Invesco Ltd. (NYSE:IVZ) Q4 2023 Earnings Call Transcript

Invesco Ltd. (NYSE:IVZ) Q4 2023 Earnings Call Transcript January 23, 2024

Invesco Ltd. beats earnings expectations. Reported EPS is $0.47, expectations were $0.38. Invesco Ltd. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by, and welcome to Invesco’s Fourth 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 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: All right. Thanks, operator, and to all of you joining us today. In addition to the press release, we have provided a presentation that covers the topics we plan to address on the call today. The press release and presentation are available on our website at 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 for 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.

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’ll open up the call for questions. I’ll now turn the call over to Andrew.

Andrew Schlossberg: Thanks, Greg, and hello, everyone, and I’m pleased to be speaking with you today. In a reversal from the third quarter, overall market sentiment in the fourth quarter turned more constructive as investors began to gain confidence, putting money back to work in the last several weeks of the calendar year. Equities and fixed income were both beneficiaries of a growing belief that central banks would cut rates sooner in 2024. The S&P was the best-performing major equity index and while outside the US, there was solid market growth in Europe, while China continued to lag. Fixed income markets performed well, led by government bonds as expectations for tightening interest rates earlier in 2024 prevailed. The market volatility and shifting macro trends exhibited this past quarter, strengthened our conviction in the areas we focused on throughout 2023, and continuing to reposition Invesco to perform through various market cycles and in front of the rapid evolution underway in our industry.

As discussed on previous calls, we continue to streamline and simplify the company for the benefits of our clients, colleagues and shareholders. The focus of these efforts is to further emphasize long-term investment quality, strengthen our diverse product offering and build on our value proposition that uniquely meets a broad range of client needs around the world. We are also tightening our financial discipline, which will further enable us to allocate resources to drive innovation and acceleration for the benefits of clients. We’re going to continue to leverage our scale to more effectively invest in profitable growth and further strengthen a culture that attracts and retains the top talent in our industry. While our work in each of these areas continues, we are making good progress, and I’m appreciative of the client focus and dedication of my Invesco colleagues around the world.

Our results, which are highlighted on slide 3 of the presentation, summarize many of these external and internal factors at play. During the quarter, we continued to benefit from growing client demand and assets beginning to move off the sidelines. In the fourth quarter, we delivered $6.7 billion in net long-term inflows, which is a testament to our advantageous position with deep client relationships, strong geographic mix and a broad suite of in-demand solutions. While organic flow growth and improving sentiment drove asset levels higher, most of the gains occurred later in the quarter, limiting the revenue impact in the fourth quarter but increasing AUM nearly 7% from September 30 levels. Several factors contributed to our strong organic flow growth in the fourth quarter.

Most notably, demand for our ETFs and our SMAs continue to drive market share gains in these important product platforms. During the quarter, we achieved $14 billion in positive flows in our ETF factor and index capabilities globally and hit a record high of $634 billion in AUM. We also produced our 13th consecutive quarter of positive flow growth in SMAs as we continue to see strong demand for custom tax optimized solutions in the US wealth management channel, in particular. The second set of quarterly organic growth drivers were the return to positive flows in two of our most critical growth areas, our China business as well as the broader Asia Pacific region and private market alternatives. While overall sentiment in China remained relatively weak, our well-established position in the country drove positive organic growth in the fourth quarter.

The majority of the flow growth came from the launch of seven new products, which were augmented by equity product sales in existing capabilities. Strong demand for these new products could signal a more constructive 2024 in China. Long term, we remain optimistic about this market and our unique leadership position within it. We continue to believe that the Chinese asset management industry will grow and mature in the coming years with the development of the local retirement and capital market systems in the world’s second largest economy. In private markets, we generated net long-term inflows led by a stabilization and modest inflow into direct real estate and inflows to credit strategies, notably bank loans, which includes CLOs. We have over $6 billion in dry powder to capitalize on opportunities emerging from the market dislocation of the last several quarters, but we will need greater market clarity before we begin to see significant growth.

Shifting to fixed income, which is a key area of strength for Invesco. We continue to see steady ongoing growth, having reported positive inflows in 19 of the past 20 quarters. Leading contributors in the fourth quarter included investment grade, custom SMAs, as well as municipal bond strategies. As investors gain greater clarity on inflation and Central Bank interest rate policy, we expect clients to move out of cash and extend the duration profiles of their fixed income allocations into a wider range of strategies. As previously highlighted, fixed income is one of our absolute strengths in Invesco, and we remain focused on ensuring we’re well-positioned to capture an outsized share of this ongoing reallocation. Finally, pressure on active equity flows continued in the fourth quarter for both the industry and for Invesco.

We continue to emphasize investment quality, product differentiation and client engagement to ensure we remain a leading provider in this space with a focus on our in-demand capabilities where we can gain market share. Despite the continued headwinds, we have seen some moderation in certain areas of active equity flows particularly in global, international and emerging market segments. Our net outflows into these important strategies moderated during 2023 to $1 billion to $2 billion a quarter, significantly lower than what we experienced in 2022. These early signs of reversal have been led by our Global Equity and income strategy, which achieved top retail selling status in Japan and delivered an incremental, $1.4 billion of net inflows in the fourth quarter.

While we are cautiously optimistic about market conditions for 2024, we remain prepared to meet client and shareholder expectations across a range of scenarios. We have the breadth of capabilities, the discipline to drive performance as well as the organizational structure and focus to ensure we are well positioned to meet evolving client demands. As market sentiment improves, this should translate to even greater scale, performance, and improve profitability. With that, I’m going to 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 4. Overall investment performance was solid in the fourth quarter with 64% and 71% of actively managed funds in the top half of peers were beating benchmark on both a three-year and a five-year basis, respectively. Investment performance improved considerably on a five-year basis, going from 65% in the third quarter to 71% in the fourth quarter reflective of improved performance that we’re seeing across several categories, including in US, global, and international equity. We continue to have excellent performance in fixed income across nearly all capabilities and time horizons. An important fact given our strong conviction in our ability to attract flows as investors deploy money into these strategies.

Turning to Slide 5. AUM was nearly $1.6 trillion at the end of the fourth quarter, $100 billion higher than last quarter end. The fourth quarter began with weak markets in October and then recovered as the quarter progressed ending the year with equity and fixed income markets higher versus the third quarter. Higher markets, coupled with net long-term inflows and favorable foreign exchange movements drove the increase in assets under management during the fourth quarter. We generated $6.7 billion in net long-term inflows, which was an organic growth rate of 2.4%, but we expect to once again outperform peers in what has been a challenging environment for organic asset growth. Looking at flows by investment approach, client demand for passive capabilities remain strong as we garner nearly $14 billion [ph] of net long-term inflows during the quarter.

ETF inflows were $12.4 billion, an annualized organic growth rate of 17%, marking this as one of our best quarters for ETF. The S&P 500 Equal Weight Index bond once again led the quarter with $4.6 billion of net long-term inflows. This ETF was also our leading flow driver for the year with nearly $13 billion of inflows. Our Q2 QM ETF through the second highest inflows in our ETF suite with over $2 billion for the quarter. The Q2 QM was launched a little over three years ago and now stands at over $18 billion of AUM, making it our third largest ETF outside the QQQ. We demonstrate the ability to sustain growth in ETFs throughout the full market cycle with organic growth in 13 of the past 14 quarters. Offsetting some of the growth in passive was $7.2 million of net outflows in active strategies.

What’s encouraging is that the level of outflows in the fourth quarter was the second lowest since the market sell-off began in early 2022. The lower level of net outflows was driven by growth in active fixed income products, led by our custom fixed income SMA, which totaled $2.1 billion in inflows. Regarding active equity strategies, we experienced another quarter of strong growth in Japan with our Henley Global Equity and income fund garnering $1.4 billion of net inflows from Japanese clients. This fund continues to be the top-selling retail fund for the industry in Japan on both a quarterly and a year-to-date basis. Active global equity products experienced net outflows of $1.6 billion, of which $1.2 billion came from the developing markets fund.

The level of outflows from this investment class has declined after significantly elevated redemptions in the second half of 2022. Looking at flows by channel. The retail channel generated $4.6 billion of net long-term inflows, while our institutional channel had net inflows of $2.1 billion. Driving the growth in the retail channel or the ETF products I noted previously, as well as the custom fixed income estimate. Growth in the institutional channel resumed after net long-term outflows in the third quarter that were driven by the global targeted returns redemptions. Moving to Slide 6 inflows by geography. Asia Pacific delivered net long-term inflows of $5.8 billion, representing organic growth of 12%, driven by growth in Japan and a resumption of growth in our China joint venture.

Japan’s net long-term inflows were $3 billion in the fourth quarter, representing an organic growth rate of 21%, driven by the Henley Global Equity and income fund as well as fixed income products. We believe Japanese markets are seeing the most constructive conditions for risk on assets in many years, and we’re well positioned to capture that growth. Our China joint venture generated $1.7 billion in net long-term inflows driven by ETFs and fixed income strategies. Turning to flows by asset class. Equities generated $8.3 billion and net long-term inflows, mainly driven by the strong growth in ETFs. Fixed income flows were impacted by our planned bullet share ETF maturities that occur each December, which totaled $2.8 billion. This is an annual occurrence, and these outflows are typically offset by new BulletShare products launched in the first quarter, where we are already seeing strong inflows in January.

Excluding these maturities, fixed income and net long-term inflows were $2.9 billion. In Alternatives, we generated $1 billion of net long-term inflows in bank loans, including CLOs and $400 million in net long-term inflows into direct real estate. These inflows were offset by outflows and other products that we classify as Alternative products, such as global asset allocation and commodity ETFs. We have a strong track record in our private markets platform with Alternatives and are well positioned to capture long-term flows in this asset class as client demand shifts to these strategies. Moving to Slide 7. Secular shifts in client demand across the asset management industry, coupled with more recent market dynamics have significantly changed our asset mix since the acquisition of Oppenheimer Fund.

Going back to 2019 after the acquisition, ETF and index AUM, excluding the Q2 have grown from $171 billion or 14% of our overall $1.2 trillion in average AUM in 2019 to $362 billion or 22% of our average AUM of $1.5 trillion in the fourth quarter. In Q2Q, a product we earn no management fees from, but does provide a substantial marketing benefit has tripled in size over this time, going from $74 million to $230 billion [ph] or from 6% to 14% of total average AUM. We’ve also seen very strong growth in global liquidity going from $82 billion or 7% of average AUM to $170 billion or 12% of average AUM in the fourth quarter. These product areas carry lower net revenue yields compared to our overall net revenue yield. During the same time frame, we’ve seen weaker demand for fundamental equities and multi-asset products, which carry higher net revenue.

This has been driven in part by the risk off sentiment that was sparked in early 2022, coupled with the pressure that we experienced in developing markets and global equities as well as the closure of our GTR capabilities. Our fundamental equity portfolio in 2019 was $348 billion or 29% of our average AUM. By the fourth quarter, that portfolio had declined to $261 million or 16% of our average AUM. Multi-asset also declined from 7% to 3% of the average AUM over this time frame. Looking at the fourth quarter as compared to the third quarter of 2023, we continue to experience similar dynamics with ETF going from 21% to 22% and the QQQ going from 13% to 14% of average AUM, while fundamental equities declined from 17% to 16% and multi-asset from 4% to 3% of average AUM in the quarter.

The result of revenue headwinds created by these dynamics has weighed on our results over the last four-plus years. While we’ve experienced excellent organic growth and lower fee capabilities like ETFs and global liquidity was not enough to offset the revenue loss from higher fee fundamental equity and multi-asset outflows. Our overall net revenue yield has declined meaningfully during this time frame, but that decrease has been driven by the shift in our asset mix not degradation in the yields in our investment strategy. Net revenue yields by investment strategy have been relatively stable within the ranges provided on the slide. The other point that I want to emphasize is that this multiyear secular shift in client preferences has been increasingly captured in our results.

Our portfolio is better diversified today than four years ago, and our concentration risk and higher fee fundamental equities and multi-asset product has been reduced. These dynamics, though challenging to manage through as they occur should portend well for future revenue growth and marginal profitability improvement, independent of market gains. 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 8. Net revenue of $1.05 billion in the fourth quarter was $62 million lower than the fourth quarter of 2022 and $52 million lower than the third quarter of 2023. The decline from last year was due largely to a $35 million decline in performance fees and the shift in our asset mix that was just discussed.

The decline in performance fees was mainly driven by lower fees generated from real estate related and other private market activities. The decline from the prior quarter was primarily due to incremental asset mix shift and lower average assets under management, partially offset by higher performance fees in the quarter. Total adjusted operating expenses in the fourth quarter were $771 million, relatively unchanged from the fourth quarter of last year. Included in fourth quarter 2023 are $22 million related to organizational change expenses and $12 million of Alpha platform related implementation expenses. Adjusting for these items, fourth quarter expenses were $32 million lower than the fourth quarter of 2022. Total adjusted operating expenses were $18 million lower than the third quarter, more specifically, looking at employee compensation that has been impacted by the organizational change expenses.

Compensation was $26 million lower in the fourth quarter, which includes $11 million in expense savings related to the organizational changes that I’ll provide more detail on shortly. Marketing expenses of $28 million were $6 million lower than the fourth quarter of 2022 as we continue to tightly manage discretionary spend given the ongoing challenging revenue environment. Property office and technology expenses were flat to last year and $4 million higher than last quarter. G&A was $19 million higher than last quarter as we typically see higher G&A in the fourth quarter. We also had $12 million in spending related to our Alpha platform implementation, higher than the $8 million incurred in the third quarter due to incremental implementation costs in the fourth quarter.

Going forward, we expect onetime implementation cost to be approximately $10 million per quarter in 2024 with some fluctuation quarter-to-quarter. We will continue to update our progress on the implementation and related costs as we move forward. Now, moving to slide 9. We realized $11 million in expense savings in the fourth quarter related to the organizational changes. On an annualized basis, we have achieved $44 million or nearly 90% of the $50 million in expense savings we expect to realize in 2024. We expect to realize the remaining $6 million in the first quarter. We’re not expecting any further significant restructuring costs associated with these efforts. The full benefits from our simplification efforts will be seen over time as we generate revenue growth and margin recovery.

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 the range and periods of revenue decline. At current AUM levels, we would expect the ratio to be at or slightly above the higher end of this range for 2024. Seasonally, we see approximately $25 million in higher compensation expenses related to payroll tax and other benefit reset in the first quarter. As a result, we would expect the ratio will exceed 42% during the first half of 2024. Moving to slide 10. Adjusted operating income was $275 million in the fourth quarter, which included the costs related to organizational changes.

Adjusted operating margin was 26.3% for the fourth quarter. Excluding the costs related to organizational changes, fourth quarter operating margin would have been 210 basis points higher. Earnings per share was $0.47 in the fourth quarter. Excluding the costs related to organizational changes, fourth quarter earnings per share would have been $0.04 higher. Effective tax rate decreased to 9.9% in the fourth quarter from 23.6% last quarter. The decrease was primarily due to a discrete tax benefit related to the resolution of certain tax matters, favorable tax treatment related to a gain on sale of certain Hong Kong pension sponsorship rights, and the favorable impact of a change in mix of income across tax jurisdictions. We estimate our non-GAAP effective tax rate to be between 23% and 25% for the first quarter of 2024.

The actual effective rate can vary due to the impact of non-recurring items on pre-tax income and discrete tax items. I’ll conclude on slide 11. As stated priority for us is building balance sheet strength. This quarter, our cash balance was $1.5 billion, and we ended the year with nothing drawn on our credit facility. We have lowered our net debt significantly, and it now stands near zero. We have a $600 million senior note maturing on January 30, and we are in a position to redeem the notes at maturity. We estimate we’ll have approximately $500 million in excess cash and will draw approximately $100 million on our credit facility to fully redeem the notes. The first quarter is a seasonally high cash usage quarter so we do expect to have a balance on the credit facility at quarter end, which will pay down as we move through the second and third quarters and reach our goal of zero net debt.

We also hope to begin a more regular stock buyback program as we move towards this goal. To conclude, the resiliency of our firm’s net flow performance and a difficult market for organic growth is evident again this quarter, and we’re 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, and we have the right strategic positioning to do so. And with that, I’ll ask the operator to open up the line for Q&A.

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Q&A Session

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

Glenn Schorr: Hi. Thank you. I’m sure you said something very intriguing towards the beginning. You said you expect clients to move out of cash into longer duration fixed income at some point. And I think a lot of us have been waiting on that. You saw some fixed income flows, but a lot more money market outflows the last couple of quarters. I’m curious where the money market outflows going in general? And how do we determine the cash sitting on the sidelines is actually waiting to move out versus it’s just treasuries and money markets that used to sit in cash, meaning is it just another cash alternative or is it actually weighting? I hope that makes sense.

Andrew Schlossberg: Yes, it does. Let me start and Allison can pick up. It’s a little of both. So, some of the money market flows out of Invesco and our business is largely corporate treasurers they’re buying T-bills directly. So I wouldn’t look at that as a great indicator from Invesco. As we’re out talking to clients and we’re looking at of where flows are going. Early signs have been clearly into ETFs, which might be telling you a little bit about conviction and maybe the lack of there full conviction. And then on the fixed income side, active and otherwise, starting to move into municipal bonds, in particular, some investment-grade strategies. Europe is picking up a little bit, but I’d say it’s pretty early days on assets moving off the sidelines.

Allison Dukes: And maybe just to put a finer point on our money market products, in particular, our liquidity products. Our client base there is about 85% institutional. So, when we see fluctuations in some of those balances, it is to Andrew’s point, really corporate treasurers taking advantage of the increase in T-bill rates and moving out of money markets in the T-bill. It is only about 15% retail, which is where — and of course, on the institutional side, they’re just limited in where they’re going to go. So, they’re going to stay and cash yielding kind of products there. The retail side is a smaller component of our client base there.

Glenn Schorr: Makes sense. So, in that revenue yield slide, you showed us the come down and you talked about not degradation of product pricing, but just mix shift. With the markets up so much, average assets ending assets way above average assets, how much of that revenue yield pickup could we see coming back the other way in the first quarter? I’m not sure you’ve gone through that math yet, but obviously, markets are up a bunch.

Allison Dukes: Yes. No, they are, for sure. And I mean, the exit rate for net revenue yield will be — it was modestly higher coming into the first quarter. I mean the delay, frankly, in the market pickup in the fourth quarter didn’t do much for revenue, as you could see, but it does portend well for just the average AUM mix coming into the quarter, and it does give us a net revenue yield coming into the quarter that’s modestly higher than the exit call it, two of the basis point there. So, very modestly higher. I think within those asset categories that we showed on that page, it’s really the mix within there as well as the mix between those categories. So, one of the elements of our revenue performance in the quarter was even in our net revenue yield within our passive capabilities.

And you saw our net revenue yield in passive declined about a basis point inside of the quarter as well, which really speaks to where client demand was in the quarter, largely for some of our lower fee products there, like the Q2 QM and the S&P 500 Equal Weight product that I noted earlier. So we do continue to see strong client demand. It’s hard to predict where the client demand will be in the first quarter, and that has a huge impact on our revenue. All things being equal though, the market run has been helpful.

Andrew Schlossberg: And the other thing I’d add, and you’re seeing it as well. I’m sure the broadening out of the market, and as Allison mentioned earlier, the greater diversification in our overall portfolio of client assets puts us in a position under any kind of market environment where we think we’re relatively well positioned.

Glenn Schorr: All right. Thanks. Thanks for all of that. Appreciate it.

Allison Dukes: Thanks, Glenn.

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

Daniel Fannon: Thanks. Good morning. I wanted to follow up on Slide 7 and talk a bit more about the Alternatives in private markets dynamics in the quarter and more prospectively, how you were thinking about the potential growth in that business, considering the broader alts bucket has been seeing outflows for you, but yes, I think there’s some underlying trends. I think you’ve talked about seeing some inflows. But curious to get a little bit more of an update.