Franklin Resources Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
May 3, 2022

There are 13 speakers on the call.

Operator

Welcome to Franklin Resources Earnings Conference Call for the Q3 and Fiscal Year 2022. Hello, my name is Grace, and I will be your call operator today. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Celine Oh, Head of Investor Relations for Franklin Resources, you may begin.

Speaker 1

Good morning, and thank you for joining us today to discuss our quarterly results. Statements made on this conference call regarding Franklin Resources, Inc, which are not historical facts are forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward looking statements involve a number of known and unknown risks, Uncertainties and other important factors that could cause actual results to differ materially from any future results expressed or implied by such forward looking statements. These and other risks, uncertainties and other important factors are just described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including in the Risk Factors and the MD and A sections of Franklin's most recent Form 10 ks and 10 Q filings. Now, I'd like to turn the call over to Jenny Johnson, our President and Chief Executive Officer.

Speaker 2

Thank you, Selene. Hello, everyone, and thank you for joining us today to discuss Franklin Templeton's results for our 2nd fiscal quarter. I'm joined by Matt Nichols, our CFO, Who recently expanded his responsibilities to include Chief Operating Officer and Adam Spector, our Head of Global Distribution. This quarter, global financial markets were impacted by a continuation of macroeconomic pressures due to increased inflation And related higher interest rates, both of which have been significantly exacerbated by geopolitical and economic shifts resulting from the Russia Ukraine war. This quarter's volatile market environment challenged industry flows, particularly in taxable fixed income strategies.

Speaker 2

We were impacted by these pressures and had $11,700,000,000 in long term net outflows. Although we continue to drive Net inflows into key growth areas and our effective fee rate remains stable. The heightened market So the implications of a rapidly changing investment environment remind us of the importance of the investments we've made over the past several years to diversify our business to better serve our clients through all market conditions. Our investment teams Each look at the market through a different lens to provide deep expertise and investment specialization. For instance, if you look at our fixed income franchise, Brandywine Global, Franklin Templeton Fixed Income, Templeton Global Macro and Western Asset, Each of these specialist investment managers has a different interest rate outlook resulting in varying investment outcomes across our products.

Speaker 2

And although we saw net outflows in certain U. S. And global taxable strategies, those were partially offset By inflows into short duration bank loans and corporate strategies. Additionally, we've been able to benefit as investors look to reposition their in search for yield across asset classes. Our flagship income fund and alternative asset strategies of Benefit Street Partners And Clarion Partners, for example, represent important diversification tools for our clients.

Speaker 2

BSP and Clarion Have been key contributors to our success and generated a combined $2,000,000,000 in long term net inflows during the Q2 and each reached Record highs in assets under management. Our multi asset class category recorded 2,300,000,000 In positive net flows for the quarter, driven by the Franklin Income Fund that has an approach that is adjustable to changing market conditions. With 75,000,000,000 in U. S. AUM, the income fund has also seen increased interest from investors in Asia and Europe And the strategy was recently launched into the SMA vehicle to meet client demand.

Speaker 2

To illustrate how we've been able to diversify into other Strategy 17 of our top 20 funds with net inflows are outside of our largest 20 funds And on average now exceed $5,000,000,000 in AUM. Close connectivity with our customers during periods of market uncertainty is Extremely important as investors look to reposition their portfolios and we've been actively engaging with our clients with thought leadership From the Franklin Templeton Institute and our specialist investment managers to help navigate how geopolitical and macroeconomic shifts Impact their investment decisions and their long term financial goals. Specifically, webinar attendance by financial advisors grew by 62% in the 2nd quarter and video views increased by 90%. Turning to investment performance, strong long term investment performance resulted in 65%, 68% and 77% of our strategy composite AUM outperforming their respective benchmarks over a 3, 5 10 year period. There was a decrease in our 1 year investment performance primarily due to certain U.

Speaker 2

S. Taxable fixed income strategies, Which was partially offset by strong performance in global fixed income strategies with notable improvements in performance for Templeton Global Bond Fund whose performance is in the top decile for the 1 year period. We continue to make progress on our corporate initiatives, which include growing alternative assets, Advancing technology to customize portfolios in our SMAs and expanding our presence in wealth management and ETFs. Our alternative asset business continues to develop growing 2.3% from the prior quarter to a record 158,000,000,000 in AUM with contributions from a diverse group of strategies, including the aforementioned 2,000,000,000 of net inflows And to Benefit Street Partners and Clarion Partners. On April 1, we completed our acquisition of Lexington Partners, A leading global manager of secondary private equity and co investment funds with total AUM of $57,000,000,000 as of March 31.

Speaker 2

That AUM will be included in our quarterly reporting starting in the Q3 and we expect further growth as a result of new fundraising. When including Lexington, Franklin Templeton increased its presence in alternatives by 39% to become a 215,000,000,000 manager of alternative assets, an area of increasing importance for both individual and institutional investors. SMA AUM ended the quarter at $126,100,000,000 We continue to make progress With SMA strategies, particularly in the use of technology to customize portfolios. This quarter, Canvas, Our recently acquired custom indexing solution increased by 21% in AUN driven by net inflows of $600,000,000 and the number of partnerships grew by 15%. Wealth Management AUM We ended the quarter at $34,100,000,000 Fiduciary Trust International generated its 6th quarter of consecutive Positive long term net inflows and we continue to explore ways to accelerate growth of the business via acquisitions.

Speaker 2

We also experienced growth in our ETF business in the quarter with positive net flows in approximately $13,000,000,000 in AUM, Which are balanced between actively managed and passive strategies. Looking briefly at our financial results, adjusted revenues were 1,600,000,000, A decrease of 6% from the prior quarter, primarily due to lower average AUM, 2 fewer calendar days and a decrease in performance fees. Expenses were flat quarter over quarter, but would have been lower had it not been for non recurring or certain episodic items That are included in our adjusted results. Adjusted operating income was 577,000,000 and importantly, Our adjusted effective fee rate stayed relatively consistent at 38.5 basis points. With 6,800,000,000 in cash and investments as of March 31, the ongoing strength of our balance sheet enables us to invest with confidence In the business and make sure we're positioned appropriately in an ever evolving industry.

Speaker 2

In closing, It's a transformative time in the asset management industry, while the economic climate and geopolitical tensions present additional complexities and uncertainties. Over the past 2 years, we've made significant strides to expand our capabilities and provide our clients with deep expertise and specialization. It's this broad diversity that is allowing us to navigate through the current volatility. I would like to thank our employees for their tireless work and ongoing efforts on behalf of our clients. Now let's turn it over to your questions.

Speaker 2

Operator?

Operator

Thank you. Your first question comes from the line of Craig Siegenthaler from Bank of America. Your line is open.

Speaker 3

Good morning, Jenny, Matt. Hope you're both doing well. And Matt, congrats on the COO Good morning.

Speaker 4

Thank you.

Speaker 3

So, given your large fixed income Franchise across Western, Brandywine and Franklin, I wanted to get your perspective on how investors are reacting to rising rates. And my question really is, are you seeing a different flow pattern or behavior between the retail And institutional channel. And then when the money is leaving, do you see where it's going? Is it going into cash, private credit, And are you able to recapture it?

Speaker 2

Well, I'm going to let Adam get into details. But I mean, we're definitely Seeing good flows into like short duration bank loans, corporate strategies. I mean, so there so it's not all There's more of a kind of a shift in where it's going. But Adam, you want to go into a little bit more details?

Speaker 5

Sure. Thanks, Jenny. First of all, I would say that the changes that we've seen are not really all that different on the institutional and the retail side. We see pretty similar patterns going Right now, that's really part I think driven by the fact of how professional the wealth channel is these days. I don't see it behaving that much Probably been the institutional channel.

Speaker 5

What we've seen is that core type strategies, intermediate duration was hit the worst. I think if you take a look at active flows for U. S. Mutual funds as an example for the month of March, The industry without something like $71,000,000,000 75% or so of that Was in core taxable fixed income. So that part of the market got hit really, really hard.

Speaker 5

Where is that money going? As Jenny see, we see short duration picking up a lot. Our short duration sales in some of our funds was up over 80%. You see it going to some credit strategies, floating rate and importantly also to private credit, where we're A significant player and that in part is propelling the growth in our alts business where in our private markets businesses As Jenny said earlier, we had $2,000,000,000 worth of growth in the quarter. The other place, especially in some of our wealth channels that we've seen a pivot to is alternative sources of yield to fixed income.

Speaker 5

And we're really pleased that we have the ability to offer our clients The income fund, which is one of our largest funds at Franklin and one of our top really flow generators for the quarter, Where we saw an increase in our net of over $2,000,000,000 quarter over quarter. And I think we have to assume some of that money from fixed income So we feel good, Craig, in general about being able to retain a portion of the outflows even though The segment where we're strongest had the worst outflows in the industry.

Speaker 3

Thank you for that. And just as my follow-up on a similar topic, as we try to forecast the model bond flows, Do you think it gets worse from here just because we've only had one rate hike and there could be 8 or 9 more? And I know that's more of a Short duration front end of the curve sort of comment and the long end might matter more, but I would love your perspective on this topic given what you're seeing from clients.

Speaker 5

Yes. I think the good news is one of the themes that we are really pleased to see across the business is the diversification. So if you ask about a number of rate hikes like that, it's going to impact our various specialist investment managers in different ways Because we have very different and differentiated positionings along the curve. So what I think that means is that Regardless of the action the Fed takes, we're going to have products that are in the performance sweet spot where we'll be able to continue. One of the continue to grow.

Speaker 5

One of the things we're really pleased with is the fact that our sales is more diversified than it's ever been before, Which means we think we have the macro environment.

Speaker 3

Adam, thank you for the responses here.

Speaker 6

Thank you.

Operator

Thank you. Next up, we have Bill Katz from Citi. Your line is open, sir.

Speaker 7

Okay. Thank you so much for taking the questions. So maybe coming to expenses for a moment, seem to be a few sort of ins and outs as I see it. Just wondering if you could unpack a little bit about what is the right start point for expenses into new quarter and how should we be thinking about the expense outlook Maybe with and without the impact of Lexington and does the charge you took for TA, Does that have any sort of incremental synergies or other impact as we look out over the next several quarters? Thank you.

Speaker 4

Okay, Bill. Thank you. Good morning. Maybe it's best if I just update some guidance and I'll also give some breakdown Inclusive of Lexington, so we can sort of reset where we're at and I'll give both annual guidance and some quarterly guidance for the next Quarter on the breakdowns. We expect full year 2022 adjusted operating expenses be in the range of €3,900,000,000 to €3,950,000,000 excluding performance fees, but now Including Lexington Partners.

Speaker 4

You may recall last quarter I had said that Our expense guide for 2022 on adjusted operating expenses would be $3,900,000 to $3,950,000 excluding both Performance fees and excluding Lexington, but now it's excluding performance fees and including Lexington Partners. That's one important Due to market conditions and revenues and assets and the management and so forth. Given we've now closed Lexington, as I mentioned, I'll give A few line items, which I hope will be useful for the Q3. We expect G and A to be in the range of $140,000,000 Again, inclusive of Lexington, occupancy to be around $57,000,000 and Information Services and Technology The information systems, sorry, and technology to be around $125,000,000 and that's all inclusive of Lexington.

Speaker 7

That's very helpful. Thank you very much. And maybe coming back to alternatives as my follow-up. Jenny, I actually heard you talk about Yes. So the good growth out of Clarion and Benefit Street sort of adding $2,000,000,000 but I also think you mentioned you had some outflows on the liquid side.

Speaker 7

So if you maybe unpack that a little bit more. And then as you think about Lexington, where are they in their flagship capital raising cycle and how can you see the opportunity to leverage

Speaker 6

Thank you.

Speaker 2

Yes. So some of the outflows were in some of our macro strategies On the alternative side, as far as Lexington and the capital raise, I mean, we're not talking specifically about the fundraise. But If you look at when we announced the deal, I think they had $34,000,000,000 in fee generating revenue or AUM and now they're up to 42,000,000,000 And so you can look at comparable secondaries and see sort of how they've done on their rates versus others. And we're really excited about it, but we're not giving any more specific details on this particular fund rate.

Speaker 5

Jenny, the one thing I might add to that is that the distribution team has been working with Lexington. Obviously, they have a long history of accomplished fundraising on their own. The areas where we think we're going to be able to add the most to Franklin Templeton are in the retail distribution of their products As well as in select markets, we've had a number of examples already where they might be strong in a particular country Or segment, but they don't quite know everyone in the market or there's a country, where they don't really have a presence. So just like we do with the rest of our specialist investment managers, It's really an opt in model and we've had discussions with them about where they're strong and where they need some help and we're filling in The gaps which we think will help their already strong sales process get even better.

Speaker 2

And I think actually, Adam, I think that's a great point. I mean, you talk about sort The big areas of growth, alternative is obviously our big area of focus. I mean BCG came out and said in 2025, All flows represent 16% of AUM, but 46% of global AUM revenue. So as we all know, flows, All flows aren't created equal. And the big opportunity we think is in the retail channel.

Speaker 2

If you just again take the 13,000,000,000,000 in assets in the top 4 largest warehouses, 1% move is $130,000,000,000 and they've all Stated that they know that the democratization of alternatives is really important as we've seen the reduction of companies going public and more and more private credit. And so we think taking our vast retail distribution capabilities and marrying it with these alternatives, it's really complicated. There's a lot of training that goes on, it's not just getting on the platform, there's a lot of material that has to be there, but it's just a tremendous opportunity. And Lexington, part of their fundraise has been successful in the retail channel. So we're excited about the We actually think secondary private equity is a great way because you don't have the J curve issue for the retail or the Or the wealth channel to actually access private equity.

Speaker 7

Thank you very much.

Speaker 4

Thank you, Bill.

Operator

Thank you. And your next question comes from the line of Brandon Hawkins from UBS. Your line is open, sir.

Speaker 8

Good morning. Thank you for taking my questions. I just had a follow-up on the, Matt, the expense Updated expense guide, really helpful to hear. What for the full year, does that Expectation include what we've seen so far quarter to date or would that be as of threethirty one when you cut that? How should we think about that when

Speaker 7

we watch the markets and calibrate

Speaker 4

It includes market to date, but obviously know how volatile the market is, Brendan. And I think we've highlighted in the past that approximately 35% to 40% of our Adjusted expense base is variable along with market and performance and I think we've also added to that the other piece, the 60% 65% in terms of long term effectiveness and efficiencies we continue to view. But so if the market gets Tougher, we're equipped to make moves, further moves.

Speaker 8

Great. That's helpful and thanks

Speaker 7

for that. And

Speaker 8

then how is it that you guys we hear a lot about Some competitors continuing to make investments and whatnot. How are you Balancing, expense discipline and holding the line with continuing to make investments The business that are so important to your competitive positioning and maintaining your strength in the marketplace.

Speaker 4

Yes, I think

Speaker 2

oh, go

Speaker 4

ahead, Jodi.

Speaker 2

Sorry, Matt. I was just going to say, you can answer more details. But I would say, philosophically, You will always see us thinking in terms of what's the long term right for the business versus any kind of short term. So We're going to work hard to reduce costs where we can reduce costs, but never at the expense of strategically positioning us for the long So we're making some significant investments in wealth technology, for example, and even in the blockchain space and others, Because we think they're going to be important over the long run. It'll take a little time for those to pay off meaningfully and hit the bottom line, but they will be really important for us in the long term position of the business.

Speaker 2

Go ahead, Matt. Yes.

Speaker 4

I think the only thing I'd add to that is I think part of your question, Brent, is how are we doing that? Where are we funding the money from when When we're managing to reduce expenses and keep up with where the market's going in this volatility, It's basically because we've also been through a very significant merger, remember. So when you go through significant Mergers, even at the holding company level where we focused most of the cost synergies, we had that creates Flexibility for the company and it continues to create flexibility for the company in terms of our operation and how we run the firm and We have to focus on one thing at a time, but we've certainly earmarked other areas where we can make moves when we have time to make the moves candidly. So that's where we get the additional flexibility from as we dig in.

Speaker 8

Excellent. Thanks for all that color.

Speaker 4

Thank you. Thank

Operator

you. Next up, we have Alex Blostein from Goldman Sachs. Your line is open, sir.

Speaker 9

Great. Thanks. Good morning, everybody. So Jenny, maybe just to build on some of your comments around the alternatives and the wealth management and all kind of your aspirations there with Lexington especially coming into the fold now. We've seen a number of players both kind of traditional and the old trying to tackle the channel.

Speaker 9

But outside of Blackstone, most people have had a Part of time really making a dent, at least so far in a sizable way. So maybe help us frame What the asset base is there today across all of your kind of illiquid products on the wealth channel, wirehouses and the like? And if you look out the next couple of years, what would you consider to be success? What would you want that to look like?

Speaker 2

I'm trying to think if we publicly mentioned what percentage of our alternatives Are in the retail channel, I don't think so. Here's what I would say. It is really complicated. We are digging in. I think Franklin Templeton has one of the strongest wealth Distribution capabilities in the industry.

Speaker 2

And so probably out of the gate, the view was, oh, this should be easy. We should be able to take our Alternative products and be able to bring them right in that channel. The reality is it requires The simplest thing is to actually get on the platforms. The much more difficult thing is the level of training and detail that's required at each of the financial advisors. They're understanding how to sell alternatives into and position them in their products, the marketing material that goes in with that, The reporting, the follow-up reporting capabilities, and so like our investment in Case, right, that's one of the types of things that enables The streamlining of a wealth manager to be able to bring alternatives.

Speaker 2

You really have to It's as if you walk into a kitchen today and we the good news is we have all of the ingredients to be able to deliver this really, really well. The difficulty is it's all about bringing those things together and executing on it to be able to kind of bake the best meal. And so we are putting a lot of resources. I got to tell you this is one of my Probably top two priorities in the firm and our top two priorities is to get this right. And so we're making sure that we're skilling up Our teams to be able to fill the alternatives, making sure that we have the specialists within each of our alternatives to be able to address the wealth market As well as supporting that with the material and the training.

Speaker 2

It took Blackstone from what I understand several years Before they were able to really make a dent in the wealth channel. The good news is they paved the road a bit for the rest of us, But it is complicated. It's more complicated than I think we understood initially.

Speaker 9

Got you. Great. Appreciate that there. Yes.

Speaker 5

Yes, I can add a couple of things to that. We don't break out specifically the illiquid alternatives, but alternatives in general In the retail channel, for us are over $14,000,000,000 and our gross sales in that channel have been over $1,000,000,000 a quarter for the last few So we see strong momentum there. And as Jenny said, excellence in that area requires really good product, which we think we have, A significant distribution force, which we have, good relationships with the home offices, which we have, but then that all needs to be knit together With really superior training, education, product people, product structuring, etcetera. And that's where a lot of our attention is at this point Because we think we have all the pieces that's bringing it together and bringing it to our partner firms.

Speaker 9

Great. Thanks so much for that. And my follow-up is back To Western for a second. Fully appreciate the industry dynamics, and we've obviously seen the flows for longer duration, more maybe credit sensitive funds face A lot of flow headwinds in the last couple of months and that may continue. But as I think about the relative position of Western against some of the other larger bond platforms, The relative investment performance has suffered quite a bit as well and that's not uncommon I guess in times of more kind of credit or duration related dislocation for Western, just given the nature of the way they invest, how well understood is that with clients?

Speaker 9

So in other words, do you guys think that The relative underperformance at Western could have a longer lasting effect on their ability to recoup some of the outflows that they're seeing right now.

Speaker 2

Well, first, I would say a couple of things. So one is, I mean, you talked to Western and they feel they have a lot of conviction And that the market is overestimating the Fed increase. Now we have different fixed income teams, Brandywine, Franklin Templeton's fixed income that I believe that that's not the case, right? That's the benefit that we have of diverse managers who are truly independent. And Western is really good at communicating with the clients about their positioning and why they're positioned the way they are.

Speaker 2

And the one thing is we've gone back and looked at Western's performance over rising rate cycles. And I can tell you, They bounced back very quickly. I mean, in 100% of cases that we looked at back to 2,000 and even before that, Within the next 6 months, they outperformed the benchmark. So are they right or wrong? There's strong conviction On their positioning, they have great relationships with clients and they are doing a great job of communicating their positioning.

Speaker 2

It remains to be seen whether they're correct or not.

Speaker 5

Yes. I'll add a couple of things to that. First of all, Jenny said they have great relationships with If you take a look at some of the industry metrics, they are literally off the chart in how they score in terms of their client engagement and client service. So very strong client relationships. And when you talk about performance, look, they had a 1 year period that was really tough as the correlation Broke down and their duration hedge didn't pay off against the credit.

Speaker 5

That's essentially what happened. But look at their long term performance. 95% of their assets are outperforming on the 3 year, 98% are outperforming on the 5 year. That is not a manager that's Performance challenge, that's a manager that has soft performance in the short run. And our confidence in our sales force still have the utmost confidence in them.

Speaker 4

Excellent. And it's and Alex, it's a different it's really addressing a slightly different question. But while we're on the topic, I think it's worth Noting from a financial perspective, the operating income impact of the flows you're referencing, I'm not just referencing Western, I'm referencing just the broader parts of fixed income are relatively low compared to the positive Great income impact we're getting from the growth in alternatives and other growth areas that we've referenced.

Speaker 9

Yes, for sure. And it's coming through the fee rate as well. Great. Thanks so much.

Speaker 6

Yes. Thank you.

Operator

Thank you. Next, we have Ken Worthington from JPMorgan. Your line is open.

Speaker 6

Hi, thank you. I wanted to Follow-up on Alex's question and your response to Bill Katz. So from a higher level, can you talk about the integration of the various alternative platforms. So you now have Lexington in the mix. Like how are you thinking about like where are you going to Integrate them and where are you going to not integrate them.

Speaker 6

And so maybe start out with distribution. In terms of integrating distribution, are you kind of Combining the different alternative sales forces together, are they being like cross trained but being kept separate? And then how are you kind of folding their expertise into your broader sales focus? And then The other part of my question is really on product development. How aggressive do you want to be in terms of product development, New products for maybe other distribution channels where you have good relationships in And how quickly can you get those products out?

Speaker 2

So why don't I start Adam and then I'll turn it to Here's the good news. Each of those managers had their own, in most cases, it was really institutional. And so they have institutional sales teams, institutional relationships and we've left those So why mess with success? But on the retail side, There has to be a leveraging of the broader Franklin Templeton. And so and this goes for our 18 specialized investment managers where You have institutional capability, you have what we call IPMs, institutional portfolio managers who are really Product specialists who sit with the investment team can be called in by the distribution team to come in and talk about the specific products And they reside with the investment team, so they're really an extension of it.

Speaker 2

And so we can call on those to Help support any of the distribution capabilities. So you could say that line is broadly Divided by institutional and wealth channel, but there's always a little bit of gray in there. And so if there are relationships that one has on an institutional that they don't have, our institutional centralized team will bring in and make an introduction into any of our specialized investment managers and it's imperative for us to make sure that there's good collaboration there. So our goal is to continue to have the great momentum as you can see with Lexington, the fact that they've You know increase from $34,000,000,000 to $42,000,000,000 pre close that obviously they have a tremendous Distribution team. But we also feel strongly that, as I mentioned, that secondary private equity is ideal in the wealth Jill.

Speaker 2

As far as product capability, one of the ways in which we think that the wealth channels could be able to The alternatives is things like 401 ks plans where you have a managed account that has an allocation And so we have a centralized product team that is going in and thinking about where they could pull in the capabilities To present a great combined solution. And we expect our teams to work together to help build those Really solution oriented type of products. Adam, you want to add anything to that?

Speaker 5

Sure. I think The one thing Jenny I would put in at the top is that, hopefully it goes without being said, but the one place where we're not going to integrate anything is on the investment teams or the investment Sorry, these trends are absolutely distinct. Jenny is right that really our distribution model in general is a generalist specialist Where the folks who sit at the center are responsible for knowing their clients better than anyone else and then bringing in the right specialists from the various specialized investment managers. On the outside, institutionally, we're actually adding specialist alternative salespeople to introduce the various alternative Firms don't have as significant of a presence. Again, it's really an opt in model and we help Each firm as they need it.

Speaker 5

On the wealth platforms, branding is an important consideration. And I think how we're tackling that at this point is that each of our alternative SIEMs are going to retain their own branding, but the distribution effort We'll be under Feet Alternatives. So there's really a single point of contact in the wealth channel, but the individual brands remain. That also really enables us to do some interesting things in terms of multi affiliate products in that channel. The product development is going well.

Speaker 5

We're focused both on one time raised products as well as evergreen products. And then another area of ours that you know we're focused on is ESG And the inclusion of ESG into alternative products is something we've focused on as well, which we think will yield significant results.

Speaker 6

Great. And just a simple reporting question. There's a pretty big gap for Lexington between fee paying AUM and AUM. How are you going to report it? Are you reporting the fee paying or are you going to report the total AUM and we'll just sort of Get the GAAP to close the fee rate or yes?

Speaker 4

Yes, I mean, yes, just to be just so we're consistent with how we report other things, we're going to report All of the AUM. We're going to be very transparent about the fee rates. I mean, if you take The full AUM, the effective fee rate is probably something like low 60s. If you include just The fee based AUM, it's going to be in the mid-80s to low-80s plus performance fees. So that's the way we'll do it.

Speaker 6

Okay, thank you. Thank you.

Operator

Thank you. Next up, we have Robert Lee from KBW. Your line is open, sir.

Speaker 10

Great, good morning. Thanks for taking my questions. Really 2, first maybe just can you update us on the wealth management channel? I know you've Talked a bit about it in a place you wanted to do some more acquisitions, but it's up to 35 Billions, head inflows, could you maybe dig a little deeper in some of the your initiatives there on Continue to drive that kind of very sticky growth business and then I'll have a follow-up on FinTech.

Speaker 2

Yes. So it's we really like that business. We have said that we it's a strategic priority for us To grow it, as you mentioned, it had 6 consecutive quarters of positive net flows. It's one of those businesses. I think the average relationship is something like 16 years.

Speaker 2

It's a great sticky business, so we like it. We had done the 2 acquisitions and We're really pleased because the AUM of those specific entities is up like 29%. So we're continuing to look For more opportunities, those opportunities will have to be additive either geographically or bring some sort of capability And we're always looking. It is an area that you've seen private equity buying up and consolidating. So We don't want to chase assets.

Speaker 2

We usually like somebody who's looking for a long term home to add capability to their To what they can offer clients by having the broader fiduciary trust. And this is one of those businesses, It's older than Franco Deppleton, it's probably close to 80 years now. And they really understand multi generational wealth, Which means education around errors and things. And so it's the right home for people who have that type of client.

Speaker 10

Okay, great. And then maybe as a follow-up, you mentioned in the press release, for example, and I know it's been, I think an interest of yours for many years is financial technology and talk about history of innovation and embracing it. But can you maybe I don't know if there's specific examples that you could call out or point to besides maybe the Embark transaction that Maybe beneath the surface you feel like have been helped you differentiate on the distribution or performance front or maybe They're just early investments, but you're particularly excited about the potential to help kind of accelerate growth over the next several years.

Speaker 2

Yes. So I'll talk about actually at a wealth advisor FinTech Conference as we speak. The AdvisorEngine, which we acquired, which has a juncture, which is a CRM system, it's for RIAs And helps them build their business. It's a small acquisition, but it's a great way to speak to I think there's something like 12,000 users on the CRM system. So it just gives us another way to talk to that channel.

Speaker 2

Go, which was developed in house is our gold optimization engine. As that gets integrated, it's a cloud based Kind of financial planning platform, it gets integrated with other platforms. It helps To sell our models and deliver our models through those and clients could choose open architecture, they can choose our proprietary models. So any of these the advisor when it became fee based, the client values the investment as a piece of it, but they also expect the advisor to do A lot more things like tax efficiency, which is of course why Canvas is so significant. So financial planning, Tax efficiency education, it really the fee based advisor is now expected to deliver with the ultra high net with Work channel used to just deliver to clients even including estate planning and trust planning.

Speaker 2

So anything that we can do That helps that advisor build their business and create loyalty is how we think about Fintech ecosystem. So they mentioned AdvisorEngine. I think that the Juncture platform has advisors of about $600,000,000,000 in assets. It just allows us to communicate and to share our capabilities. It's obviously their discretion.

Speaker 2

And so helps us just build deeper relationships. Jenny, I

Speaker 5

would also add that it really helps us talk to A wider group of people at an investment investor instead of just talking to people who are in the CIO organization, You're now talking to the business management group and you're talking about how they want to run their business and you're talking to them about how to help grow their business, Which in the end helps position you better when you're actually trying to sell an investment product.

Speaker 10

Great. Thank you so much for the add and color. Appreciate it.

Operator

Thank you. Next up, we have Michael Cyprys from Morgan Stanley. Your line is open, sir.

Speaker 11

Hey, good afternoon. Thanks for taking the question. Just on the SMA front, I was hoping you could maybe elaborate a bit more on some of the initiatives I think you mentioned that the Franklin income strategy, you're now offering that in SMA. Maybe you could talk a little bit about how you navigated some of the Challenges and complexity of offering such a strategy like that in SMA and how you're thinking about offering other additional strategies in the SMA wrapper?

Speaker 5

Yes. The complexity is largely come from a technological and operational standpoint. And that's where Legg Mason had a real Lead on the industry, the number one provider of model based SMAs, really strong technology and operational platform That we are now onboarding legacy Franklin Strategies on to which is accelerating their growth. So if you take a look Recently of what we've been where we've been flattish in SMAs, it's really because we've seen Some outflows on the legacy side with groups like Western and ClearBridge, but strong inflows onto newer Since that we've onboarded onto the platform like Martin Currie, Franklin Templeton, Fixed Income, the Canvas platform. So again, we see Diversification paying off well in the SMA space.

Speaker 5

We think that the other way that this could really go is Adoption outside of the United States, where we have some interest in some of our distribution partners to grow SMAs there as well.

Speaker 11

Great. And just a follow-up question for Matt. With the $6,000,000,000 of cash and investments on the balance sheet, maybe you could just help flush out how much would you think is truly excess here that you're sitting with today? I think you had called out around $4,000,000,000 after regulatory capital and product development. Is that the right number we should be thinking about that's truly excess?

Speaker 11

Or maybe you can help bridge the remaining gap there?

Speaker 4

Yes. I mean, I think we We define pure excess as being a lot lower than that. You know how conservative we are, Mike. So I think we put it around $1,000,000,000 But as I've mentioned beforehand, if you're talking about M and A, for example, Your transactions are structured in a way that is sensible in this market in particular. The capability to be able to do larger things with In a structured way, so you need less upfront is something that means that That amount of excess cash, let's say, can be stretched to create a much larger opportunity if there is one out there for us.

Speaker 11

Got it. And any help on bridging from the $4,000,000,000 down to the $1,000,000,000 that you referenced?

Speaker 4

Well, we have There's a little bit of regulatory capital in there, a few $100,000,000 I think we put that on the chart. Then We have a supplemental liquidity provision internally where we like to have several months of Operating expenses in the form of cash on our balance sheet, that's the second thing. The third thing is we Just spent $1,000,000,000 that we put that in the footnote in the commentary just to make sure this was clear that The cash and investments are as at threethirty one, but we spent $1,000,000,000 of the cash on the upfront consideration for Lexington. That bridges the gap really. Yes, and then you got the $1,000,000,000 surplus that we just talked about.

Speaker 11

Great. Thanks so much.

Speaker 6

Thank you.

Operator

Thank you. Next, we have Dan Fannon from Jefferies. Your line is open.

Speaker 12

Thanks. I wanted to just follow-up on, I guess, that topic and your appetite here for M and A, Given obviously you just closed on a large deal and you've been acquisitive for some time. So as you think about this backdrop, is there Certain property you've obviously been linked also in some of the news more recently with other larger properties. So can you talk about your appetite for larger M and A In the short term and longer term where those kind of product gaps, I think are mostly in alts, but are you looking also in other kind of more traditional areas

Speaker 2

So I would say, we haven't changed our listen, anytime there's We've obviously just done a deal and the markets are choppy, so the bar gets raised, but we're always running the business for the long term. So that's first. With respect to product gaps, I would say that in the alternative space, we actually feel really good about the breadth of capabilities that we have. Infrastructure is probably the one hole that's broadly left and then it's more about geographic. If the Clarion, for example, may not have a lot in Asia, so it's always hard to So a real estate manager if there isn't some local product or Benefit Street, same thing, more U.

Speaker 2

S. Focused. So if there were capabilities, But bar is very high for us now. We've also said wealth management is important for us. And I would say from traditional, I'm trying to think, but the problem is the only area would be if there was an ETF manager that made sense for us.

Speaker 2

That could be an interesting sort of traditional. We have so far gone with the organic growth on that and really like the capabilities we have, But if there was the right opportunity, maybe that would make sense for us. So and then of course, obviously, Wealth Management.

Speaker 4

Yes. And there's some specialists in here in the alternative asset area where we do have a couple of gaps and we've talked I mean, I think just at a high level, it's worthwhile making the point that from 0, pretty much 0 3 years ago or so, we about 15% of our AUM is now in odds. I think that's probably translates into Like 18 or so percent of revenue and probably more like 20% plus in operating income. And our objective overall is Jenny mentioned earlier that half of revenues are going to eventually come from alts in some form or another or private markets broadly defined. And Yes, we intend to continue to increase that percentage contribution from alternative assets.

Speaker 12

Got it. And then a follow-up on flows and Just the institutional backlog, first off, if you could maybe talk about the makeup of that historically when like Mason disclosed that it was a lot of Western and I do want to follow-up on Western as well and talk about if you could give us the numbers of kind of the makeup of what would be the core And core plus AUM because those numbers are pretty stark in terms of the performance. And if I remember correctly, I think most of that is institutional. So in terms of the potential for redemptions, as you think about that book, maybe in the context of Institutional backlog as a whole for the firm and then kind of looking at the Western potential risk of some of the institutional AUM, kind of some context around kind of the more near term dynamics and conversations with clients and flow trends.

Speaker 5

Sure. First of all, have we had challenges in core and core plus? Absolutely. But there's still Very, very significant asset gathers and among our top funds for gross sales. So while the net hasn't been strong, we still see a real commitment of clients There.

Speaker 5

And I think that shows in the funding pipeline where we still have a Significant chunk of Western product in there. But if you take a look at that and we don't really break it down by SIM, But I don't believe there's anyone, Tim, that accounts for more than 25% of that funding pipeline. So again, as we continue to diversify our business, we're seeing On the wealth front as well as on the institutional front. The other thing about Western is they manage a lot more Then core and core plus and as sales have slowed down in those areas, we've seen a pickup in some of the other areas. And again, Western is more active than some of their other funds.

Speaker 5

If you don't get to a point where you have 95% of your assets outperforming over the 3 year without taking some risk in the shorter term. And right now that risk hasn't paid off. But I think the market understands well the way that Western manages money and it will pay off over time. As Jenny said, Every time they've had a dip like this before, they've come roaring back.

Speaker 6

Okay. Thank you.

Operator

And we have a follow-up question from Bill Katz from Citi.

Speaker 7

Maybe 2 parter. Jenny, you mentioned that getting the ultralight into the retail wealth management is sort of 1 or 2 of your key priorities. Can you maybe expand on what your top priority is? And then for Matt, I'm sorry to belabor the question here. Can you just come back and unpack the expense numbers a little bit more and pretty substantial improvement in efficiency and so Appreciate revenues are down.

Speaker 7

How much of the incremental savings is coming from the legacy business versus maybe more synergized opportunity With Lexington. Thank you.

Speaker 2

Yes. So I mean, I would say our priorities, one is to making sure that we have the right product capabilities for the And so that's why we keep our eye open On M and A opportunities, 2, is making sure that we're able to distribute them in all the channels where appropriate. And Bringing that we recognize, as I said, not all flows are equal, that alternatives accounting for 15% of AUM 46% of revenues is a really important area of growth. So we got to figure out how to get that done right. And then I think from a disruption, we think about making sure that right now that we're not just focused on what has to be done now, but We're focused on looking around the corners and so that's why we keep our eye on FinTech investments, things we think blockchain can be very disruptive.

Speaker 2

So those are kind of the high level Strategic initiatives that we think about and then it's about operating this business as effectively and efficiently as we can. There's fees only go one way in this business. And so you have to be constantly pushing yourself to make sure you're as efficient as possible. We made the decision to outsource a lot of our back And that was a recognition that the honestly, the service providers have become more efficient than we could be. Initially, we were The largest global manager and there wasn't any service provider that could cover us completely, now there is.

Speaker 2

And so those are all ways to continue to reinvent The way we operate our company to make sure that we always have efficiencies to deal with the fee pressure as well as the capability to invest in new opportunities.

Speaker 4

And in terms of the cost question, expenses question, Bill, there is 0. I mean, it might be a tiny amount, but there are 0 cost synergies associated with the Lexington transaction. It's all about revenue synergies As it is, by the way, across all of the alternative asset firms that we or SIEMs that we've acquired, There may be things like Workday Financial and implementing that across the firm and modest Expense savings around that, but that doesn't really in fact, it doesn't move the needle. So there are 0 of The expense reductions I've referred to are from the Lexington transaction is all from legacy and in response to the market dynamics.

Speaker 2

Actually, I just want to add one more on a priority, because I can't even believe I'm embarrassed if I missed it. Look, sustainable finance is here to stay and we made the hire of the Sands since and so that we can have a voice at Top of the table, we think ESG is probably the long term, it's really about long term impact Companies as well as to the community and environment. And you look at Europe where ESG and we recognize with the current conflict and prices of oil that People may change their priorities of how they think about it, but the reality is in our own world we see 40% of the pipeline coming from Really Article 8 and 9 type products and we think that's here to stay. So making sure that we're on a product development and as Adam mentioned, Including in the alternative space, making sure that we have top sustainable finance type of products is really important to us.

Speaker 6

Thank you again. Thanks, Bill.

Operator

Thank you. This concludes today's Q and A session. I would like to hand the call over back to Jenny Johnson, Franklin's President and CEO, for final comments.

Speaker 2

Well, once again, I would just like to Really thank our employees for their hard work and remaining focused on our clients and each other, particularly this time. This has been a quarter of Really massive outreach to clients. And thank you all for participating in this call. We look forward to speaking to you again next quarter. Thank you, operator.

Operator

Thank you. Thank you, presenters. This concludes today's conference call. Thank you all for joining. You may now disconnect.

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Earnings Conference Call
Franklin Resources Q2 2022
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