Franklin Resources, Inc. (BEN) Earnings Call Transcript & Summary

Okay. Great. Good afternoon, everybody. Thanks for joining. We're going to get started with our next session. It's my pleasure to welcome Jenny Johnson, Franklin Templeton's President and CEO; and Matt Nicholls, the firm's CFO. Under Jenny's leadership, Franklin has done a number of really transformational things in the last almost 2 years. Now there's an acquisition of Legg Mason. There was obviously most recent acquisition as well in the secondaries business. So lots going on. I appreciate you guys making the trip Al, I think this is probably the fathers out of all the companies that came out to the conference, but it's great to see you in person. Great to be here together. So thanks for being here.

Thanks for having us.

So look, Jenny, I want to start a question with you regarding just the competitive positioning of Franklin and the changes that have really occurred in the last couple of years. As I said earlier, a couple of very large deals, important deals to pivot the business towards faster-growing area, particularly within private markets like we see with Lexington I guess the #1 question is, how do you see Franklin positioned strategically today versus a couple of years ago? And do you feel like you have enough building blocks to sustainably change the firm's organic growth to be in a positive territory, especially on the fee basis, not just the AUM basis?

Yes, sure. So I would say -- I mean, we had kind of laid out some product gaps that we felt we had. This was, gosh, 5 years ago. And a couple of the areas where core -- Core Plus Fixed Income and alts. I mean, those are probably the biggest categories that we knew we needed to fill. Legg Mason filed a couple of those. And it was a lot about trying to find the right properties and also having them want to be with us, right? So that's always part of this, you have to make sure the cultures come together. And I look at where we are today, at the end of last year, we were running at about a 9% negative net flows. Now we're down to 1.9% negative. So it's a good improvement. We had I think at our peak, we had concentration in a single product at over 25% of our AUM. Not a single strategy has more than 5% concentration. So -- and when we look at our flows, we have somewhat of a concentration in the redemption area, but in the sales flows, really, really good diversification. So when you asked the question about the building blocks, we feel very good about the breadth and depth of the capabilities that we have now as a firm.

Great. And do you think that's enough now to get you where you want to be? Or are there still pockets where you feel like you might need to add inorganically?

So first of all, I think in since you're wearing in Michigan, when you're going to catch the ball, don't go focus on the end zone make sure you get the ball. And so we've done a lot of acquisitions, and we're very much focused on making sure that we successfully integrate them. Having said that, if I look at kind of areas where if you put a wish list out there, the right things came up, we'd say infrastructure, although hard to always kind of get that kind of manager. From a geographic standpoint, there might be some geographies where we could have greater capabilities that are focused on, say, Europe. And so as those things come about, we would be -- we keep a robust balance sheet to make sure that we have flexibility. We've stated that we want to double the size of our high net worth business. So as we get bolt-on properties that either add some sort of capability or a geography for us there. We're interested in increasing that. So I would say that the big categories that we said we were looking for when we filled those and now it's much more about specific niches as they come up.

Great. Well, let's talk about some of these big categories. Maybe we'll start with Lexington first, given it's one of the recent transactions you've done. Maybe a 2-part question there. Can you give us a sense in sort of market dynamics supporting their growth across global secondaries, co-invests and middle market? And when we look forward, what are you excited about from their kind of stand-alone organic growth perspective to help us frame the revenue growth profile of that business?

Sure. So I think, first of all, the rationale of why we did Lexington. First of all, the organic growth rate standalone was strong, institutional. The growth in the private markets across all the asset class and alternative assets, very important. We had a private equity piece missing from our lineup. We started it hard, and we looked at direct private equity versus the secondary markets and we thought the secondary market for us has greater applicability to the resources that we have in the future. So it was great in the sense as a stand-alone growth story to Lexington and the secondary private equity business, but we thought in the future, we could bring an additional growth aspect to it through frankly, the applicability of the secondary, the diversification of the private equity business to a broader group of clients, whether it's RIA channel, whether it's broader solutions business that we have, our Franklin Templeton. So that's the key reasons why we landed on the secondary business and why Lexington. In terms of the dynamics supporting the business currently, we like to believe that the statistics or something like this in 2 years' time, 50% of revenues in the asset management business are likely to be tied in some form or another to the alternative asset business. Of that 50%, 50% is probably going to be linked to some form or another to private equity. So to not be in the private equity linked area, if you're adamant that alternatives are going to be important, is probably a bit of a misfire. You've got to get that right. And this was our group to solve that issue for our clients and for our revenue streams.

And just a couple of things to add on that. I mean we do think that like it's great to be in a space that we're one, the fees are pretty stable, so that's good news, but also where the pie is just getting bigger. And if you look at the number of private-backed companies in the last 2 decades is up like 5x, right? So it's just a sign of private equity doesn't seem to be slowing down. You have half the number of listed public companies. So having -- being a firm where our roots from the retail side and you look at the penetration of retail in the private markets, it's around probably 3%. It's definitely under 5% and a real desire to increase that. I think a lot of people would feel like it's -- it's a problem actually if only the wealthy qualified investors can capture the best returns that happen to be captured by the private company. So you've got to figure out a way to do that. We actually think the secondaries in private equity is a great way to do that. You don't have the J curve that can be damaging for -- it could be difficult for a retail investor. And the secondaries themselves have kind of vintages built into the fund structure. So we actually think it's a great way as people are talking about allocating more there. We think the secondary markets grow bigger as the private equity market continues to grow. And then it also, as it starts to take off in the retail channel, it's a great type of property to do that.

Great. Well, let's spend a couple more minutes on that. And I was hoping to just spend a good chunk of time on just the alternative strategy broadly for you guys. Pro forma for Lexington, you guys will be a $200 billion in alts AUM. We talked about that being about $1 billion in management fees across a number of different independently run managers that you have under the umbrella now. What's sort of the vision for Franklin's alternative platform over the next couple of years? What kind of organic growth do you think you're able to deliver? And how do these pieces ultimately come together?

So I mean I think first and foremost, all 3 properties, if you think about that we acquired, Benefit Street Partners on the private credit, Clarion and the real estate and Lexington Partners in the PE space have very robust pipelines and capability to raise assets on their own, right? So they have great institutional capability to raise assets. So we don't have to do anything to add to continue to get that kind of growth. But because we think that there -- we're at that stage and does it happen this year where it takes off in the next 2 years, but that there is going to be a shift where retail clients start to getting higher allocations. And some people say that, that's probably a 10% allocation up from a 3%. That's just a massive amount of money right? And that's where we think we can add. If you try to predict the timing exactly when you see that take off, I think that's a little bit more difficult. But there's no question that when you take our retail distribution along with those great properties, and they've really not penetrated retail space at all. We think it's a really good opportunity.

And just on the growth rate. I mean, we -- we've grown our alternative asset business, I guess, in the last 12 months at about 20%, and I divide that into 2 really 10% organic, 10% just a market increase in assets on the management. We see no reason why that shouldn't continue. And frankly, when we look at the various asset classes that we're now in, they're growing at a higher rate than that. And notwithstanding where the valuations are in some of these markets, the -- again, when you get to the secondary nature of the business, there shouldn't be a reason why that area in particular shouldn't grow across all the asset classes. So another reason why we focused on the secondary businesses as the primary markets grow, we assessed to be in the secondary business across credit, real estate and PE will increase. So we think that's and just, frankly, just attracting a getting a factor achieving a fraction of that market share is a significant most on the $1 billion, $1.2 billion management fee income, excluding performance fees that we have highlighted.

Right. So let's focus on that a little bit. Look, retail alts clearly a huge theme. We've heard about it for several quarters now from a number of the players, I would say, traditional alternative players in the space have been branching out there. The industrial logic between kind of partnering, manufacturing and distribution makes total sense, right? To your point, you guys have the distribution, you now have added product capabilities, so check. In terms of putting this into practice, what are you guys doing there, right? So the 3 operate independently. They have their own distribution for now. How are you guys trying to organize this internally to leverage your distribution on that product manufacturing side? Is that going to be done by the same people that lesser going out and selling a Franklin Income Fund or like Mason Western Fund? Or is that a separate team? Kind of how does it actually work in practice?

So I think this is like a big debate that everybody has in this space. But for us, we've really redesigned our distribution with everything else going on with the integrations, we actually kind of change the model of our distribution, which is creating a more regional model. And because we have so many brands, we don't own the alternatives brands, but even within the retail, I mean in the traditional space, we have specialists within the investment teams and then general is out in the field, and so they can pull in the specialist. Now having said that, you may have a specialist who has relationships with RIAs that happens to have sold real estate historically. And so they're going to be able to go straight to the group and be able to sell Clarion CPREIF for something without having to necessarily go back to the generalist. But the goal is you first -- and you talk to anybody, any gatekeeper in this space, they will say the differentiation and performance in the alts space between the best and the worst is dramatic. So it's really important to get properties that are good performance. You got to get through there. And then once you get there, you actually -- with the adviser, there's much more interest in brands they know than new brands. So it's hard. Like we're looking at you go sell Clarion, BSP Lexington was what we're kind of hearing is you probably sell Frankly Templeton Clarion, right, because that actually is easier for the adviser to sell. And then you have an environment where you're hearing the distributors want to minimize the number of partners and say, we want to deal with 10 partners. It's easier for us to deal with 10. We got to do all this due diligence to do the same amount of firm due diligence on a $1.6 trillion manager like Franklin Templeton that has all these different capabilities as we have to do on a $50 billion manager. So if we can gather all that capability with that kind of one-stop shop that benefits us as a firm. And so we think having one really, really top performing alts managers gets us through the gatekeeper and then two, having that Franklin Templeton trusted brand with the adviser is actually going to be a benefit to be able to get some traction in that space.

Yes. Does it require different product creation. So right now, a lot of the funds a lot of the managers on the private alts side for you guys, have kind of flagship structure like Lexington did in particular, right? So to bring that product to retail do you need to come up with a different wrap or a different structure, and that it will kind of take some time? Or is that something that you could do rather quickly?

There's ones out in the market that have proven that they work. And again, one of the things we talk about a lot as a firm is what is our expertise. Our expertise is managing money and creating alpha. We deliver it in whatever vehicle our clients want it delivered in, right? So we're agnostic to the vehicle. So whatever vehicle works for that channel, we're going to structure product to be able to make sense for that channel.

Got it.

And other thing is the larger we become in alternative assets across the different asset classes, the more it justifies. It's basically moving capital into the area that supports it. So we'll have a lot more specialists, more people in our academy training our clients to help to sell the alternative assets. So the capital allocation question around what does this all mean? It means we're just putting more about capital against the alternative assets.

Got it. Makes sense. Well, speaking of wrappers, I want to shift gears a little bit. I want to talk about separate managed accounts. It's another big theme in the space in the traditional asset management space for sure. You highlighted that the firm runs about $125 billion and assets there with positive flows in the last 4 quarters. So maybe spend a minute on the growth strategy within SMAs, how you leverage that across different products, revenue contribution and ultimately, the organic growth outlook you see in that part of the business.

So -- well, first of all, so why -- so we're the third largest SMA provider. Canvas, the acquisition that we did with Ochanosy Asset Management, OSAM, they bring a technology that allows us to actually enhance the SMA business that we do by really taking active strategies, doing -- using the technology behind it and even doing an ESG overlay and make him tax efficient. So we think that space is really important. Why is it important? Because fee-based advisers have a hard time buying and holding single mutual funds for years, right? So if you take a mutual in strategy, you deliver it in the SMA vehicle and it's a great way for that advisor to look like they're continuing to do this actively managed. So important, Legg Mason was the third largest. What's been interesting, I think we've had -- I think our growth is like 28% -- 25% this year. 45% of the flows came from traditional Franklin Templeton managers. So we've been able to take more of the Franklin Templeton and leveraging that SMA vehicle that Legg Mason had in the relationships at Legg Mason now. So it's been a really good cross-sell opportunity.

Great. So look, another area of focus for you has been Fiduciary Trust. And before the larger deals that you've done, I think in pre-led you've done a couple of smaller deals there on the high net worth side. And again, it's a business that not a lot of investors talk about, but it is in an attractive secular growth part of the market. So I'm curious to get your thoughts about -- or again, similar line of questions, right? Organic growth runway competitor advantage kind of how you see that business growing for you?

So the -- I mean, fiduciary trust like it's unbelievable brand. They've been around -- I think they were set up in the early 1930s by 5 wealthy families. This is a firm that understands true ultra-high net worth, multigenerational money management and the issues that go with that. We have said that we wanted to grow them. I think they were about $25 billion. We said we could see it being $50 billion, we're now at $38 billion. We will continue to add by buying kind of larger RIA multifamily type offices, RIAs to bolt-on and they will either bring capabilities like Athena asset management brought us really, really great ESG experience, Penn Trust, had a specialty in special needs trust. So they'll -- and they opened up geographies that fiduciary trust didn't exist in. We love the business because while it can be a longer sale, you tend -- it's very, very sticky as far as the assets. So -- and the multiples, of course, have been -- you tend to -- when you go and are looking to buy one of these RIAs. It's really the RIA who is choosing which firm they want to be. There's so much desire in private equity money going there that you're really kind of competing with. Do they want to be with your type of firm? And we tend to win that if the firm is looking for true additional capabilities, estate planning, education for the errors, all those things come as part of that. What's interesting is the dynamic that the fee-based adviser is experiencing is now that there's been transparency around how the advisers paid, there -- the client is demanding more from that adviser. So the adviser is no longer just managing money the client looks at maybe 1/3 of the value of what they pay the adviser fees for the management of the money they're saying, what else are you doing for me? I want financial planning, I want tax efficiency. I even want you to educate my errors. I talked to a financial adviser who had to negotiate the prenup for the client, right? Like they're looking for those additional things. Well, that's something that Fiduciary Trust has always had to do for their clients. So it's been for us also a great opportunity to understand where the evolution of those advisers our distribution partners are ending up going. And we think there's services there that we're already providing that we can provide to those distributors.

And let's just say in terms of the inorganic activity experience that we've had in the last 2 acquisitions, where we acquired Athena and Penn Trust. Those 2 things have grown double-digit growth since we acquired them, probably is a function of some of the things that Fiduciary Trust bought to the table, but also just the distraction that you can go through in terms of trying to figure out where you're going to be longer term, just has gone away completely in those companies. And the complementary to Jenny's point, the complementary expertise and what they provide specialty lease point entrust ESG angle Athena against what Fiduciary Trust, core businesses, it was really complementary. We see a really large pipeline of opportunity in the inorganic segment. And that in itself, it's not just growth through the inorganic activity itself at attractive basically arbitrate multiples. But the targets themselves or that the team that becomes part of the company that becomes part of the Fiduciary Trust is likely to grow faster than they otherwise would. And they help Fiduciary Trust overall growth there.

Right. And the double-digit organic -- that's organic growth?

Organic.

Okay. Let's pivot a little bit. We focused a lot on the good stuff. So like a lot of the growth areas. We talked a lot about the alts, the RIA market. I want to talk about sort of the more challenged areas in the business as well and call it, for the lack of a better term, kind of like the back book, right? stuff that still kind of holding you back from breaking into sustainable positive organic growth. We've seen an improvement there, but still some challenges. So I guess, part one, how do you sort of think about the pace of outflows from some of these more challenged strategies. At some point of time, the law of smaller numbers will actually probably work in favor. There's just not as much left. But so -- but ultimately, how do you define the risk in the sort of the back book?

So first of all, I mean, at one point, one strategy was more than 25% of our assets, right? And the second that doesn't perform, that's a massive headwind. Today, there's not a single strategy that's more than 5% of our assets. So we just don't have the same kind of risk that we did. And so when you look at our sales, our sales comes from a very diverse group of products. Our redemptions still tend to be a little bit concentrated in some of those legacy strategies that underperformed. And I think today, something like 54% of our mutual fund AUM is 4 and 5 star rated by Morningstar up from like 43%. So we feel good about the tailwinds that are coming along. That's why I said we were at negative 9%. We're down to 1.9% negative flows. But it's continuing to improve. And it's just a different business and a different makeup now.

It's hard to say in the way that those things you're referring to are much smaller, not just a little bit smaller, but significantly smaller than that, multiple smaller. So it really is as it really is that point. I mean we leveled out, but also there's just so much more of that even if we have issues with it, the impact is much less on the company. And I would say that the flow story, what we said. And as you -- I think you know, in the context of doing a larger merger, usually, the flow story is a lot more patchy and there's not unusual to have pretty substantial outflows at particular points in time. We didn't really experience that. We actually slowed our outflows substantially. And then when you pick up what created those outflows was -- I think it was one thing that's a couple of billion dollars related to the merger itself, with Legg Mason. The other things are sort of lumpy underperforming things or concentrated things, low-margin things quite -- you can say we're quite fortunate there were things that we had sort of thought where they are at risk. When you look at that and where we're at today in terms of this quarter, for example, it's going to be very interesting. We feel pretty optimistic given where we're at over the last 2 months. It could be a real turning point in terms of going from negative to positive.

That's great. All sounds great. So let's talk about some of the macro factors for a second. Not surprisingly, the last 2 days, focus on higher interest rate inflation has been definitely top of mind. When I think about the impact of higher rates on fixed income businesses broadly very basic thought process the higher rates, bad for fixed income, right? So curious how you think of that for Western, in particular, with a lot of core, core plus type of product, if we see same pace of interest rate increases as the forward curve implies or maybe a little bit faster. Is there any risk there? How is the management team sort of adjusting for that kind of different macro backdrop?

Well, first of all, it's interesting because I mean this is where -- I think it's really great to have such the broad breadth of capabilities because you just take a question about where rates are going, and you talk to the Western team, the Brandywine team and the Franklin team, and they are all in a slightly different space. Now of course, we love that because it's like that's the greatest hedge that you have, right? And we -- the thing that we really do is encourage them to talk to each other. We want them to stick to their guns and never interfere with that, but we want to make sure that they got the benefit of being able to have the debate internally. But -- so we are really on the spectrum of where rates are, we literally are on all sides of that. I would say the good news is their fixed income will always have a market, right? There's just a need for that. And so yes, you can say it's a headwind. And remember, fixed income is a lot of different things from a credit standpoint, there's a lot of different things that you can do to adjust from just duration and worrying about rates. And that's where active management in that, I think, is so important. But there is -- continues to be a very important need for fixed income regardless of, I think, where the rates are. I don't know if you want to add anything?

No, I mean there's obviously the relative value discussion and there certain components, fixed income to do quite well in a rising rate environment just when they do constables.

Yes. No, look, it makes sense. The benefits have been a diversified platform. So that maybe pivoting over to talk about P&L for a second. I do want to spend a couple of minutes on expenses. So a number of moving pieces, obviously, with M&A, but let's just keep Lexington outside of the conversation and focus on Franklin stand-alone M&A and sort of the framework for expense growth into 2022 relative to the $4 billion or so of annual run rate expenses we saw in the fourth quarter. I'm not sure if there's a specific numbers you want to share at this point or at least a framework of how to think about the level of expenses for next fiscal year?

Yes. I mean obviously, it's very early. We're 2 months into our first quarter for the year for fiscal 2022. I think the guidance we gave initially was in the event that markets stay relatively stable. Who knows have given the -- let's go over the last few weeks, but the market stay approximately where they are we would expect our revenue to stay approximately where it is to low single digits increase, and we'd expect our expenses to stay approximately flat under those circumstances. So again, if revenues are up by low single digits, we'd expect expenses to stay flat. That is not at the expense of not investing in the business. It's because we do get that question of the, okay, well, if you're managing to keep expenses flat when the markets are doing quite well or even rising a little bit and we're getting some organic growth in the system how can that mean you're not -- expensed are going up. Well, remember, we do still have some expenses rolling through the Legg Mason acquisition. And we've got things internally. We announced our fund administration outsourcing. We announced our transfer agency outsourcing just a few weeks ago, that was a big move for us. Now other things internally that we're finding create some interesting cost saves. And that's where we're able to evolve that into investing in the business, being more efficient, but also being able to make sure that our comp and benefits keep up with the market even in a slow growth, let's call it, low growth environment. And that's where we think that sort of our base case isn't unexpected.

Got it. And the flattish expenses are call it about $4 billion for next year, that already contemplate the outsourcing things that you announced more recently, I think, since quarter end or could that create an additional lever for expenses?

I mean it does include it because of the reinvestment that I was just talking about. But I would say between $3.95 billion and $4 billion is at this point, realistic.

Great. Okay. maybe a little quick another one on capital, and that's both for Jenny and Matt. Clearly, we've seen you being acquisitive. It sounds like there are more things that you could do if something comes across and you certainly have the balance sheet capacity to do it. But the stock's multiple is certainly pretty discounted, and we've had this conversation in the past. So where does the buyback fit into the framework over the next 12 months, assuming that there's no significant M&A activity and maybe it's a big if, but curious if you have any thoughts there.

I mean, it is a bit of a quarry because obviously, we do share what you just said about our valuation and therefore, you'd say, why don't you buy back more shares? Well, the reason why we don't is because we just see so much continued evolution in the sector where we can take advantage of it by using our capital to create new growth. Some of that's through acquisitions, some of it is through seed capital investing, co-investing, some of it's going into slightly new business lines within the asset management industry. Every dollar we buy back of shares, obviously, we know that's like immediately retiring a preferred return, and we're very attracted to doing that, but not at the expense not to get to keep up with where the market is in. We've got a very long-term view of that. So our capital allocation strategy is to be very disciplined with the dividend. We'd like to continue the trajectory that we've had with the dividend for many, many years to buy back enough shares to hedge our employee grants at least. And then the rest of it, which we're estimating for 2022 will be about $1 billion left, that's going to be growing the business. And then will only be, if that builds up cash, $1 billion, $2 billion, $3 billion, it will only be then when we will start accelerating more share repurchase. Because obviously, we're not just going to sit on cash and do nothing with it. But from what we see, the pipeline of M&A, the demand, frankly, from our specialist investment managers for new strategies, distribution investments. I think it Seed investment.

Seed Capital.

We returned $700 million of Seed Capital over the last 12 months into $7 billion of AUM. So there's a tenfold return there, if you will, on how we invest in capital. We have $2.3 billion of Seed Capital at the moment and co-investments. We don't see a reason why that should be a little bit more, but we're very discipline how we circulate that. But that -- and that $1 billion, we also shouldn't underestimate what that means in terms of M&A it's not just $1 billion. We just acquired Lexington Partners. And if you do 100% valuation analysis, you can see it's a $2.8 billion transaction. We did that spending $1 billion in the first year. But what we do as we look forward, we say, okay, if we can structure the transaction that aligns interests that helps us maximize the deployment of our capital means we're literally we know, obviously, we're going to spend more than $1 billion on Lexington. That's spread out over 5 years, and it's both purchase price and alignment of interest in additional compensation for the team we're acquiring, it kind of works really well. So when we think about $1 billion in 2022, that does not mean only $1 billion in M&A, maybe could meaningfully more if we find the right target for us.

Great. Makes sense. Well, we're definitely out of time. I think we're about 3 minutes over. So no time for audience Q&A. Thank you both so much. It was really great to see you, and I hope we get to do this again next year.

Great. Thank you.

Thanks very much.