Westwood Holdings Group, Inc. (NYSE:WHG) Q2 2023 Earnings Call Transcript

Westwood Holdings Group, Inc. (NYSE:WHG) Q2 2023 Earnings Call Transcript August 4, 2023

Operator: Good day and thank you for standing by. Welcome to the Second Quarter 2023 Westwood Holdings Group, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today John Ehinger, Head of Legal.

John Ehinger: Thank you, and welcome to our second quarter 2023 earnings conference call. The following discussion will include forward-looking statements that are subject to known and unknown risks, uncertainties and other factors, which may cause actual results to be materially different from those contemplated by the forward-looking statements. Additional information concerning the factors that could cause such a difference is included in our press release issued earlier today, as well as in our Form 10-Q for the quarter ended June 30, 2023 that will be filed with the Securities and Exchange Commission. We undertake no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

You are cautioned not to place undue reliance on forward-looking statements. In addition, in accordance with SEC rules concerning non-GAAP financial measures, the reconciliation of our economic earnings and economic earnings per share to the most comparable GAAP measures is included at the end of our press release issued earlier today. On the call today we have Brian Casey, our Chief Executive Officer; and Terry Forbes, our Chief Financial Officer. I will now turn the call over to Brian Casey.

Brian Casey: Good afternoon, and thank you for listening to our quarterly earnings call. As of July 1, Westwood has been a publicly traded company on the New York Stock Exchange with the symbol WHG for 21 years. Throughout our entire 40-year history, Westwood has remained focused on helping our clients achieve their objectives by executing our disciplined investment processes to generate portfolio alpha without taking excessive risk, and this has delivered excellent compound rates of return for our clients. John Wooden’s Pyramid of Success has been an essential road map for us since our firm’s inception and his principles formed the foundation of our firm’s culture. Our culture has enabled us to innovate and grow over time in a principled way.

We’ve shared our long-held values and principles with our new team members at Salient, as we think about new ways to serve clients using the broader spectrum of strategies that are now available to us. We will continue to embrace our values, as we tackle the substantial changes confronting our industry, including the continued speed of innovation, and related demands for technology, consolidation among many asset managers, the rise of alternative investments, and shifting demographics that have influenced buyer behavior, and I didn’t even mention AI. Looking back over the first half of the year, I’m pleased to share several positive items with you. LargeCap and SMidCap experienced positive net inflows in the institutional channel during the second quarter.

Despite significant outflows affecting our industry, Westwood retained all of its institutional clients and maintained its consultant ratings. Just as an example, the month of May saw the largest outflows in the LargeCap value category for 15 years, while Westwood’s LargeCap value flows were positive for the second quarter. The broad market particularly in the last two months of the quarter gained a surprising amount of bullish momentum despite many potential risks, including continued tightening of an already restricted monetary policy. The S&P 500 Index gained 8.74% for the quarter, but these returns were skewed by a handful of growth in tech names, which pushed the index higher. The stock market has become very top heavy recently with performance driven by the largest market cap names in the index.

However, we have also been seeing increasingly broad participation with more risk-on stocks across the market cap spectrum. Growth stocks were the clear standout overall for the quarter, outperforming value stocks by more than 3:1 in the LargeCap market indices. Against this backdrop of continued market volatility and uncertainty, 60% of our U.S. value strategies outperformed their benchmarks in the second quarter and 80% of them remain ahead for the trailing one year ending in June, adding to their solid long-term track records. Over the trailing five-year period all of our U.S. value strategies with track records extending into those periods are ahead of their benchmarks. Within our multi-asset team, our broader asset allocation strategies bumped up against the largest and most expensive names in the high-flying S&P 500.

On the fixed income side, bond prices declined and yields rose as investors priced in additional interest rate increases. Interestingly funds with more exposure to lower-quality bonds, such as leveraged loans and high-yield corporate bonds fared better than higher quality bonds showing that investors are prepared to take on risk. All of June, all three of our multi-asset strategies ranked in the top third of their Morningstar peer categories for trailing three and seven years and scored top 20% ratings for trailing five years. Our newest strategies coming from the acquisition of Salient Partners asset management business performed well, with two-thirds of them adding to their solid performance records against benchmarks, while Westwood Broadmark Tactical Growth and Tactical Plus, both posted positive absolute returns.

Our Tactical Growth and Tactical Plus funds are designed to help investors sidestep market downturns. Equity valuations remain above historical averages, and we remain vigilant as the road ahead is likely to be bumpy. If global economies enter a somewhat synchronized recession and markets correct, we expect these strategies to shine, as investor capital is protected. Our MLP & Energy Infrastructure mutual fund underperformed its benchmark amid the risk on rally, but the strategy’s fundamentals remain strong which should support future expansion in the midstream energy space. In the short run, asset outflows are continuing here as investors take profits, following strong performance from the 2020’s pandemic-driven lows. I’m pleased to report that the MLP & Energy Infrastructure, SMLPX mutual fund ranked in the 26th percentile for the quarter and rose to claim four stars among its Morningstar peers.

Our Global Real Estate and Select Income strategies, delivered another quarter of positive returns for our investors, as both funds remained ahead of their benchmarks year-to-date. These funds are performing well as designed to deliver consistent income in the form of robust dividends on both their common and preferred shares. For the quarter, Global Real Estate and Select Income ranked in the top 10% versus Morningstar peers and Global Real Estate scored a top 1% among its eVestment non-U.S. diversified REIT peers. Over the trailing one-year period ending in June, both strategies landed in the top third. And over the trailing three years, they made it into the top 15th percentile bracket in Morningstar universes. Looking forward, these strategies can provide investors with alternative sources of income, inflation protection be exposure to real assets, low correlations to traditional asset classes and market volatility mitigation.

Investments, Finance

For Wealth Management, our strategy’s performance was mixed. Our High Alpha Strategy rebounded strongly with a top ranking among its eVestment peers. Our more seasoned Select Equity and Dividend Select strategies lagged in a market, driven higher by the price the S&P 500 stocks. However, they provide broad exposure to large blue chip equities consistent with the investment objectives of our high net worth client base. One of our newest strategies for high net worth clients our Regional Banking Strategy, just finished its first full quarter by outperforming by more than 400 basis points. The RBS strategy leverages our strong fundamental research and allowed clients to take advantage of the market dislocation experienced by the banking industry, earlier this year.

Expectations for continued volatility underscore the importance of Active Risk Management. Our Wealth Strategies are positioned to preserve capital with strong down capture and benefit investors in a flight to safety. As I mentioned last quarter, Vista Bank shares completed the acquisition of Charis Holdings. As a result of our ownership stake in Charis, we are now a stakeholder in Vista Bank, which is known as an entrepreneur’s bank serving North, Central and West Texas through its 14 banking locations. We plan to expand our relationship with Vista, as our wealth clients want competitive deposit yields and friction-free loans and we began to earn referrals from Vista’s 15,000-plus customer base. Shifting now to distribution, persistent inflation, Central Bank rate increases including the latest just last week, economic uncertainty and stretched equity valuations have weakened sales activity generally within the industry.

In our institutional channel outflows and income opportunity in LargeCap were the largest drivers of flows in the quarter, as inflows of $163 million were offset by outflows — for net outflows of $275 million. 60% of the outflows reflected one income opportunity account loss. However, that client remains a long-term partner with Westwood, investing in our LargeCap value strategy since the year 2000. In terms of client retention, other outflows were driven by client rebalances and we had no client losses in the quarter. Our industry continues to experience an extremely challenging sales environment due to fears of a recession and a risk-free rate of return of more than 5%. Bright spots include the retention of our consultant ratings in several key categories and one large consulting firm upgraded its rating for income opportunity.

The technology enhancements we implemented earlier this year have led to greater than 50% increase in outsourced CIO meetings and our RFP activity this year has outpaced activity for all of 2022. These factors underpin our optimism for the second half and into 2024. Within our intermediary channel gross inflows of $179 million were fully offset by outflows resulting in net outflows of $195 million for the quarter. Outflows were centered in our MLP and Tactical Growth strategies. Energy sector flows continue to be negative industry-wide as investors take profits following two years of strong performance coupled with a decline in crude oil from a peak of 130 early last year to below $70 at the end of June. Tactical Growth outflows resulted from one client loss and a shift by investors towards risk on categories rather than asset preservation.

In a market correction, we expect our Tactical Growth and Tactical Plus strategies will provide investors with downside protection. The highest net positive intermediary flows occurred in Alternative Income and Select Income, with the addition of new client assets. Looking at intermediary flows nationally across all product categories, we’ve seen the largest year-over-year dispersion in well over a decade. So far this year, 14 of the top 20 categories for net inflows focused on fixed income, particularly short and intermediate-term investment-grade securities as cash yields now exceed 5%. Equity products experiencing net inflows aside from the S&P 500 Index funds are mostly international equity funds. This scenario contrasts dramatically with 2022, when the top 20 categories for net inflows featured strong representation from US equities.

The pendulum has swung very far in terms of industry asset flows, but we anticipate that markets will find a middle ground as we move into 2024 and beyond. Considering the addressable market for categories in which we compete, our share remains stable or is actually growing. For example, our alternative income strategy which competes in the relative value arbitrage category. And Select Income, which competes in the preferred stock category have both enjoyed net inflows this year despite large category outflows. Westwood is broadly outperforming its US value and multi-asset peers in terms of asset retention in these challenging times. The reception to Westwood’s new products added via the Salient transaction has been very positive and we believe they will provide meaningful benefits to our distribution efforts over the longer term.

As part of growing our alternatives business, this year we completed successful asset raises for three funds from highly regarded fund sponsors, including an energy fund, a real estate fund, and a Marina fund. We don’t have final numbers until we’ve received all subscription documents but early indications are that we raised nearly $60 million across these three private funds bringing our private alternatives to nearly $250 million. Expect to hear more as we expand into the alternative space an asset class with strong secular growth trends and better fee yields. Moving to our Wealth Management business. Overall flows were negative, due to tax payments and client distributions but we’re pleased that client losses were few. Our client retention rate remains above 95% as the group experienced inflows of $67 million offset by outflows of $132 million for the quarter.

Our strategic projects are beginning to bear fruit. We’ve been carefully assessing how to best serve each of our clients marrying their unique investment needs with our wealth capabilities. Realigning clients along channels that best serve their needs will produce a better experience for all our clients. In addition, our relationship with Vista Bank has been well received by clients and we expect our adviser client web portal to be fully operational by year-end. Summing up, stock market has become very top heavy this year with performance mostly driven by the largest market cap names generally growth-oriented technology stocks. As the quarter ended, we were pleased to see increasingly broad participation, including more risk-on stocks across the market cap spectrum.

Given the economic risk, it remains to be seen whether we’re at an inflection point in terms of performance drivers. Regardless, we remain focused on high-quality businesses trading at an attractive price. These basic tenants form Westwood’s strong investment foundation. Our investment teams continue to deploy their disciplined investment processes and our business units are working hard to bring our message to prospects, retain clients and provide excellent client service. We are serious about capitalizing on our energy expertise with the expansion of several funds including several now in the incubation stage. We’re getting closer to finding a seed investor for our sustainable energy fund and we just launched an energy secondaries fund last week.

We are noting a shortage of available capital in the traditional energy space and many investors are selling for non-fundamental reasons. To us, energy fundamentals look strong and we’re happy to buy LP interest at discounts of 25% to 50%, especially since oil and gas demand should grow more than 20% annually over the next two decades. And the world will need to invest $12 trillion in capital by 2050, just to keep up with the demand. I’d like to close with one observation. In my 31 years at Westwood, I’ve never seen our sales team busier than they are today. Our sales team completed 995 meetings during the quarter, which set an all-time record. Near-term flows may not reflect our team’s schedules of heavy travel and extensive meetings, but we strongly believe that they will in time.

Meanwhile, we’re focused on things we know can deliver results. The first is attitude, the second is activity and the third is breadth of product knowledge to inform and help advisers best serve their clients. I believe that Westwood has these characteristics in abundance. And when the tide comes back in, the spade work we’re doing now will lead to much better flows ahead. I’ll now turn the call over to Terry Forbes our CFO.

Terry Forbes: Thanks, Brian, and good afternoon, everyone. Today, we reported total revenues of $21.9 million for the second quarter of 2023 compared to $22.7 million in the first quarter and $15.6 million in the prior year second quarter. Revenues were lower than the first quarter on lower performance-based fees. Revenues were higher than last year’s second quarter reflecting higher average AUM following the acquisition of Salient Partners Asset Management business during the fourth quarter of last year. Second quarter net income of $2.9 million or $0.36 per share compared favorably with $0.7 million or $0.09 per share in the first quarter due to changes in the fair value of contingent consideration, offset by lower revenues and higher income taxes.

Non-GAAP economic earnings were $5.7 million or $0.70 per share in the current quarter versus $3.6 million or $0.45 per share in the first quarter. Second quarter net income of $2.9 million or $0.36 per share compared favorably with last year’s second quarter net loss of $0.4 million or $0.05 per share, primarily due to changes in the fair value of contingent consideration and higher revenues partially offset by higher expenses, primarily employee compensation and benefits expenses following the acquisition of Salient Partners Asset Management Business in 2022. Economic earnings for the quarter were $5.7 million or $0.70 per share compared with $1.6 million or $0.20 per share in the second quarter of 2022. Firm-wide assets under management and advisement totaled $16.2 billion at quarter end consisting of assets under management of $15 billion and assets under advisement of $1.2 billion.

Assets under management consisted of institutional assets of $7 billion or 46% of the total, wealth management assets of $3.9 billion or 26% of the total and mutual fund assets of $4.2 billion or 28% of the total. Over the quarter, our assets under management experienced market appreciation of $0.5 billion and net outflows of $482 million and our assets under advisement experienced market appreciation of $46 million and net outflows of $56 million. Our financial position continues to be very solid with cash and short-term investments at quarter end totaling $38.1 million and a debt-free balance sheet. I’m happy to announce that our Board of Directors approved a regular cash dividend of $0.15 per common share payable on October 2, 2023 to stockholders of record on September 1, 2023.

That brings our prepared comments to a close. We encourage you to review our investor presentation posted on our website reflecting quarterly highlights as well as a discussion of our business, product development and longer-term trends in revenues and earnings. We thank you for your interest in our company and we’ll open the line to questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from Macrae Sykes with GAMCO. You may proceed.

Macrae Sykes: Good afternoon, everyone.

John Ehinger: Good afternoon, Mac.

Macrae Sykes: Great. I had just two questions. The first was, given where we’ve moved away now from the closing date of this merger, do you think there’s any attrition or churn that sometimes occurs with mergers? Do you think that is affecting any of the flows at this point?

Brian Casey: I think we’ve done a really good job of hanging on to our clients. I think the — any deterioration in AUM has come from really — primarily, the energy sector and that has been more due to a big decline in price from 130 last year to under 70 in June. And simply just a real bias towards not owning energy, I mean I’ve been in this business a long time and I can remember when energy was north of 20% of the S&P and it’s less than 5% now. And yet it’s something that we all use every single day. So, it is interesting what’s going on. We’re value investors at heart and we like to see opportunities and we think there’s a lot of opportunity in the energy space.

Macrae Sykes: Great. And I wonder if you could go a little bit deeper kind of on the wealth management effort. I mean you’ve done a good job putting the Salient and Westwood together, and wealth is been some outflows. And it seems like you have the brand you have the tech at this point you have the local scale. What’s sort of missing there to get to healthier trends?

Brian Casey: I don’t know that anything is missing. I think we’ve worked really hard to put all the pieces together. I think there’s clearly a lot of competition in the wealth space. Everybody’s got a little different mousetrap. We’ve spent a lot of time in the last few years building on the planning side of our business, which is in much slower sales cycle. When you start with a financial plan, sometimes it takes many months, many quarters to get somebody across the line. And I’m always reminded that when we’re prospecting for new business, in our high net worth business, you’re talking to somebody who may have had a relationship with an adviser for decades. And so, we’ve got to show them that we have a much better offering and we have to disrupt the relationship that they have.

So, it’s not easy to bring in new business into the wealth channel. But when you do, if you do a good job for them over time, they tend to stick with you. And we’ve had across the board pretty good performance in our wealth products. They’re designed to protect capital on the downside and participate on the upside. We’ve also done some unique and interesting things that are more opportunistic. We did a bank fund here in the — a couple of months ago. We’ve done an electric vehicle fund. We’ve done a High Alpha fund that is very much a growth-oriented strategy. So, we have a lot of entrepreneurs that are clients and they like for us to give them an opportunity to show the expertise that we have. And we’re entrepreneurs too. So it’s fun to respond to that with a product offering that they’re excited about and that we have fund manager.

Macrae Sykes: Great. Thank you, and congrats on the strong strategy performance this quarter.

Brian Casey: Great. Thanks Mac. Appreciate your questions.

John Ehinger: Thank you. Anybody else?

Operator: No more further questions. And I can turn it back to Brian Casey for any closing remarks.

Brian Casey: Great. Well thanks very much for taking time to listen to our call today. We appreciate you being interested in Westwood and being a shareholder. Please visit our website westwoodgroup.com. Call me directly or Terry Forbes our CFO, if you have any additional questions. Have a great afternoon.

Operator: Thank you. This concludes today’s conference call. Thank you for participating. You may now disconnect.