Invesco Ltd. (NYSE:IVZ) Q3 2023 Earnings Call Transcript

Invesco Ltd. (NYSE:IVZ) Q3 2023 Earnings Call Transcript October 24, 2023

Invesco Ltd. misses on earnings expectations. Reported EPS is $0.35 EPS, expectations were $0.36.

Operator: Welcome to Invesco’s Third Quarter Earnings Conference Call. All participants will be in a listen-only mode until the question-and-answer session. [Operator Instructions] As a reminder, today’s call is also being recorded. Now, I’d like to turn the call over to Greg Ketron, Invesco’s Head of Investor Relations. Thank you. You may begin.

Greg Ketron: Okay. Thanks operator and to all of you joining us today. In addition to today’s press release, we’ve provided a presentation that covers the topics we plan to address. The press release and presentation are available on our website, invesco.com. This information can be found by going to the Investor Relations section of the website. Our presentation today will include forward-looking statements and certain non-GAAP financial measures. Please review the disclosures on Slide 2 of the presentation regarding these statements and measures as well as the appendix or the appropriate reconciliations to GAAP. Finally, Invesco is not responsible for and does not edit nor guarantee the accuracy of our earnings teleconference transcripts provided by third-parties.

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The only authorized webcast are located on our website. Andrew Schlossberg, President and CEO; and Allison Dukes, Chief Financial Officer will present our results this morning and then we will open the call up for questions. I’ll now turn the call over to Andrew.

Andrew Schlossberg: Thanks Greg and good morning to everyone. I’m pleased to be speaking with you today. But before I begin my commentary on the quarter, I did want to take a moment to acknowledge the humanitarian crisis in the Middle East. We are deeply saddened by the loss of life and devastation and the impact it’s had on civilians across the region. We’re focused on the safety and the well-being of our colleagues and their families and our thoughts are with everyone who has been impacted by the heartbreaking recent events. But now turning to the topic of the third quarter earnings, I’ll start today’s presentation on Slide 3. Volatility and uncertainty continue to define global financial markets with interest rates rising and investors awaiting more clarity from central bankers, there’s an extraordinary amount of cash that’s been moved to the sidelines where investors can earn acceptable returns, while they await more certainty.

The slowing and narrowing investor activity has been a near-term challenge for our industry, but it also sets the course for an eventual reallocation and money moving back into higher risk-based assets. Our results, which are highlighted on Slide 3, in many ways, reflect these dynamics. However, our unique positioning with deep client relationships, a strong geographic mix and a broad suite of investment solutions helped us deliver positive net long-term inflows in the third quarter. One of the primary contributors to our relative net flow strength is our robust ETF and SMA platforms. Our ETF business delivered record flows in the third quarter, which were concentrated in our leading factor-based capabilities. It was one of the strongest ETF quarters we have experienced as we continue to gain market share.

We captured nearly three times our industry share of net asset lows to our market share of AUM, and importantly, over three times of our industry share on a revenue flow basis as well. Additionally, we continue to enhance the commercialization of our SMA platform and are seeing strong momentum in flows, particularly within fixed income, where we have posted 12 consecutive quarters of positive net flows despite the challenging market environment. Within these vehicles, we are well-positioned to meet the increasing interest around personalization and tax optimization that we’re seeing by wealth management clients in both the US and around the world. While areas of growth like ETFs, SMAs, and fixed income have been strong for us this year, we continue to see flow pressure in active equities.

While headwinds have persisted in this asset class industry-wide, we are beginning to see marked improvement in Invesco, in particular in the global, international, and emerging market equity segments. In aggregate, our net outflows in these strategies are significantly lower than what we experienced in 2022 and have stabilized at around $1 billion in outflows each of the last two quarters. We continue to put considerable effort into further improving investment quality, product differentiation, and client engagement in these capabilities to ensure we are well-situated ahead of the eventual renewed demand in these important and higher fee-yielding asset classes. We’re going to spend some time on the call today highlighting how we’re positioning the firm against shifting investor demand, its impact on our asset mix, net revenue and our net revenue yield, and how we’re organizing to meet the evolving client demand in both the near and the longer term.

As we’ve outlined previously, we are undertaking a multi-quarter plan to simplify and streamline the organization to position the firm around rapidly evolving client demands. Our aim is to operate with more agility, improve our consistency of investment quality, create a more seamless client experience, and more efficiently leverage our size and our global scale to enable better outcomes for our clients and drive even greater profitability. We have already made meaningful progress in these areas and we will continue to execute pace in the coming quarters. Some of the key highlights on the evolved investment platform that we have achieved to-date include the following; we’ve established a unified globally integrated fixed income platform, we’re creating a single, highly focused multi-asset group from three distinct teams.

We’re bringing together leadership across our fundamental active equity teams and we’re further strengthening our private market platform that spans both real estate and private credit capabilities. Notably, all of these simplification efforts will enable us to more fully take advantage of the benefits of our State Street Alpha platform, as a single global investment operation engine across asset classes. On the product and distribution side of our business, we’ve also made considerable progress in repositioning growth and efficiency. We’ve combined our ETF, SMA, and model portfolios efforts into a single strategy and group. Going forward, we believe that these capabilities will be the leading vehicles of choice for our clients. Our established infrastructure, brand, and innovation will enable us to continue to lead and bring both active and passive capabilities to investors in an even more personalized and efficient way.

We’re also continuing to prune our product line and we’ve reduced it by over 150 products in the past year. Further, by globalizing many aspects of our marketing and digital delivery, we’re finding opportunities to leverage our scale, simplify our applications, unify our data, and use technology to strengthen these capabilities while lowering costs. There are efficiencies to be gained from all of these simplification efforts, which we are beginning to realize and we will continue to do so over time. However, these efforts are much more or more about — much more than just expense savings. We view these as drivers of revenue acceleration, which will allow us to improve our investment quality, reallocate our expenses and capital base much more effectively, and deliver sustainable profit growth and margin expansion and time.

Moving ahead to Slide 4. As investors gain greater clarity on inflation and Central Bank interest rate policy, we expect clients to move out of cash and extend their duration profiles of their fixed income allocations into a wider range of strategies. Fixed income is a clear area of strength for Invesco and we’re focused on ensuring we are well positioned to capture what we believe will be an outsized share of this reallocation. As you can see on this slide, our $500 billion plus fixed income platform has strong investment performance, requisite scale, diversity across asset classes and client geography, it spans public and private investments, and it has a robust offering of both active and passive products. The globally integrated institutional quality platform has been a consistently strong grower for Invesco, having posted long-term net flows over the previous 18 quarters and it’s very strong top-tier investment returns across a wide range of fixed income capabilities.

A few highlights to note on our favorable position that are on the page include our global liquidity capabilities, which have grown AUM by over 150% over the past five years, and we’re now squarely in the top 10 of institutional money fund managers in the top five amongst nonbank-owned providers. Our stable value capability is well-placed in DC platforms and ranks as a top manager in the US institutional marketplace. Our municipal capabilities rank in the top five largest among mutual fund managers in the US and number two amongst high-yield muni fund managers. Within our investment-grade capabilities, our relative performance has been improving since the recent mini banking crisis and our long-term performance strength has helped us nearly double our AUM in the past five years.

Furthermore, our global and emerging markets fixed income capabilities of stellar performance and are very well placed for growth in the UK, European, and Asian institutional and retail markets. And finally, we believe that significant opportunity exists for even greater expansion of our fixed income ETFs and bank loan capabilities which are two notable strengths of Invesco. So, against the backdrop where clients are seeking to work with fewer asset managers to meet the breadth of investment requirements, fixed income is clearly an area of our business that is poised to continue to gain market share and drive even greater profitability as the eventual rotation beyond cash unfolds. Finally, and before I turn the call over to Allison, I want to take a moment to highlight on Slide 5, another important piece of the Invesco investment thesis, our strategic relationship with MassMutual.

Our engagement with MassMutual has many facets that create a meaningful, mutually beneficial strategic relationship. First, MassMutual is one of our largest investors as both a common equity and preferred shareholder. So, we’re mutually aligned to delivering profitable growth and long-term success against the backdrop of an evolving industry. MassMutual is also a significant investor over the past years and supporting many of our newly launched private market and other key strategies with a total of $3.5 billion of commitments. Notably, this is three to four times the multiple of seating of our own products on our own balance sheet. MassMutual has significantly increased their commitments since the inception of our relationship, and this is meaningfully bolstering our growth trajectory in our private markets business, both institutionally and in our wealth management channels where early access to capital is paramount to setting the course for growth.

Finally, we work closely with MassMutual on behalf of their clients and we are pleased to be a third-party manager of $9 billion of assets through their insurance and broker-dealer channels, where we ranked the largest sub-advised and defined contribution investment-only manager on the MassMutual platform. To summarize, this is a powerful and important relationship for Invesco with significant potential ahead. We continue to explore avenues with MassMutual to make this relationship even more meaningful in the future. With that, let me turn the call over to Allison for a closer look at our results, and I look forward to your questions.

Allison Dukes: Thank you, Andrew and good morning everyone. I’ll begin on Slide 6 with investment performance. Overall, our investment performance was solid in the third quarter with 67% and 65% of actively managed funds in the top half of peers are beating benchmark on both a three-year and a five-year basis, respectively. This is in line with those time frames in the second quarter. We did see investment permits improved considerably on a one-year basis, going from 67% in the second quarter to 70% in the third quarter, reflective of the improved investment performance we are seeing across several categories, including global and international equities and alternatives. As Andrew noted, we have excellent performance in fixed income across nearly all capabilities and time horizons, an important fact given our strong conviction and our ability to attract flows as investors deploy money into these strategies.

Turning to Slide 7, AUM was $1.49 trillion at the end of the third quarter, $51 billion lower than last quarter. The quarter began with what appeared to be a continuation of a recovery in markets, albeit uneven that we saw in the second quarter. However, that quickly shifted to a risk of posture again as the quarter progressed and uncertainty grew, marking another volatile quarter for markets worldwide. Market declines, coupled with foreign exchange movements, drove the decline in AUM. Despite the market volatility, we did generate $2.6 billion in net long-term flows, and we expect we will outperform peers in what has been a very difficult environment for organic asset growth. Client demand for passive capabilities remain strong as we garnered $13.5 billion of net long-term inflows during the quarter.

ETF inflows were $11.8 billion, marking one of our best quarters for ETFs. Our SMB 500 Equal Weight Index funds led the quarter with $3.6 billion of net long-term input. This ETF is also our leading flow driver year-to-date, with our newer QQQM, drawing the second highest flows in our ETF suite year-to-date. The QQQM was launched three years ago and has attracted $14 billion of AUM since inception, now making it our fourth largest ETF. We’ve demonstrated the ability to sustain growth in ETFs throughout the full market cycle with organic growth in 12 of the past 13 quarters. We also saw solid growth in our index strategies with $2.3 billion in net long-term flows for the quarter. Offsetting some of the growth in passive was $10.9 billion of net outflows in active strategies.

Contributing to the outflows was a single sizable redemption in our global targeted return strategy. This strategy has been in significant outflows for several years and now has less than $1 billion remaining in the fund. In September, we announced plans to close the fund and focus on other capabilities within our multi-asset franchise where we are seeing stronger client demand. Our global active equities, which includes the developing market funds were also drivers of net outflows in this quarter. The level of outflows from this investment class has moderated after significantly elevated redemptions in the second half of 2022. Looking at flows by channel, the retail channel generated $4.3 billion of net long-term inflows, while the institutional channel had $1.7 billion of net long-term outflows.

This was driven by the global target of returns redemption. Outside of this redemption, we would have had $800 million in institutional inflows for the quarter. Moving to Slide 8 and closed by geography. Asia-Pacific delivered net long-term inflows of $2.8 billion due to growth in Japan, which offset outflows in Greater China during the quarter. In Japan, we experienced another quarter of strong growth with our Henley Global Equity and income funds, guarding $1.8 billion of net inflows from Japanese clients making it a top-selling retail fund for the industry in Japan on both a quarterly and a year-to-date basis. We are well-positioned in Japanese — as Japanese markets are experiencing some of the most constructive conditions for risk on assets in many years, including favorable new regulations.

After resuming organic growth in the second quarter, our business in Greater China experienced net long-term outflows of $1.9 billion for the quarter. The outflows in our China JV were $1.7 billion. Outflows were concentrated in fixed income, where continued weak market sentiment and interest rate tightening has led to diminished growth across the industry this year. However, as China’s economy recovers, Invesco is extremely well-positioned to capture additional share in the world’s fastest-growing market. Turning to flows by asset class. Equities generated $7.4 billion in net long-term inflows, mainly driven by the strong growth in EPS. The $2.4 billion in outflows in alternatives was largely driven by the previously mentioned single client global targeted returns redemption.

Excluding this redemption, alternatives were in flight inflows of $100 million. We have a good track record in our private markets platform within alternatives and are well-positioned to capture long-term flows in this asset class as client demand shifts to these strategies. We have over $6 billion of dry powder to capitalize on opportunities emerging from the market dislocation of the last several quarters, but greater market clarity will be required for this opportunity to meaningfully materialize. Fixed income net long-term flows turned modestly negative with $1.3 billion of net outflows with growth in investment grade, SMAs and global debt, offset by the outflows experienced in China. As Andrew outlined, we like our position in this space and believe we are well-positioned to capture flows as investors put more money to work in fixed income products.

We have the track record to support our conviction with 18 straight quarters of net inflows prior to this quarter. Moving to Slide 9. We’ve provided additional insight into our portfolio and the trends driving our revenue profile. Secular shifts in client demand across the asset management industry, coupled with more recent market dynamics, have significantly altered our asset mix since the acquisition of Oppenheimer Funds. As you’ll note, ETF and index AUM, and this excludes the QQQ, have grown from $171 million or 14% of our overall $1.2 trillion in AUM in 2019 to $318 million or 21% of our nearly $1.5 trillion of AUM in the third quarter. We’ve also seen very strong growth in Asia-Pacific, driven primarily by our success in China. During the same timeframe, we’ve seen weaker demand for fundamental equities, driven in part by the risk off sentiment that was sparked in early 2022, coupled with the pressure we experienced in developing markets and global equity as well as the closure of our GTR capabilities.

Our fundamental equity portfolio in 2019 was $348 billion or 29% of our AUM. At the end of the third quarter, that portfolio was $242 million or $0.16 of our AUM. The result of revenue headwinds created by these dynamics has weighed on our results over the last two years. While we have experienced excellent organic growth and lower fee capabilities like ETFs and liquidity, it was not enough to offset the revenue loss from higher fee, fundamental equity outflows, and market depreciation. Our overall net revenue yield has declined significantly during this timeframe, but that decrease has been driven by the shift in our asset mix, not degradation in the yields of our investment strategies. Net revenue yields by investment strategy have been relatively stable within the ranges provided on the slides.

The other point I want to emphasize is that this multiyear secular shift in client preferences have been increasingly captured in our results. Our portfolio is better diversified today than four years ago, and our concentration risk and higher fee fundamental equity has been reduced. These dynamics though challenging to manage through as they occur, should portend well for future revenue trends and marginal profitability improvement, independent of market improvement. Further, we now have a more diversified business mix, which better positions the firm to navigate various market cycles events and shifting client demand. Turning to Slide 10, net revenues of $1.1 billion in the third quarter was $12 million lower than the third quarter of 2022 and $7 million or 1% higher than the second quarter.

The decline from the third quarter of last year was due largely shift in our asset mix that was just discussed. Total adjusted operating expenses in the third quarter were $789 million, $48 million higher than the third quarter of 2022 and unchanged from the prior quarter. Included in our third quarter operating expenses were $39 million of compensation expenses related to the organizational changes we are making to position the firm for greater scale and profitability as we grow our revenue base. In the second quarter, we had $27 million of compensation expenses related mainly to executive retirements. The full benefits from our simplification efforts will be seen over time as we generate revenue growth and margin recovery. To this point, we have identified $50 million of annual run rate expense savings that will be realized by the beginning of 2024.

The restructuring costs associated with these efforts were $39 million in the third quarter as we accelerated several of the reorganization activities that we were undertaking into the quarter. Next quarter, fourth quarter, we expect an incremental $15 million to $20 million of expense associated with these efforts, bringing the total expense associated with the efforts to $55 million to $60 million. As we’ve discussed, we managed variable compensation to a full year outcome in line with company performance and competitive industry practices. Historically, our compensation to net revenue ratio has been in the 38% to 42% range, trending towards the upper end of that range and periods of revenue decline. At current AUM levels, we would expect the ratio to be slightly above the high end of the range for 2023 when excluding the cost pertaining to executive retirements and other organizational changes.

Marketing expenses of $27 million were $6 million lower than the prior quarter and $3 million lower than the third quarter of last year as we continue to tightly manage discretionary spend given the ongoing challenging revenue environment. Property, office, and technology expenses were relatively unchanged as compared to last quarter and the third quarter of last year. Another area in which we are diligently managing expenses as G&A. G&A expenses of $108 million in the quarter were down $6 million from the prior quarter. Compared to the third quarter last year, G&A expenses increased $2 million. However, the third quarter of this year includes $8 million in spending on our Alpha platform, which prior to the second quarter of this year was included in transaction integration and restructuring expenses.

We expect quarterly average spending on our Alpha platform to remain near this level for the next few quarters. Moving to Slide 11, adjusted operating income was $309 million in the third quarter which included the costs related to organizational changes. Adjusted operating margin was 28.2% for the third quarter. But excluding the costs related to the organizational changes, third quarter operating margin would have been 350 basis points higher. Earnings per share was $0.35 in the third quarter. Excluding the expenses related to the org changes, third quarter earnings per share would have been $0.07 higher. The effective tax rate was 23.6% in the third quarter. We estimate our non-GAAP effective tax rate to be between 23% and 25% for the fourth quarter of 2023.

The actual effective rate can vary due to the impact of nonrecurring items on pre-tax income and discrete tax items. I’ll finish up on Slide 12. Stated priority, where I’m pleased to say that we’ve made significant progress in building balance sheet strength. This quarter, our cash balance exceeded $1.2 billion. We’ve lowered our net debt significantly, and it now stands at less than $250 million. I’m pleased with the improvement we’ve made on the balance sheet as we continue to work to bring net debt excluding the preferred shares down to zero by the second half of next year. Our leverage ratio, as defined under our credit facility agreement was 0.7 times at the end of the third quarter. We have an opportunity to further address outstanding debt with the maturity of the $600 million in senior notes at the end of this January.

We ended the third quarter with zero drawn on the credit facility. To conclude, the resiliency of our firm’s net flow performance in a difficult environment for organic growth is evident again this quarter, and I’m pleased with the progress we’re making to simplify the organization and build a stronger balance sheet while continuing to invest in key capability areas. We’re committed to driving profitable growth and a high level of financial performance. We have the right strategic positioning to do so. And with that, I’ll ask the operator to go ahead and open it up to Q&A.

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Q&A Session

Operator: Thank you. [Operator Instructions] And our first question comes from Glenn Schorr with Evercore. Your line is open.

Glenn Schorr: Hi, thanks very much. So, I appreciate all the commentary you made around fixed income. I’m still, I guess, a little surprised for everybody that flows haven’t been stronger. Can you talk about what signed post you think clients are looking for? Is it literally just the end of rate hikes and economic outlook? And are you seeing that in dialogue with in solutions, through RFPs, things like that? And then maybe just the same comment on with — in your words, an extraordinary amount of casing on the sideline money market or money markets were in outflow? Thanks a lot.

Andrew Schlossberg: Hey Glenn, thanks, it’s Andrew. I’ll start and Allison will chip in as well. The cash on the sidelines a bit, but whether it’s from wealth managers or from institutions, it’s something like 25% to 35% portfolios are allocated to that from best we can tell from lots of conversations with clients. And I think it’s exactly what you described, waiting for clarity from central banks, waiting for a reason to move off the sidelines and get paid to do so. Conversations have been very active whether it’s through our solutions efforts or just through direct conversations. And it’s — I think it’s really those things and that’s straightforward and simple. On the money market side, Allison, why don’t you pick up?

Allison Dukes: Good morning Glenn. What I would say about our money market portfolio is about 85% of our portfolio is positioned with an institutional client base. So, think about that is being managed by corporate treasurers and those funds are going to stay and save for assets. So, I think what we saw in this quarter was a repositioning in the treasuries just given the opportunity that those presented and just the yield that the treasurers are seeking. That will also, in many respects, prevent those funds from being deployed into more risk on strategies like equity. So, the composition of our money market client base, I think, is important as you think about it being 85% institutionally owned.

Glenn Schorr: I appreciate. One just quick follow-up is as you noted, the fee rate on fixed income is obviously lower than overall. But I would imagine there’s some pretty high incremental margins. If flows do happen in the way you think into fixed income as people start extending duration, how should we think about that interplay between fee rate and margins kind of like the same conversation we’ve had for years? Thanks.

Allison Dukes: No, your assumption is correct and that you’ve got a relatively fixed cost base underpinning that fixed income portfolio. So, you should think about flows into fixed income as being accretive to the overall firm operating margin. So — and I think that’s look, that’s a lot of what we want to draw out in providing some of this additional color is where we are seeking to grow through scale and where that will be accretive to margins, overall fixed income is certainly an area where that is true.

Andrew Schlossberg: And Glenn, we — some of the things we talked about last quarter and this quarter, we further brought together elements — disparate elements of our fixed income platform, and we wanted to call up a scale in that platform for just the reasons Allison described.

Glenn Schorr: Thank you.

Operator: Thank you. And our next question comes from Craig Siegenthaler with Bank of America. Your line is open.

Craig Siegenthaler: Thanks. Good morning everyone. So, maybe just starting where you left off, with 25% of portfolios sitting in cash and waiting for rates to stop going higher, which bond verticals are you the most positive on in 2024? And also, do you think active fixed income can garner significant share? Or do you expect most of the flows to come from passive, which you’d also benefit through the ETF platform?

Andrew Schlossberg: Yes, hi, it’s Andrew. Just maybe I’ll pick up on the second part first. We think it will come in both active and passive. And as you said, the diverse range that we have in both, in some ways, we’re a bit indifferent, but the conversations are happening on both sides of the equation. In terms of areas that are particularly of focus and things that we’re having conversations about it, we’re well positioned, the municipal portfolio, whether that’s investment grade or high yield, the performance is stellar. The funds are highly rated, they’re well known, and that’s probably the first protocol we would point to. On the investment-grade side, European corporate bonds had been of interest and have been an area where we’re positioned well.

And then really just anything across as people move a little further on the curve, even elements of our short-term fixed income portfolio. So, it’s pretty wide ranging, but I’d sort of point out those areas, in particular, especially because we’re just well — we’re well placed there to take share.

Craig Siegenthaler: Thank you. And just for my follow-up on Investor of Great Wall in China. Flows are negative in 3Q. I just wanted your perspective on if you thought they would snap back on a near-term basis. Or if you think we’d go through a longer term time period here where you’d see net outflows from China?

Allison Dukes: Good morning Craig, I’ll start. I think the most important component of the flows in IGW was really that it was driven by fixed income. And I think we’re just seeing with the interest rate tightening that’s happening inside of China, a diminished appetite for fixed income overall. We actually saw inflows in equities over the quarter. So, we do think it’s hard to gauge exactly the timing as to when economic sentiment will recover there. I think we’re confident the government is doing quite a bit to try to stimulate some stabilization there and improvement in the sentiment overall. Hard to say exactly which quarter that will be and when things will snap back, we do — we are very confident — very well-positioned when that does occur.

Craig Siegenthaler: Thank you, Allison.

Operator: Thank you. And our next question comes from Daniel Fannon with Jefferies. Your line is open.