Franklin Resources Q1 2023 Earnings Call Transcript

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Provided by Quartr
January 30, 2023

There are 14 speakers on the call.

Operator

To the Franklin Resources Earnings Conference Call for the Quarter Ended December 31, 2022. Hello. My name is JP, and I will be your call operator today. As a reminder, this conference is being recorded. And at this time, all participants are in a listen only mode.

Operator

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 section 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, Celine. Hello, everyone, and thank you for joining us today to discuss Franklin Templeton's results for the 1st fiscal quarter of 2023. I'm joined by Matt Nichols, our CFO and COO and Adam Spector, our Head of Global Distribution. We're pleased to answer any questions you have. But first, I'd like to call it a few highlights from the quarter.

Speaker 2

Despite the challenging market backdrop in our 1st fiscal quarter, we saw a number of positive developments to further diversify our business. This quarter, we continue to see net inflows into key growth areas such as into our 3 largest alternative managers, Benefit Street Partners, Clarion Partners and Lexington Partners as well as Multi Asset Strategies, ETFs And our custom indexing solution platform, Canvas. We were also pleased to see additional positive indicators impacting our business, Including an increase in our institutional one but unfunded pipeline and improving overall investment performance Across our strategies, I'll cover all of this in more detail momentarily. While the industry landscape remained under pressure, We have continued to benefit from our diversified mix of asset classes, geographies, client types And Investment Vehicles. Turning now to flows.

Speaker 2

We generated total net inflows of $6,600,000,000 this quarter, Inclusive of $17,500,000,000 of net inflows from cash management, long term net outflows were $10,900,000,000 and included reinvested distributions of 12,100,000,000 This quarter, we saw net inflows into key growth areas of client demand. Starting with alternatives, as mentioned earlier, Our 3 largest alternative managers, Benefit Street Partners, Clarion Partners and Lexington Partners, Each had net inflows for the quarter totaling $2,400,000,000 Multi asset net flows increased almost fivefold From the prior quarter to $2,400,000,000 driving the interest in the multi asset category was our flagship Franklin Income Fund With its flexible approach to changing market conditions, the US70 $1,000,000,000 fund is now rated Forestar's overall by Morningstar and continues to have strong performance. Our broader multi asset Solutions Strategies were also in net inflows. Fixed income net outflows of $13,300,000,000 We're primarily due to certain U. S.

Speaker 2

Taxable and global opportunistic strategies. Client interest, however, Continued and we benefited from having a broad range of fixed income strategies with non correlated investment philosophies, Including net inflows into certain core bond, U. S. Income and tax efficient strategies. We are pleased to note that Western's performance reverted back to its leadership position during the quarter.

Speaker 2

At quarter end, 89% of the firm's strategies outperformed the benchmark on an AUM basis for the quarter And Western's 2 primary core bond funds were ranked in the top decile on a quarter to date basis Versus their respective peer groups. Equity net inflows were 300,000,000 And included $9,000,000,000 in reinvested distributions. This quarter, the risk off environment continued to impact investor sentiment On certain growth strategies, which were offset by positive net flows into strategies such as large cap And all cap value, large cap core and emerging markets. Cash management generated the highest net inflows in over a decade With $17,500,000,000 of inflows were driven by institutional demand for low risk assets At a higher risk free rate and diversified across client type. As a leading SMA provider, Particularly in model delivery, we ended the quarter at $105,000,000,000 in SMA AUM.

Speaker 2

Canvas has achieved net inflows every quarter since the platform launched in September 2019 And AUM increased over 25% in the quarter. ETFs had $1,000,000,000 in net inflows And reached $13,300,000,000 in AUM. We launched the ClearBridge Sustainable Infrastructure ETF during the quarter And added specialized sales resources to strengthen our ETF efforts. We were also pleased to see our institutional pipeline of 1, But not funded mandates increased by $8,800,000,000 to $23,800,000,000 And included a $7,500,000,000 fixed income institutional mandate. Turning now to performance.

Speaker 2

Our investment teams Have remained true to their distinct disciplines and time tested approaches relentlessly searching for those long term investment opportunities That market dislocations often present. We saw an uptick in relative investment performance in nearly all standard time periods. This quarter, the majority of our strategy composite AUM and mutual funds AUM outperformed their benchmarks and peers, respectively, On a 1, 3, 5 10 year basis. In addition, 51% of mutual fund AUM Within funds rated 4 or 5 stars by Morningstar. As I've said time and again, the next decade is not likely to look like the last And we continue to invest strategically in areas that are shaping the future of our industry.

Speaker 2

Alternative investing is one of those areas. During the quarter, we closed the acquisition of Alcentra, a leading European alternative credit manager. This acquisition increased our alternative credit AUM to $78,500,000,000 And as for secondary private equity, As of November 30, Lexington had raised $12,800,000,000 for its latest fund and continues its fundraising efforts. Alternative assets now account for $257,000,000,000 or 19% of our total AUM And a higher percentage of adjusted revenue. We are now one of the largest managers of alternative assets And are realizing our aspiration to be one of the few diversified firms globally that offers the major categories of alternative assets.

Speaker 2

One of the lessons that 2022 taught many investors is that diversifying beyond traditional asset classes To solve for their long term goals is probably a good idea. We think this will drive increased adoption of alternative assets in the Wealth Channel where we've made progress. We continue to focus on product development and suitability, Sales and marketing and client education in the distribution of alternatives in wealth management. For example, Benefit Street Partners Announced the launch of Franklin BSP Private Credit Fund, investing in U. S.

Speaker 2

Middle market private credit seeking to generate strong current income And superior risk adjusted returns across market cycles. In November, the Franklin Templeton Academy announced launch of its alternative education program as part of our ongoing effort to build knowledge and proficiency Around the alternative investment landscape, the program offers a comprehensive curriculum on various types of alternatives, Including courses on private equity, real estate, private credit, infrastructure and hedge strategies. Touching briefly on our financial results, which reflect 2 months of Alcentra given its closing on November 1. Ending AUM was $1,390,000,000,000 an increase of 7% from the prior quarter primarily due to market appreciation And the addition of Alcentra. Average AUM decreased by 1.5 percent to 1.35 trillion Adjusted revenues were $1,440,000,000 a decrease of 6% from the prior quarter.

Speaker 2

The decrease was driven by lower adjusted performance fees and lower average AUM. However, the effective fee rate, Which excludes performance fees, was 39 basis points, a slight uptick compared to 38.8 basis points last quarter. Adjusted operating income was $395,100,000 a decline of 20% from the prior quarter Or 12% excluding annual deferred compensation acceleration for retirement eligible employees of 37,000,000 We continue to benefit from a strong balance sheet with total cash and investments of $6,600,000,000 at quarter end After reflecting the purchase of Alcentra and payment of fiscal year end cash bonuses. Let me wrap up by saying that Over our 75 year history, our North Star has always been the clients we serve. We are committed to continuing to seek opportunities to To expand our capabilities to provide investors with financial investments that are important in reaching their goals.

Speaker 2

Finally, I would like to thank our global employees without whom our progress would not be possible. Their work is greatly appreciated and I thank them for their many contributions to our organization. Now let's turn it over to your questions. Operator?

Operator

The confirmation tone will indicate your line is in question We request that you limit to one initial question and one follow-up. Our first question comes from the line of Glenn Schorr from Evercore. Your line is now open.

Speaker 3

I guess a question on the fixed income side. We saw outflows in Q4, but the outlook for 2023 should be a lot better for the industry. Just curious on that thought overall and how you think Western in particular is positioned in the year ahead? Thanks.

Speaker 2

Great. Thanks, Glenn. I mean, first of all, as we mentioned in the quarter, the core bond portfolio at Western had In net flows, we continue to see really strong sales. On the gross sales for Western products, 89% of the strategies outperformed. Actually core plus and core ranked 2nd and 8th percentage in there against their peers for the quarter.

Speaker 2

So really good, I think good recent performance. The pipeline over $10,000,000,000 of the pipeline is Western. As we mentioned, the $7,500,000,000 mandate is part of Western's. But beyond that, they're just getting great support. But I Here's what makes us really excited.

Speaker 2

Many of the institutional players have been a little bit slow. That's why I think we've seen Real strikes in our institutional money funds and a lot of flows going there both in the last quarter and continuing through January. As you see institutions waiting to figure out kind of when the rates peak, but as they You know, ventured back into the space, we have 3 phenomenal brands between Franklin Brandywine and Western. And to just punctuate that the Brandywine Global versus Western Core Plus and Franklin Core Plus from their excess returns Only correlate 0.12 and 0.17. So regardless of what type of view people have on Fixed income, we've got really, really great brands in that area.

Speaker 2

Adam, you want to add anything to that?

Speaker 4

Yes. I would just add, Jenny, that the performance turnaround is really across the board. If you look at where our global bond fund is, that's now top decile As well. So really good performance everywhere. On top of that, I would say that one of the things that differentiates us is the breadth of fixed income we offer.

Speaker 4

We see a number of DB plans now more fully funded. We're able to offer them liability based fixed income. You can look at what we do in high yield, in Global bonds and muni. It's really a breadth of capability in fixed income and we're seeing demand grow in all of those sectors.

Speaker 3

I appreciate. Thanks. Jenny, maybe I'll keep it at the high level because Look, the margin compression is impossible to manage when the market drops as much as it did. Again, as you think Rolling forward, we got the benefit of the market lift in the Q4 and early this year. Just curious on how you're thinking about what you do actively And proactively in 2023 and where you think we can get to in a normal backdrop if there's such a thing?

Speaker 2

Sorry. So are you asking in the sense of what, M and A, in the sense of expense?

Speaker 3

I apologize. I'm really talking about The adjusted margin and expenses, just expenses up, revenues down, it's hard to do in the short term when the markets drop. But how you're approaching That margin or is that an outcome? In other words, do you manage towards it or is it an outcome of the environment?

Speaker 2

So I don't think we managed margin. I'll let Matt jump in on this, but you're absolutely right. I mean, this is one of those businesses where you get a disproportionate benefit to markets going on the upside because And your margins could expand and then you're slammed on the downside because you can't possibly adjust your expenses quickly enough. I think the good news is the work we've been doing, Part of it is just when you do the amount of M and A we do, you're naturally kind of reinventing how you work and figuring out where you can take out costs. And so we've been able to absorb a lot of the expenses that we've had in the M and A.

Speaker 2

But Matt, you want to talk about kind of expectations on margins Going forward based on where the market is?

Speaker 5

Yes. I mean, I'll just say a few things on that and I'm happy to provide The guide, maybe that will be another question that will come up. But generally speaking, 35% to 40% of our adjusted The expense base, as we communicated in the past, is variable in nature with the market and performance. And we're always Very much looking at the other 60% to 65% of our expense base to see if we can be more efficient and effective, In particular, in a difficult environment. And frankly, some of the transactions we've done on the M and A side have prompted further reviews of those sorts of Activity.

Speaker 5

So we're very active around that. In the down market, as you alluded to, Glenn, that we've experienced, it takes some time for carefully Adjustments to keep up with revenue declines while making sure that we remain competitive in terms of compensation and investing in the business, and we've done both Those things, competitive income and we continue to invest in the business in a significant way in our opinion. But we've also taken or in the process So taking significant action across the business to make sure that we're being disciplined and continues to be disciplined with our expenses. So We paused non essential hiring. We've just completed a voluntary buyout process excluding our investment staff.

Speaker 5

We've got an execution plan in place to introduce additional operational efficiencies across the firm. As you know, in the last 3 years, In addition to savings from a merger transaction, we've already outsourced operational activity that's Created efficiencies for our funds, 1st and foremost, but have also lowered future CapEx expenditures for our firm, while Frankly, also simplifying our company operations. And what this has enabled us to do is continue to invest heavily in the business where we need to in the areas of Growth that we've talked a lot about. But at the same time, it's also enabled us to keep our expenses very much in check, Including the margin.

Speaker 3

Okay. Thank you for all that management. Thanks.

Speaker 4

Thank you.

Operator

Your next question comes from the line of Ken Worthington from JPMorgan. Your line is now open.

Speaker 6

Hi, good morning. Thanks for taking the question. So Jenny, you mentioned fixed income performance has really improved. Is 1 quarter of great performance enough Given the more positive backdrop for fixed income and credit, and what is the risk that there's a lot of money movement In the industry and fixed income for 2023 and Franklin misses it due to weaker performance from last year.

Speaker 2

Well, again, I mean, you have core bond, which is a net flows of, I think, a $1,500,000,000 this quarter. And Core Plus is one of our top selling funds. So even though it's still in that outflows, it's dramatically improved in outflows. You know, Templeton Global Bond, I mean, it's amazing when you look at that. As Adam mentioned, it is beating It's Benchmark and peers in all four time periods.

Speaker 2

So it's a pretty massive turnaround. I think it's outperforming its benchmark 1200 basis points for the quarter, which you carry that back. So on you always performance is always going to Predict the future, if you look at that 87 of 134 fixed income composites, so this is Across the firm, in the 1, 3, 5 10 year periods is only underperforming in one period. So we actually think we're incredibly well positioned. And again, as I mentioned earlier, the diversification of the excess returns between Brandywine Franklin And Western gives people a chance to frankly hedge themselves within our own enterprise, Or if they have a view, can express it with one of our managers.

Speaker 2

And as we've said, that Western has been a little bit more Viewing that I think that rates will probably decline maybe towards the end of the year, which Temple, which the Franklin side probably would say it's more like in 2024. So the key is that I think we have Great opportunities wherever you want to be in the fixed income and we think that people now that you can get actual returns in fixed income, you're going to see more allocations there.

Speaker 4

Great. Yes.

Speaker 5

Sorry, that's not just the public markets, that's the private markets also. So Benefit Street Partners, our center. So they've got some very strong performance and interesting funds and both in demand.

Speaker 4

Great. Thank you very much. Yes. I was just going to say we've seen clients build multi fixed income sleeves with different Franklin components. And oftentimes that's adding additional assets because they see how uncorrelated the various strategies are with each other.

Speaker 6

Thank you.

Operator

Your next question comes from the line of Alex Blostein from Goldman Sachs. Your line is now open.

Speaker 7

Hey, good morning everybody. Thanks for the question. I was hoping we can dig into your old Franchise for a couple of minutes. If we look at the AUM excluding Alcentra this quarter, AUM seems to be kind of flat actually down a little bit sequentially. So I'm just curious what's offsetting sort of the good fundraising momentum that you mentioned.

Speaker 7

Now I know the convention of AUM is not in the same as fee paying AUM, so maybe it just kind of helps unpack what fee paying AUM has done over the last couple of quarters, What it is now and what are the drivers of fee paying AUM in Alts over the next several quarters?

Speaker 2

Matt, do you want to take the details?

Speaker 5

Yes. The core of the question and then Jenny and Adam you should answer more is The outflows and the softness that we've experienced in alternatives, Alex, is driven by the liquid ops area of the firm. It's not our primary kind of private market specialist investment managers in BSP, Clari and Lexington have all experienced positive flows in organic growth. So I think what you're referring to is the overall Number when you exclude Alcentra where that is, it's slightly negative. That's driven by outflows and softness In both performance and flows on the liquid on the liquid pulse side.

Speaker 2

Yes. So that would be K2 and Western macro ops It would be the 2 areas that you're seeing. Everything else is actually growing. In the Lexington, Benefit Street Partners And Clarion have walked around.

Speaker 7

Yes. And can you help us to just break down fee paying AUM, kind of What's liquid versus what's illiquid? And as you sort of think about the pipeline of opportunities On the more private side of things, it would be helpful just to get a little more granularity. So for instance, like the Lexington $12,500,000,000 or $12,800,000,000 fundraise Is already all in the fee paying AUM number and is it a management fee or is that going to turn on once the fund is closing? So just a little more granularity that would be helpful.

Speaker 5

Yes. The Lexington Fund has been go ahead, Tony. Go

Speaker 2

ahead, Matt.

Speaker 5

The Lexington Fund has been raised so far, that's All fee paying, Alex. So it's the future raise that they're Continue to work on that isn't yet included. But the number that we put into the executive commentary is included.

Speaker 2

And basically, the when you ask for liquid versus illiquid or tied up, I'm assuming you're talking about tied up assets. Essentially, most of BSP, Clarion and Lexington Partners are all long term tied up assets. Obviously, K2 has their liquid alts, So those that have more flexibility, and you see that in reduction numbers, as well as macro ops.

Speaker 7

Got it. Thank you. Maybe just for a quick follow-up. I was hoping you guys could hit on the institutional pipeline. Very nice to see an improvement sequentially.

Speaker 7

Can you talk to the fee rate on the overall institutional pipeline and the timing of conversions as you expected today?

Speaker 4

Yes. I would say that the timing is going to be typical of what we've seen in the past. I think it's usually about Half of that pipeline or so converts in the quarter. I wouldn't see a real change in that. In terms of the fee rate, We tend to have scaled fee schedules.

Speaker 4

So when you have larger mandates, those price a little cheaper than smaller mandates. We have A big chunky one in there right now. But in general, I don't see that the fees we've been charging on institutional asset management changing All that much quarter over quarter. Great. Thanks so much.

Operator

Your next question comes from the line of Bill Katz from Credit Suisse. Your line is now open.

Speaker 5

Yes. Thanks so much. I was wondering if we could just talk

Speaker 8

a little bit about where you see the exit base fee rate at the end of the year versus what you Sort of reported. And then as you think about your commentary about sort of money continue to go into institutional cash management and some of these larger fixed income mandates, How does that sort of play off against what's happening on the alternative side?

Speaker 5

Yes. Hey, Bill. So on the fee rate, we expect it to remain around 39 basis points and it may be slightly higher than that for the year as a whole, but that's where we expect As we've discussed in the past and you know this well that the upward pressure on the fee rate is if we I'm more successful in expanding our alternative asset business and if equities continue to come back that pushes up. If we get this continued flow into money market funds and broader fixed income on the institutional side in particular that could push the Fee rate down, but as we have modeled that and looked at the mix of our business, we think that 39 basis points It's a very reasonable excluding performance fees is a very reasonable guide for the EFR.

Speaker 8

Okay. Thank you. And as a follow-up, I was wondering, Matt, if you could talk a little bit about maybe update us on expenses and How to think about maybe the run rate numbers. So a couple of variables looking at the quarter, sort of unpacked the $37,000,000 on the deferred comp side. Does that pull forward Expenses and then your guidance last quarter was much more elevated to some of the non compers what you reported.

Speaker 8

Can you talk a little bit about Any timing issues there or how to think about the rest of the year? Thank you.

Speaker 5

Yes. Thanks, Bill. Yes, there was some movement with respect to some of the numbers in the different components from One quarter to another. But what I'll do is I'll walk through where we see the Q2 of 2023 in terms of different components. And then I'll give you a high level of where we think we're going to be for the entire year also, which hopefully would be helpful for modeling purposes.

Speaker 5

So I already mentioned to you about the 39 basis points for the effective fee rate. That's where we see things remaining in the next quarter. All these numbers obviously are inclusive of continuing to invest in the franchise and a full quarter of Alcentra. Last quarter was just 2 months. This quarter, of course, it's the full it will be the full 3 months.

Speaker 5

For comp and benefits, assuming 50,000,000 Performance fees, and I'm happy to answer separate performance fee question. But assuming $50,000,000 per quarter for performance fees, The comp and benefits should be back down to between $700,000,000 $710,000,000 This is inclusive of salary increases And the 401 and health plan resets. So again, comp benefits 700 to 7.10. We expect IS and T to be between 115 and 120, so it's relatively flat. We expect occupancy to be around 60, relatively flat and this is inclusive of Continued normalization of return to office that we're seeing on a global level.

Speaker 5

G and A, We guide to a high $140,000,000 so $147,000,000 $148,000,000 something in that area. This is inclusive of our estimate of where we expect placement fees to be and also reflects continued normalization of T and E expenses, which We put in the $50,000,000 to $20,000,000 per quarter. So we expect the tax rate to remain in 25% to 20 7%, Eric. If you think about annual guidance, again, inclusive of continued Important investments in our organic growth strategies. It's obviously still pretty early in the year and we're experiencing Fighting market uncertainty, as we've all been talking about.

Speaker 5

But all else remaining equal, despite The improved market conditions in the quarter, which has been somewhat of a surprise, I think, to us all, we're going to stay with The annual guidance that I provided last quarter, which is for the year adjusted operating expenses Between $3,950,000,000 $4,000,000,000 We're probably on the higher end of that, frankly, because of where markets have gone to over the last month or so. But we're keeping the guide between €3,950,000,000 to €4,000,000,000 excluding performance fees Performance fee compensation. Just a reminder that this includes a full year of Lexington. Last year's numbers was only 6 months, Additional 6 months with Lexington Partners plus an 11 months of our Centra as we closed on November 1 and Our fiscal year end is ninethirty. So on a net basis, our expenses, whilst remaining equal, are projected to be lower Then last year, taking into account the Lexington and El Centro additions, lower by Low single digits, 2%, 3%, something in that area.

Operator

Thank you. Your next question comes from the line of Brennan Hawken from UBS. Your line is now open.

Speaker 9

Thanks for taking my question. So thinking about the what drove the variance, Matthew, to the fee rate Last quarter, what do you think caused that to work out to be different than you had expected and a little bit lower? And How should we think about potentially those factors playing into the outlook for the fee rate to be stable at 39?

Speaker 5

Yes. So We decided to or that our partners at Lexington Partners decided to hold off on a closing From what they were expecting to do, there's a little bit more in December, and they decided to hold off until this quarter that we're in now. So that was probably Something like a 0.4 basis point difference. And then product mix was something like A 0.3 difference from where we were thinking that we could be on the high end of the 30 9. So I think I had said We expect to be more in the mid-thirty 9s.

Speaker 5

It could have been as high as 39.7 or 8 or something like that. It could have been as low as 39 and I sort of guided in the middle of that. We ended up being a bit tough because of those two things. The reason for the increase EBITDA from 38.8 percent to 39 percent was because of we increased alternatives. We added Alcentra, that probably added something like 0.3 basis points.

Speaker 5

And then as we've mentioned, we Added quite significant money market assets, which is not a really low fee, by the way, but it's obviously a lower fee Then alternative assets is probably something like 0.1 or 0.05 of the difference. And the reason why we feel comfortable with 39 is when we roll the business forward and we look at the projections for our alternative asset business, So reasonable market assumptions around equity and even with the significant opportunities in fixed income, one It's neatly sort of offsetting the other and we come out to around 39 basis points. We think that's a reasonable guide.

Speaker 4

Okay.

Speaker 9

Thank you. Appreciate that Forward looking comments on fee rates are challenging. So thanks for that additional color. That's helpful. When we think about You guys have spoken a lot about the bond outlook and the increased interest.

Speaker 9

So that's all very, very helpful context. One of the components of concern that I hear from investors is the deterioration that we saw last year in Western's performance track record. Can you Speak to whether or not this interest is pertaining to some of those strategies that do tend to be larger that has Following on to tougher times on the performance end of things or is it into other products or is the interest happening despite that setback in performance Because there's focused on there's a focus on different sort of time frames or whatnot. Any additional color would be great.

Speaker 2

Yes. I mean, I think the message that we're Given there's a lot of interest in Western, I mean their core bond and core bond plus are some of our biggest grossing sales funds and CorVon netted $1,500,000,000 this quarter. So Brenna, I think we feel really good about Western and the flows there.

Speaker 10

Excellent.

Speaker 4

Yes. I would say that also, Core Plus is still our biggest selling fund, Right. They had some performance challenges, but client stuck with them. They've been doing this for a long time. And again, 89% of their AUM outperformed for the quarter.

Speaker 5

Sorry, I was on mute. The other thing I was going to add to that is, again, maybe it's an obvious statement, but On the institutional side in particular, investors expect to have a consistent process and a view From a portfolio management perspective and WES and the stock to what they said they're going to do and this is the outcome from that and But we have a very broad range, as Jenny mentioned, of other views internally. And so we have a lot of fixed income opportunities, whether one works well or not. There's others that will offset that. So a lot of opportunities across the franchise, both public and private markets.

Speaker 4

And Western Pipeline is building significantly as we speak.

Speaker 2

Right. Thanks for

Operator

that. Your next question comes from the line of Craig Siegenthaler from Bank of America. Your line is now open.

Speaker 11

Good morning, Jenny, Matt. Hope you're both doing well.

Speaker 5

Good morning. So,

Speaker 11

my question is on retail alts. Many Pure All Firms have been building out their retail distribution efforts pretty aggressively since 2020. But Franklin has always had a very Strong retail effort going back kind of more than 20 years. So I wanted to hear you articulate how you're using Your global retail distribution really has an advantage for your all affiliates like Clarion, Lexington, Benefit Street And also how the affiliates are also leveraging their own local sales teams versus Franklin at the Center?

Speaker 2

So I'll start and then Adam, why don't you jump in. So I think, look, retail alts is really complicated. And it's really complicated because you have to start by 1, you have to have the right products that fit in the right vehicles, which is tougher in these illiquid asset classes. Then you have to, educate and convince, the gatekeepers essentially at the distributors. And then you have to educate your entire sales force to be able to understand it.

Speaker 2

It is a different sale Then let's say a traditional mutual fund. And then you have to be part of educating financial advisors on why this particular product With its characteristics make sense in a portfolio. And unlike an institution, I always say that one of the things I think many of the All providers who sold historically to institutional channels is you just have to convince an institution why this fits in. A financial advisor To understand, every end client's liquidity needs, which makes it really tough at the tip of the spear. The good news for us is we have very good product offerings now with all of our managers between BSP has multiple products with their BDCs and their integral funds, Clarion with their CP Reef and their Opportunity Zone, we already K2 has quite a few products in the liquid alt space.

Speaker 2

We actually also You don't have and then Lexington is now just getting launched on I Capital. So we've been able to get quite a few products now on Caisson I Capital, Which is really important for the RIA channel so that they can handle the paperwork and the follow-up capital calls, which is one of the great pain points for advisors. But when we look internally, it was clear to us that you couldn't have a wholesaler necessarily take it all the way to the end sale. And so we've created, we've talked about it, it's been probably almost a it's probably been 6 months, it's kind of a joint venture Between our alternatives teams and our distribution team, where we are hiring specialists to support The traditional distribution on the retail channel or the wealth channel to be able to drive that very end sale. And we've been in a phase of doing a lot of hiring there.

Speaker 2

And I can tell you that we feel good about the traction we're getting. Adam, you want to add anything more to that?

Speaker 4

Well, yes, you took most of it, Jenny. But what I would say is that On top of that, this is a great example of where we're able to use our unique structure in terms of brand. So our alternative firms have great brands in the institutional or less known in the wealth channel. So we're still Really putting the brands forward, the DSP, the Lexington, the Clarion's and the institutional channel. But when we go to market in the wealth channels, we're going to market as alternatives by Franklin Templeton.

Speaker 4

So that is really playing off of the brand name that resonates So well in those channels. And again, it's another place where we're using our generalist specialist model. So that where our salespeople who have long standing relationship Some significant AUM in the wealth channel. They're going in as the lead, but they're introducing our alternative specialist, which we've filled out. It's over 35 people now.

Speaker 4

And those folks people are just focused on the wealth channel. The other thing, I would add to that Is that we've invested really heavily in education because we think that the first way to get growth in the channel is Product development, having the right product and the right wrappers. Soon after that, it's building education so advisors understand how to use these products. After that, it's sales, and that's where we have the alternative specialists working with our field force in concert with each other.

Speaker 5

And I'll just add one other thing from a finance perspective for what it's worth. This is not a short term Project or something like that in turn. This is a very long term, very strategic decision that we've made to invest In this separate group basically that's between 2 other major areas of the firm that requires its own separate marketing, sales, Product strategy education, as Jenny mentioned. This is a very expensive endeavor that we've thought through very carefully, And we justified it by the fact that we have acquired leading businesses in the alternative markets, alternative asset markets That we think long term are highly interesting and applicable to the broader markets. But just as a reminder, We acquired these businesses because they had their own institutional growth.

Speaker 5

And what we're talking about here on top of that is additional growth In the long term that we think we can capitalize upon.

Speaker 4

And as a mark of progress, we are currently in market with Clarion, with DSP, with And our venture capital group, all of them in the wealth channel are actively raising assets.

Speaker 11

Great guys. Thank you for the very comprehensive response there. I have a follow-up and it's more of a CFO type question for Matt. But I wanted to get a little more color on your alt net flow definition in the $2,400,000,000 that you highlighted in the quarter. Is the inflow the initial sale or is it when the Cs actually turn on with the product?

Speaker 11

And then also do you include realizations in the outflow or are they included in the market appreciation and other line of the AUM roll forward?

Speaker 5

No, the realizations are included in other market. They're not particularly material for us, which is why we do it that way. As we continue to Expand our alternative asset business, we continue to review that. I don't actually know off the top of my head on the $2,400,000,000 of positive Net inflow, what is fee paying is probably 80% of it, but we'll come back to you on that Specifically, I'm pretty sure it's like 80%, something like that.

Speaker 11

Excellent. Thank you, Matthew.

Speaker 4

Thanks, Craig.

Operator

Your next question comes from the line of Dan Fannon from Jefferies. Your line is now open.

Speaker 10

Thanks. Good morning. I wanted to have another question on fixed income and understanding or acknowledging your Comments on Western and those funds still being on the gross sales side quite strong. But if I look at gross sales since you've owned Legg Mason, This was the 2nd lowest quarter for gross sales. So maybe talk about where you're seeing the traction in gross sales outside of Maybe the core and core plus.

Speaker 2

Are you speaking specifically just fixed income or equities as well?

Speaker 10

Just fixed income. Fixed income, this was the 2nd lowest gross sales number since you've owned Legg Mason. So we've already talked about So I assume there's something else that's maybe having some slowdown?

Speaker 4

Well, what I would say is that if you take a look at where the yield curve is right now and look at Shape of it and look how much you can make on the short end, and it's a record quarter for us in cash management. So a lot of that really is just, I think a temporary phenomenon where fixed income investors are able to park money on the short end, get a pretty attractive yield and wait for the right entry point.

Speaker 2

But munis, we're getting a good traction in munis. We have some in the SMA channel, we have some muni ladders That are very successful for us. I mean actually from a diversification, 11 of our top 20 net inflows Our outside our largest 20 funds. So it's actually pretty broad diversification. And U.

Speaker 2

S. Income, some of the multi assets have components in them, obviously, that are fixed income that are getting flows too.

Speaker 5

Okay. And

Speaker 10

then just thinking about performance fees, I know obviously very hard to predict, but It seems like you are seeing redemptions in your liquid strategies. So maybe get a sense of kind of where performance sits broadly within the alternative universe and how we should, I guess maybe performance fee eligible AUM today versus a year ago, high watermarks, other kind of maybe numbers or things you can put around to give a sense of this year's outlook For performance fees maybe versus last year or other time periods.

Speaker 5

Yes. Thanks, Des. So performance fees, as you know, as you just said, difficult To predict, given the strong performance in related funds, and we do have strong performance, I think literally, I mean, I think it's in 90% of our alternative asset funds are in the area where they're outperforming or in Strong performance territory, let's say, in the performance fee zone. We expect Continue earning performance fees on a fairly consistent basis at this point. And that's why we've Guided to $50,000,000 per quarter up from you may remember several quarters ago we used to guide to $10,000,000 to $25,000,000 or so about that, but that's now up to $50,000,000 And we think that we can achieve that on a fairly consistent level.

Speaker 5

There are, however, as you allude to, there's some So the characteristics within performance fees related to time and redemption type activities. So for example, in the last quarter that we reported, I highlighted, I believe, on the call that we had a redemption that led to a $55,000,000 additional performance fee for the quarter out of Clarion. So our guide is going to remain at 50,000,000 And all I'd say is that we have based on our performance and our mix of assets and the time horizon with the funds, we have potential to exceed that As we continue to grow our alternative asset business. But I'd certainly say forward looking performance is looking strong, On both an absolute and relative basis, we've expanded our alternatives significantly. It's the reason why we've guided higher $50,000,000 per quarter.

Speaker 5

But as you know, last year, we had $500,000,000 in performance fees. So, yes, it shows what the potential is. But again, we think 50 is the right guide for that per quarter. Thank you. Thanks,

Operator

Doug. Your next question comes from the line of Patrick Davitt from Autonomous Research. Your line is now open.

Speaker 10

Hey, good morning everyone.

Speaker 2

I just have

Speaker 10

one kind of broader philosophical question. You're obviously getting really good traction with your ETF suite and news flow kind of suggests that you've been more active converting mutual funds to ETFs than some others. Obviously bond ETFs appear to be getting a lot more traction over the last year or so. So could you speak to your willingness to get more aggressive with ETF conversions And what is the debate kind of for and against going down that road?

Speaker 2

So first of all, We're really proud of our ATF franchise and the team that we have, They were all very experienced. They were originally with BGI back then. And we've launched the suite today In our I think at the end of the quarter, we announced it was about $13,300,000,000 ATS. We had 44% were active, 30% passive and 26% smart beta. We were really one of the first multifactor smart beta managers.

Speaker 2

In this quarter, even though on $13,300,000,000 in AUM, we had $1,000,000,000 in net sales. So clearly, one of the fastest growing of that $200,000,000 was essentially a conversion from mutual funds. But the other $800,000,000 came from actual sales in the globally, so U. S, Europe, Canada, Australia. So what we do is we'll look at a strategy and we consistently hear That distributors don't particularly want an ETF and a mutual fund to be exactly the same Because that can cause suitability issues.

Speaker 2

And so you have to be really careful about differentiating The ETF and the mutual fund. And in the case of the 2 that we converted, we thought they were really well positioned funds, But probably in the not getting traction in that channel, many advisors sell just ETFs, so they won't sell mutual fund. And so In order to get traction with those advisors, you actually have to have ETFs. So we're always looking at our lineup and deciding whether or not it makes sense To do a conversion, there's a little bit of complexities in doing a conversion because sometimes the existing fund holders may not be Well, to make want to hold a ETF and so you have to go through that process. But anywhere where we think there's Well performing, but not getting traction mutual fund, we will consider whether it should be converted into an ETF.

Speaker 4

And the only add I would have to that is we have to look at who holds the mutual fund to the extent for instance that it has a large retirement or 401 holding That can sometimes make the conversion a little more complicated. As Jenny said, our ETF strategy I think is pretty differentiated With the 44% inactive, it's also global. That's the other thing I would add. So when we look at that $1,000,000,000 Hello, about half of that came from outside of the U. S.

Speaker 4

And we're also willing to put differentiated asset classes like our infrastructure income into an ETF, I think that's a little different. And then the final piece, I would add is that even when we're in passive, which is the minority Other ETFs, they're in niches where we think we can be highly cost competitive and differentiated like single country ETFs.

Speaker 5

I think the other thing I'd add, I think we put this into the prepared remarks. But It's not insignificant point that we've reorganized this group in ETFs to be more focused with their own sales Effort embedded within the team. And it's similar, frankly, to what Jenny has reorganized around our multi asset solutions area. These are the areas where we are Heavily investing with resources and focus as opposed to them being part of a very large Group is attempting to do lots of different things. So and we're seeing some green shoots from that reorganization work and focus Across the franchise, and I'd point out both Multi Asset Solutions and the ETFs in that regard.

Speaker 10

Thank you. Thank you.

Operator

Your next question comes from the line of Mike Brown from KBW. Your line is now open.

Speaker 8

Great. Hi, good morning.

Speaker 12

So I wanted to ask on Good morning. And I wanted to ask on real estate. So with Clarion's just over $80,000,000,000 or $83,000,000,000 or There's clearly some challenges facing the industry. Can you just provide us with an update on what you're seeing from this asset class and how you think investor sentiment could progress from here. And then if possible, could you just touch on how much that contributes to performance fees and other revenue?

Speaker 2

Yes. I'll take the first part of that question. Matt, I'll have you touch the performance fees. So remember, Clari has primarily been an institutional manager. So it's only been recently that we've brought them into the wealth of retail channel.

Speaker 2

And With respect to that, it's a very small CP REITs. It's a small fund that is growing quickly and there's been minimal redemption requests there. From the institutional side, first of all, Clarion's real estate portfolios have focused on industrial, Multifamily, life sciences, self storage, that's 85% of their portfolios and those have held up incredibly well. And as a matter of fact, I think their performance has only dropped about 1.5%. With respect to rejection queues, you have seen them move from positive queues to now negative And in those, they're not as for me, institutional clients, there's a real recognition that You don't want to hurt the value of the portfolio by creating false liquidity.

Speaker 2

And so they actually can choose whether or not They want to meet any of those redemption requests. And on average, they target to try to meet about 10% of the redemption queue and that's Often about 5% to 6% of a NAV per quarter. So it's very different than the issues that you have In the wealth channel. And again, they're really new to that wealth channel. CP REIT, I think, is structured very similar To Biri as far as the kind of interval nature of those rejection, we think that's the right way to do it for that channel.

Speaker 2

But again, their clients today are really primarily institutional clients. And sorry, the redemption queues Mostly have been it has not been performance issues because they've done very, very well in performance. It's been the fact that other parts of the institutional clients Portfolio haven't performed well and they needed to rebalance because now they're over weighted on real estate. Matt, you want to touch on the performance, please?

Speaker 5

Yes, will do. Thanks, Jenny. And one very important correction, Jenny, sorry to correct you, but one very important correction is that When Jenny mentioned about basically the 10% of the Q Being paid out, that's not that doesn't translate into 5% to 6% of NAV Per quarter, it's 5% to 6% of NAV per annum. That's for the year. Just want to make sure that's very clear.

Speaker 5

Okay. And that's of their choice. Just to be clear, as Jenny also mentioned, there isn't any forced liquidation in an industry like this where it wouldn't necessarily be the most productive For the portfolios or for the investors. So in terms of performance fees, frankly, Clari It's quite significantly above the threshold. So we would be surprised if we didn't see Continued performance fees being paid on meaningful portion of Clarion funds Over the next year or plus.

Operator

Your next question comes from the line of Michael Cyprys from Morgan Stanley. Your line is now open.

Speaker 5

Hey, good morning. Thanks for squeezing

Speaker 13

me in. Matt, question for you, wanted to come back to expenses. So here you on a net basis that it's about 2% to 3% lower. I was hoping you might be able to elaborate

Speaker 12

on how you're able to achieve that. What would you say are the top 3 to 5 areas that are most meaningful and driving that decline. And do you view this as a 1 year efficiency drive or would you envision limited to declining expenses as you look out beyond this year.

Speaker 5

I think, yes, we certainly look at These expenses being structural expenses beyond the year, obviously, there's always a portion of variable expenses that you expect to come down As a function of the market, we're very disciplined around that. So it's almost a mix of those two things. But because we've been through a meaningful merger Involving 100 of 1,000,000 of dollars of expense reductions and efficiencies, it basically forces You to look very carefully at all of the operation and that we've doubled the size of our company from an assets under management perspective. We're much more diversified across the franchise. Our operation is, therefore, quite a bit more complicated.

Speaker 5

But at the same time, There's some interesting synergistic work that can be done to gain leverage from having that type of operational expertise across the franchise. We also are very fortunate to have centers of excellence in Hyderabad and in Poznan in Poland. And we intend to Further capitalize on the fact that we've been in those places for many, many years. It's not a new thing for us to have those centers of excellence. So we're very focused on that.

Speaker 5

So it's It's really a combination of being, obviously, in a difficult market, being more disciplined around who do we really need to hire, who do we really need to replace When we have departures, it's executing upon the voluntary buyout and reducing Layers in the organization and expanding and analyzing span and layers of control. And it's the execution plan around our transactions where we've really been able to take More costs out than we anticipated, and a lot of that's gone to the margin and given us margin expansion opportunities on the upside, But also, reasonable amounts gone into investing in the business. So we're always careful to balance getting the margin right and managing to keep Investing in the business. We've also got while we've done the largest outsourcing already on the operational side with Fund Administration and Transfer Agency, The other big project, for example, we're looking at across the firm now is our investment technology operation. And that's a really major one, multi year project.

Speaker 5

And all of our specialist investment managers are on board with this. We believe that having a consistent system and vendor across The firm makes a ton of sense. We can have specialization still in the individual groups. But it's things like this that makes a material difference in How efficient we are, how effective we are, and candidly how we work together across the company.

Operator

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

Speaker 2

Okay. Well, I just want to thank everybody for participating in today's call. And once again, we'd like to thank our employees for their hard work and dedication. And we look forward to speaking to all of you again next quarter. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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Earnings Conference Call
Franklin Resources Q1 2023
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