conference to your host, Sean work.
Sean Rourke
Thank you, Vivian, and good morning, everyone.
On behalf of Virtus Investment Partners, I would like to welcome you to the discussion of our operating and financial results for the fourth quarter of 2023. Our speakers today are George Aylward, President and CEO, and Mike Angerthal, Chief Financial Officer. Following their prepared remarks, we'll have a Q&A period.
Before we begin, please note the disclosures on page 2 of the slide presentation. Certain matters discussed on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, and as such are subject to known and unknown risks and uncertainties, including but not limited to, those factors set forth in today's news release and discussed in our SEC. These risks and uncertainties may cause actual results to differ materially from those discussed in the state.
In addition to results presented on a GAAP basis, we use certain non-GAAP measures to evaluate our financial results or non-GAAP financial measures are not substitutes for the GAAP financial results and should be read in conjunction with them. Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in today's news release and financial supplement, which are available on our website.
Now I'd like to turn the call over to George. George?
George Aylward
Thank you, Sean, and good morning, everyone. So I'll start with an overview of the results reported this morning before turning it over to Mike to provide some more detail, though, still volatile markets trended more favorably in the fourth quarter on views of inflation and interest rate expectations, leading to an increase in assets under management and while we had net outflows driven by open-end funds consistent with the industry as well as specific institutional accounts, we also had strong retail sales, including the highest retail separate account sales in two years, positive net flows in retail separate accounts and ETFs, each of which had an organic growth for the full year. Lower total operating expenses for the quarter with other operating expenses essentially flat for the full year, increased return on capital, including $20 million of share buybacks, attractive investment performance, core strategies, both long term and for the one-year period and repayment of debt ending the quarter with low net leverage and a well-positioned balance sheet.
Turning now to a review of the results. Total assets under management increased 6% to $172 billion, primarily due to favorable market impact in the addition to positive net flows in retail separate accounts, sales increased 7% to $6.2 billion due to a 12% increase in retail sales, with particularly strong growth in retail separate accounts, which grew 15%, led by private client open-end fund sales increased 9% with sequentially higher sales of domestic equity, fixed income and alternative strategies. Net outflows were $3.8 billion compared with net outflows of $1.5 billion last quarter. So by product, institutional had net outflows of $2.2 billion compared with net outflows of $0.4 billion last quarter and included redemptions related to repositioning by several retirement plan mandates. Institutional business is inherently variable on a quarterly basis, but has generated organic growth in three of the last four years with contributions across affiliates, strategies and geographies. Retail separate accounts generated positive net flows of $0.4 billion and were positive for the full year. As we previously said, we continue to see retail separate accounts as a key growth area as we expand offerings with additional strategies to complement our strength in small SMid and mid-cap equities.
Open-end net outflows of 2 billion compared with 1.5 in the third quarter due to a higher level of redemptions across strategies, though SMidCap and global equities continued to generate organic growth. Etfs, again generated positive net flows and for the full year delivered 14% organic growth as we've continued to broaden the product lineup with additional distinctive active strategies in terms of what we saw in January for flows retail and institutional net flows were each improved meaningfully on the retail side, while it was just one month, January was the best month for net flows in open-end funds. Since September of 2021 with net outflows for approximately 150 million. That represents less than 25% of the average monthly net outflow in the fourth quarter with improvement across asset classes, including including breakeven net flows in domestic equity and positive net flows in alternatives.
I would also note that earlier this week we reopened two capacity-constrained small-cap strategies that have been closed since 2018 and have already seen a meaningful level of interest for them.
For institutional. We had a large funding early in January that had been delayed from the fourth quarter. All else being equal, Institutional is generally trending towards flat net flows for the first quarter based on known and expected upcoming funding and redemption activity. This business can fluctuate in the short term, and we have seen a more prolonged funding cycle. However, the pipeline continues to be strong in terms of size and with broad representation across affiliates, strategies and geographies. Our fourth quarter financial results reflected lower average AUM, largely due to the timing of market performance and net outflows, partially offset by lower total operating expenses. The operating margin was 33%, down sequentially from 33.9 due to lower investment management fees and was up 120 basis points from the prior year period. Earnings per share as adjusted of $6.11 compared with $6.21 in the prior quarter and were up 18% from $5.17 in the fourth quarter of 2022.
Turning now to capital. During the quarter, we continued to take a balanced approach to capital management. We repurchased approximately 90,000 shares for $20 million, up from 15 million in the prior quarter. For the full year, we repurchased approximately 224,000 shares and reduced outstanding shares by 1% in 2023, we increased our quarterly dividend by 15%, our sixth consecutive annual increase in our dividend. We also repaid the remaining 20 million outstanding on our revolving credit facility. And ended the quarter in modest net debt position and gross debt below one times EBITDA as we continue to generate significant cash flow, providing ongoing opportunities to invest in the growth of the business and return capital to shareholders.
With that, I'll turn the call over to Mike. Mike?
Mike Angerthal
Thank you, George. Good to be with you all this morning. Starting with our results on slide 7, assets under management at December 31st, assets under management were 172.3 billion, up 6% from 162.5 billion at September 30th due to $14.3 billion of favorable market performance, partially offset by net outflows of 3.8 billion. Average assets under management in the quarter decreased 3% to 162.7 billion with ending assets 6% above QUARTERS average. Our assets under management represented a broad range of products and Asic institutional, our largest product category was 37% of AUM. Retail separate accounts has delivered consistent organic growth and is at 25% of assets, up from 16% five years ago. We also remained well diversified among and within asset classes, alternatives and multi-asset, in which we had limited presence several years ago totaled over 20% of our AUM reflecting the results of our strategic efforts to expand capabilities, particularly and less correlated strategies. In addition, on a geographic basis, non-US clients were 18% of AUM and generated 10% organic growth in 2023. We also continue to have compelling long-term relative investment performance across products and strategies. As of December 31st, approximately 69% of institutional assets 86% of retail separate account assets and 62% of our rated mutual fund assets were outperforming their benchmarks over five years. For mutual funds, 71% outperformed the median of their peer groups over the 5-year period. In addition, 69% of rated fund assets had four or five stars and 90% were in three, four or five star funds. We had 38 funds that were rated four or five stars, including 11 with AUM of EUR1 billion or more. I would also note that our managers performed well for the full year 2023 with 58% and 90% of institutional and separate accounts AUM, respectively, beating benchmarks for the period, while 55% of mutual fund AUM beat benchmarks and 70% outperformed the median performance peer group.
Turning to slide 8, asset flows. Total sales of 6.2 billion increased 7% from 5.8 billion due to growth in both retail separate accounts and open-end funds by product institutional sales of $1.2 billion compared with 1.3 billion in the prior quarter, which included the issuance of a 300 million CLO retail separate account sales of 2.1 billion increased 15% from 1.8 billion, led by meaningful growth in private client sales. Open-end fund sales of $2.9 billion increased 9% from $2.7 billion, primarily due to higher sales in mid-cap SMidCap and bank loan strategy. Total net outflows were 3.8 billion, which compared with $1.5 billion of net outflows in the prior quarter. Reviewing by product institutional net outflows of $2.2 billion included approximately 1 billion of redemptions from several long-standing retirement plan mandates. These accounts, each of which were in different investment strategies, reposition their risk allocation due to the planned level of funding. As always, institutional flows will fluctuate depending on the timing of client actions in retail separate accounts, positive net flows of 0.4 billion increased from 0.3 billion in the prior quarter, and both intermediary sold and private client continued to generate positive net flows. For the full year, retail separate accounts generated 2% organic growth for open-end funds. Net outflows were 2 billion compared with $1.5 billion in the third quarter due to higher redemptions across strategies in retail funds both SMidCap and global equity continued to generate positive net flows. Etfs were again positive and on a full year basis generated 15% organic growth. Global Funds were essentially breakeven for the quarter with 9% organic growth for the full year.
Turning to slide 9, investment management fees as adjusted of $174.4 million decreased $2.9 million or 2%, reflecting the sequential decline in average assets under management, partially offset by higher performance fees, which were 3.3 million, up $1.6 million last quarter. For the full year, performance fees were $4.5 million, which compared with $1.8 million in the prior year and $2.6 million in 2021 based on our institutional accounts with performance based fee structures, which are highly dependent on those strategies, investment performance relative to benchmarks, we would expect performance fees to be in a range of 3 million to $5 million per year. The average fee rate of 42.6 basis points increased from 42 basis points in the prior quarter and included 0.8 basis points from the performance fees. Excluding performance fees from both periods, the average fee rate was flat at 41.8 basis points.
Looking ahead, we continue to expect the average fee rate to be toward the low end of our 42 to 44 basis point range, which is modestly above the normalized fourth quarter level. As always, the fee rate will be impacted by markets and the mix of assets.
Slide 10 shows the five-quarter trend in employment expenses. Total employment expenses as adjusted of $96.7 million decreased 2% sequentially, primarily reflecting lower variable incentive compensation. As a percentage of revenues, employment expenses were 50%, relatively unchanged from 50.1% last quarter. Looking ahead, it would be reasonable to anticipate employment expenses to continue to be in a range of 49% to 51% of revenues. As always, it will be variable based on market performance, in particular as well as profits and sales.
For modeling purposes, the first quarter will also include seasonal employment expenses, which are incremental of this out.
Turning to slide 11, other operating expenses as adjusted were $31.2 million, up $1.1 million or 3% from the third quarter. The sequential increase largely reflected higher travel and related activity, as well as the impact of increases in market data costs. I would note that on a full year basis other operating expenses of $122.8 million were essentially flat with the prior year, even with the addition of a new affiliate in April.
Looking ahead, the quarterly range of 30 to 32 million for other operating expenses as adjusted it remains reasonable.
Slide 12 illustrates the trend in earnings. Operating income as adjusted of $63.9 million decreased by $3.1 million or 5% sequentially due to the lower average assets under management, partially offset by lower total operating expense. Operating margin as adjusted of 33% compared with 33.9% in the third quarter.
With respect to nonoperating items, other income as adjusted increased by 0.5 million reflecting higher earnings on equity method invest.
Total net interest income decreased modestly from the prior quarter, which included a higher level of CLO interest income from a recent issuance and reflected lower gross debt. Net income as adjusted of $6.11 per diluted share declined 2% of $6.21 in the third quarter.
In terms of GAAP results. Net income per share of $4.21 compared with $4.19 per share in the third quarter and includes $0.71 expense for fair value adjustments to affiliate noncontrolling interests, $0.36 of CLO issuance expenses, $0.18 of acquisition and integration costs, and $0.13 of fair value adjustments to contingent consideration, partially offset by $0.35 of realized and unrealized gains on investment.
Slide 13 shows the trend of our capital liquidity and select balance sheet items. We ended 2023 with appropriate levels of working capital and modest leverage, providing meaningful financial flexibility to invest in the business, our turn capital and repay debt. During the quarter, we repaid the remaining $20 million balance on our revolving credit facility and ended the year with net debt of $19 million, representing net leverage of 0.1 times EBITDA. We also repurchased 97,952 shares during the quarter for $20 million, up from $15 million in the prior quarter. For the full year 2023, we repurchased 223,807 shares for $45 million and reduced the share count by 1.3%.
I would also note, as a reminder that our intangible assets continue to provide a cash tax benefit at current tax rates. We estimate the tax attributes could provide a cash tax benefit of approximately 19 million per year over the next 10 years.
And with that, let me turn the call back over to George. George?
George Aylward
Thanks, Mike. Okay, so we'll now take your questions. Debbie, would you open up the lines, please.
Question and Answer Session
Operator
(Operator Instructions) Crispin Love, Piper Sandler.
Crispin Love
Inside the morning, everyone. Appreciate taking my questions. Just first, on the institutional flow side, you mentioned that the outflows in the quarter were driven by some of the repositioning by some of the large retirement plan mandates. Can you just provide a little more detail there? Heard some of the more constructive color on on January in the first quarter, but is repositioning number time mandates something that you'd expect to see more of in 2024 through the year? Or can just the institutional flows here just be lumpy based on the quarter and could trend closer to more recent levels.
George Aylward
Yes, couple of comments and then Mike can add to that. So yes, every retirement plan pension plan has a different attributes and is at different points in terms of funding cycles, right. So again, I think what was unusual for us is that multiple plans each with different clients, different strategies, reaching a level of funding and given the strength of the ending of the market here, it's done, it's not unusual to them for a plan or any client actually to kind of reposition their risk profile and kind of lock in where they are in terms of funding. So it was unusual to have that number of different clients from different regions in different areas, do it at the same time. So again, we would normally you would normally would see over the lifecycle of depending on how markets are doing when you are talking specifically about pension plans and retirement plans as they achieve certain of their funding requirements or if they achieve full funding, they're going to immediately they should immediately lock in whatever those returns are of the general business. Institutional is variable in nature because the other thing that we would normally see and I wouldn't be surprised if it emerges more this year is even if you're not in a retirement plan that you're not locking in funding, you're changing your outlooks for our going forward, right? So plans that might be overweight fixed income may decide to take more risk spectrum on the equity side that creates opportunities or vice versa. So they'll will be very related to individual.
Mike, any other color on the retirement plans themselves?
Mike Angerthal
No, I think you I think you touched on it. I think from our perspective, those redemption levels were sort of at the fee rate of our blended fee rate. So nothing unusual other than for multiple plans to all rebalance in this relatively short period of time,.
George Aylward
Which is unusual thinking about kind of what happened at the end of the year in the markets. Right. So you were in that environment where there was a nice pop in equities, so.
Crispin Love
Okay, great. And then just, Michael, just on the institutional fee rate increased by about three bps in the quarter? And was that a higher level than we've seen for several quarters? Is that mix of assets or anything to call out there? Does that have anything to do with the redemptions?
Mike Angerthal
No. And the performance fees in the quarter were 3.3 million, which ticked up a bit and really was driven by institutional accounts. So we we tried to normalize that in our disclosures. And looking ahead, I think 42 to 44 for our blended fee rate remains appropriate for modeling and as we go forward. So if looking at the adjusted fee rate on a normalized basis is a good way to think about it going forward.
George Aylward
Yes. So when we disclose the impact of the performance fees on the institutional. So it's always good to look at it with and without kind of look at the trend of the underlying accounts.
Crispin Love
Perfect. That makes sense. And then just one last question for me, just on the noncontrolling interest on the adjusted income statement, the dollar value here was at the lowest level for a few years. Can you discuss kind of why that was the case in the quarter and just some of the adjustments there that the doc compare GAAP to non-GAAP?
Mike Angerthal
Yes, the noncontrolling interest early relates to the the portion of sustainable growth advisors that the company does not own. And you may recall last year we did increase our ownership from 70 to about 75% in the third quarter. So really the change primarily reflects the change in ownership. So as we look forward, I think a good way to model the non-controlling line is taking an average really of those two quarters third quarter and fourth quarter as a good benchmark. I'm looking forward.
Crispin Love
Perfect. Thank you. I appreciate taking the questions.
George Aylward
Thank you.
Operator
Bradley Haid, TD Cowen.
Bradley Hayes
Hi, good morning. It's probably Hayes on for Bill Katz on how recently have you got multiples impacting the way you're thinking about deal opportunities as well as what you're seeing in the market.
George Aylward
So in terms of I'm sorry, you said with the impact of which multiple takeout multiples is in here, that broke up a little bit? Yes. We continue to evaluate the opportunities that are currently out there and multiples will sort of ebb and flow debate based upon the asset class and this specific opportunity set kind of release. So there has been some pull in of some of those multiples. But when you're dealing with there's different ranges of multiples that would be reasonable depending on whether you're talking about a traditional opportunity versus that, which is in the more private or or non-correlated kind of a section. But so we stay cognizant of those and factor those in as we think about our opportunities.
Bradley Hayes
Okay. On Azure, net debt to EBITDA sits quite low on how does this play into or change your thoughts around the cadence of capital return? Clemens?
George Aylward
Yes. In terms of capital, again, we're currently, as you're pointing out our level of leverage, our incumbency is relatively modest. We generate a good level of cash flow. We continually to evaluate how do we best deploy that, including in growing the business, which is fundamental to generating long-term shareholder value. We're keeping the debt at reasonable and modest levels. And then again, the stock buybacks, which again, we've consistently done generally maybe some times with some changes in terms of priorities within an individual quarter. So to us they're all important. And again, they'll generally vary based upon relative attractiveness, i.e., how is our stock trading in a certain period or what's happening with interest rates as it relates to debt. So we feel good that we're very well positioned and we have that flexibility to really avail ourselves of different opportunities. And those do include the M&A transactions, which while not fundamental to our strategy for long-term growth is something, as you know, consistently done over a period of time.
Bradley Hayes
Okay, great. Thank you. And then just one more question on where do you see the best potential for flows, perhaps either specific asset classes or funds you're feeling particularly strong about?
George Aylward
Yes, we see it's a great question. I mean, the areas of opportunities we do think on the we go through the of the pendulum, right. So I think on the retail side, we continue, as we said in our prepared comments, retail separate accounts continues to be great area growth, as is ETFs. And a lot of our product development and introduction is really focusing on those areas. And we do continue to see opportunities on the retail separate accounts as well as on the ETFs, particularly actively managed ETFs. So that's been a lot of areas. So we continue to see that.
Great. But for us, institutional you know, in spite of the lumpiness you're seeing in this quarter where the outflows were elevated. And again, we had a lead deposit in January that that would have should have occurred in the fourth quarter. We see that as a good opportunity, particularly non-US, right? And we've highlighted that before. Where is many of our managers and capabilities are not as well known and we put a lot of our resources and efforts in terms of doing that. And that's why we think we've seen some growth in the non-US client base. I think Mike cited 18% and continuing to have strong growth there. So I definitely think those are two areas that we've highlighted and we'll continue to highlight as areas of growth in terms of strategies, we offer a broader range because you could have a certain signal. We're seeing clients on the retail side going to that nice January we saw and it was really nice to see a strong January as we did where certain people that were hoarding cash in the fourth quarter were finally redeploying into equity. But simultaneously, we saw strength in alternatives for people looking for non-correlated. So the reason that we we tried to focus on having diversity of different asset classes and strategies is because of the diversity in the client needs. So, you know, for us in having 38 funds that are in the high star category, they'll each have opportunities depending upon different client.
Bradley Hayes
Okay, perfect. Thank you very much.
George Aylward
Thank you.
Operator
Michael Cyprys, Morgan Stanley.
Michael Cyprys
Great, thanks. Morning Monday.
George Aylward
Morning.
Michael Cyprys
Morning. Hoping we could maybe start off on the retail separate accounts. Maybe you could just elaborate on some of the areas that's driving the improving strength that you guys are seeing on the separate account side maybe you can elaborate on which some of the underlying strategies that are helping lift that higher on a gross sales basis? And then on the private client business, maybe you could talk about the opportunity set that you see over time to further expand that part of the business?
George Aylward
Sure, sure. On the first piece, and then Mike will have some additional color so retail separate accounts have been consistently strong for us. So we actually had a pretty much a a nonstop series of quarters of inflows until a little bit of breakage in the doldrums of the market. So we've consistently had growth. And I think as Mike has pointed, it's gone from about 16% of our assets five years ago to quarter of our assets today. So it's always been a growth area for us. Our greatest strength has been in this in the small caps, the SMid and the mids. That's still a good opportunity. We're actually seeing that as well in July and January in terms of what people are looking to. We also know the reopening of some of our small-cap strategies as well what we're also then looking to expand. We have other offerings on the fixed income space, and we're continuing to develop some additional ones. So what our hope is to continue to have the strength and the continued positive flows with our existing strategies, which are probably overweight equity, but really trying to expand that offering set from some of our fixed income strategies that don't have full availability at the speed areas yet and continue to build that out. So we're kind of very optimistic about where we think the opportunity set there is someone going to come on that. And then private client.
Mike Angerthal
Yes. And I would just add that to reiterate, the small and the SMid cap has been a consistent area of growth and on private client, we've really expanded that had some good traction on that part of the business from Kayne Anderson Rudnick as well as some fixed income flows that we saw from our team at SYKES, are you seeing it across affiliates? And it's been a consistent area of growth for us. And it's an area we've invested in and selectively added resources and has expanded contribution to our AUM. It is an important part of the growth that we see going forward.
Michael Cyprys
Great. And just in terms of capital allocation, how should we be thinking about as we're updating our models of buybacks, debt paydown, how are you guys thinking about us about that? And maybe you could just remind us of any potential earn-out payments that will be a use of cash flow in the coming years?
George Aylward
Yes. So in terms in terms of the capital, again, we are currently at low levels of leverage. We generate significant cash flows. And as we look at the quarter, we sort of do evaluate all the categories. One thing to highlight is Mike had noted earlier, first quarter is one of our biggest cash utilization quarters. So if you look historically in terms of how we've deployed cash in the first quarter, you will generally kind of see that that because so much cash is used for the annual incentives, which is our largest expense. That will then have an impact then on how much we might avail ourselves in other things still. But we do view share buybacks as a great use of our capital and continue to have that as a priority. So I can't give you any specifics, but it will be in the context of where we are in terms of our cash. Nick? Yes.
Mike Angerthal
Just specifically, Michael, as you recall, the first quarter also does include a revenue participation payment annually. It's been around the 25 million market a last several first quarter. So I'd expect it to be it's somewhere in that level. So in addition to annual incentive and other cash needs in the first quarter, we will be expecting to make that payment.
And then I would note in addition to the buybacks, we've obviously raised the dividend six consecutive years and have had a nice our growth rate of the dividend of close to 30% in that period of time. While we've done that, we've also reduced the share count probably close to about 12 or 13% over that six year period. So that balanced approach to capital management. You're seeing growing the dividend consistently and reducing the share count consistently over time. And we think all of that is ways to create value to shareholders.
Michael Cyprys
Great. And just final question from me on M&A. I was hoping maybe you could elaborate a bit on the M&A pipeline and conversations that you're having with prospective candidates in the marketplace. How would you sort of characterize those conversations today versus maybe six or 12 months ago? What are some of the properties that are coming across your desk? And where do you see some of the biggest opportunities for M&A at this point?
George Aylward
Yes. I think in terms of the conversations, again, the number of conversations and the frequency remains pretty consistent. I mean, there are a lot of conversations going on. And but I do I do think they really become much more in terms of conversations and strategic fit and alignment of interests and much less in terms of just, you know, auction processes. So we're and continue to be interested in many of the conversations that we're having. And but again, I think they are more in terms of trying to make sure there's good strategic fit specific areas where I think we've kind of alluded to where we we and others have interest in is in some of those areas that are less of the traditional and more of the alternative types of strategies.
Our last two transactions were on the liquid alts side in terms of the alpha Simplex as well as the event-driven at West Chester. We continue to see that as an area to expand our offerings because we're I believe we're very well represented on the equity and fixed income spectrum so that that is an area that we're interested in, but we consider different alternatives and different opportunities as they arise. As I said before, for us, it's always important that our long-term growth strategy does not require M&A to be successful. So we do focus on the organic side, but we're very excited about the number of opportunities that we do think could ultimately be out there, but only if they make sense for us and only if there are the right use of our capital at a point in time.
Michael Cyprys
Great. Thanks so much.
George Aylward
Thank you.
Operator
This concludes our question and answer session. I would like to turn the conference back over to Mr. Aylward.
George Aylward
Very Thank you. So I want to just thank everyone for joining us today. And as always, we certainly encourage you to give us a call if you have any other further questions or need information. Thank you all. Have a great day.
Operator
Conclude today's call. Thank you for participating, and you may now disconnect.
