AllianceBernstein Holding L.P. (AB) Earnings Call Transcript & Summary

Good morning. I'm Mike Cyprys, Morgan Stanley's brokers and asset managers analyst. Before we get started, I've been asked to direct your attention to some important disclosures on the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative. So with that out of the way, welcome to our fireside chat with AllianceBernstein, and it's my pleasure to welcome Seth Bernstein, President and CEO of AB. The firm oversees about $596 billion in client assets across institutional retail and private clients. AB is putting up some strong gross sales and unlike many in the industry has delivered consistent active equity inflows. In addition, their relocation to Nashville is going to be a driver of expense savings in the coming years. Seth, thank you for joining us today.

I'm delighted to be here. Thank you for having us.

Great. So I'll kick off the discussion, and then we'll leave some time towards the end for any questions that come in. Through the webcast portal, investors, you can feel free to submit on the web portal. So Seth, it's certainly a unique time here that we're all living in today. I believe most of your workforce is still working remotely now for, I think, probably around 2 months or so. Can you just talk about how you're managing the firm through this crisis and what your priorities are today?

Yes. Thanks. If you had told me 4 months ago that 97% of my people would be working remotely for what's now over 3 months, and we would be handling volumes that are much higher than normal and increasing our engagement with retail, private and institutional clients, I would have told you, you were out of your mind. And I think that reflects 2 things. First, that the technology platform and backbone we built is far more robust than I appreciated. And so this could -- we could operate indefinitely, although I'd prefer not to, in a remote setting. But secondly, that the generational divide between what productivity tools are available and utilized is really a gaping one in my industry. And maybe I'm speaking only for AB, but I think there's considerably more productivity benefits we can gain by more integration of technology into our everyday businesses. And we're doing that. And we have some signs of success there. But to me, we were focusing prior to the crisis on really several things: first, delivering differentiated return streams. Our proposition is that active management has to earn its place in our clients' portfolios. Passive is the default option in liquid markets unless you can deliver a return stream they want and they can't replicate. Secondly, we got to commercialize and scale our product suite. We invest an enormous amount and a lot of time rebuilding the firm post the prior final crisis. And we have done, I think, a remarkable job creating a very different equity platform than the one we used to have and continued to benefit from the strengths we have in our fixed income pace while building a de novo alternatives platform that needs to continue. And finally, and I think critically importantly, we've been focused on just relentless expense management. The industry's dynamics, if anything, are accelerating off the themes that we've been facing for years, continued fee erosion, continued growth of passive, risk of commoditization. So the industry has been both blessed and blinded by a remarkable business model. And we need to be at the forefront in ensuring our fixed costs are an increasingly small component of our total costs because only by being flexible in that manner can we be successful and sustain ourselves over the longer term.

Maybe we could continue along the lines on that cost saves expense point. How would you say this COVID-19 work-from-home environment has altered, if at all, the opportunity for incremental cost savings for the firm going forward? And is the Nashville relocation and cost saves still on track at this point?

Let me take the second part first, and I'll go back to the changes. The relocation and savings are absolutely still on track. We continue to project $75 million to $80 million in annual savings, post our departing our New York City offices and leases in 2025. And as I think we've shared in our last earnings call, we expect to see some accretion this year, more next year from the move to Nashville and onwards up to 2025. The timing of the physical relocation has probably been delayed by virtue of the pandemic. Construction stopped on our new building. So I'm calling it a quarter, but we were hoping to be in by the end of this year. We're probably in by the end of first quarter, maybe into the second quarter of 2021. And so our timing there has been held up. From a cost perspective, they're ins and outs. I don't think it really changes it all that meaningfully either way. What is interesting is that we had, I think, at the end of the first quarter, roughly 720 or 600 -- around 700 people in Nashville. Our target's to get up to 1,250. We're still hiring, but hiring is slowing. I mean it's just -- it's harder to do remotely. That being said, we're all operating with -- except for some critical functions remotely. So our need for space in the interim is actually down. And so we've been renting that on short-term leases. And so that could well be adjusted. But getting to my second -- to the first part of your question, there -- I suspect the genie is out of the bottle with regard to working from home. We've been resistant as a firm, and I personally have been to it because I think intimacy builds trust, builds culture, it enables us to be more effective at training and passing down knowledge. I still believe that to be true, but I absolutely think that there will be permanently going forward some percentage of our workforce, that's always working remotely. So in theory, globally, that should reduce our space needs. The offset to that is, we probably need to have a lower density in our sort of open plan of the space globally. And for the most part, we meet it today, but I don't know if that's true globally. And so we need to adjust and figure out where we ultimately stand from an expense savings perspective post-crisis. But I do think that we should be careful about predicting structural changes so close to the event. I think we all suffer from a recency bias. So I'm certainly willing to make the prediction that we're going to see more people permanently working from home, but I'm hesitant to pontificate on this topic for long because I think there's still a lot we don't know.

Okay. Maybe looking back to the events in March when the fixed income market seized up. What lessons do you take away from that experience in terms of how fixed income portfolio managers managed their books and how money managers communicate expectations to clients around liquidity?

Look, I think there was no market that was more adversely impacted than fixed income. The tragedy of that, of course, is while we couldn't define what had in fact happened, predict exactly what did happen, the structural imperfections of the fixed income market were incredibly evident to me and others running fixed income businesses in the global financial crisis 10, 12 years ago. Market structure is unstable. As you know, a very small percentage of fixed income instruments actually trade daily. And what I really think it speaks to is the fact that the industry needs to push forward in evolving to a daily pricing, but periodic dealing model in our mutual funds. And I'll come back to ETFs later, but the truth of the matter is very few instruments trade. There is no maturity transformation. So somebody is taking that liquidity on the other side of that trade, when anyone redeems. And you have clear issues among your investors in treating all customers fairly and marking becomes more of a challenge. So swing pricing, which is not permitted here in the United States, but is broadly used outside the United States is probably appropriate. But ultimately, I think our clients would be much better off having interval funds or something that deals in a predetermined way, so that we can manage liquidity more appropriately, hopefully, get better performance because we have to hold less cash. And the fact of the matter is people don't need daily trading, daily settlement, daily liquidity on long-term fixed income funds. They don't need it in equities either, but the fact is the market is more liquid in that regard. Now there are obviously parts of the fixed income market, particularly shorter and that have much better liquidity attributes and certainly within the government bond markets. But I think those structural issues need to be addressed. And to date, there's been very little willingness to do that. Ultimately, I don't see any long sort of silver bullet to the market structure deficiencies in the marketplace. So I think that puts a premium on portfolio managers to be much more disciplined about liquidity and how they manage their portfolios. And so if you look at munis, which may be the most extreme example as a class. While longer-term credit quality is deteriorating the municipal sector and certainly, the pandemic and the resulting economic crisis is going to accelerate that. Muni credit has always benefited from being very slow to transition. And when you see the pricing gaps in munis and the disappointment that clients saw in looking at their first quarter statements in April and what were typically a very high-quality portfolios, I think, is a wake-up call that we need to think about better ways to provide market -- the market structure to change. Now I would also say that the Fed and the treasury did a remarkable job putting a floor on the fixed income markets generally. And so the better conditions we see today are artificial. We just need to acknowledge that. But they're going to be around for a very long time, I suspect.

And staying on the topic of fixed income. When you look at the low level of interest rates today, maybe they go lower, maybe they go a little bit higher on the back of fiscal stimulus? How are you thinking about the risks from the level of interest rates to fixed income demand and how portfolios are constructed and what actions can you take to manage around this?

I think this is a really significant question for -- it's a public policy question, first and foremost because fixed income cannot play the role that historically it did in pension schemes or frankly, in retirement accounts. By virtue of near 0 rates and potentially negative rates, fixed income no longer provides an income component, and I'm talking very high-quality fixed income for a moment. Fixed income still is a diversifier. And equity-driven returns need -- portfolios need a large liquid market diversifier to manage volatility. And fixed income, arguably, at least at the moment, has improved from a diversification perspective, by virtue of the fact that your duration extended as interest rates fell. And so all things being equal, an investor needs less fixed income to achieve the same characteristics from a volatility perspective than she did do before. That does have an implication, I think, longer term for demand. However, risk aversion is very widespread. And we never quite got over the last financial crisis, and I suspect fixed income will continue to benefit as -- to be perceived as a safe haven by investors. And again, I'm really talking about high-quality fixed income. Also, the regulatory changes that would have to be made to reduce the bid for fixed income over time from institutions. I think that's going to be a long timing coming. I think that the interest and income as population gets older only increases. I think the world needs to understand that income is very difficult to obtain to meet current expectations for retirement. And so we're going to have to learn more and more from countries like Japan on how to manage that, which is it's really less about income and more about cash flow. And every time Mrs. Watanabe in Japan has bought a non-yen-denominated fixed income mutual fund in the past 20 years with a few acceptances, she's seen her net asset value decline. But the income as she's defining, it has been pretty high. And so they become effectively self-amortizing. And I think that has pretty profound implications for how fixed income is sold over time. And that -- same is true of higher risk fixed income like emerging markets and high yield. So I think the offset, of course, to lower structural demand is that all things being equal, rates should go higher because there should be less demand for it. But we're in an extended period of financial repression, the Fed's balance sheet continues to grow, and it's not just government securities anymore, it's also corporates and even now high yield. So I think the day of reckoning is pretty far off, but the day of reckoning is we can see it.

And if that day of reckoning occurs, I guess what in your view could potentially replace certain aspects of fixed income as a diversifier in portfolios, particularly if rates were to go meaningfully higher?

There is no -- I don't think there's a silver bullet to that question. First of all, the diversification benefits of fixed income have been particularly apparent and beneficial in the last 25 years. Fixed income hasn't always provided that diversification benefit. And it could switch again. It's the income component of fixed income, which is, I think, is easier to place than that diversification benefit. I think the diversification benefit needs a very deep market. So liquid alts don't have a deep market from which to fish and you have a very high exposure to manage our skill in long-short hedge funds to try and manage if your goal is sort of market neutral. So I think it's going to be a variety of different solutions that are going to have to be added to that diversifying component of the people's portfolios. And I think cash will likely be a piece of that despite its negative carry on a real basis. So I think people will value liquidity, and they'll use cash for that. I think fixed income, albeit less will be there. And I think for income, people will always look to high yield and emerging markets and other lower-rated parts of the fixed income market to be a principal source for that.

Maybe shifting gears over to equities. You've been putting up some strong flows and active equities here bucking the trend here, 12 straight quarters of organic active equity growth. How are you continuing to evolve your approach to active equities and what is a broadly challenging backdrop for active equities? And as you look out the next several years, what do you think it will be -- what will it take to be successful given the degree of competition, the growing amount of data and advances in technology and certainly the growing size of passive?

Well, look, I think we know how to battle passive. And that's to recognize that only the skillful are going to win over the long term. And to be skillful, you really have to have an idiosyncratic return stream as a manager on a rolling basis for a very long time to earn your way into a sophisticated investors portfolio because they're basically going to supplant passive to allocate you that capacity. And that's in larger, more liquid markets. And we will continue to seek within our own teams, but also outside the firm, teams that have really an interesting edge and that edge today is increasingly utilizing more advanced forms of technology and data mining capabilities in order to develop that edge. Active fixed income is increasingly quantitatively based. Not all, there's still a number of fundamental managers who have the talent to do it, but I think the hurdle is higher. And so there are going to be fewer of them. And not all of our teams are going to be in sync with their markets. And so what's critical for us is that we have a number of strategies and teams, none of which really dominate our flows, and we have the diversification within equities to have services that are appealing in different market contacts. I do think that this disruption, this crisis really may be I think amazing opportunity to find new teams because we have a pretty compelling proposition. We can get you to scale. We are an active shop. We understand what the framework needs to be to ensure long-term success for equity teams. And I think we're a pretty appealing place for them to go because as a consulting firm that's made its living, criticizing big multi-manager firms like AB told us a few months ago. We're getting really concerned about the ability of some of our smaller boutiques to last out this crisis given its duration and severity. I thought it was ironic, but I think it's also an opportunity. So I think that really does give us a leg up and I intend to use it.

And you mentioned part of the liquid alternatives part of the business there, an area you guys have extended into, also private credit on the alternative side, you've been extending into. Can you talk about how these parts of the business are holding up through this volatility? And how does this environment change the outlook for growth in those parts of the business?

We spent a lot of -- we have liquid alternatives in our multi-pad long-short equity business called Arya, where we are bringing on new teams, and we continue to see growth there. We're still small relative to the big players in that space, but that's been a bright spot area generally. And we want to continue growing that. In private alts, or illiquid alts, we've really been focusing our attention in private credit as I think almost everyone else has. I don't know if the world is looking for another private equity manager right now. And I think there were enormous number of startups in private credit that are going to struggle to make it through this crisis. A, because it is in middle market and maybe smaller markets credit where the epicenter of the damage of this crisis is probably going to be most manifest. And certainly, in real estate as well. We have a middle market lending business. And we have commercial real estate debt business, both -- they're separate from one another. Look, they both have challenges in their portfolios, as I suspect everyone else does, but they seem pretty manageable to us at this point. But it's pretty hard to forecast this economy. And so I don't want to sit and tell you it's all clear, but we're feeling like we have a pretty good situation at the moment. I think there are going to be more opportunities to find managers because the prices for -- I'm sorry, for private credit managers got pretty undisciplined over the last few years. And I think there's going to be a remarking of that space in consolidation.

And shifting gears over to the institutional business coming out of the first quarter, you had a very strong pipeline over $15 billion as of the end of March. What sort of client activity and allocation shifts are you seeing since the end of March and relative to what you saw in the first quarter? And any sort of color you can share maybe on where the pipeline stands today?

Sure. Institutional has really been a bright spot for us, and it's really been driven by equities and alternatives and to a much lesser degree than historically in fixed income. I would say, we just did a TALF offering, which was immediately subscribed and institutional. And so that's kind of exciting and fixed income-oriented. But it's been principally equities and alternatives. Look, the degree of search activity in the fourth quarter and right before the crisis was very high. That activity is continuing, but it's at a more muted rate for sure. Our pipeline has continued to benefit, but we've also seen fundings, too. So we feel like that's a pretty good story still. And we're getting much more support from consultants in equity, so I'm happy about that. And to your earlier point, I think most of that is replacement demand, not new equity allocations. Or if they are new allocations, they're people rebalancing into it.

And shifting over to retail. You've had some very strong and record retail sales in the first quarter, up about 37% year-on-year, I believe. Can you talk about some of the underlying drivers of success there on the retail side? And what's resonating most in the retail channel?

Well, our retail is a bit different than everyone else's. Our biggest retail business is in Asia. And it's been really strong, particularly strong in the first quarter. And while we have more diversification, i.e., some equities and some multi-asset, that's always been, for us, a income-driven fixed income phenomenon. And we saw big outflows in the first quarter, although I was feeling better about it because relative on a proportional basis to what we had seen historically, it's always been volatile. It actually performed fairly well for us. It's turned positive again post the first quarter. And so we -- it continues to be a really important place for us. In the U.S., we've seen continuing growth. And March was our fourth highest sales month there. April was pretty good. May has been pretty good, but levels are much more muted today, but we're flowing positively overall. And in the U.S. building equities. Sorry, I just wanted to make that. And in Europe, it's more of a mix between equities and fixed income.

Great. Okay. Continuing with the retail theme, the wholesaling capability and wholesaling force, an area you've been building out in recent years and using mobile technology tools to help make your wholesalers more efficient. I was hoping you could talk about this a little bit more and maybe touch upon what's left on your to-do list at this point in terms of evolving the wholesaling technology force and capabilities here and maybe touch upon how the wholesaling force is adapting to this work-from-home environment as well.

Let me answer that, but -- by giving you a sort of health warning that we're in the sort of unusual time, and we're not visiting people's offices in the normal course. So it's accelerating, I think, what were some of the trends that were already happening in the wholesaling space. We've made big investments in sales enhancement and enablement technologies and data. We've had new sales enablement tools, mobile CRM, dashboards. I think that's, frankly, table stakes today. I think most firms are using that. Our wholesalers are really focusing on figuring out how we can do mass customization and scalable personalization. And what we mean by that is, we need to develop service models that allow the wholesalers to really customize their communication services to specific advisers or adviser cohorts based on the product ownership and the interest and service needs. We can do that. We can toggle much more effectively now. And as I was alluding to at the beginning, I think our investment in wholesalers here in Asia and in Europe is really much more about technology deployment going forward than people. And we're price takers, both on the distribution side and the manufacturing side of our business in the sense that I want the most talented people making their careers here, and I'm not going to use comp as a toggle, unless it's an extraordinary situation we're facing. Therefore, I have to replace people with technology and get much more leverage from the people we have in place. I want to continue developing their skills, further training them. And that's what we're doing today. So for example, in the wholesaling space, utilizing data to inform our kind of sales prioritization to optimize our efforts. We need to leverage digital much more broadly to touch new segments at the market and align quickly with their preferences. We got to make sure the user experience is consistent across our clients in the field. And we also have to ensure that our multichannel experience is also consistently useful. It's a lot of blocking and tackling. There's no -- again, there's no one thing we're doing that's going to change it. But it's an evolution. And frankly, this crisis is a catalyst to force us to do that more quickly and more comprehensively.

Great. Well, I'm afraid we're out of time, Seth, I'll have to leave it there. Thank you so much for joining us this morning.

Well, thank you for having me, and have a good day.

Great. Thanks, everyone. And please join us for our next session starting shortly at 11:00 a.m. Thank you.