Invesco Ltd. (IVZ) Earnings Call Transcript & Summary

Before we get started, I’ve been asked to direct your attention to important disclosures on 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. Welcome back to Morgan Stanley's Financials Conference for Day 3. I'm Mike Cyprys, equity analyst covering brokers, asset managers and exchanges from Morgan Stanley Research. And welcome to our fireside chat with Invesco. It's my pleasure to welcome and introduce here Allison Dukes, Invesco's Chief Financial Officer. Invesco, as many of you know, is one of the largest global asset managers with over $1.5 trillion of client assets under management across a broad range of products and capabilities. Invesco is putting up some strong organic growth over the past several quarters with significant contribution from the investment solutions team. Today, we're going to dive into some of these growth areas for Invesco as well as key themes across the asset management landscape. Allison, welcome. Thanks for joining us.

Good morning, Mike. Thanks for having me here. It's great to be here. I will -- sorry, go ahead.

I was going to say, great. So I understand you'll kick off with some opening remarks, and then we can have a fireside chat.

Okay. That sounds great. Yes, I'll just make a couple of quick points as we just think about sort of the drivers of our results of late, and maybe we can dive into a few different areas. As you know, and as you mentioned, through May of 2021, we've seen 11 consecutive months of net long-term inflows, and that includes almost $54 billion just in the first 5 months of 2021. Our investments in the key capabilities that we've really been focused on for some time, and our focus on clients is what really continues to produce the good momentum that we're starting to enjoy at this point. We're making progress across all of our channels, across asset classes and across regions. We saw a significant improvement in retail flows continue into the first quarter, and that's really what is contributing to the improved results across the United States and the Americas more broadly. And in Asia Pacific, in the first quarter, we again had one of the region's strongest quarters ever that came off of a record quarter in the fourth quarter. And as you mentioned, our solutions-enabled institutional pipeline is really growing meaningfully. We can certainly spend some time talking about that this morning. Solutions has enabled over 60% of our pipeline through the end of the first quarter, including a fairly significant mandate that fully funded in May. And on top of that, we really just continue to be focused on the themes that we've been talking about for just about a year now. Really focused on generating positive operating leverage and improving our operating margin overall. We've been -- we announced our strategic evaluation in the fourth quarter of last year, which is a goal of driving out $200 million of operating expenses by the end of 2022. And through the first quarter, we're about 50% of the way there. At the same time, we're focused on strengthening our balance sheet, and we're starting to see some good results and good momentum there with improving leverage and improving liquidity. And we just are opportunistic as we think about the opportunities that we may have to delever over time. In concert with that, as we make progress with our efforts to build financial flexibility, our Board approved a 10% increase in our common dividend in April. So another positive signal, positive sign as we continue to focus on improvements overall. And so with that, I think that kind of probably covers the landscape. We can go in a lot of different directions, but I'll turn it back to you, Mike.

Great. Why don't we start with the current backdrop and any sort of lessons learned coming out of the pandemic? I guess, as you kind of look back at the past year, what were some of the key learnings that Invesco's had navigating through the crisis? And can you also talk about how Invesco is transitioning back to the office today? And are there any permanent changes in the way Invesco is conducting business?

Yes. Look, I'm sure the answer would be the same for just about everybody, but tremendous learnings over the last year, 1.5 years almost since we started this as we think about the impact to our Asian offices, really started 1.5 years ago. I think it's pretty stunning how we were able to continue to manage over $1 trillion in assets and 100% from home across 24 countries. I think the learning is it's possible. It's not ideal, but it's very possible. And it's really interesting to think about the ways in which we can engage with our clients in an entirely digital platform. We reshaped our client delivery model last year to an entirely fully digital enablement platform, and that gave us the opportunity to meet our clients where they were. That said, we all missed the opportunities to be together and in front of clients and with each other internally. And so we're working on our return to office plans as we speak. We've got a coordinated global approach. But at the same time, we've got -- so we've got a global task force. At the same time, we have representatives from across the business, really focusing on each region with some local flexibility, just given the regional circumstances that we're facing. We're calling it our new normal, which what we're trying to do is move from a largely work-from-home environment to this largely work-in-the-office environment. But it will mean different things for different people in terms of their function and their roles. So not every office, not every team will be 100% back. There will be some, certain roles and certain functions that can be done more largely from home. So we're learning as we go, and we're doing it in a very detailed bottoms-up fashion as we look to really plot what the future looks like. We're also starting to see a return to travel. It's modest, but we saw definitely a little pickup in travel in April and May, as some of our clients do want to see us in person again, and we're starting to get back out there and have some in-person engagement. So I can't tell you we've got it all figured out. I think we're working through what that hybrid environment's going to look like, along with everybody else. I think it is going to be a hybrid for the long term. I do expect to see reduced internal travel. I think the ways in which we've learned to engage with each other seamlessly across continents through these digital mediums is very efficient. And I don't think we'll go back to flying across the country or to a different continent for a few hours of meetings. So I think it will look a little different and we'll take advantage of the technology, but we need to be together, too.

So Invesco's also seemed to have turned the corner and inflected to positive net flows. I think you mentioned 11 months now, 3 quarters. Is this the new normal for Invesco? And can you talk about what's driving this strength? And what would you say is different today versus the past couple of years that saw a more challenging flow dynamic?

Yes. I mean, look, I do think what we're seeing today that there is sustainability in these positive results that we're seeing, and it's really a result of the investments we've made in our business for years, and they're starting to pay off. There were some challenging years that predated this 11-month turnaround. And that was a combination of the integration of Oppenheimer, which had a breakage in there that was difficult to overcome there. And just as we were starting to come out of it and just as we were starting just to turn the corner, I think we probably would have been in a position to demonstrate positive flows, COVID hit. And so the combination of that made for a challenging couple of years, but I think what we're seeing now is really the investments we've made in some of our key capabilities where there's real client demand starting to pay off. And these are key growth areas like our ETF franchise, fixed income, China, our solutions business and our alternatives and global equities. All of these are capabilities where we've really been laser-focused and we're seeing the strong results start to pull through. At the same time, we've really doubled down on our focus with our clients and just making sure that we're being highly visible with our clients and really digging in, understanding where their demand is and where their growth needs are. So I think the trends that you've seen over the second half of 2020 and really the first part of this year are consistent. I expect to see some continuation. There will certainly be ebbs and flows but continuation of some of those trends. The strength we're seeing in our long-term ETF net inflows is very encouraging. You've got active flows across both our balanced and our fixed income capabilities. And then the institutional pipeline has held very strong. We're really seeing a continual funding and replenishment across the institutional pipeline, and it's quite well diversified as well. And then finally, the growth in Asia Pacific. It's -- our China JV and the Invesco Great Wall has certainly been the main driver of growth there, but I'd note it's not just China. We're seeing good growth across Singapore, Japan and other markets inside of the region.

Great. Well, a lot of areas that love to dig into a bit. Why don't we start off with the institutional side? Your solutions-enabled pipeline, I think, was nearly about $45 billion at the end of March. Certainly, it seems like you've had some funding since then. But yet we've seen that replenish even in prior quarters. So maybe you could just give us a flavor of what sort of capabilities are resonating most with clients. Maybe you could talk about some of the competitive dynamics and where you see the opportunity for additional mandate wins and, certainly we will be all ears if you want to give us an update on the pipeline.

I'll save the main update for the pipeline for July when we report second quarter results. But I think what you saw in the first quarter results that the pipeline grew to about $45 billion, and we were transparent then, and of course, it's more public now that, that included a very sizable passive index mandate coming out of Asia Pacific. It was announced in May that that was from IOOF in Australia, which was a $17 billion mandate that has almost entirely funded in May, and that was a very significant win. It was really, as I said, a passive indexing mandate that was assisted by our solutions advisory team and an opportunity for us to really leverage our in-house indexing capabilities and grow with what we believe is a very strategic client and a strategic region. Taking that out, if you take out that $17 billion mandate, the size of the pipeline was largely consistent with where it's been for the past probably 4 or 5, 6 quarters, both in terms of size of the pipeline but also the average fee rate. So it's really been holding quite steady. You expect some lumpiness in an institutional pipeline, and there is a little bit of lumpiness. But for the most part, it's well-diversified across our 3 regions. And in terms of the capabilities, to your question around where is the demand, I'd say it really spans active equities. Alternatives, certainly, including our direct real estate capabilities, fixed income and then our factor and passive equities. Those are the capabilities that are really resonating with our clients. And in terms of competitive dynamics and your question there, look, clients are really focused on fewer money managers. And for us to be successful, we have to be able to do more and deliver more. So we think part of our success is really the broad range of capabilities that we can bring to the table. We're really talking about solutions and thought leadership and our custom portfolios is really being these successful ingredients that we need to capture market share. And I think our indexing capabilities that we've developed, in conjunction with our ETF business and our self-indexing, in particular, along with the analytical capabilities that we can demonstrate, are where we're starting to really see strength in the institutional channel and the build in the pipeline. And what we know is just that when you go deeper with some of these institutions, when you really can get to know them and you really bring the breadth of capabilities. You can really continue to expand these relationships. And we see that augmentation that happens with these relationships just outside of the pipeline. So the pipeline is merely sort of a bellwether indicator, if you will. There's a lot of organic growth and augmentation that comes outside of the pipeline with these institutional clients.

Great. Maybe just a little bit bigger picture on the institutional channel itself. Maybe you could talk about some of the broader trends that we're seeing out there. You did mention the sort of shift to fewer managers that asset owners are putting in place. But in particular, I'd be curious, any perspectives on where we are in this in-sourcing versus outsourcing dynamic, if you will?

Yes. We certainly observed that there's a general migration to an outsourcing model in the smaller end of the corporate pension plan market, although you've recently seen some outsourcing of some larger defined benefit plans. We also see that perhaps the largest of plan sponsors with in-house teams managing very large passive portfolios on their own, and we're working with product providers like an Invesco for unique products as they continue to build their portfolios. You've got insurance companies that might have internal teams to manage their general accounts. And that's really where we fit in the market and what we do with most of our plan sponsors. We're really starting to see, I would say, a continued interest -- not starting to see, but continuing to see, interest from clients in barbelling with some desired exposure to index capabilities, balanced with exposure to things like our alternative strategies. And so we've got the relationships where they're buying investment products from us and utilizing our diversified platform to just build their broader product offering. And again, that's really where our focus has been, is diversifying our set of capabilities so that we're able to meet client demand wherever they're seeking that exposure, all wrapped with our solutions team. That really puts us at the table for these client conversations and making sure that we're using proprietary tools to analyze those portfolios for these large plan sponsors and identifying gaps that they might have.

Great. Maybe shifting over to the retail part of your business, Invesco's had a remarkable turnaround on the retail side in the U.S. and the U.K. Can you talk about some of the trends that you're seeing in this channel over the past couple of months and which strategies you're seeing greater demand on the retail side?

Yes. It's been a meaningful turnaround in our retail channel. We went from significant outflows last year. I think outflows in 2020 were probably around $30 billion to net inflows of about $21 billion in the first quarter of this year. The drivers are a few things. It's our positive ETF flows. ETFs have been a real bright spot for us. And in fact, we continue to capture more than our market share of the flows in these recent months. I think we were capturing somewhere around 6.5% of the flows in the first quarter and our market share is around 3%. So we're punching above our weight there. One of the other drivers is the fund launches. We've had in Invesco Great Wall, our China JV, highly successful and really focused on the retail channel. And then we see some success, too, with our fixed maturity funds in Asia, and that's been another driver of the positive turnaround in retail. And if I think about some -- just kind of how retail has been shaking out in the first quarter, it was about 25% from our active strategies and about 75% from our passive strategies. And all of those drivers are pretty consistent with what we saw in the last half of 2020. So we continue to see some of these trends just carrying into 2021, particularly our -- the interest in our ETFs and our fixed income capabilities. And then finally, I'd say, I can't talk about that without mentioning really our ESG capabilities and our presence there and that being another positive driver of the retail flows. We're the second largest provider of ESG ETFs in the United States, and we continue to see strong demand for those capabilities as well.

One of the trends that we hear more and more about these days on the retail side is the shift toward more customization and the shift to retail separate accounts. Can you talk about Invesco's initiatives there?

Yes. We think that's probably an area to watch, especially with the potential for some type of tax reform on the horizon. We do think SMAs are going to be really a key area for tax strategies with ultra-high and high net worth retail investors. And delivering our investment capabilities to clients across some sort of innovative kind of customizable wrappers really will remain a strategic priority for the organization. We have about a 30-year legacy in retail separate accounts starting with the Merrill consults platform that we acquired back in 1987. And today, we manage about $12 billion in AUM with fixed income and equity SMA offerings available across major platform providers. And so we really think retail SMAs are poised for strong growth given the intersection of several trends. Really that demand for client customization, which I've touched on a couple of times, lower account minimums and really just the democratization that's available there due to technology, and just the ability to own fractional shares and then that desire for greater tax efficiency as well.

Given the flow dynamics that we were talking about here with the funding on the institutional side, which is generally lower fee, and the larger mandate, which is also a lower fee, but strength on the retail side, that tends to be higher fee. Maybe you could just talk a little bit about the fee rate dynamics, more near term, but then also how you're thinking about that over the next 12 to 24 months?

Sure. Yes. Near term, I think -- well, look, I'm going to maybe take it in reverse order. I mean longer term, we continue to see just a steady grind on fee rates because of the demand for lower fee passive strategies. And so that's just a reality that we work through and we contend with, and we want to be well-positioned to capture that client demand where it exists. And that's why it's so important to us to offer a diversified platform and solutions that are really there to customize and capture that client demand. What does that mean near term this quarter or next quarter and beyond? I mean, there are a few things probably that are specific to us to call out. One would be the funding of the large lower-fee Australian mandate, that $17 billion that funded in May. That's sizable. It's chunky. It does have an incremental slight downward impact on our net revenue yield in the second quarter. that probably fully reflects into the third quarter. We also continue to see money market yield waivers negatively impact our yield. In the first quarter, that was about 0.3 basis points from the fourth quarter into the first quarter, probably 0.6 of a basis point overall inside of the quarter. I mean -- and fee waivers are pretty consistent in the second quarter. And so there is a bit of a drag pending anything we may hear from the FOMC today around fee waivers as we continue to work through this low rate environment on the front end of the curve. And then you've got things like market performance and the impact of net long-term inflows, which have been very positive. And so those are some of the positive offsets that carry all of that. Net-net, I'd say it's going to be consistent with what we -- with the longer-term view, which is there's just this really steady, very modest grind. But what we're trying to do is not so much manage to that because we want to capture demand where demand is. What we have to do is manage our operating expense against that and really think about our operating leverage and making sure that against this backdrop of demand for lower fee-passive capabilities, we're really hyper-focused on our operating expense base and delivering positive operating leverage, which for us was about 2x, 2x in the first quarter. And again, that's a function of scale and profitability and really focusing on those dynamics.

And now that you've turned the corner here on organic growth and positive flows, how are you thinking about organic revenue growth and incremental profitability on the incremental flows coming in the door?

Yes. Look, as we think about incremental profitability, we really have to position that expense base to make sure we maintain that strong operating margin. So again, I've said a few times we talked about the diversification of our platform and positioning our platform to capture client demand. So as we do that, then we have to really look at how are we going to generate that positive operating leverage to make sure that as we're capturing that client demand, we're really at worst, neutral to our operating margin but ideally really creating positive operating leverage and improving our operating margin. So we look at things like our operating expense per average AUM and really trying to drive that lower. So as our AUM is growing, really holding that operating expense base constant or taking cost out in connection with our strategic review so that we are, in fact, creating that positive operating leverage. And so whether the volume is coming through our lower fee capabilities or are higher fee capabilities, we look at how we deliver for our clients. So we're really focused on capturing that incremental profitability on the flows. So it's -- we're not going to starve our way to a higher operating margin. It's really thinking about how we reposition our expense base and how we continue to invest in the capabilities that are going to drive profitable growth.

One of the other areas of strength you mentioned was ESG and Invesco, I believe, is the second largest provider of ESG ETFs. Can we talk about your strategy there? How are you approaching new ESG products? And more broadly, if you could just update us on your overall ESG initiative across the firm? I believe you're targeting 2023 for full integration.

Yes. And maybe I'll start there. As you know, we're aspiring to 100% ESG integration across all of our investment capabilities by 2023. Right now, we're probably at about 75% of our investment teams that have attained an integration level that we would kind of call minimal but systematic integration. So what does that mean? It really means that our ESG approach is defined and it's consistently applied across the investment team. That ESG considerations are applied in the selection of investment decisions. That the dialogue is really a key component of the standard conversation with our clients and that a high-level ESG policy exists. And we can reference that policy and the disclosures in all of our documents. And so -- and that's really as we think about embedding this integration across all of our investment capabilities, the type of work we're trying to make sure is fully ingrained, and we're getting there. In terms of dedicated ESG AUM, we manage about $40 billion in dedicated ESG AUM. And that includes over 100 ESG funds and mandates that would be really across a variety of strategies and geographies and client types. And we're really continuing to execute on that focused strategy to deliver differentiated value to our clients. We do think we're leading the way in ESG ETFs and thematic products and innovation, and we're going to continue to pivot our efforts to meet client demands in different regions there. As you know, we are the second largest provider of ESG ETFs in the United States, and we're certainly seeing good demand for those capabilities, and we're going to continue to monitor our market share in segments of the ETF market, where we decide to compete and really judge our success and our results against some of these key metrics.

Alternatives has been another key product of growth for Invesco over the years. I believe your business in alternative was about $180 billion today, of which about $100 billion or so is in private markets. I think real estate has been a big contributor to that and to your growth. But I guess just as you look forward, which strategies and products do you think are going to contribute most to your growth from your alternative platform?

Yes. I mean, Mike, I'll start with real estate. It really is one of our key organic growth opportunities. We have a great business. We're fortunate to have a very strong global real estate business and platform that's got experience investing through multiple cycles, multiple asset classes across the risk spectrum from core to opportunistic investments in both debt and equity. It's about an $83 billion AUM business. $63 billion of that would be direct. It's really been built on serving some of the largest institutional investors in the world. And it's a mature business but one that we see great growth opportunities from and one we can continue to scale. That said, as we look forward, we see some of the largest opportunities for growth in real estate and our ability to democratize our private real estate capability to retail investors as retail investors seek exposure to private real estate assets. An example of this would be the launch of INREIT, which became effective with the SEC just last month. And INREIT really enables us, I guess, as the opportunity to bring our market-leading, our institutional real estate capabilities together with our retail distribution platform. And so that's one we're excited about, and we have high expectations for it in the future. But I'd also mention our private capital and senior loan capabilities. We continue to see improving investment performance there and good demand for our capabilities at the same time.

Great. And within private market space, we've seen a number of distribution platforms emerge, such as iCapital, Moonfare, to name a few to help facilitate access to individual investors, to your point on democratizing access. How do you view the opportunity for partnering with these platforms? And maybe you could talk about how you're interacting with them today?

Yes. I'd say we're always exploring potential partnerships and opportunities that we might have with private wealth distribution partners. We want to broaden access to our private funds beyond just our institutional investors. They're critically important, but we also see the opportunity to capture flows from private wealth clients at the same time. I'll say we're not able to talk about a lot of our specific products or distribution partnerships. We have a lot of distribution partners that operate under private placement rules. But I will tell you, we continue to be very focused on those opportunities and, again, democratizing access to real estate investments for retail investors. Within INREIT in particular, that offering is up to 2.4 billion of shares in the primary offering, and we're excited about the opportunity that, that presents.

Maybe shifting over to China. Your Great Wall JV has been probably one of the most successful JVs in China. Can you talk about what's driving the success there? And I know you've applied to increase your ownership. Maybe you could just give us an update on where that stands today.

Yes. I mean it is -- as you know, has been an incredibly successful effort for us. And we're in China in a pretty unique way. We started with our joint venture there about 18 years ago. And it's really with the financial arm of a state-owned energy company. But we, as the 49% owner, came in and have management control, and we've had management control from Day 1, and we named it Invesco Great Wall. So we've been building a brand there under our name for 18 years, and we're able to operate really as Invesco in China. And that's, I think, just important to note as you think about the driver of the success there and why it's worked so well. And it's really a multidimensional kind of JV, too, where we have very strong relationships with both the banks and the insurance companies as well as digital platforms that are very impactful to our distribution in the business there. I think -- we continue to invest. We've been ranked the #3 foreign asset management firm overall in China, [ twice even ] again this year. We were ranked #1 for our China onshore business in that same study, which really I think, highlights the success we're having in managing Chinese money in China. In terms of increasing our ownership, we do continue to be in active dialogue with our JV partners around gaining additional ownership and be going from 49% to 51%. But I think that's an opportunity over time. It's one we'll stay focused on the right time and making sure we're being thoughtful there. But I do think it's unique in that 49%, we have management control. And so it works really well for us, and it's really a terrific relationship with our Chinese partner.

Great. Maybe shifting over to expenses. You're targeting $200 million in net expense saves by 2022. I think you've mentioned earlier, you've already realized half of that in the first quarter alone. But the overall magnitude expenses has not necessarily declined as meaningfully since the program was announced. Maybe you could just walk through some of the areas of savings, areas where you're investing. And what would you say the opportunity is to seek expense efficiencies beyond the $200 million?

Yes. Look, it's -- this is hard work. And I think everybody in the company would tell you, this is hard work, and we're proud of the success we've demonstrated so far. When you're in a rising market like this and you're experiencing strong organic growth plus the rising market, it's not easy to see the hard work. So I'm thrilled about the positive results. I certainly don't want that to take away from a lot of the great work that's been done and the decision-making to really take discrete expenses out of the operating expense base. And that's why it's been so important for us in these last couple of quarters to do the walk that we do through our earnings presentation to really show the line items that are impacted quarter-to-quarter. So we can really demonstrate that progress against the goal. I'd say the goal is, as we've said multiple times, we're looking across the operating expense base, thinking about our target operating model and reallocating our operating model to make sure we're positioning people where we can take advantage of the growth that we've been talking about this morning. Looking at our real estate occupancy. Certainly, the environment with COVID gives us the opportunity to think about that and where we can extract some real estate operating efficiencies and then looking at our third-party sourcing and tech and ops efficiency. All of these are different pillars that give us the opportunity to take cost out and reinvest. Again, our $200 million is a net target. We are looking to go beyond that so we can continue to reinvest in the business. But we're not waiting to get there and then reinvest. We're investing as we go. And I think that's also why we see sort of the expense base holding relatively steady when you take out some of the variable expenses that you would expect with the improvement in revenue as well as some of the seasonality we saw in the first quarter. In terms of the types of areas where we're investing, I mean, again, it's really those key capabilities like our ETF franchise, investing into China, investing across our alternative capabilities and all those key growth capabilities that we've been talking about. Those are where we really do think we can create that positive operating leverage and capture outsized growth.

Great. Well, almost out of time. So this is probably our final question on capital management. You raised the dividend. Cash is now building on the balance sheet. Is there a certain level of cash or a milestone that you'd like to see before share repurchases could make sense to restart? And could that make sense even in the second half of this year?

It could. But what I would add to that in terms of our own thinking as we think about our balance sheet and just the financial flexibility that we're trying to achieve in the long term, and we continue to be very focused on our leverage profile. And we think there are opportunities to continue to improve our leverage profile. And so as we think about building cash, our priority is, number one, reinvest back into the business. And that is -- that's where we really think we can deliver the most growth on behalf of our shareholders. We also think there are opportunities to continue to delever, and we've got some maturities in '22 and '24. And so we're going to be really balancing our cash profile with the idea that we want to be opportunistic, should that make sense, to continue to delever. And then, at the same time, very focused on continuing to deliver a modestly growing and sustainable common dividend. It puts share repurchases probably a little bit behind those other priorities. We do think that is a longer-term opportunity, but our leverage profile is one we want to be very conscious of as well.

Great. Well, I'm afraid we're out of time. We'll have to leave it there. Allison, thank you so much for joining us today.

Thank you for having me.