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

Next, it is my pleasure to welcome President and CEO of AllianceBernstein, Seth Bernstein. With $620 billion in assets under management, AllianceBernstein has been one of the strongest organic growth stories in the space for quite some time now, including in active equities, which is clearly differentiated in today's space. Further, the firm has been gaining traction with a lot of alternative strategies and continues to have a strong position within credit. We look forward to getting an update from Seth on how he's positioned the firm for 2021. So welcome. And Seth, for -- thanks so much for joining us today.

Alex, I'm very happy to be here. Thank you for asking us.

Awesome. For everyone on the webcast, I think there is 1 brief slide that Seth wants to speak to. So if you have the presentation, just flip to Page #2, and Seth will spend a minute on that, and then we'll jump right into Q&A.

Okay. Well, thank you very much. Like -- look, first just as we start, I want to provide a brief overview and update on the key points we measure ourselves against for investors, which we introduced earlier this year. They're shown on this slide. We remain confident in our ability to drive sustained growth, driven by differentiated investment performance. In the third quarter, we drove 5% active annualized organic growth, and that's ex the AXA outflows, continuing the trend we've established over the last 5 years of balanced growth across asset classes and distribution channels. Importantly, we also remain focused on identifying investment capabilities to add through inorganic growth. We're excited about the opportunities to expand our suite of higher fee alternatives. The recent launch of our European commercial real estate debt business, an extension of our U.S. capability, which Equitable plans to support is a good example, I think, of the strong mutual interest in expanding our yield enhancing longer-dated alternative strategies. We plan to pursue similar strategies to extend other alternative capabilities globally in the future. As another demonstration of Equitable strategic commitment, Equitable helped to seed our first CLO vehicle, which closed with a $400 million raise in late October. This capability fits nicely as a direct extension of our large leverage finance high-yield business. We remain committed to driving strong incremental margins of 45% to 50% through leveraging scale growth. And then executing on our national relocation and cost savings initiatives. In the third quarter, our operating margins expanded both year-over-year and sequentially, with G&A up less than 2%, excluding a write-off of onetime legal fees. As a partnership, we continue to benefit from a durably low tax rate of less than 10% value in which -- and we think that's valuable in times where taxes, I think, are really on upward pressure. And as we continue to pay out 100% of our adjusted income, supporting a robust distribution yield of approximately 8% in a low rate environment. So I'm excited to share with you our progress, and we'll continue -- and as we continue to evolve. So with that out, let me turn it over to you.

Perfect. Seth, your prepared remarks took away from half of my questions.

That was my goal.

Just kidding. So all right. So I wanted to start with a little bit of a broader question around sort of macro asset allocation trends. Just given the time of the year and also the fact that 2020 has been tremendously volatile and [indiscernible] near all-time highs, rate's all-time lows; obviously, the economy, the recovery is underway for 2021. I'm curious, what are you seeing in some of the larger themes from investors around the world when it comes to asset allocation over the next 12 to 18 months in terms of, obviously, the asset class?

Yes. Look, with the caveat that valuations are high, rates are amazingly low, we have still macro events out there, whether it's Brexit imminently or the handover in January in the United States. There's still a lot of uncertainty in the air. But all of that being said, markets have been remarkably well behaved. And in the near term, we see a continuation of these trends as it relates to flows. We in equity market should continue to be supported by historically low rates and what is an amazingly accommodative Fed, which is stated that it's comfortable tolerating more inflation than it used to. Look, we still see deflationary secular trends of technology and globalization in the broader marketplace, so they're fighting an uphill battle. Until the interest rate picture changes, equity markets should continue to benefit as the Fed effectively forces investors out of bonds and out of cash into equities. Equity dividend yields will also play a more prominent role relative to fixed income than they have historically just given the absolute level of rates. Style shifts growth to value may continue in the near-term as the market anticipates economic normalization post-pandemic, but we still see strong global demand for our core and global equity products. ESG intensive portfolios are a particularly good growth opportunity for us. While income continues to resonate among both institutional and even retail clients, we share the concern that flow trends and fixed income could ultimately begin to reverse, given that the role of fixed income is much harder to justify and define in a marketplace bounded by or perhaps not bounded by 0 rates. The fact is you need less fixed income for a given maturity then you did before to provide the same level of diversification benefit. Yet there's no clear replacement given the liquidity needs to provide a large diversification benefit. So there isn't a better option today than fixed income, but therein lies the opportunity. Investors need to be comfortable with higher complexity and higher risk to earn the same returns which we think paves the way for continued alternatives growth. So for example, our middle market lending service, our commercial real estate debt business, where we're raising assets for our [ cred forefund ] and other securitized strategies. We anticipate alternatives will continue to grow healthily, and we're posturing our portfolio appropriately to participate in what is an awfully hungry yield market. Our institutional pipeline reflects these trends, with equities and alternatives representing about 80% of the pipeline's annualized fee base. But we still -- it's very lumpy for us because we've big fixed income and customized retirement strategies moving in and out, but that trend is holding for us. In private wealth, look, we continue to see opportunities to customizing portfolios. For example, by combining concentrating equity satellites and higher returning of liquids with core exposures to manage fee and risk budgets. We see growth there and continuing interest in tax loss harvesting strategies. I think alternatives will also continue to be used to enhance, shield and to find outcome products and also perhaps to be used to manage downside risk. So all in all, we see a continuation to the trend, but let's not kid ourselves, we should be anticipating higher volatility going forward.

Yes. That all makes sense. I mean, look, I was encouraged by your comments around the equities business, obviously, right? And not surprisingly, with the Fed doing what they're doing, it should push people up the risk curve. The interesting element of your story obviously has been the fact that your active equity business really stood out over multiple quarters now, and that's both on the institutional side, and I think on the retail side. So maybe help us peel back the layers a little bit here and work through sources of strength in terms of both products and distribution, what sort of differentiates AllianceBernstein's approach within active equities? And how we should think about the sustainability of these flows, given the fact that maybe there's a little bit more of a win at your back from the macro dynamics?

Look, I think it's best to understand that our strategy in equities evolved significantly post the last financial crisis, where this firm's performance, its revenues probability was really tied to our historical value equity franchise. The firm had to reinvent itself, when that franchise faced really significant redemptions post the financial crisis. And so we built the equity franchise following the crisis, and we've been very thoughtful and disciplined about measuring idiosyncratic or nonsystematic portion of the turn stream, which we think can't be replicated. We think that's a very important distinction because we don't think institutional clients, more sophisticated investors, are going to buy beta. But they're really going to be willing to buy our return streams they can't replicate net of fees. Those are the only safe havens, in our opinion, and because it's active management, the performance is going to ebb and flow given market cycles, given manager insight. So we measure existing teams that way. And we've expanded that into fixed income, although that's more of an art form so far, but we're making progress there. And when we look at new teams to recruit and build on our platform, it is an essential part of how we analyze it. Do they have an enduring edge in their ability to generate non systematic returns. That, to us, is critical. We need to be fairly high active or very high active share, really to exist in the world where strategic normals are expressed and that -- I think that's where we are. Sorry. Additionally, look, we went from a model where we were effectively 2 teams globally to 5 to 7 teams globally in our equity business. We've had -- we gave up having 1 very scaled product in a world where we think more concentrated strategy differentiated in terms were going to dominate. I think we've been right so far, but that's hard to maintain. That's why we need a diverse portfolio of those services. And from a client service and support perspective, we've been attentive and responsible -- responsive, I think, to the needs of consultants and more sophisticated buyers. Look, consultants who have bought in after a crisis acknowledged, we are one of the few really stable platforms out there and consultant advocacy has really been critical for us in turning around our institutional business. It really has driven significant demand over the last 24 to 36 months. Whether it's upgrades for our select long/short strategy or a Global Core or Eurozone, equity means sustainable growth. These are really important. They drive a lot of our flows. And most of those are brand -- brand new or products that are new to us over the last 5 to 7 years. So we have done the work, and now we're harvesting, but that's going to change. And we certainly recognize, Alex, that we are stronger today in core and growth than we were historically in value. And so if we really rotate much more into value, we're less well positioned, but we have elements in our value business that are performing well. But that's where we are. And that's what I -- where I think we've built what I believe is a very competitive platform.

Right, right. Makes sense. Let's spend a couple of minutes on fixed income. And a couple of part question here. But I guess, at first, if you look over the last couple of months, we've seen a slowdown in AllianceBernstein's taxable fixed income flows. There are a handful of products where near-term performance or the year-to-date performance, I should say, has been somewhat challenged. It didn't seem to have really been a problem in kind of Q2, Q3, but might have starting to come down -- have a little bit more of an effect more recently. Any observations on the ground you're seeing? Is it simply a idiosyncratic near-term performance issue? Or is that some of the other things you talked about, right, like the low yield environment is just not great for fixed income?

Look, I think, certainly, Alex, while it will be convenient to sort of cite macro trends, and they're certainly there. We certainly had our own performance challenges in the end of the first quarter in light of the drawdown following the pandemic. That being said, we've worked a lot of that off. And actually, if you look at our U.S. high yield, if you look at our American income, which is our largest single product, their performance is recovering and it's quite strong. But global high-yield still is challenged and working through it. That's our second largest product. What is -- I think it really reflects there 3 things for us: One, that demand in Asia, which has always been really important for our retail business has been more episodic this year than it was last year. It was very strong going into the crisis. It disappeared. What pleasantly surprised me was I expected given history, we would have seen much stronger outflows. We really did on a relative or absolute basis. Certainly saw them, but they weren't as bad as they had been historically, given a similar kind of sell off. So I feel very good about that. The second thing in Asia, what was going on is that investor sentiment really shifted to domestic or really Chinese equities over the course of the year and financials IPO up until its pulling was a real -- drew real interest in that market from people who typically are buying yield in the U.S. marketplace. So we saw that as well. All of that being said, we've seen more recently better flows in there, but it's not back to where it was. I really think it's less a performance issue today than the fact that we were seeing very low yields earlier in the year. As yields have backed up a bit, I'm a little more hopeful there. And so I think we're in pretty good shape. We've certainly had much stronger performance in this quarter to date and in the third quarter. So I think we're doing better there. I'd like to just switch to institutional because actually, we've seen ex AXA pretty strong flows. Now they're much lower fee as you know, but we continue to see institutional demand there, which [indiscernible] the broader business, and it's a pretty high-margin activity for us.

Right. Any strategy within institutional specifically within fixed income?

Mortgages have been good, in particular.

Got it. Got it. I guess as a follow-up to that. I was hoping we can hit on some of the bigger implications for active fixed income managers in a low rate environment. And I think you alluded to some of that about to be more maybe idiosyncratic or taking more of an equity approach to fixed income in order to really differentiate yourself in the space. But look, bigger picture, right, if you look at this environment with low yields, it should be great for passage. So the absolute level of fee rate as a percentage of spread available is just much more attractive in the passive [indiscernible] within fixed income. As an active manager, how do you battle that trend?

Look, I think the trends you identify are absolutely true. Look, lower fees increased the -- I'm sorry, lower yields increase the focus on fees. And frankly, particularly in core strategy, the alpha opportunity is just not that great to offset the fee burden in retail, much lower burden, obviously, in the institutional space. I'd also point out that, that market is incredibly mature. And it's where you've seen the biggest penetration outside the traditional treasury area, where ETFs have already grown to be a pretty significant component of it. All of that being said, let's just recognize that fixed income benchmarks generally our outgrowths of the discipline that developed in equities rather than the reverse. Fixed income and historical multi-asset portfolios is where you banked gains and equities, where you had lower volatility and diversification. Remember, the Ag is an issuance weighted index. Think about that. It's an almost adverse selection index in one respect. So that's an issue in and of itself, which gives rise to much more customization than we see in equity. Secondly -- and we can do that because we're much more automated than a lot of people. Secondly, what I think is also the case here is that for passive managers, very hard to replicate an unreplicatable index, right? So you're always going to have tracking error. So I don't think that to get out of jail free card for active. I think it just means you better get your costs down hard because ultimately, we're in a secular low rate environment. And in a low rate environment, ultimately, the diversification benefit of fixed income, particularly for institutions, can be achieved through extending duration. You don't need as much of it, if you're not getting the income picked up from it. So the truth of the matter is you have to have more active exposure in fixed income to be compelling. For good or bad, we've never been that big in core. We were always a big credit [indiscernible]. And that has been a better place to be. And that's not to say we wouldn't have wanted to be a large core manager, we just never historically developed that capabilities prominently. We also have always favored global over U.S. home. So while intellectually, a more compelling argument, people still have home country biases in the way they manage their own money. So I think -- we think there is a lot more active management value in credit. We're spending a lot of time doing it. And frankly, most of our -- certainly from a revenue perspective and a lot of our assets are much more income-focused than they are core or investment-grade focused in that regard.

Yes. Yes. No, that makes perfect sense. All right. Maybe we can pivot a little bit to talk about the alts. Growing the alternative franchise and multi-asset products has obviously been a strategic focus for you guys. You outlined that earlier. As these businesses scale, talk to us a little bit about where you're seeing most traction? I know you mentioned the CLO business, that sounds like it's going to be one of the newer avenues for growth for you guys. But just broadly speaking, as you build-out, continue to build out the alts, where is the path going for you guys in that part of the model?

Okay. Let me just break it up between private and liquid. In liquid alts, we have Arya, which is our multi-pad long short managers, had a very good year. And I think that's immensely scalable. I think that model will resonate. It has the performance fee issues of any alternatives manager, but that's really our largest public alts commitment. We continue to add teams within that. Flipping back, we really are focused on private credit is where we want to play. Why is that? Because we really were building it hand-in-hand with AXA first and now with Equitable. So as they both look to increase yields under general accounts, we became a preferred source for that provision. And that we have institutionalized that and formalized that relationship with Equitable. And that's why equitable is the cornerstone investor on our new commercial -- European commercial real estate venture. And we have a number of others we're working on with them. There's nothing imminent, but we continue to recruit teams. We thought a lot in private credit about going out and buying a manager. The problem is we're not the only ones who had that insight. And so I think you're paying a lot of dough for the privilege. We think what's interesting about our value proposition as a platform to a talented team is that we can get them to scale by virtue of our relationships of Equitable, AXA, and our own distribution channels a lot faster than most other firms can. So we'd rather get the ups from our shareholders through owning them through that growth cycle. That doesn't mean that a good alts manager was going for a lot less money in a downturn. I wouldn't look at it, of course, I would. But the fact of the matter is, we don't really want to pay the last dollar for the opportunity. We'd rather grow it ourselves. And I think we have a pretty compelling proof statement in both privates and publics that we've been able to accomplish that. We're not always right, and we shut them down when we're not. But I think we've had a pretty good batting average in that regard. So the European commercial real estate debt is our newest endeavor, we -- as I said, we have several others. CLOs we include here, but it's really not an alternative. It's just a natural extension of our public credit capabilities in fixed income. And look, we're going to continue to expand those capabilities across the world. So really, the commercial real estate is a derivative of what we already did in the U.S. middle-market lending, we see similar opportunities. That business is based in Austin. It's done very well through the cycle. We'll look at aircraft leasing, we'll look at a lot of asset-backed and infrastructure kinds of ideas. But at the end of the day, I am looking for something that is significantly leverageable because in the alts space, I don't want to lock myself into a model, which has very high costs and low returns for my shareholders. As the GP, we need to make a compelling return on it.

Right, right. So this actually kind of dovetails into my next question. I wanted to hit on Equitable as one of the key points you made or the relationship with Equitable you guys have, you made that as one of the key points you addressed earlier on in the presentation. And the question for you is really around twofold: One, to what extent are you guys -- to the extent that you're already working with Equitable, what is the opportunity set to combine and get a larger share of sort of their addressable market within Equitable rights or just get a larger share of allocations as they kind of reposition their portfolio? But more importantly, almost, how can you leverage this experience in expanding your footprint with other insurance companies? Is that a big benefit or is that maybe some way actually detriment to you because of that relationship, so it's hard to compete.

Well, look, I think that, look, we already managed the vast majority of Equitable's general account. But that general account was incredibly high-quality versus any U.S. competitor of Equitable. In part because AXA had a more risk adverse approach to managing the general account because they're Solvency II based. And so we've been under Equitable's leadership implemented with them, hand and glove, thoughtful strategy of raising the yield on that portfolio. And so we want to accelerate that. And so that's exactly what we've been doing. And look, there's a lot of room to run. They have the ability to be the cornerstone investor through the first several funds of every one of these things we're undertaking. Ultimately, we need a validation that's not Equitable to make this work. And that's -- as a fiduciary, they want us to do that as well just to make sure that what they're buying is fit for purpose. And we think that's critically important from a validation perspective. With -- I think you're absolutely right. Taking the skills in managing a liability-driven portfolio like Equitable and bringing it to a broader universe of perspective and clients is very important to us. We have the skills, being part of AXA, that could have created problems historically because AXA was in every -- virtually every portion of the insurance industry. Equitable is much more defined and it's quite a mature part of that business. So we do business with a number of Equitable's competitors already, both in fixed income as well as in multi-asset and variable annuities and elsewhere. And we're growing that. We've built in our multi-asset group incremental capabilities. We made a small acquisition earlier this year called Anchor Path with a really interesting risk-managed multi-asset strategy for insurers that we manage for a number of clients, particularly in the Midwest. So we are building it. It's still going, but I'm pretty upbeat about where its potential leads us. And finally, venerable. Now the Venerable acquisition of block of Equitable's liabilities policies arises because it was, we thought, very important. When I say we, in that sentence, I'm really referring to Equitable's management committee to validate our prudence in reserve policies, methodology and policy. And in fact, Venerable is a very sophisticated buyer of risk, arguably amongst the most. And we thought -- and I think the market agrees that they are considerably more comfortable with the adequacy of Equitable's reserves today by virtue of that Venerable transaction. We will retain management over roughly 80% of those assets at the current fees. Now fees can change for everything. I'm not aware of any change, but they're always subject to change. So I don't want to give you the impression anything is locked. And if they don't like our performance, they can certainly terminate us. But we're looking at other stuff with them. And they're very sophisticated. I think they'll make us better, and I think they want some diversification. But I'm excited. I'm excited as part of Equitable, but I'm also excited because it opens up a new avenue for AB.

Right. Great point. All right. Can we have a conversation about asset management without talking about consolidation. I feel like every time we have a conversation, there's a new deal that's been recently announced or rumored to be announced. So I generally feel like you've been very vocal about your overall view on consolidation in the space. But curious if anything's changed, and if anything, from your perspective, could make sense for AB and really from a capacity perspective, how would you approach if something interesting did come along?

I really would have hoped you said, and thoughtful, but okay, certainly, have been [indiscernible]. Look, I wouldn't rule out a large-scale transaction. M&A deals are often just as hard if they're small as they are when they're big. There's a lot of brain damage involved in them. But yielding synergies and professional service firms, particularly in this industry has proven really hard to do. Even when it's been done well, and there are examples. Invesco has done a number of very successful acquisitions. That's it. In this kind of climate where people are looking for excuses, consultants are looking for excuses, and you're short the option on the client, it almost doesn't matter whether you achieve the expense savings. The issue is, can you keep the assets? And given that your short that option, I'm just skeptical, a lot of these things are going to end up as they're modeled. But again, it can happen. If you really have locked assets, I think it can happen. If you were to buy -- I'm being hypothetical, if we were to buy an affiliate of an insurance company's asset management business, yes. And I think that's what Venerable -- I'm sorry, that's when I think [indiscernible] and Venerable have really caughtened onto is kind of a brilliant insight. You can absolutely do that. But those are hard to get done. There's value-added in doing them, but I just think they're hard to do. So yes, the ambient talk of activity is soaring. That's absolutely true, and we're seeing more and more chances. But one that I find particularly interesting is the Eaton Vance acquisition. Because to me, what's interesting being around this for too long, is that the prohibition or sort of the sacred cow of not integrating asset managers and distribution may not be quite as sacred as it was 5 years ago. Now I think the reason for it, and maybe it's a unique opportunity is because the whole debate around active, I'm sorry, the whole debate between proprietary versus third-party and the core of a client's portfolio has really migrated, I think, to active versus passive. And so a lot of clients just have thrown up their hands and say, "Look, let me be passive in the core and take my risk in more -- in those areas which have a richer opportunity set, i.e., alternatives for the active management." So I think that may be part of it, but I also think that clients are a whole lot less concerned when it's algorithmic, like parametric. Or when JPMorgan uses its ETFs and its own portfolios. I think that's easy to explain and ultimately easy to defend to a regulator. So I do think that must have been an important part of the consideration in that case. But that's the only one that I've seen lately that has really caused me to think, "Ah, maybe there's something different and interesting here."

Got it. And with respect to you guys specifically, any change in strategy, any different thoughts? And to what extent can Equitable be helpful maybe in some ways when it comes to capacity of doing something sizable?

We absolutely work hand and glove with that when we're thinking about acquisitions. And look, ultimately, own 2/3 of the company. So I would be a fool not to, but we do anyway. It's an important part. And as I said earlier, we're building the alternatives platform in partnership with them. So absolutely, and I think you will find that they would be quite supportive if it's logical and compelling. But look, they have their own constraints, but their intention is to be constructive.

Well, perfect. We're pretty much out of time. Seth, thank you so much for joining us. Really appreciate you being here. Hopefully, next time you get to travel downtown, and we get to do this in person.

And maybe the grimmest hotel of any conference in the world.

[indiscernible]

Anyway, thank you very much for having us. We really enjoyed it. And good bye. Thank you.

Thank you.

Bye-bye.