Virtus Investment Partners : Fourth Quarter 2023 Transcript

Corrected Transcript

02-Feb-2024

Virtus Investment Partners, Inc. (VRTS)

Q4 2023 Earnings Call

CORPORATE PARTICIPANTS

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OTHER PARTICIPANTS

Bradley Hays

Analyst, Cowen & Co. LLC

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MANAGEMENT DISCUSSION SECTION

Operator: Good morning. My name is Didi and I will be your conference operator today. I would like to welcome everyone to the Virtus Investment Partners Quarterly Conference Call. The slide presentation for this call is available in the Investor Relations section of the Virtus website, www.virtus.com. This call is being recorded and will be available for replay on the Virtus website. At this time, all participants are in a listen-only mode. After the speakers' remarks, there will be a question-and-answer period and instructions will follow at that time.

I will now turn the conference to your host, Sean Rourke.

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Sean P. Rourke

Vice President-Investor Relations, Virtus Investment Partners, Inc.

Thank you, Didi, and good morning, everyone. On behalf of Virtus Investment Partners, I'd like to welcome you to the discussion of our operating and financial results for the fourth quarter of 2023. Our speakers today are George Aylward, President and CEO; and Mike Angerthal, Chief Financial Officer. Following their prepared remarks, we will have a Q&A period.

Before we begin, please note the disclosures on page 2 of the slide presentation. Certain matters discussed on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, and as such, are subject to known and unknown risks and uncertainties, including but not limited to those factors set forth in today's news release and discussed in our SEC filings. These risks and uncertainties may cause actual results to differ materially from those discussed in the statements.

In addition to the results presented on a GAAP basis, we use certain non-GAAP measures to evaluate our financial results. Our non-GAAP financial measures are not substitutes for GAAP financial results and should be read in conjunction with them. Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in today's news release and financial supplement, which are available on our website.

Now, I would like to turn the call over to George. George?

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George Robert Aylward

President, Chief Executive Officer & Director, Virtus Investment Partners, Inc.

Thank you, Sean. Good morning, everyone. So, I'll start with an overview of the results reported this morning before turning it over to Mike to provide some more detail.

Though still volatile, markets trended more favorably in the fourth quarter on views of inflation and interest rate expectations, leading to an increase in assets under management. And while we had net outflows driven by open- end funds consistent with the industry, as well as specific institutional accounts, we also had strong retail sales, including the highest retail separate account sales in two years; positive net flows in retail separate accounts in ETFs, each of which had an organic growth for the full year; lower total operating expenses for the quarter with other operating expenses essentially flat for the full year; increased return of capital including $20 million of share buybacks; attractive investment performance across strategies both long term and for the one-year period; and repayment of debt, ending the quarter with low net leverage and a well-positioned balance sheet.

Turning now to a review of the results. Total assets under management increased 6% to $172 billion, primarily due to favorable market impact in addition to positive net flows in retail separate accounts. Sales increased 7% to $6.2 billion due to a 12% increase in retail sales, with particularly strong growth in retail separate accounts, which grew 15% led by private client. Open-end fund sales increased 9%, with sequentially higher sales of domestic equity, fixed income and alternative strategies. Net outflows were $3.8 billion and compared with net outflows of $1.5 billion last quarter. So, by product, institutional had net outflows of $2.2 billion compared with net outflows of $0.4 billion last quarter, and included redemptions related to repositioning by several retirement plan mandates.

The institutional business is inherently variable on a quarterly basis, but has generated organic growth in three of the last four years with contributions across affiliates, strategies and geographies. Retail separate accounts generated positive net flows of $0.4 billion and were positive for the full year. As we have previously said, we continue to see retail separate accounts as a key growth area as we expand offerings with additional strategies to complement our strength in small, SMID, and mid-cap equities.

Open-end net outflows of $2 billion compared with $1.5 billion in the third quarter due to a higher level of redemptions across strategies, though SMID-cap and global equities continued to generate organic growth. ETFs, again, generated positive net flows and for the full year, delivered 14% organic growth as we've continued to broaden the product lineup with additional distinctive active strategies.

In terms of what we saw in January for flows, retail and institutional net flows were each improved meaningfully. On the retail side, while it was just one month, January was the best month for net flows in open-end funds since September of 2021, with net outflows of approximately $150 million. That represents less than 25% of the average monthly net outflow in the fourth quarter, with improvement across asset classes, including breakeven net flows in domestic equity and positive net flows in alternatives. I would also note that, earlier this week, we reopened two capacity-constrainedsmall-cap strategies that have been closed since 2018 and have already seen a meaningful level of interest for them.

For institutional, we had a large funding early in January that had been delayed from the fourth quarter. All else being equal, institutional is generally trending towards flat net flows for the first quarter based on known and expected upcoming funding and redemption activity. This business can fluctuate in the short term and we have

seen a more prolonged funding cycle. However, the pipeline continues to be strong in terms of size and with broad representation across affiliates, strategies and geographies.

Our fourth quarter financial results reflected lower average AUM, largely due to the timing of market performance and net outflows, partially offset by lower total operating expenses. The operating margin was 33%, down sequentially from 33.9% due to lower investment management fees, and was up 120 basis points from the prior- year period. Earnings per share as adjusted of $6.11 compared with $6.21 in the prior quarter and were up 18% from $5.17 in the fourth quarter of 2022.

Turning now to capital, during the quarter, we continued to take a balanced approach to capital management. We repurchased approximately 90,000 shares for $20 million, up from $15 million in the prior quarter. For the full year, we repurchased approximately 224,000 shares and reduced outstanding shares by 1%. In 2023, we increased our quarterly dividend by 15%, our sixth consecutive annual increase in our dividend. We also repaid the remaining $20 million outstanding on our revolving credit facility and ended the quarter in modest net debt position and gross debt below 1 times EBITDA. We continue to generate significant cash flow, providing ongoing opportunities to invest in the growth of the business and return capital to shareholders.

With that, I'll turn the call over to Mike. Mike?

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Michael A. Angerthal

Executive Vice President & Chief Financial Officer, Virtus Investment Partners, Inc.

Thank you, George. Good to be with you all this morning.

Starting with our results on slide 7, assets under management. At December 31, assets under management were $172.3 billion, up 6% from $162.5 billion at September 30, due to $14.3 billion of favorable market performance, partially offset by net outflows of $3.8 billion. Average assets under management in the quarter decreased 3% to $162.7 billion, with ending assets 6% above the quarter's average.

Our assets under management represented a broad range of products and asset classes. Institutional, our largest product category, was 37% of AUM. Retail separate accounts has delivered consistent organic growth and is at 25% of assets, up from 16% five years ago. We also remained well diversified among and within asset classes. Alternatives and multi-asset in which we had limited presence several years ago totaled over 20% of our AUM, reflecting the results of our strategic efforts to expand capabilities, particularly in less-correlated strategies. In addition, on a geographic basis, non-US clients were 18% of AUM and generated 10% organic growth in 2023.

We also continued to have compelling long-term relative investment performance across products and strategies. As of December 31, approximately 69% of institutional assets, 86% of retail separate account assets, and 62% of rated mutual fund assets were outperforming their benchmarks over five years. For mutual funds, 71% outperformed the median of their peer groups over the five-year period. In addition, 69% of rated fund assets had four or five stars, and 90% were in three, four or five star funds. We had 38 funds that were rated four or five stars, including 11 with AUM of $1 billion or more.

I would also note that our managers performed well for the full year 2023 with 58% and 90% of institutional and separate accounts AUM, respectively, beating benchmarks for the period, while 55% of mutual fund AUM beat benchmarks, and 70% outperformed the median performance of the peer group.

Turning to slide 8, asset flows. Total sales of $6.2 billion increased 7% from $5.8 billion due to growth in both retail separate accounts and open-end funds. By product, institutional sales of $1.2 billion compared with $1.3

billion in the prior quarter, which included the issuance of a $300 million CLO. Retail separate account sales of $2.1 billion increased 15% from $1.8 billion, led by meaningful growth in private client sales. Open-end fund sales of $2.9 billion increased 9% from $2.7 billion, primarily due to higher sales in mid-cap,SMID-cap and bank loan strategies. Total net outflows were $3.8 billion, which compared with $1.5 billion of net outflows in the prior quarter.

Reviewing by product. Institutional net outflows of $2.2 billion included approximately $1 billion of redemptions from several long-standing retirement plan mandates. These accounts, each of which were in different investment strategies, reposition their risk allocation due to the planned level of funding. As always, institutional flows will fluctuate depending on the timing of client actions. In retail, separate accounts, positive net flows of $0.4 billion increased from $0.3 billion in the prior quarter, and both intermediary sold and private client continued to generate positive net flows.

For the full year, retail separate accounts generated 2% organic growth. For open-end funds, net outflows were $2 billion, compared with $1.5 billion in the third quarter due to higher redemptions across strategies. In retail funds, both SMID-cap and global equity continued to generate positive net flows. ETFs were again positive and, on a full-year basis, generated 15% organic growth. Global funds were essentially breakeven for the quarter, with 9% organic growth for the full year.

Turning to slide 9, investment management fees as adjusted of $174.4 million decreased $2.9 million or 2%, reflecting the sequential decline in average assets under management, partially offset by higher performance fees, which were $3.3 million, up from $0.6 million last quarter. For the full year, performance fees were $4.5 million, which compared with $1.8 million in the prior year and $2.6 million in 2021. Based on our institutional accounts with performance-based fee structures, which are highly dependent on those strategies investment performance relative to benchmarks, we would expect performance fees to be in a range of $3 million to $5 million per year.

The average fee rate of 42.6 basis points increased from 42 basis points in the prior quarter and included 0.8 basis points from the performance fees. Excluding performance fees from both periods, the average fee rate was flat at 41.8 basis points. Looking ahead, we continue to expect the average fee rate to be toward the low end of our 42-basis-point to 44-basis-point range, which is modestly above the normalized fourth quarter level. As always, the fee rate will be impacted by markets and the mix of assets.

Slide 10 shows the five quarter trend in employment expenses. Total employment expenses as adjusted of $96.7 million decreased 2% sequentially, primarily reflecting lower variable incentive compensation. As a percentage of revenues, employment expenses were 50%, relatively unchanged from 50.1% last quarter. Looking ahead, it would be reasonable to anticipate employment expenses to continue to be in a range of 49% to 51% of revenues. As always, it will be variable based on market performance in particular, as well as profits and sales. For modeling purposes, the first quarter will also include seasonal employment expenses, which are incremental to this outlook.

Turning to slide 11, other operating expenses as adjusted were $31.2 million, up $1.1 million or 3% from the third quarter. The sequential increase largely reflected higher travel and related activity, as well as the impact of increases in market data costs. I would note that on a full-year basis, other operating expenses of $122.8 million were essentially flat with the prior year, even with the addition of a new affiliate in April. Looking ahead, the quarterly range of $30 million to $32 million for other operating expenses as adjusted remains reasonable.

Slide 12 illustrates the trend in earnings. Operating income as adjusted of $63.9 million decreased by $3.1 million or 5% sequentially due to the lower average assets under management, partially offset by lower total operating

expenses. The operating margin as adjusted of 33%, compared with 33.9% in the third quarter. With respect to non-operating items, other income as adjusted increased by $0.5 million, reflecting higher earnings on equity method investments. Total net interest income decreased modestly from the prior quarter, which included a higher level of CLO interest income from a recent issuance and reflected lower gross debt. Net income as adjusted of $6.11 per diluted share, declined 2% from $6.21 in the third quarter.

In terms of GAAP results, net income per share of $4.21 compared with $4.19 per share in the third quarter and included $0.71 expense for fair value adjustments to affiliate non-controlling interests, $0.36 of CLO issuance expenses, $0.18 of acquisition and integration costs, and $0.13 of fair value adjustments to contingent consideration, partially offset by $0.35 of realized and unrealized gains on investments.

Slide 13 shows the trend of our capital liquidity and select balance sheet items. We ended 2023 with appropriate levels of working capital and modest leverage, providing meaningful financial flexibility to invest in the business, return capital and repay debt. During the quarter, we repaid the remaining $20 million balance on our revolving credit facility and ended the year with net debt of $19 million, representing net leverage of 0.1 times EBITDA. We also repurchased 97,952 shares during the quarter for $20 million, up from $15 million in the prior quarter. For the full year 2023, we repurchased 223,807 shares for $45 million and reduced the share count by 1.3%.

I would also note, as a reminder, that our intangible assets continue to provide a cash tax benefit. At current tax rates, we estimate the tax attributes could provide a cash tax benefit of approximately $19 million per year over the next 10 years.

And with that, let me turn the call back over to George. George?

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George Robert Aylward

President, Chief Executive Officer & Director, Virtus Investment Partners, Inc.

Thanks, Mike. Okay. So we'll now take your questions. Didi, would you open up the lines, please?