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

Great. Well, good morning, everybody. Thanks. Thank you for joining us. Next up, it is my pleasure to welcome Seth Bernstein, President and CEO of AllianceBernstein. Under Seth's leadership, AllianceBernstein has been a standout performer with consistently positive organic growth and stable fee rates driven by its leadership in active equities, strong performance in fixed income and increasing contribution from private markets. We look forward to catching up with Seth on how AB is planning to sustain this momentum into 2022 and obviously getting your perspectives on the investment landscape broadly. So great to see you. Thank you for being here.

Thank you very much for having me.

Oh, this is great. So I wanted to kick this off with just a top-of-mind investment themes discussion. 2021 continued to show remarkable strength in equity markets, but obviously, rising inflation pressures and prospects of higher interest rates might complicate things and not to mention the lingering COVID issues that we've seen in the last week. So given AB's broad-based investment capability set, spend a couple of minutes on what are some of the top-of-mind investment themes into next year you expect to impact asset allocation trends and what you're hearing from clients.

Look, I agree, we agree with your basic thesis that look, we're in a more uncertain time, right? We don't know how much inflation is going to get embedded, how much of this is really transitory. I think the answer is less than we thought. I think that we're dealing in a world where -- what is the appropriate monetary response to that? And then finally, of course, there are going to be continuing variants until it's stamped out. So this is an endemic, right?

Right.

It's not a pandemic anymore. And so how we manage it is critical because the economy cannot afford another heart attack like it had in January -- I'm sorry, in March of last year. So we're very focused on it, and we don't have any insights, unfortunately, that you guys don't or the rest of this room doesn't have in that regard. When we look at the markets, the markets have behaved remarkably well. Of course, they have. You've seen stimulus and easy monetary policy on the scale we've never seen before. Inflation, despite this recent uptick, remains pretty muted. And there's a lot of pent-up growth still to be had. So we're pretty upbeat on 2022 from a growth perspective, but we've got some fundamental challenges to face. Number one is valuations are pretty toppy, at least from traditional measures. We know that if there is more embedded inflation that impacts longer-duration assets like growth, certain kinds of bonds, and most portfolio managers haven't managed in a higher inflation context. And so we think a lot about that. In equities, look, we continue to think there's value in equities. We're trying to stay away from the indices where there's a considerable concentration. You know that the broader FAANG phenomena is still present, so most stocks have substantially underperformed the broader market. And so we do see value there. And I say that cognizant that inflation has insidious ways of playing with value, tech being an example. So we are selective, but we think active management in equity should be able to prove itself. Pairwise correlations should be declining. They are. And so we're interested in that. In fixed income, very -- much less opportunity in fixed income, and you have to be active to outperform. And we have a barbell philosophy. We like to bend against the wind with respect to [ dobbies ] and credit. And we think about credit as a global asset class, not a U.S. asset class. We think there is value in EM. We think there is value in certain parts of Global High Yield. And so we continue to kneel against the trend in the marketplace, and we've seen pretty good performance there as well. But the area that I'm more concerned is that the convention of having a static 60-40 or 70-30 portfolio was broken, and it's not going to be repaired in an era of low returns. And the implications of that are pretty formidable. The role of fixed income, there is no obvious replacement. People talk about all day long, you can. It's just you don't have enough liquidity, you don't have enough depth, and you're really reliant on active management to ensure it actually works. So I don't -- there are pockets of alternatives where that's real, and we continue to believe there's real value there particularly in private credit. But in our own view, if you're looking for the same targeted return that you were hoping to get on a 60-40, you have a much higher component of equities going forward that in and of itself is more model. And fixed income's value is impaired because it can't provide the income support. So you've got to go into credit, which is effectively directional equity risk, the risk you're -- the kind of credit you undertake. So we think it's a much bumpier ride. I think you have to be flexible on how you manage around it, but clients have to remain invested. They have no choice. And there's still a considerable amount of assets to reallocate. Most investors have not reallocated, particularly institutional investors, around higher rates. So we think there's more to come on that front. And there's more activity we see, less in fixed income but in equities and ultimately institutional space related to those reallocations. I think there's going to be a continued drive to private credit simply for the yield picked up anyway. And I think that's both institutional and retail.

Great. Lots to digest there, so why don't we dig into a couple of these things? So one is, I guess, around fixed income, right? So you made a point that investors have not really reallocated for the current rates backdrop or expected rates backdrop within fixed income. What do you expect that to look like, right? So in which areas do you think they're going to have to lean more aggressively? And it sounds like credit. Where do you think they're going to pull back from? And then we look at AllianceBernstein specifically, you guys have had phenomenal performance in fixed income this year, significantly beating the benchmarks. Credit last year was a little bit bumpier, so maybe that's one of the reasons flows into taxable bond funds have not really improved in '21 yet. Is that on the come? Is that the pipeline that you kind of see building for yourself into '22?

So let's take it in its pieces. Look, rising rates is a headwind for all fixed income. But ultimately, from my way of thinking, there's a light at the end of the tunnel, and it's not an oncoming train. We are reinvesting at higher rates, higher yields to attract more buyers. So once you get through this period of rising rates, and I think we're pretty -- do 10 years get up to 2.25%, 2.75%? Sure. I can see that. But it's very hard for us to get our heads around north of 3% certainly for any sustained period of time. So in theory, from our perspective, you're looking at a flat or higher curve, which in and of itself is not great for fixed income investing. We've been moving in durations in anticipation of that. But in our view, our own flow challenges in Asia, which were -- absolutely were performance-related in part last year, had even more to do with the relative attractiveness of local equities, particularly Chinese equities. And look, Greater Chinese investors, at least to who we do business with, really do look at our relative performance of credit as an asset class as opposed to our relative performance versus our peers. It's much less about us, good and bad, in that regard. I think more recent volatility in Chinese equities will help us, but it's hard to predict it. What I would say is, had we had this kind of volatility in performance in 2012, 2015, 2017, we would have anticipated much bigger outflows than we saw. So I'm actually kind of pleasantly surprised by that. The other thing we're seeing is more maturation amongst the investors in what they're buying. So equities has been, for the first time for us, a meaningful chunk of what we're doing in Asia, more in Japan than in Greater China but still in Greater China, and multi-asset portfolios for the first time. So we still think there's an enormous amount of growth to come from there, and fixed income will come back in that space.

Great. Let's talk a little bit about alternatives and private markets. It's a huge part of the allocation puzzle, right, not just the institutional but increasingly retail as that kind of part of the distribution model starts to adopt more of the private market solution. So I know it's been one of the key strategic priorities for you, to expand AllianceBernstein to private markets more broadly. We've seen nice progress there over the course of 2021. So maybe tell us a little bit about the vision you see for the private markets for the next few years...

Look, we continue to see it as 1 of our 3 or 4 key growth areas.

Yes.

We -- and I say that mindful that multiples are really, really high. Valuations are toppy. We're clearly not the only ones who see that proposition. I think what's different about our approach is we've been more explicit about our desire to buy smaller teams. If we're going to pay a toppy multiple, I'd rather get the growth from my clients and shareholders in the process. Better returns tend to come in earlier funds, and so I'm willing to take that risk. And that's what we've done. That being said, we're not shy. If we saw a really great opportunity with a larger private credit manager, we would seriously look at it, and we have. We've looked at a lot of the ones that have traded, and there are more to come in that space. But look, the leverage is wildly in one direction, and so we have to be defensive in how we go about it. There are pockets within private credit we're still really interested in, infrastructure, even high-grade private credit because frankly, the yields are so thin that we think that a number of our high-grade buyers are going to be moving into private space, too. That market is much harder to the source because of the natural [ arm of ] the public market there. But there is appetite. I think finally, also in asset-backed and other particular areas, we'll be aggressive. So we have areas to pursue there. Equitable is a really important part of that equation for us. We already have $120-odd billion permanent capital with them, but they need to up the yield in that portfolio. They're far from alone. And so it's an important space for us to work collaboratively with them because our value proposition is we can get them to scale faster. That, with our private wealth channel, has enabled us to do that. We have evidence of our capability of doing it.

Right. And as you think about your current private market strategy footprint, just keeping the M&A or new team hiring aside for a second, which ones, I guess, are you most sort of optimistic about? And where do you see the most kind of room to run, right, in terms of what you already own from a capacity perspective?

Market lending has a lot to run. We see growth equity potentially coming out of that. We do some of that in that -- in those funds today. We have opportunities to move into particular verticals, whether it's SaaS technology companies where we actually have a long tradition of lending to. So we see real opportunities there, and we have a number of different vehicles -- [ so many capital ] vehicles to enable that to happen. In our commercial real estate debt business, our European commercial real estate debt business is growing at a pretty fast clip. We just put it into place in the last 18 months. I'm pretty optimistic about that. And we have very good reception to our latest round of funding in the U.S. So they're growing at a pretty comfortable clip, and that's incrementally a much more profitable play for us. And so we want to -- it's a virtuous cycle in its own right.

How critical is it for you to get larger here via M&A? So you mentioned, obviously, valuations are not cheap. We've seen a couple of your peers do deals in the space just this quarter, both T. Rowe and Franklin. Is that something that you guys feel like you need to do over the next 12 to 18, 24 months, whatever, to become a real scale player in the space as others grow or between Equitable and what you do inorganically, there's enough runway?

Look, we think we can double this business without organic growth over the next 3 to 5 years -- I'm sorry, without inorganic growth.

I got you.

So no, I don't feel any gun to our heads. I think we're still pretty early innings, and I think we have credit cycles to weather through. I mean we're going to have -- we're coming into one ultimately given what's being originated today on the terms that's being originated. So I think we have to be patient. We're not capital-rich. I don't know that we want to compete on capital. We have to compete on our ability to be the kind of home that an investment team feels it can grow and thrive in. And that's a particular kind of team. We're not going to buy a business and keep it entirely separate. That's just not a model that we think works. And I think it runs the risk of creating a multi-boutique model, which as strategies commoditize, it becomes an awfully difficult place to achieve expense savings. And so we're really mindful of that.

I got you. Let's spend a couple of minutes on Equitable, a really important part for you guys, obviously very important in the buildout of the alternative capabilities. Talk to us a little bit about the opportunity to do more for Equitable. I think maybe 3-ish percent of AB's total revenue now comes from the Equitable relationship directly. But can you do more for them? That's point number one. And point number two, to an extent where you spend more time with that, is that an enabler for you to do more for other insurance companies or it's actually a detractor where you're kind of married to them, so there's not a lot of opportunities to service other parts of the insurance sector?

Let me take it in turn. There is more to do with Equitable on several planes. Let me go through that. They've already committed to funding $10 billion of permanent capital in the private alt space. I think it will be more, I hope it will be more as we find new opportunities. And they have a long time horizon to implement that. That's really important. It's a cornerstone for us. It's part of our appeal, I think, to a number of teams. Additionally, look, we look at areas to work with them, whether it's in areas like extending private wealth and other areas in terms of whether it's RIA channel and elsewhere. We don't have anything in motion there, but we look more broadly than just their general account to help us. Additionally, they are our first call when we need to fund a large acquisition, be it in stock, i.e., through dilution or through outright investments on their behalf. So we see that as really a multifaceted relationship. We have a joint management team that meets regularly to discuss strategic issues between the 2 firms and together, and it's working pretty well. But let me just sort of move forward. Equitable as an insurance company does present problems with carriers who are directly competing with them. That being said, we do business with almost all of them. We have 75 third-party insurance clients. It's a pretty fast-growing business for us. Venerable has made us a preferred provider. Now that we -- they were introduced to us through Equitable, but they have given us business from other opportunities they're working on. So I think it's pretty promising. So I don't really think it's fair -- and certainly, compared to when we were principally owned by AXA, which is -- there's a few parts of the insurance industry AXA didn't compete in. It's a lot more manageable.

Yes. All right, let's shift gears a little bit. I want to spend a couple of minutes on active equities. It's a real differentiator for you guys. Clearly, the industry has faced headwinds in this business for many, many years. When we look at your results, you guys are doing about 8% annualized organic growth year-to-date, building on last year's. I think it was 4% to 5% last year despite challenges in the market. So what differentiates you? Obviously, performance is table stakes, so -- and you have that. But what else? Because it feels like great performance is no longer enough in active equities...

Look, I'll give you 3 reasons. First is when we rebuilt -- when my predecessors rebuilt the equity platform post the financial crisis, we spent a lot of time thinking about, in the world of passive, what is a defensible business proposition in active equities? And we quickly alighted to the notion that if we can generate a return stream they want, they can't replicate, then we have a potential opportunity. And so we measure all of our investment teams in the good markets on their idiosyncratic or nonsystematic returns. We look at that on a rolling basis. We measure it quarterly for them. It's part of their scorecards. They look at it. I think it's a really important discipline. That is in the fundamental streams screens we look at as we look at potential managers to buy. Secondly, we're a firm people in this space want to work at. There are just fewer and fewer homes for talented long-only managers. And I think we have a proven track record of giving them the rope, giving them the resources and staying out of their way as investors to help them accomplish their objective. That doesn't mean we aren't a pain in the a** when we're negotiating with them and setting the guidelines around what they're doing. We are. But we fully integrate them into our technology and distribution platforms, and we let them run. And that has been pretty compelling to attract and retain talent. I think that's different. Thirdly, I would point out that there's a degree of luck in it. And I don't mean to be flippant about it, but Bernstein was done as a value shop. We didn't go and build new value teams. We went and built new growth and core teams globally. And it's -- those have been -- growth in particular has been the factor of choice. That being said, had value flipped back, I'm not sure we would have done as well as we have. But at the end of the day, we've also been investing a lot also in our distribution, in particular, how to position us, how to inform and educate clients and how to measure our performance because we're pretty prescriptive in how we define what we're delivering and hold ourselves to that, whether it's in ESG, where I think it's critically important because of the pervasiveness of greenwashing, but also in more traditional spaces, they want to see how you're generating those returns. So we're very transparent. So I don't know that any of them in and of themselves, those factors, is unique to us or disproportionate. But I think the combination has worked well.

I got you. So speaking of distribution, your Private Wealth business had a really nice turnaround recently. We've seen it accelerating growth over the course of the year. Maybe a couple of points on sort of the drivers behind it and how you're thinking about sustainability of organic growth from that part of the model.

Look, better performance certainly helps, and we were struggling with that a bit last year. But the fact is our value proposition has been and always will be, if it's up to me, around wealth planning. We're really good at it, and I'm a client of a number of shops, my old shop included. And we're just different, and word-of-mouth is how we win with centers of influence. That has -- we need to continue investing to build out those capabilities beyond just wealth management but life advice and so forth and building a compelling, curated set of pieces on lifestyle and living. We're doing much more of that. Additionally, we've opened the platform to feed more open architecture and alternatives. I know that sounds paradoxical to you. But I don't think most of our clients care anymore about open versus closed. And absolutely, I'm speaking my own book, but I managed JPMorgan's business and private bank and Chase in this space. I think the discussion among clients in the core of their portfolio isn't about open versus closed. It's about passive versus active. And we have a better mousetrap. We use passive extensively. We don't have unintended bets with multiple managers doing the same thing. So we're much less diversified. We're not overdiversified. And we have one layer of fees, and we tax-manage. That's pretty compelling. So we're cheaper. But that's not why people buy. They buy because they trust the FA and they see value in the wealth advice. And I think we are increasingly recognized for that. We train all our own. We don't hire from others, and that slows our growth for sure. But we're also not buying books. So it's a very distinctive approach to the business, and it's been really important to launch a number of our new strategies particularly in alts. So we think it's integrated and important to our longer-term success.

Yes. I mean at the end of the day, it comes down to returns. To your point earlier, the 60-40 is broken. You got to provide something a little more differentiated in the wealth channel.

That's right.

That makes sense. You mentioned ESG. Let's pivot to that and spend a couple of minutes on that. Obviously, a very important theme for the industry broadly. AllianceBernstein ESG portfolio was purpose -- now stand, I think, at about $27 billion. And you highlighted a number of upgrades these strategies got over the last couple of quarters from consultants, et cetera. So maybe walk us through how you construct and differentiate these strategies in the marketplace, again, with so many other managers jumping into the same -- on to the same theme and whether or not we should expect to see sort of further acceleration in organic growth from these strategies?

We are seeing it. They have been a really important driver of our organic growth in equities this year. And the support we're seeing from them institutionally is very encouraging, and that's global. But let me go through that. I don't share this sort of notion that ESG is the godsend for active management. If you're underperforming, you're underperforming, and you can underperform on that axis, too. And so in my way of thinking, we've got to apply our fundamental research orientation and skills and do this better with the particular point of view that resonates with people. More than 2/3 of our assets already integrated, that's table stakes, to borrow from you. We have databases for fixed income and equities, but we are sharing data on common issues around ESG factors. But we take it much further, and let me be very specific. First, we entered into a partnership 3-plus years ago with Columbia and their climate school. We were their first partner. And we developed with our people a curriculum for just our investors. We put every investor in the firm around the world through that program in order to make sure that they understood the impacts, the negative and positive externalities of climate change on the cash flows they're discounting. And so it really is incorporated. We've also transitioned that partnership, and we brought a lot of -- over 1,000 clients and consultants where we've transitioned that partnership into an ongoing research agenda, which we jointly author and research with the Columbia professors on various topics, on cold fusion, on melt, on carbon sequestration. I can't even pronounce it anymore. So we have a constantly evolving agenda. And we're measuring, which I think is the final point. The portfolio is with purpose. We try to use an activist approach to investing and use our proxy voting hand-in-hand to effect change beyond just incremental returns. For example, we focused on 350 companies that we cover and petitioned them and their Boards to include specific climate targets in the compensation of their corporate officers, for example. It's becoming more and more of the unifying agenda for the firm, and it helps that we've been delivering from a performance perspective. But that's not a given. We're going to have to deliver on multiple levels to keep that momentum moving.

Do you think that mode that you're just describing will be enough to prevent passive from coming after that corner of the market, right?

No, not at all. I think passive will be, over time, as threatening there as it is across the [ house ]. I don't believe there's a natural level of passive. I think you're delusional to think there is.

Yes.

The proportion of a client's liquid assets in passive could be 100%. So you better figure out a way to be relevant, net of fees, net of taxes.

Right, right. So speaking of fees, one of the points I made earlier that you guys have enjoyed stable fee rates, and a lot of it is a function of the mix given your growth in active equities, given your growth in private markets. As you think about direction of fees and any risk you see in any parts of the model relative to your returns, what are some of the key kind of risk areas?

Look, it's from where you start, right? So the firm was 70-30 equities 15 years ago. At the bottom of its recovery, it was 70-30 the other way. So we had a little tailwind by nature because we're replacing lower fee in fixed income with higher fee in equities. I think that has a good long way to run, but alternatives has also been in addition to that. And by the way, Alex, I don't know of a category where we've seen real stability. I think there's weakness across the board. We even see some weakness in alternative strategies. Weakness is an overstatement but maybe less pricing power than there once was, and we shouldn't be surprised by that. More than all of our stability and slight increases in our fee mix is -- fees has been due to mix. So I don't want to leave people with the impression otherwise. I would tell you that quarter-by-quarter, we will likely miss that by virtue of winning a big lower fee customized retirement solution mandate, doing some big passive stuff for Equitable or another big institutional client. So it's not a given, but I think the trend continues.

Got it. Well, sticking with P&L for a couple of minutes, let's talk about expenses and margins. And look, inflation is clearly top of mind for investors today at this conference but really over the last several months. You previously talked about expectations for expense growth to maybe reaccelerate a little bit as the world normalizes. So any framework we should be thinking about expenses for AB into '22? And maybe from a maybe multiyear perspective, your comments on the operating margin would be helpful as well, taking into account some of the incremental inflationary pressures.

Sure. Look, I think we were surprised by the inflationary pressures that became evident after the first quarter. In particular, wage price inflation in the financial services sector, which really hasn't seen that other than in the private alt space for a long time. I guess people in this room don't need me to tell them that. I'd see that as transitory. I don't really see that as permanent because I don't think the dynamics have changed structurally. It will accelerate our replacement of -- in functions of technology for people, as it will for, I think, the economy more broadly. And we're on that path. But I would -- and in fact, we are already seeing replacement or greater scalability of people. In fixed income, we've actually lowered the number of people in that business as we've grown assets, absolute numbers. So we think there's more room to run there particularly as trading and research becomes more automated and electronic in the way it's transacted. I'd further say that lower-wage people were overdue for increases. So I don't think that's coming back. I just think there will be fewer of those roles generally in the economy. What I would further say to you is that the increases in market data, consultants' fees, those were higher than we had anticipated. And now market data always has this blessed position of being able to outpace inflation. It's only caused us to work a lot harder in thinking about ways to seek alternative sources of that data or use less of it. So I think it -- there are limits to our willingness to absorb those costs, but they've been more meaningful. I think that travel and entertainment have gone up, but the overall level of travel will not. We will never have the degree of business travel that we were used to in 2019 and forward. So I don't think that's coming back. So I think the pace of increase in expenses will be lower next year, but it will still be elevated relative to prior years. From a margin perspective, look, we think it's very important that our incremental margin be between 40% and 50%. We think it's a high-margin business, and we should be able to demonstrate that to our clients. We're not -- I'm sorry, our investors. We're not going to do that every quarter, every year. But this year, we're pacing the 49%, which is lower than we've been in prior years. We've been investing a lot in private client, in our distribution spaces and in private alts. So I'm comfortable with that. We can afford it because we are getting incremental growth from it.

Yes. Great. We've got a couple of minutes left on the clock. So if anybody has a question, there should be mics coming around. We have one up front, please.

[indiscernible] Nashville...

Is your last name Bernstein?

[ It is ].

Okay. Then I'll answer the question.

It's a question on Nashville.

Nashville is working well, but let me go through that. We have about 900 people there, so we're about 3/4 of the way. Our target is 1,250. Of that 900, about 175 have migrated from other locations. The rest we hired there. So we were able to hire the kind of talent -- people were willing to move there, whether it was from New York, Atlanta, Chicago, where there was a deeper bench of financial expertise to tap, but that doesn't mean we've been able to fill all areas. It's not an area of tons of international tax expertise, for example. It's a domestically oriented industry, health care, that dominates the economy. What's interesting and we didn't count on, we may have been -- I wish we had moved 2 years earlier because one of the reasons, critical reasons we moved was, we knew we were pretty high up the food chain for investment talent, and we didn't think we were anywhere on the food chain for technology talent. And we knew that tech skills, data skills, digital signs generally were arguably the most important issue we had in terms of evolving the business over time and had to come out of the factory on to the floor in the individual areas, be it client groups or investment teams. The people we're hiring are much more proficient today. Everyone in fixed income we hire can write in Python. I don't know what they'll write in tomorrow, but they're much more programming-oriented in the way they're approaching their job. A lot easier to hire there than here for that stuff, here in New York. What we didn't anticipate was that Amazon was going to put 5,000 PhDs in their logistics group out there, and Oracle was going to follow them. Long term, that's fantastic news. It will create a node in Nashville with a lot of tech talent. But in the short term, it's made it really hard for us to hire. So that's the one part of it. The building was later than we would have helped, but everything shut down during COVID. But all in all, I think we're looking at sort of 4% accretion this year for Nashville. And we're still looking at the $75 million to $80 million of savings once we roll off the leases here in New York. So it's been working pretty well so far, but it's not over.

Great. One right here, please.

I would like to [ talk about ] a number of my questions.

But you're not named Bernstein?

Starts with B. Yes, [ but in general around ] [indiscernible] C-Corp [indiscernible] I'd like to [indiscernible]

Right. So a question around C-Corp [ LP ] structure.

I don't have any sort of deep religious conviction about being a partnership. What I do know, though, is as a fiduciary, if I can't be highly confident post the conversion, the stock multiple is going to expand enough to take -- to offset that tax drag, then I'm detracting value from the firm. And so I can't justify it to myself. And the work we've done suggests we're pretty fairly valued against our competitors, including the tax impact -- excluding the tax impact. So it's hard to justify it right now. I would argue, though, and we've done a lot of work around this, the reason the private alts firms converted in part was to get into the indices, which would broaden their attraction much beyond their traditional buyer base. Because of Equitable's ownership, we won't get into those indices because they effectively have a control position. And so the lack of liquidity, even if we were a C-corp, would still be a hindrance in attracting shares -- I'm sorry, building a position stock. So I'm not -- it's not obvious to me that these benefits are that compelling. Sorry, $0.04 -- not 4%. I thought I said $0.04. I apologize.

I thought you said $0.04 as well. Yes, yes.

Okay. I'm going to get yelled at later.Sorry.

Great. All right. Well, I think we'll leave it at that. Well, Seth, thank you so much for doing this.

No, thank you all very much.

This was great. Great to see you in person.

Take care. Thank you.

Yes.