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

Okay. Wonderful. We're going to get going with our next session. It is my pleasure to welcome Seth Bernstein, President and CEO of AllianceBernstein, with over $600 billion announced under management. AllianceBernstein has been one of the best organic growth stories in our space as management continues to pivot the business towards faster growth areas such as private markets, including, of course, some of the recent acquisitions you guys have made in the space. In addition, the firm's partnership with Equitable and its sizable wealth management franchise provides the firm with unique product development and growth opportunities that help AllianceBernstein navigate what obviously has been a more challenging macro backdrop like we've seen this year. So Seth, welcome. Always great to see you. Thanks for being here.

Thank you, Alex, and thank you for reading my script. I think you did it beautifully.

[So you try]. My introductions keep getting longer and longer. I keep reminding myself that I've got to try to shorten them, but there's a lot to say. So look, I wanted to start actually on some of the recent announcements, you guys announced a sale or partnership, the GB partnership with SocGen for the research business with an option eventually for SocGen to buy you guys out entirely in 5 years. So before we get into the core business, the asset management business, maybe spend a minute on the structure, why structuring this way made sense for you? And ultimately, what are some of the revenue and cost opportunities you could see for that business as a larger organization and which way you guys will be able to participate in that?

Okay. Thanks. Look, if you were going to build an asset management business from scratch, having a sell-side research business is sort of intuitively the core business...

No offense...

No, no. I'm just sort of saving the obvious, but it has long been our brand. And a lot of the people in this room, I think, even some of the cheaper ones I know in the room actually pay for the services from Autonomous and our Bernstein clients. So it has stood the test of time. I think it has a reputation, which is unusually strong in this space. But the industry is faced with the secular challenge derivative of active management generally. And so the business has been one where it has continued to evolve where our principal competitors, the bold bracket firms use it as really a cost center to support a range of other businesses that are critical to its P&L and its corporate relationships. So a tough market for us to compete with, tough market to see secular growth in. And I concluded a long time ago that we may not be the ideal owner of a business like that long term, but it is our brand. And we've gotten a lot of really talented people who have come across the aisle and have played critical leading roles in AllianceBernstein, and we continue to benefit from having them. They're profitable, not as profitable as the rest of our business. And so we've been thinking about how to maximize the value of it in a way that ensures that there's a really attractive career path for the analysts in that business because that's what SocGen is buying into. What we saw was that SocGen has 3 revenue streams that other firms benefit from that we don't: prime brokerage, equity derivatives and in equity capital markets. We're not a principle so none of those are available to us today. And we wanted to find a partner who had those capabilities or the potential to develop them because we thought the revenue synergies and adjacencies there would prove attractive and could ultimately enhance the growth potential of that business. In fact, in my mind, SocGen is an ideal partner in that regard because the cultural risks of the transaction were reduced by the lack of overlap, both in the United States and Asia, which are the preponderance of that business. There is some overlap in Europe. It wasn't critical for the economics, at least as we were concerned with respect to their ability to actually create an equity capital markets business or for that matter, to grow the prime brokerage business. They're a preeminent equity derivatives player, a critical capability for a lot of our sell-side clients, particularly our hedge fund clients. And if we simply could tap into that, that could be much more valuable. From our perspective, what does it give us? It gives us a much simpler business model going forward, it reduces our capital deployment significantly reduces our complexity as a firm. And frankly, we think there's upside to the valuation, which we haven't disclosed, but we think it's pretty compelling, given the business' value as it exists today. So the question is, what do we do with the proceeds of that? We haven't decided that yet. As you all know, we're a partnership. So we don't typically retain assets capital in the business, but we could pay down debt, we could do a special dividend, we could buy back stock. It's more in a year away or it's a year away. So we have the time to figure that out. So I think it repositions us effectively. I think the joint venture protects the culture, which is important. Robert van Brugge, who has successfully run that business for a long time will continue to run it with his leadership team and some members of SocGen joining. And again, the expense savings arising from it are really with respect to Europe, it's really a revenue play in the rest of the world.

Great. All right. Well, let's pivot and talk about the core business, the asset management business for you guys. So if you look at 2022, obviously, a very challenging year for the markets with really an unprecedented rise in interest rates that we've seen in recent history. One of the topics that we've been asking is probably going to continue to ask over the course of the next 2 days is really how that's changing client portfolio locations and we've heard from a couple of private market firms early this morning, but you have kind of a unique position because you obviously have a very sizable liquid business and you're running in the liquid [indiscernible] business as well. So more holistically, how are you thinking about LP or institutional client or retail client allocations evolving on the back of everything that just happened.

Well, in one respect, it's quite exciting in that, painful as it's been, there's been nowhere to hide. So I'm sort of looking forward, not backwards because I don't want to cry again. And when I think about what is out there for the first time in close to 13 years, we're getting nominal rates that are actually pretty attractive. Where fixed income in a multi-asset portfolio actually plays a role other than a diversifier it can actually provide income. So when we look, for example, in our American Income or Global High Yield services, which are flagship products for us, particularly in Asia, the yield to worst on that is kind of high 8s to 9s now. And that's beginning to track flows for the first time in a couple of years, not strong flows, but positive flows. And I think that's important because I think we'll see carry into that once we get past the tax loss harvesting and the issues that we face here in the U.S. in December of this year. So I think fixed income is setting itself up for a much more interesting year that will also benefit us and I think, frankly, income-oriented savers with respect to their fixed income portfolios going on next year. So I certainly think there will be, once we see the terminal rate on 10 years and the Fed begin to actually stop raising rates, which I don't frankly see until the second half of next year, the market will buy as rumor sells to facts. So I think we'll see flows beginning sooner, but I don't know that. I think, frankly, the employment report on Friday should temper people's enthusiasm because given that this is the most attenuated down cycle we've ever seen because there's so much damn liquidity in this system. So as people continue to defer going back into the workforce, inflation remains an issue. And in the U.S., we have a different issue than almost anywhere in the world, our inflation is service based, it's not as much goods based. And we've got to break that. And so I think that that will take us into a recession. And whether that starts in the second quarter, I don't know, but I think we'll begin to see that exit [10-year] rates somehow late in the first or early second quarter, where I think gives people comfort to start stepping back in, in earnest. Look, I think private capital, particularly private credit, has a secular wind to its back. It's certainly a more challenging fundraising period. It's got to be, [you are the denominator of that working] right now. But look, people, particularly retail, at ultra-high net worth are underinvested in the space. They're going to need that income that private credit can provide. So I think that continues to see secular growth. With regard to equities, equities are getting toward fair value again, at least in our estimation. They're not cheap. So I think it takes time. I think there are other macro factors out there. This is a year that's really been dominated by macro, more so than any year I can remember. And one of those macro trends is the strength of the dollar itself, which has been a headwind to U.S. equity earnings. That could reverse as the dollar begins to weaken, as the rate cycle turns. So that could be a benefit for equities next year. But I think analysts need to catch up to where corporates really are, and so we could continue to see negative revisions into the fourth quarter, into the first.

Yes. Fair enough. Taking that discussion more to the micro level when it comes to your guys' business. As you mentioned, AllianceBernstein should be a pretty meaningful beneficiary of return of flows into fixed income products. But at the same time, when we look at the relative investment performance, many active managers struggled to deliver upside against the benchmarks in fixed income. And you guys...

Including us?

Including you guys. So as you think about the importance of relative performance and the ability to capture that flow, is that a huge risk when it kind of comes to getting some of that flow back? And why wouldn't they just all go to passive products?

I think in liquid markets, you should assume a lot of it goes to passive products. We build in equities, in particular, our platform with 2 principles in mind. One, we assume that the core of our clients' portfolios are passive in liquid markets because it's probably the right answer, particularly tax advantaged in the form of direct indexing. So if that's the core, you better have active equities that are providing a high active share [rate] that's idiosyncratic that you can't replicate through a factor and net of fees or ultimately a revenue stream your clients need and want and can't replicate themselves. We're going to ebb and flow like every active manager in that regard. We're very comfortable we are able to do it. That's how we measure our investment teams; we net them against their factors and try to identify that non-systematic component of the return stream, and that's what we look for in new teams that we buy. So I think we are trying to be a satellite provider in those portfolios. There continues to be strong demand for those. But we say that in the context of a market that's secularly declining with respect to the participation of active management. I think in small cap, in EM, there will continue to be lots of opportunities to find interesting managers to buy or acquire that we could get to scale. We're looking to do that. I think that's a much more interesting play for us because the payback is very quick. And so we're looking at that, and it's also from a cultural and operational perspective, not a heavy lift to bring them on. We continue to be very wary of larger acquisitions in that respect.

Great. Let's talk a little bit about private markets. It's been a big area of focus for you guys, especially with the CarVal acquisition a couple of months ago. I guess one, maybe can you update us on their own fundraising efforts and sort of what's coming up for CarVal in the next 12 to 18 months. But more broadly, as you think about how they fit within AllianceBernstein in areas of synergies, whether it's from a distribution perspective or product manufacturing perspective, what are some new things you're discovering now that you've kind of owned this asset for a few months?

So in the third quarter, which was the first quarter we owned them, we saw approximately $2.5 billion in incremental commitments. We are in the market for our clean energy program, it's our second clean energy fund. Initial interest has been pretty strong, and we're also seeing interest to be through our distribution through a competitor of Goldman's now. And we anticipate launching that through our own private wealth channel next year. But look, as I said, it's a more challenging fundraising market for the more macro impacts that I alluded to earlier. But we continue to see very strong interest in it. Next year, their main fund launches, I think, with the next round. And remember, CarVal started as a distressed player. And so we think there's a really interesting potential play. Because this recession, I think, in its nature is fundamentally different than what we've seen post global financial crisis. The Fed is not going to bail it. This could be one of the longer term. This could be one that's deeper. So the quality of your credit underwriting really matters. And frankly, this is a team that's been together for 30-plus years that has experience through cycles. Most people putting money to work today have not been through a sustained downturn. So I think we're going to learn a lot. Additionally, one of the things we're working on with them, CarVal, as well as across our firm are utilizing liquids and privates in vehicles with limited liquidity. I say that fully cognizant of the stories around Blackstone and [AB] I think it's the right structure. I think this is an important test of that market's durability. I think Blackstone did absolutely the right thing. The buyers need to understand that liquidity is not on call. And so that's a maturation question. I'm really interested to see how that works because I think it has a lot of opportunity for us, particularly in Asia, where I think we have a stronger brand, a big reputation in credit where we can take that and run with it.

Yes, makes sense. So speaking of retail, you've obviously made it a big focus point from your own growth perspective and when you think about your own wealth management business and how that interacts with the rest of AllianceBernstein. What are some of the interesting opportunities you see to kind of grow that part of the business through both new kind of product innovation, whether it's private or not, and kind of leveraging the private wealth channel market?

I think for us, it's very much a blocking and tackling business. We absolutely intend to continue increasing the penetration of private alts in our clients' portfolios. And those private alts aren't just ones that we manufacture. We also have fund-to-funds vehicles that we use for that and third party where we don't generally manage assets that are suitable for them. So for example, private equity or real estate, where we use third parties where we have a lot of confidence in their ability to execute. So that's continued to be a growing share of our private clients' portfolios, and they've done well with the diversification that that's provided. That moves a pace. Secondly, what Bernstein Private Wealth is known for is its wealth planning, working particularly with business owners on liquidity events. While that trend has slowed down, we have a lot of clients who are poised to face that liquidity event as the market begins to turn. We spend a ton of time advising them pre-liquidity, and that builds up. It's not a backlog in the traditional sense because it's not in their control necessarily to execute, you need a willing buyer and markets that will fund that. But that's been a big source of growth for us in the past and continues to more than offset the outflows from our more traditional mature business that Bernstein has had for the last 50 years. We continue to do that. We've seen real growth in our tax-managed passive strategies within our private wealth business. And we continue to bring on larger teams each year, of people to train and develop in the system. So we want to increase our FA count and ultimately open additional offices in underpenetrated parts of the markets, whether it's in Arizona or in Texas or places like that where we're underpenetrated relative to the coasts.

Got it. Let's talk a little bit about some of the new product wrappers that you guys have been coming up with and active ETFs definitely come to mind. It's an area you've been a little bit more active in, I guess, with respect to expansion. Starting really, I guess, with fixed income. So as you look forward, what role do active ETFs play in what you're trying to build? How do you see yourself expanding maybe into active equity on the trust...

So we've launched 2 this year, as you know, [tap in year], one is a tax aware, Strategy 1 is a short duration, both are short-duration fixed income. I think they're appropriate for the market today to really grow and breakeven in the ETF space, you're really talking about a 3-year investment cycle to get that up and running. So we're very early days into it. It feels pretty good so far. We filed for a number of equity and multi-asset strategies. We think it's a particularly interesting wrapper for our more systematic investment styles, particularly in fixed income, but also in equities and multi-asset. And so we look to have a much more heavy issuance next year -- launches next year in that space. So less focused on fixed income, more on equity and multi-asset. Ultimately, for tax-paying individuals, it's a better wrapper than a mutual fund for those assets that are suitable for it. I don't see it as a huge revenue opportunity. I think it's really a preference question for us, and we need to go where the clients are. And we should frankly be indifferent to the wrapper that the structures and it should make sense for the client. Ultimately, I can see a world given how we're automating SMAs where our high net worth and ultra high net worth, most of that business is in some form of automated SMA form like our fixed income muni SMAs, which have been growing pretty rapidly. I think we'd like to see that in equity strategy, particularly dollar-denominated equity strategies, which you can do it with. And I think the rest could be in ETF form. But I do think we all need to be focused about liquidity, particularly in fixed income because I don't think daily dealing for credit makes sense.

Yes. I know you mentioned, don't think of that as a huge revenue contributor over the near term, but how do you think about that there's actually a way, potentially a risk, of cannibalizing your active or your mutual fund wrappers?

I don't think it's a risk in cannibalizing active. I think ultimately, we're going to go where Morgan Stanley and Merrill and [UBS] want us to go in that regard and meet their preferences. And so I think there is always a risk of that. We're trying to launch newer strategies at the moment to avoid that. So we're not cannibalizing existing ones. But ultimately, if that's what the clients want, we're going to provide...

Want to have product there. Okay. Let's shift gears. I want to spend a couple of minutes on the insurance channel. It's been, again, an important area of focus for the firm. Obviously, you have equitable and you've leveraged that relationship quite well. And I guess hoping to expand that, I think on the last earnings call, you guys did a pretty interesting kind of separate section on the insurance marketplace and what AllianceBernstein kind of sees themselves in that part of the market. So I guess, what are your sort of aspirational goals? And how meaningful do you think third-party insurance business could be for AllianceBernstein over the next 2 to 3 years?

Look, I think long term, it's a really critical, probably the critical institutional marketplace for us. It's the largest pool of fixed income that we don't really participate in. I mean, we have a fairly broad customer base in insurance, but a lot of that isn't fixed income, it's in equities or privates. But we'd like to be able to be a true full-fledged partner to them as they think about managing that general account. We have a lot of years of experience helping AXA and Equitable in that. We haven't invested the resources historically that I think we should have and it's a big focus for us to do it today. Look, the dream idea is to find a midsized insurance company that wants to outsource as a general account, and we'd be interested in taking the team to do that and using that as a base. The truth is the moon and stars have to align for that to happen. It's a pretty low probability outcome. So we can't build a strategy around that, although if that opportunity arose, we would certainly look at it seriously. That would be the largest single thing I can imagine doing, something like that, but it would be very much in support of building out that broader platform. I want to make money doing it in traditional fixed income and really grow it through the cross-sell. I think that's interesting. And I think we've demonstrated the ability to do it. And the reason CarVal was so interesting to us, besides the fact it wasn't an auction is that CarVal had 4 or 5 different verticals of really interesting non-CLO kinds of fixed income choices for asset owners to look at and utilize that were frankly from a regulatory capital perspective, pretty attractive. So it really ticked off a lot of boxes for us. So we're not really looking to add to that right now. We've never made an acquisition of this size and the history of firms buying other firms is just not a great one. And I'm very mindful of that. So we're going to spend a lot of time and be very careful on how we execute this.

Yes. Speaking of institutional business, maybe you can touch on the institutional pipeline and the dynamics you're seeing there. So as of the end of last quarter, the pipeline was around $25 billion, up really considerably, I think of something like 140% quarter-over-quarter. And importantly, with an improving fee rate, which has always been a big part of the story for the firm. I guess what are your expectations for funding this pipeline, again, considering that markets remain fairly uncertain?

I think we continue to see buildup in the pipeline, and we see buildup, frankly in private alts and in equities, which improves the fee rate. What changes that are the lumpy occasional wins we have in our Retirement business for our customized retirement services or our lifetime income solutions. Those are low fee, but very big size and we benefited from that in the third quarter. But even net of that, we were growing and the fee mix improved. We continue to see it, albeit slower with respect to fundings, they're absolutely slowing down, as you would anticipate. It's hard to estimate it. We keep in pretty close touch with clients on the timing of it. We haven't seen meaningful cancellations or anything. But I think people are slowing down towards the end of year. We'll see. I think we're entering into that 2- or 3-month period where there tends to always be seasonal reallocation. But I think we just have to assume that in a market like this, we're going to see slower realization.

Got it. Okay. Let's pivot a bit and spend a couple of minutes we have on the clock left here on just P&L and the company. Now clearly, tough backdrop, a lot of your competitors, a lot of your peers are seeing operating margins compress. That's not surprising given what revenues has done for the industry. When we look at AllianceBernstein and just taking your comments from the last quarter's call, 2022 adjusted operating margin is likely going to be somewhere in the high 20s, our number -- not your number, but kind of in that range. So as you think about balancing investment needs versus supporting margins into 2023, is there a probability or possibility to be getting back into positive operating leverage into '23? Or just given the market backdrop and the where you're exiting is just too hard to know?

Look, our exit run rate versus that in 2021 to '22 is going to be lower, right? That's just a function of the math and the markets itself. Flows really have a de minimis impact on that. Look, if markets stabilize from here, which is a big if, and they certainly could take another step down, I think it's hard to see meaningful improvement without some real growth in appreciation and values. But I think over the next several years, we have 2 non-markets-related events happening, which actually should be pushing up our margins irrespective. One is the joint venture itself for Bernstein Research, that will increase our margin. And I'm ignoring these -- well proceeds just doesn't matter in that regard, it just doesn't impact our margins. Secondly, with respect to the move to Nashville, the big kick was when we moved out of our current location here in Manhattan when those leases roll off. And so both of those have yet to come to pass. So I think longer term, I'd be surprised if we don't have positive operating leverage in the system to really generate that. So -- and I guess with respect to both of those items, any way to help frame what the kind of run rate margin could be or what the tailwind at least could be from the lease roll off in 2024... Because I guess, in '24 and '25, that's when we're going to see a more structural step up in the margin anyway...

Right, by the end of '24, I mean, it's a big chunk. I mean, it's meaningful. I don't know that we've ever actually given the percentage of that $75 million to $80 million savings that we saw as associated with the lease itself, but it's meaningful. And with regard to Bernstein, it's of a kind of similar impact. So I think they're both meaningful in their individually and collectively.

Great.

Right. We got a couple of minutes left on the clock. So if anybody has any questions, just raise your hand and we'll get the mic come around. Yes. One in the back, please...

I guess I'd be curious to your thoughts given that you guys are such a great fixed income manager, you guys obviously made a bet on CarVal with kind of private credit. But now obviously, as we kind of continue to roll forward some of the impacts of the rate hikes, some credit issues appear to be kind of like coming out through some of the kind of other conference presentations. So do you think that this might put kind of the private credit theme on hold or maybe as it relates to like kind of some of these retail products and tip it more in favor of flows to kind of core fixed income and other products that might do better in a recession?

I think that I'm very curious to see what the default rates are and the recoveries. That's going to be very much a function of the depth and duration of the recession we face. So there are too many imponderables to really get there. What I would say is most asset owners' private credit programs are structural now, and they've established targets for it. I think you'd have to see appreciable value destruction to change the strategic asset allocation decision most of them have reached. I think for ultra high net worth and high net worth, where the penetration is de minimis today, obviously, if you saw a very ugly period that's going to slow down or potentially stop the penetration of these kind of vehicles into that marketplace. So I don't even want to speculate on it. I just think I don't know enough to have a view. My hunch is that they'll do okay, unless you're seeing a kind of recession we haven't seen in 30-plus years. And a lot of this lending is to service firms rather than manufacturing firms today. So whether it's roll-ups, whether it's middle market businesses that tend to be more service oriented. I don't see -- I mean there is a very big software service element to that lending, in our middle market lending business, for example, it's a pretty big -- that's a pretty strong, robust business model. But these are sectors that don't have a lot of history from a credit quality perspective to really have much insight on. So I'm pondering it but I don't have a great view of it yet.

Do you think the yield differentiation is still interesting enough when you compare liquid credit. So you guys mentioned some of your own products, right, like American Income, 8%, high yield, high single digits versus what you could get in private markets right now?

Look, I think the fact that private markets for a while were divorced from public market yields is irrational and ultimately need to be predicated off of some sort of benchmark. And so as public credit becomes more competitive, again, I think it becomes much more relevant. So that illiquidity premium you're paying for needs to be significant enough to make it worth it. So they're going to reprice -- and frankly, in our commercial real estate business, for example, we're seeing very different terms in pricing today than we were even 3 months ago because people have been abandoning that sector, right, pretty broadly.

Great. Okay. Any other questions? Great. Well, we'll leave it there.

Thanks so much. It's great to see you. Thank you.

Thanks for doing this. As always.