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

Before we get started, for important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Good morning, everyone. I am Mike Cyprys, equity analyst covering brokers, asset managers and exchanges for Morgan Stanley Research. And welcome to our fireside chat with AllianceBernstein. And we're excited to have with us here, Seth Bernstein, President and CEO of AllianceBernstein. Under Seth's leadership, AB has been a standout with consistent positive organic growth with strength across active equities, fixed income as well as a growing contribution from private markets. AB, as many of you know, is a leading global investment management firm with nearly $700 billion of assets under management. Seth, thanks for joining us here.

My pleasure. Thank you for having me.

Great. And welcome back. It is good to see you again in person. I know very bright here with all the lights.

It is just totally ridiculous.

All right. Why don't we start out with the current environment?

It sucks.

Well, maybe we could double click on that. I'd love to get your perspective here just a little bit more broadly on the macro. Clearly, a different picture than what most of us expected heading into this year. As an experienced executive, you know having lived through many cycles...

Age difference. It's okay, I am over it, over it.

Experience tenure, how are you -- oh, they dimmed the lights a little bit. Thank you so much.

They do that. Thank you.

Just -- so how are you thinking about this period of higher inflation, higher rates, elevated market volatility? And what does that mean? What are the implications for a money manager like AB?

Let's start with the implications upfront. I think the implications are pretty clear. It's going to be -- it has been, and I suspect it will continue to be a really tough year for money managers generally, arising from the fact that it's a procyclical business model. It doesn't get a lot more procyclical. Well, you have a lot of leverage, it does, I guess, but we don't. And so you rise and you fall with markets. But the ultimate underpinnings of the industry remain compelling. You feed on a -- on an asset, which has a positive long-term skew from the valuation perspective as the prices tend to go up over time in equities. It's an ad valorem in the sense that irrespective of your contribution positive or negative in the strong market, you're going to do better, whether you deserve it or not. The capital needs are de minimis, and it's a pretty high-margin business, and if you're returning it to shareholders, it's a pretty -- it can be a pretty attractive proposition. It helps that it serves a public good and it's a demographic matter, people need to be saving more. So broadly, I think the industry was complacent that those factors would continue to protect it forever. But of course, digital -- the digital evolution, data science has changed the game pretty profoundly and the water is getting hotter in this pot. And so we have to figure out whether we have to jump out or not. But in the sense that active management has to prove it's worth every day. The people in this room who are managing money have to be generating better returns than a client can otherwise get by investing in a market-weighted, cap-weighted index. That is a tough hurdle. And the industry, by and large, has failed across that hurdle. The macro environment we face today is unlike any I've lived through in 40 years in the -- or nearly 40 years in the business, in that we are coming out of a period of remarkable fiscal stimulus, coupled with the most fluid and relaxed monetary policy any of us have lived through. And that's been going on since the financial crisis to varying degrees. And so we have to raise interest rates, while at the same time, the Fed is going to be reducing its balance sheet, which will more directly impact the backend of the curve. At the same time that fiscal stimulus is running out, and I suspect won't be renewed at least in the United States, just given the likelihood that of a Republican victory in November. And so with that sort of backdrop, it's a pretty volatile brew. That's okay. The industry needs corrections or self-repairing and we're now getting to the point with the backup in rates, which has been at a faster rate and more severe than any time in my lifetime certainly, where it's become pretty interesting again to be a fixed income investor. And indeed, we are beginning to see clients, particularly offshore, wanting to have fixed maturity bond -- fixed maturity fund offerings because they want to call the top. Now I think it may be premature to call the top. I think you need to see the Fed really take decisive action and meaningful changes in CPI. We've got to break the back of the momentum and last Friday clearly didn't help and the market reaction reflects that. So I don't think there's news to people in this room about what ails the country from that perspective or the broader global economy. But fixed income is becoming much more attractive. It's gone through a very tough period where even its role in a multi-asset portfolio was in question, certainly by people like me. And so I think that evolution changes. I think with respect to equities, we've already seen the 30-odd percent drop in growth from its peak, there's more to go, which I think is healthy. The breadth of this market needs to become wider and that's important for the ultimate viability of the economy and the global economy. And so I think it's ultimately a good thing, but there's going to be a lot of blood on the floor and there already is.

Well, that's depressing.

Yes. Okay. Well, you asked. I'm just giving it to you. What do you want?

Okay. Well, against that backdrop, maybe let's shift and talk...

Well where have you hidden? Where have you been able to hide? And then when was the last time a fixed income investor had a 12% negative return, right? So it's been awfully tough, but you all know that, if you don't, fair, you should.

We'll come back to some of those themes we'll dig in a little bit. First, let's shift and talk about the firm's strategy. You've been CEO now going on 5 years over...

Over 5 years.

Over 5 years, okay. Over which period AB has distinguished itself as an organic grower and what has been a difficult environment for active management, broadly speaking. So can you just update us on the firm's strategy going forward? And what should we expect that might be different or similar versus the past?

Fine, happy to. AB had its own sort of near-death experience back and after the financial crisis, which was self-inflicted. As a private client, I felt it in a very real way. And my predecessors, I think, did a remarkable job making tough decisions, stripping back everything it could in order to reinvest and rebuild a much more diversified and robust equity business than we had before and to start a private alternative business. I took that lead and ran with it. I wish I could take entire credit for it. My mother used to tell me I should, because they're going to blame me when it goes wrong. And what they did and what we've continued to do is to look for teams where we think they have an enduring edge, a different perspective and a pedigree that we can get the scale faster than they can do it on their own or at their current employer. And what we do to analyze that is we try to regress the return streams against the factors that underpin them and see if there really is a persistent idiosyncratic return -- positive return because that is the only reason a client is going to buy my strategy if they're defaulting to pass it in more liquid markets anyway. So I've got to earn my place in that portfolio. And we've done a really good job. We track our teams on those metrics. Ultimately, my dream would be to pay them on those metrics, but I'm a taker of talent, not a setter of pricing in the marketplace. So we've done a very good job rebuilding the equity teams, and I'd like to continue doing that. So I think a message there is we will continue to hunt for teams in little parts of the market, whether it's EM in China, in small cap and spaces where we feel we could take them to a much more interesting place. And I think the competition, unlike in private alt is much less, and the payback is much faster for us and our unitholders. So we will continue to do that. We will -- so we will continue to diversify the platform into private alt. We've just -- we will close at the end of this month, beginning of next month, our largest acquisition since Alliance's purchase of Bernstein -- of CarVal. CarVal more or less -- it doesn't double, but it gets us up to roughly $50 billion of private alt, almost all of which is private credit. That's where we want to be for 2 reasons. One, I think we're still earlier in the development of that market, having grown up in fixed income. It's one I've watched both on the private and public side for a long time. Secondly, our relationship with Equitable and our institutional links more broadly enable us to have a pretty compelling proposition to a management team to say we really can get you to scale faster, and we have a track record with our commercial real estate debt teams, with our middle market lending team of giving them the autonomy and the resources, the risk control distribution capability, operational and technology support to let them grow and be an increasingly important part of our mix. So we're going to continue to diversify. If you look at our forward calendar and our backlog and it's really been -- except for the really lumpy target date things we win, it's really the largest single source with public equities in our pipeline, and continues to be. So that's where we're going to continue to focus. We have a fixed income business, which really is income-oriented. It's been traditionally, despite what I just said, more retail-oriented. And we've been very strong in Asia. I wish I could tell you that was visionary brilliance on our behalf. I think part of it was luck and great local management that enabled us to do it, and we want to continue capitalizing by advancing and building out in China. We've been approved. Let me be clear what I'm saying. The regulator has approved us filing our application. We have not received our application yet -- I'm sorry, our approval to operate yet as a fully owned foreign management -- funds management company in China. But we're hopeful that we will get that. And that's despite the noise in U.S. -- Sino-U.S. relations. I think it's a once-in-a-lifetime opportunity because China will close the store at some point. And I think interestingly, we have a reputation that's much greater in the East than it is here in the West because of our success in Greater China. That's what we're up to.

Great. Why don't we shift and talk about flows, I'll start first with fixed income, touching upon some of the themes perhaps you were mentioning earlier. So AB has a strong high-income suite with retail fixed income, particularly non-U.S., a recent source of pressure that as it relates to flows. So I guess what's your view on what inning are we in? At what point are rate increases going to be enough to sort of entice investors to come back into the space? And are any green shoots emerging?

Yes, there are. As I mentioned earlier, we're beginning to see private banks and others begin to sponsor fixed maturity fund issues, which is when they're ready to call the top. I think we're -- it's still a little early. But when you look at pre-fee yield to worst on our global high-yield fund, you're in the 9s. These are becoming pretty compelling numbers for people to get into. The issue is what are your inflation expectations. I'd note that breakevens -- inflation breakevens actually are down significantly since April. And so whether the world thinks inflation is beginning to -- the growth in inflation is beginning to base down, the markets are beginning to recognize that. I still think we're a quarter or more away from that when there will be decisive evidence that gives people that comfort to invest. Credit defaults have not yet spiked up. That's the other shoe to drop. I think it's less of an issue than it was post the financial crisis for sure. And look, there are weaker credits and weaker standards out there. But the fact is there's still an enormous amount of liquidity in the system. That will be soaked up over time. But they can continue to fund themselves at the moment. We haven't seen defaults yet pick up in our portfolios. We tend to be more diversified than most of our peers, which enables us to ride that out, but we tend to be long credit as a firm. So our outflows in Asia have been pretty modest given the rate increase we've seen and certainly relative to history. But -- and -- we have a few days of inflows from time to time, but it hasn't shifted. I don't want to give you -- muni SMAs in the U.S. have been sort of remarkably consistent for us. They're not as high as they were last year or earlier this year. Seeing brackets around your returns at the end of the first quarter was a pretty sobering experience for most wealthy individuals who haven't seen that before. I think they're going to see it again in the second quarter. So I think there's more disruption to go in the muni market, but the muni market is pretty attractive on a taxable equivalent basis and certainly on a credit adjusted basis. So we've been bucking the trend, and I think we'll continue to for a while. We have a better product, I think, than number of our peers.

Great. Why don't we shift and talk about equities? You've been one of the few players in the public domain that has been consistently putting up positive flows into active equity products. I think a lot of the strength you've been having there has come from some of your non-U.S. and growth-oriented products in some areas where performance has perhaps slipped a little bit more recently. So perhaps you could break this down to product performance, distribution. How do you see the growth trajectory going forward on the active equity side?

Look, we've been pleased by continuing positive flows in equities and we had a bit of a bounce back from negative flows in April and May, as I think most people could see in our AUM report. Equity was a driver of that. We continue to see good demand for our growth products in Asia generally and Japan in particular. Part of that is also helped by the weakness in the end. So it's not just us. We did see performance weaken. We had much less of the mega cap stocks in those portfolios that's actually helping us now. So our relative performance is picking up, and that's been pretty good. We've seen institutional interest and in fact, demand is switching more to institutional in our value products and in our core products, less obviously in growth. But it's -- institutional is more episodic, but we're seeing more consultant interest and focus around it. So we've seen a modest improvement in investment performance both in equities and in fixed income over the course of the second quarter. And I hope that persists. We -- look, I think with regard to small cap, which has been an important area for us, that's been amongst the hardest segments. Of course, it has. It has a tech orientation, and it's very long duration. It's getting -- it's looking a lot more attractive. And so I'm not comfortable yet calling it, but I think you'll see a reversal later in this year, beginning of next year in terms of demand for equities more broadly because ultimately, I think we're going to head into a recession faster than a lot of other people do. Certainly, Europe is. And I think the sooner we do and the quicker we mark ourselves to the market, the quicker the recovery can get started. So I do think there's an adjustment underway.

So do you think we need to be kind of heading into the recession for equity close to recover or kind of you'd be going through it?

I think it will be going through it.

Going through it. Okay, let's talk about distribution. I think your global distribution platform is a key element of the success that you guys have been having. Perhaps breaking it down to the institutional and retail side. How does AB differentiate itself when it comes to distribution in the different regions? Where have you made some of the most progress? And where do you still have more opportunity ahead?

Look, Asia has always been a star for us on the retail side. It continues to be very strong for us. And I think it's reflecting itself frankly in the smaller outflows in fixed income than what we would have historically seen there. So it's not accretive from a revenue perspective, but it's defensively valuable at this moment in the cycle. U.S. retail has really been growing robustly for us. And we -- our first quarter was our second best -- or no, it may have been our best gross sales quarter ever, and that was really driven principally out of the U.S., which is really the first time where we've seen that kind of support out of the U.S. Part of it is fixed income and the SMA side in particular, but much more of it is on the equity side. So that's really where the strength, and Europe has been cutting along and -- but has not been a big contributor to us yet. We continue to do some tactical hiring in Europe to beat ourselves up in Italy and other countries where we see real promise. We're a very small player. So market share gains for us are not that hard. And that's true in the U.S. as well. And so that's been a [indiscernible]. With respect to institutional, it took us a long time to repair our relationships with the consultants following 2010 to 2014 -- 2009 to 2014. We have gotten an enormous amount of support, and that continues to be the underpinning of what is a more robust institutional pipeline than we've had historically.

On the retail side, can you just, maybe spend a moment just talk about how you're servicing and interacting today with the retail wealth intermediaries, how do you see that changing? And how do you expect this to look in the future?

I think more of it will be home office focused. That trend has been going on for a while for the industry generally. We're certainly equipping our people when they're out in the field to be much more thoughtful on how they structure their calling efforts and utilizing mobile technology to understand who owns what in that office, what's selling, what's not selling and specific -- highlighting specific funds proactively that compare well to existing fund selections that are -- that these brokers have on their platform and have given to where our clients stay. So we're much more proactive in that dialogue, training them to deliver that in the course of those meetings. But the home office is making more and more of the decisions. We spent a lot of time in terms of educating them in our approach to managing portfolios, our risk overlays, our ESG integration and philosophy around managing portfolios for purpose, which is our brand of what we do, where we're trying to measure nonfinancial returns to the portfolios we manage. That has resonated quite a lot in terms of educating people. It's also in regard to retail practice management. We've always been good at, and it's one of our key calling cards when we go into the big wire houses and some of the regionals and helping them train their FAs. So we see it as a comprehensive ongoing training program, complementing the underlying product performance and communication. So I think it becomes more automated over time, more of it's centered in Nashville than it's been historically here in New York, most of our salespeople are now located in Nashville or regionally in the offices they're in. And that transition has gone very well for us. I guess the final part of our distribution, people look at our private wealth business differently, but it is a distribution zone. It's been critical to the development of our private alt platform, but also now is continuing to improve and grow. It's about $110 billion of assets at the end of the first quarter. So presumably it's lower today, but has been continually supportive of the strategies we've been developing.

You mentioned portfolios with a purpose. Why don't we talk about that? ESG remains a really important theme for the industry, you guys stand out with about $28 billion in those strategies, I believe. Can you just walk us through how you construct these portfolios, how you differentiate these strategies in the marketplace versus others that are out there?

Yes, I think we take -- we started -- our firm has always been hyper analytical. It's just who we are. We overthink things. We have too many consultants who now have jobs there. And so we really were thinking about, first, how do we make our -- all of our investors irrespective that they are managing portfolios or purpose or not aware of the externalities of these clients -- I'm sorry, these companies' operations and making sure when they're discounting those cash flows, that are incorporating those negative externalities or positive externalities, again, even if they're not focused as an investment goal or theme around achieving nonfinancial improvements on behalf of our clients. I'm very comfortable we have given them now the training through our joint curriculum of Columbia, where we forced all of them, some weren't really jumping up and down to do it, to go through and learn about climate change and its first order, second order, impacts and what -- how to think about these evolving challenges that we're facing and the new opportunities that fall out of that. In addition, we have a research agenda that we developed quarterly with Columbia that rolls forward on a variety of basic research topics. We're not asking us to tell us how to invest. Rather, we're asking -- asking them to help us think about fusion and nuclear power and how it evolves and becomes part of a solution rather than part of the problem. Because even in ESG, there is a considerable debate of what is qualified and what is not. So in France, nuclear has always been part of the solution. In the United States, we haven't built a plant since the mid-1970s, which is I think really problematic because I think nuclear has to be part of the solution. What we won't do is exclude if a client wants us to exclude a sector, we of course will comply with that in our portfolios with purpose. We have funds that wouldn't be classified necessarily in your definition of ESG because we're looking to reduce, for example, carbon footprint. And so it may be that we own Total because they're going to be generating incremental cash flows and actually reducing their carbon footprint over time. If you look at the firms that have filed the most-green patents, patents that seem to be related to reducing carbon emittance. A vast majority are filed by exactly those companies. And of course, it is. It's the companies that have to deal with the real-life issues around the negative externalities of their business. And I think for a number of clients who want to think broadly, your impact in improving maybe better in a striver portfolio like that than one that just avoids on its face hard asset companies to invest in. But as the controversy is around DWS and what we're hearing about with the SEC continue to evolve, the industry and the regulators need to sit down and finalize and define what we mean by these terms that we're throwing around so loosely because I worry that clients don't necessarily understand what they're buying, don't understand that there is implicitly a cost to excluding sectors in their businesses. And thirdly, that regulators will use it as an opportunity to pick off companies who may deserve to be picked off, but we want rules to understand how the world works. And so I think it's an evolving business. I think we've taken a thoughtful approach to it. And I think we'll continue to grow. It has resonance with not all our customers, but with a growing piece of our customer base.

If I could just follow up on that point there. You raised an interesting point around it doesn't resonate with all customers, maybe some, but how do you navigate that from a broad-based perspective when you think about ESG, different -- it means different things to different customers...

Correct.

Which means customization becomes maybe more important. So how do you see that? How do you...

Much easier to do with institutions. Look, we have -- doing business in China is a big issue for some of our clients, some of the places we do business. I'm just pointing out there are lots of issues beyond whether it's a green fund or not that get clients agitated today. So institutionally, we can structure around what they want. We need to be totally transparent and measure what we're doing. And I think keeping it simple, keeping it focused and keeping it straight is how we're going to navigate this effectively. We are not all things to all people. On the other hand, I think we've got 30-plus years of transition to a non-carbon-based economy, and it's a rich man's problem to sit here and criticize it and shut down all coal plants. But when you're in India facing 43 and 45-degrees Celsius weather every day, are you really going to shut those plants down? Even though they're contributing to that? No, you're not. And so we need to just be clear about how we're trying to navigate. Some people will accept it, some won't. But we need to make sure that people aren't misled by what we're doing.

Okay. Why don't we shift and talk about expenses? AB has shown some good margin expansion in recent years, including during the pre-COVID periods. So I guess how are you thinking about managing margins here? Can you maintain the momentum and pre-tax margins that you gained during the pre-COVID period?

Look, we've asked people to focus on our incremental margin and our incremental margin in the first quarter was negative. Of course, it was asset prices declined and our expenses didn't decline proportionately to it. It will be very difficult for us to maintain that progress that we've had. And we've been pretty, I think, clear with people who follow us most closely that were price takers of talent, not price setters of that talent. People in the industry know comp is going down by -- just by a function of where asset valuations are. But it also is a function of investment performance and it's a function of flows. And so we're very clear with our people about that, and there is flexibility in our comp to revenue, but it's not necessarily only in one direction, which has been down, we were over 50%, I believe, in the years prior I arrived. We were 46.4% last year. We're going to try very hard, but I suspect we may see some weakening of that trend this year because we're in a down market. But we're a cyclical industry, and we're -- and our largest single expenses...

And how are you thinking about managing the trade-offs around managing costs and are growth projects still on the agenda year?

We have 5 key initiatives that we're really focused on. We're going to continue to fund them through the cycle. We're going to try and defer other things. We will defer other things and maybe even slow down some of the things. We don't have to do this year or next. But our goal is to continue building out in China. We have to build out our private alt business. We will continue to invest in our distribution platform. We will continue to build out our private wealth business. And we will continue to deepen the technology integration across the firm. So we're going to do all of that, and we're going to have to fund that by being much more disciplined in how we're -- what expenses -- discretionary expenses we can take on and make some tough decisions.

Now you guys were ahead of the curve with the move to the Nashville relocation. How much more runway is there from a P&L perspective with that? Are there opportunities that the firm might look to just as an effort to move the cost curve down?

Well, look, we've already -- we initially indicated we were going to move 1,000 jobs to Nashville. We've up that to 1,250. It could be higher than that. We have investment teams who are interested in relocating portions of their team down there, and we've already done that with parts of fixed income and parts of equities. I suspect that will continue. We will -- the big -- well, Nashville's already a positive contributor to us. It's been accretive. It was accretive last year to the tune of $0.06 per unit. The real payday doesn't happen until the leases in New York run off, which is in -- at the end of '24. So the big impact is still out there. So we were forecasting between $75 million and $80 million. We're continued to be comfortable with that estimate. The dynamics of how we're getting there is changing, but we're still comfortable with that estimate.

Great. Why don't we see if there's any questions from the audience? Over here. We have a question up from the front.

Could I just ask a little bit on the kind of evolution of your distribution strategy for Europe? And what's the importance of, say, fund distribution platforms versus going direct to wholesale channels and others? How do you think about the approach from here?

Look, I think in certain parts of Europe, we'll go to the fund distribution platforms, Italy being a perfect example of that and Spain. In the U.K., given the concentration, that's increasingly the case, but you are still the big IFA market in the U.K. and the [ OIX ] platforms are very important for us. So we'll continue focusing there. I think in Germany, it's more of a mix for us. But ultimately, we have to pick the markets where we're really going to play in aggressively. We don't -- France is not a market that we have a particular edge, France is a very big domestic fixed income business and tends to be more fixed income oriented, while Southern Europe is as well. They're much more open to nonlocal players in that space, and we've had a lot of resonance there. The U.K., we've always been underpenetrated in, and we've seen some real momentum in the last 1.5 years that continues with the big, I guess, for lack of a better word platforms. And so I'm hopeful that will continue to be the case. But we're going to use a lot of technology, and our goal is not to put people on the ground everywhere.

About 2 minutes left. Maybe with the remaining time, we could talk about alt and CarVal. You announced the acquisition back in March. Maybe you could just update us on your alt footprint here now post that.

So we will close at the end of this month, beginning of July. We'll have roughly $50 billion of private alt. The vast majority of that is credit. We have really 4 principal teams. We have a middle market lending business, which was the first that came out of Barclays after the crisis, and we've built it a lot. We just hired a small group of people and now built it to about 45 or 50 people based in Austin. That's the single largest piece today. Then we have a commercial real estate debt business that was part of our larger real estate footprint. We spun off our equity part of that business, the company is now called Prospect, which we continue to distribute for them, in our Private Wealth business. They've had terrific returns. But we were not making any money on owning it. We have started a European commercial real estate business that has attracted real interest. Now my own thought is as market slowdown and the economy is weak and real estate will be hit first in terms of new development and financing. There will be prepayments will slow for sure in Europe and in the U.S. So those may slow, but middle market lending, we haven't seen that yet, but I suspect it will be sensitive to the market as well. CarVal is the final piece of that. CarVal has been around for a really long time. I've known them when I was in High Hill 30 years ago. And I've always admired them a lot. They tick off a lot of boxes for us, whether it's in renewables, infrastructure, transportation, based lending, asset backs, distress. So I think we have a lot on our table. And frankly, the job really begins now after we close. We don't want to blow it. And we also don't want a multi-boutique. We don't want a lot of locked fixed costs in the system. So we want to keep that investment engine independent, robust, making their own decisions on people and comp, but we want to manage the rest of the business centrally, risk controls, platform, sales and basic corporate structure. So that's our goal. It's not that complicated. I don't think we're doing anything big. We have a lot on our plate right now in terms of acquisitions. We'll continue to talk to teams in equities and fixed income that offered a multi-asset that offer sort of differentiated return streams. That's our plan.

Great. Well, we have to end it there. We are going out of time. Thanks so much, Seth. Thank you.