Invesco Ltd. ($IVZ)

All right. We're going to go ahead and get started. Good morning, everyone. I'm Mike Cyprys, secretary analyst covering brokers, asset managers and exchanges for Morgan Stanley Research. And welcome to our fireside chat with Allison Dukes, the Chief Financial Officer at Invesco. As you all know, Invesco is a global asset management firm with over [ $2.1 trillion ] of assets under management. The company has a significant presence in retail and institutional markets across the globe, serving clients in more than 120 countries. So Allison, thanks for making it out here to New York and joining us here today.

[indiscernible] to be here. Thank you.

I thought we could start with the current backdrop and environment. Clearly been a lot of volatility [indiscernible] created, potential for meaningful shifts in asset allocation decisions. So I would be curious to hear your perspectives around what changes in client behavior have surprised you the most this year? Where do you think investors are still underpositioned? And how do you see [indiscernible] owner allocations perhaps evolving?

Yes. Well, again, thanks for having me. We released our flows last night for the month of May. So maybe I'll start there as we think about where investor demand is and what we're seeing. So our flows for the month of May were $19 billion of inflows [indiscernible] a very strong April, which was also $17 billion, $18 billion of inflows. So I'd say at it's -- just to start, demand is incredibly strong. And we have really benefited from, I think, the diversification of our product capabilities, in particular, and you're starting to see just the strength and the power of that. We've delivered over $150 billion of inflows over the last 18 months, very consistent inflows for several years now. So we're proud of that. We're excited about that, but also gives us the opportunity to really see the breadth of where investor demand is today. A couple of points. I would say, one, with this cash, $35 billion, $36 billion or so of inflows that we're seeing just to start the second quarter. The QQQ has actually turned back into positive flows. So that was negative in the first quarter, about $11 billion [indiscernible] positive for the first 2 months of this quarter. So back to the volatility and your question, and where are we seeing investor demand? We're seeing investor demand for the NASDAQ 100 Index, in QQQ product, in particular, as a way to play I would say, the AI trade, in particular, and that's certainly coming through. We're seeing good strong demand for fixed income capabilities that continues to be broad-based and really across the globe across all 3 regions. I think important to note that the demand we're seeing outside of the United States has been very strong this year and continues to drive a lot of our flows. About 40% of our AUM is outside of the United States, pretty well balanced between Asia and Europe. Both have seen good strong demand. Very supportive overall. China continues to be a driver of flows for us, very strong inflows in China in April continued into May. Japan has been a driver of flows. This is -- it's an interesting time because the volatility in the geopolitical landscape is very high. And yet, there seems to be an investor sort of ease with this volatility, and a lot of cash that [indiscernible] to be on the sidelines that continues to come into the market. And then last, but importantly, our ETF franchise. So that's about inclusive of the [indiscernible] at about $1.2 trillion now. And you're seeing really strong flows, both into the broader ETF lines, as well as the QQQ. I noted the [ Qs ] were outflows in the first quarter, ETF have been positive all year long.

So you mentioned a number of different products and geographic regions there. If we fast forward 2, 3 years from now [indiscernible] growth initiatives, which we'll come back to and dig in. But which are the growth initiatives that [indiscernible] do you think will be the most meaningful contributors to organic revenue growth at Invesco? Is it ETFs, fixed income, private Asia, personalization?

I mean I think my answer is yes to all of those in some ways because we've got a mix of wrappers, asset class, region and kind of investment strategy and all of that. And I think they're all going to matter. I'd say all 4 of those that you mentioned, ETFs, personalization, Asia, fixed income, they're all going to be incredibly important drivers. What I like about our particular portfolio is I don't think we're dependent on any one of those. We are a very well diversified platform today. Much more diversified than we were 5 years ago. And that is across both investment style, wrapper, asset class and region. I mean we're really able to, I think, benefit from each one of those different aspects of the portfolio, and we're not concentrated on one. And that has reduced some of the risk profile behind our financials as well. So when I think about 2 or 3 years from now, yes. I think ETFs are still going to be a really important wrapper. We are committed to active asset management as well. We really have been focusing on our investment performance there. We're seeing the benefits of that. We're seeing investment performance improve. We've seen outflows narrow. That said, the demand for [ passive ] I don't think is going to stop. And I'm pleased with our position there and just how diversified that is. Personalization is a really important trend. We can certainly touch on that. I think we will continue to see demand there. Will it be at the size and the scale of ETF? Probably not in 2 or 3 years. Nonetheless, it's going to be a really important driver of future flows.

So of those -- sorry, were you going to...

You're going to pin me down on one?

Or two. Or rank order.

If I had to say what is the single largest? You'd have to say ETFs just based on the scale. We're the fourth largest ETF provider, $1.2 trillion, just given where the demand is. Just a sheer quantum of flows. It'd be hard to say it'd be anything but ETF. I'd say second, and that probably Asia because of our position in both China and Japan.

Okay. Let's dig in. That's a good segue. My next question is on ETFs. So I had a hunch you probably would have say that. Active ETFs. You launched 4 new active ETFs in the first quarter, I believe it was. Talk about the active ETF strategy, the approach there, the traction that you're seeing, what the product pipeline looks like?

So yes, 4 new ETFs, active ETFs in the first quarter, a little over 1/3 of our ETF launches have been in active ETFs. So I think, look, active ETFs in a lot of ways, it's built into the ethos of who Invesco is. Smart beta has always been a really important part of our overall ETF platform. And so the idea of really taking an actively run product, packaged in a passive way. I mean that has been the ethos of a lot of what we do behind the smart beta aspect of our portfolio. So it's just an extension of that in many respects. So we have about maybe 40 or so active ETFs, a little over 40 active ETFs today. I think they're approaching maybe [ $40 billion ] or so in AUM. So as you think about just the overall opportunity there, it's really an extension of who we are. We're going to be very thoughtful about those launches. We really are a believer in new launches. We think that's probably the best way for us to play that trying to port active strategies into active ETFs. We don't necessarily think that necessarily gets us anywhere, or buys anything. I know some will do those conversions. I [indiscernible] we will ever, but I'm not sure that's really the way we're going to play this opportunity because, again, we think we can really build on the profile that we have today. We're going to not so much focus on the number of active ETFs, but rather the right ones and successful launches of those and really investing behind those as we continue to look for scale there.

And what would you say differentiates the active ETFs that succeed from the dozens that don't?

It's probably the same as what the answer would be for any other ETF, or active mutual fund, which is investment performance. First and foremost, we're focused on client outcomes. And so our thought is always lead with what is the client demand and how do we exceed client expectations by delivering great outcomes? So success is going to be on the efficient delivery of those client outcomes. So yes, they've got to be well priced. That's just table stakes. But decisions aren't made on price alone. They're made on outcomes. And so our focus is going to be on innovative strategies, innovative solutions that really exceed expectations.

Okay. While on the ETF topic, let's talk about the QQQs and beyond. How are you viewing the flagship QQQ fund, particularly in light of new competitors that are entering the space?

So the QQQ, just a level set, especially in light of our May AUM announcement last night at QQQ sits at about $500 billion in AUM. When you add on the related family of products around the QQQ, you're over $600 billion today. So it's a very sizable flagship fund and related innovation suite attached to that. We have been at this for over 20 years. So the QQQ is really benefiting from many years, decades of marketing spend behind it, billions of dollars spent in marketing behind it because that prior structure required us to spend all that money on marketing. So it has a brand that is its own brand and the QQQ is one of the most well-known ETFs in the world. Now -- and is certainly an interesting place at the moment as it tracks the NASDAQ 100 and the IPOs that are coming over the next few weeks. I think you're seeing a lot of demand for the QQQ as a way to play the AI trade. That's been there for a while now, but certainly, as we look at some of these new IPOs that is inherent behind that. As we think about some of the new launches that are coming, I mean, look, we feel really good about the installed base we have there for a lot of reasons. One, not just the sheer quantum of size, $600 billion across the suite. But also just the tightness of the spreads there, the liquidity that's behind it. The embedded derivatives and options that are attached to it. This is a very, very deep market that we have built over 20 years. You've got deep tax gains that are there as well. So I mean it's -- the switching costs are going to be incredibly high. So not only do we not worry about the switching costs, we also think this is the clear leader in the way to play a NASDAQ 100 and just -- it's really bought, not sold. It is such a well-known brand at this point. So we feel good about that. We also think that it's a big market, and there's a lot of opportunity there. And we know that from our own case study of launching the QQQM a few years ago. When we launched that -- we had an opportunity to kind of really cannibalize the QQQ in some ways. We wanted to make sure we had another adjacent product that we could create revenue from when the QQQ was in its prior structure. In the time that we have launched the QQQM, it's approaching $100 billion today at that same -- over that same horizon, the QQQ tripled in size. So we didn't cannibalize the QQQ at all. There was ample market set and capacity to support growth of both of those products.

Staying with the ETF topic. One major topic this year has been the potential for intermediary platforms to assess distribution fees or rev sharing arrangements on ETFs. So where are we in that journey? And how do you see that evolving? Is it ETF revenue share on net flows, on AUM? Does it rebase existing AUM? And I think you had mentioned it's not material to Invesco. Why is that? How is that the case?

So while it's getting some airtime now, the journey has always been there. We've been in the journey. It's just picked up a little bit of public steam. So we would say we're always in that journey. And working with our distributors on platform fees is -- that's just business and that's how business has always been done and will always be done. And it [indiscernible] as the demand for mutual funds have been declining and the demand for ETFs has been improving, that's changed the economics for the distributors. And so, rightly so, there are ongoing conversations always around the value that is provided by those distributors and making sure that there are appropriate economics shared on both sides. So that's always been there. That won't change. That will continue to be the way in which we do business. Those conversations aren't about existing -- about existing AUM or existing products. Those conversations are generally about new funds that are launched, new AUM that come in. And where we want support, where we need help, or we need support where we need value creation. And so that is something that when we say it's not material to us, it's because it's just embedded in the cost of our economics [indiscernible] today. It will be so in the future. There are always going to be thoughtful decisions and conversations with all of our distributors. I think, again, this is where we feel good about our position as one of the largest ETF investment managers in the world. We're the fourth largest and continue to grow. We have the benefit of scale and that gives us a good position as we think about the relationship we have with all of our distributors and is a broad -- we have a broad client list of distributors.

Not material to the P&L because it's a -- it's on new sales AUM arguably benefits scale providers like yourselves. But I guess, how do you think about that cost of that new gross sale is on a go forward versus what it had been in the past. But then I imagine also the incremental margins are also significant, too?

It's a -- that's a very hypothetical question because it all comes down to what's -- this is all the hypothetical next new product. Where is it going to be priced? I mean, it starts with how do we price it? And then how do you think about the economic sharing around that? So it all goes into the equation to make sure that they're appropriate margins for all parties there. So I guess I'd say this way. Our objective has been, and is, and always will be to continue to improve our own operating margins. We're demonstrating that. And we can get to that later. As we continue to improve our own operating margins, we do that decision by decision, product by product, cost by cost. Everything has to make sense in the isolation of that product and that conversation. So in that next new product launch, might we have a -- look, I just want to be really clear. I mean the conversations we're having, there's nothing new happening. So there's not a real change in the way in which business is conducted at Invesco day-to-day. So these are very hypothetical sort of ideas around what could happen over the years. I mean, could margins get more competitive? I think that's just how business is. I mean just in efficient markets, everything is always more competitive. And so you're always looking for ways to create more efficiencies to offset some of those challenges. And that's kind of inherent in everything we do.

Okay. Fair enough. Sticking with intermediary retail. We talked about ETFs. Let's shift and talk about SMAs, models, another area of success and [ strains ] for the industry here. So maybe you could update us on your SMA and model portfolio initiatives. How broad-based is that offering today relative to where you would like that to be, and talk about some of the steps that you're taking to drive further adoption and acceleration there?

So SMAs for us about $40 billion or so. That would be probably 75% of that would be fixed income SMA. So our history and strength has really been on fixed income SMA. Had very strong growth rates, I think, somewhere around maybe 18%, 19%, 20% [indiscernible]. So nice growth rate, but off a small base. And so the opportunity we have is to continue to broaden that out. We really think personalization is a very important trend. We don't think that's going anywhere. In fact, we think it's probably going to pick up even greater demand over the years. And so we get excited about the opportunity to be thoughtful to be creative there to be innovative. I think there are a lot of different opportunities. Certainly, AI is going to [indiscernible] this yet another place where AI is going to be an enabler and giving us the opportunity to do these things at scale. Personalization at scale is always a bit of an oxymoron. So how do you do that in a way that you can do it responsibly and profitably. Those are going to be some of the opportunities that we think about models. We've probably been not as focused on in the past, and that's an area that we think we've got an opportunity to be a little more focused on our own models, not just participating in other models. And so that's one, again, as we continue to really refine the building blocks of Invesco, and that's been our focus over the last years is focusing on those individual building blocks, improving them, doing them efficiently, really thinking about the margins behind that, the cost to deliver. As we have these building blocks better built out. Now we've got the opportunity to bring these together, I think, and really capitalize on the trends around personalization, customization and grow that SMA lineup and model [indiscernible] for ourselves.

You mentioned AI as an enabler of personalization. Can we double-click on that for a moment? And how do you sort of contrast and think about the role of the asset manager in there versus the wealth manager and the intermediary? Because I imagine they would probably say something similar.

Yes. Look, I mean, AI is a -- it's a yes for all of us. It's relevant in every part of the value chain now. And it's going to -- I think it's changing so fast. We're all seeing new opportunities, new ideas changing by the week, by the months. And so it's going to be in every aspect of the value chain. For us, it's going to be a part of revenue? Does it create new revenue? Hard to say. Does it make -- does it improve outcomes that create better investment performance? It should. Does that then become normalized across all fund managers, all asset managers? Perhaps. And so then are you actually differentiating? I don't know. I mean this is -- we're playing a long arc at this point. Fundamentally, it is the opportunity and the opportunities already here to rethink how we're doing everything and to augment humans at just about every level of the value chain. And I think certainly in personalization where we can do large task volume path more efficiently without a human. Those are some of the opportunities you're going to see in actually delivering revenue more effectively. Does it deliver the next dollar of revenue itself? I don't know, maybe. I think these are some of the opportunities that are still evolving by the week.

Private markets. [indiscernible] focus area for [indiscernible] investors or the industry, your platform today, over $130 billion spans private real estate, private credit solutions. Talking about some of your initiatives there. How you're positioning to accelerate growth? And maybe also touch upon the defined contribution opportunity set as you guys are looking at that?

Yes. So level set, our private markets business is about rough numbers, $165 billion AUM business today. So it's a fairly large private market business. As you said, primarily real estate and credit. The real estate side of that would be rough numbers, [ $80-or-so billion ]. And that has primarily been an equity business, a little bit of a debt business that's growing there as well, but primarily has been institutional institutionally focused. The credit side is really built off the backbone of a bank loan and CLO business and more recently augmented by more alternative credit strategies, direct lending distressed lending. So we're in the early stages, many, but certainly in the early stages of shifting that business from a purely institutional focused business to one that also capitalizes on the trends that are happening on the retail wealth management side. In the real estate business, we started by launching our first open-end fund there in REIT a few years ago. And then have built upon that with [ IRX ], which is a 1031 exchange, open-ended evergreen fund. And more recently, [indiscernible], which is the debt side of that. That has been a very good strategy for [ Fin craft ] continues to grow steady new flows every month. I think that strategy is up to maybe closer to about $4 billion in size today. So we've now again, got the building blocks that are important for delivery into the wealth management channel. Likewise, building out through our partnerships on both the real estate and credit side the partnerships that we've announced with [ Bearings ] and with [ LGT Capital ]. With Bearings that is a dynamic credit opportunities fund and with LGT, that will be -- that will build on more infrastructure and equity opportunities, the capabilities that they bring to the table as well and future product launches to come with that one. At all of these are giving us the products and the blocks that we think we need to not only participate in the retail wealth management opportunity but in defined contribution. We've launched -- starting to launch some new products that we think actually can -- we'll be well positioned in the [indiscernible] contribution plans. We just launched one on the real estate side with one large partner there, and we're going to be able to, I think, continue as a core plus fund that will be well positioned for defined contribution plans. This -- I think it's going to take time. I think that we're going to find these really thing and defined contribution nicely with target date funds and some of the life cycle funds. I'm not sure they're going to be stand-alone products in DC plans. They may initially at least fit into sleeves as investor comfort and education improves over time. I think it's going to be a slow build, but a really important build. We know there's demand. We're seeing the demand from plan sponsors. So as regulation continues to improve, we think we're well positioned to participate.

At the beginning, you mentioned that was an area of strength that you were seeing. Can you maybe elaborate on which parts of Asia? I think you were mentioning Japan, [ probably I presume ] China too. What types of strategies -- and talk about your initiatives there to grow that part of Invesco's footprint as you look out over the next 5, 10 years, where are you most excited?

So let me start with China. So our biggest driver in China is our joint venture that is located in China. It's a domestic for domestic business, and it's at about $155 billion or so in size. We're the largest foreign own asset manager in China. We are a top 10 retail wealth management provider in China as well. The growth there has been pretty steady for a number of years now as that investment economy continues to improve as they are looking to create investors across their economy and the investment acumen is continuing to move out the risk profile. We're participating in that. So in recent quarters, most of our growth is coming from fixed income plus products, which is really a balanced product. And that's been really that as they move out the risk spectrum from money markets to fixed income now and fixed income plus, that's been the biggest driver of our float, but they're broad-based. Equities represent about 20% of our portfolio in China. Flows are really driven across the asset classes, and we are seeing a real pickup in adoption of ETFs there. We just started launching ETFs in China, maybe 3-ish years ago. And we continue to launch a mix of product wrappers. But we -- there is still tremendous market opportunity there as you have hundreds of millions of people that are not investing at all yet. So there is tremendous opportunity. We're well positioned to participate in that. Japan, $100 billion or so, probably a little over in AUM. That has been a terrific market for us over the last few years. We have a very strong position in the retail wealth management side there and institutionally. A lot of demand there continue to have good strong demand for fundamental equity there. So while we see less demand in the United States, that's an area where we see steady good inflows, in particular, for income-producing products. We've had our Global Equity and income fund has been a very strong driver of growth in Japan, steady flows there for a number of quarters now.

That's the product at [ Henley ]?

It's managed out of Henley, yes.

Okay, that one.

[indiscernible] is in the U.K., not everybody knows that.

Let's shift gears. Investors have spent a number of years modeling lower net revenue yields at Invesco. It seems like [indiscernible] be nearer the end of that journey perhaps, maybe inflection in heads. So how are you thinking about that? What gives you confidence that net revenue yields are beginning to stabilize?

Sure. I'd start with net revenue yields just an outcome of the mix of AUMs today. So it's not an input. It's not a driver. We don't see fee rate pressure. So what we see is net revenue yield has been declining because of the growth in AUM in our lower fee products. So it's just the average of the fee rate of the AUM today. So first quarter net revenue yield was, I think, 22.8 basis points. The exit rate coming into this quarter was about 22.7 basis points. We have started to see diminishment of the pressure there. We started to see some stabilization in the first quarter. But as you think about where flows are and where AUM is, I mean, you have to think about the mix there. So one thing I would point to is if you look at the QQQ and the flow release last night, the AUM in the QQQ is about $120 billion higher than the end of the first quarter. So $120 billion of growth in 2 months, about a 6 basis point net revenue yield. That would put pressure on the net revenue yield for the second quarter but that, more importantly, creates massive revenue growth for the second quarter. So you just -- net revenue yield is just a mix of the fee rates. The revenue growth behind that, both from the flows and from the growth in AUM, terrific revenue growth, terrific dynamics behind that. Our focus is always on operating margin, not on that revenue yield. So our focus has been and will continue to be on how do we create that [indiscernible] of operating leverage. And so I'll take this opportunity to shift to operating margin. And in the first quarter, we had an operating margin of 34.5%, which was 300 basis points better than prior year. First quarter is always our seasonally low quarter, just given some of the seasonality and compensation expense in Q1. So 300 basis points year-over-year improvement in operating margin even with declining net revenue yield. So I hate to say it. We don't really feel like net revenue yield matters, I guess, is what I would say. It's not really what drives revenue growth. What drives revenue growth is growth in AUM and growth in organic flows. And we want to manage our costs against that. Our stated objective had been for a long time get back to the mid-30s in operating margin on a path to [indiscernible] seasonally low quarter. We're on a good path to get back to the high 30s and feel really good about the momentum behind that.

Great. You covered my next question, so I can move on. Let's talk about AI. Certainly getting a lot of attention across markets and quickly move from experimentation to implementation across the asset management industry. Invesco has spoken about a broad adoption internally. So I guess as you look across the firm today, where are you already seeing some of the most tangible methods from AI?

Yes. It's everywhere now, and it's almost hard to keep up with the benefits because the benefits really are -- they're popping up all over the place day-to-day, week-to-week, especially as we continue to deploy licenses across our firm for our employees in training. And we're spending a lot of time on training and really monitoring the usage and thinking about those licenses, and the deployment of the licenses and encouraging our employees to be thoughtful, but also creating the right governance around that. It's really important. We have the right governance and a handle around what's happening, and how we start to monetize the benefits of some of this. There's also the effort that we and everybody must have at this point, which is as your employees are using tokens from other software providers and deploying this, there's a cost headwind that can come in. So we have to be in front of that and make sure that we couldn't build it better ourselves. And if we can build it better ourselves, we'll build it better ourselves. So we want to utilize the technology in a cost optimized way so that we get to these productivity enhancements. And we're seeing it across the board. I mean everything from investment research investment performance and aspects of revenue and portfolio managers and how they are utilizing it. to things in the finance function, and how you think about large volume tests that can be done very differently that are low value-add test that can be done in a way that is much more productive, and we can [indiscernible] humans up to be much more thoughtful and add value in different places. I think the opportunities are everywhere. Some of the other tangible benefits. I mean, procure-to-pay orchestration layer. Those P2P layers, AI was probably an early place -- that P2P was an early place you could bring AI into your ecosystem. We did, like many others, and really see some of the benefits of that document capture. I mean these are easy, low-hanging fruit, but you can't not take advantage of that productivity everywhere. I think this is going to be another enabler to scale. And another enabler for us as we continue to really focus on great client outcomes how do we do so by improving our operating margins rapidly along the way.

And how are you managing the token costs while also driving ROI along the way?

Yes, it's a good question. I mean, look, you have to be really thoughtful just in your own procurement function about making sure you have the skill set of individuals who understand this and all the contract negotiations that they're doing just as a part of their job every single day. The game has changed. That is a really important thing to be in front of. And we don't want to tell an employee no to using a productivity-enhancing tool, but we want to do it in a way that we're eyes wide open around what are we getting for that incremental cost. And so you have to be really aware of the way in which it is being used inside of your own firm in order to make sure you're forcing the productivity for the increased cost.

Tokenization is another topic that's gaining some traction, including amongst traditional asset managers launching, partnering, including you guys, you recently announced the partnership with [indiscernible] I think it was to manage a tokenized bond funds. So talk about your initiatives, your strategy and what we might see from Invesco as we look ahead here?

Yes. Look, this is another really interesting technology, and this is a way for us to partner and learn. And we're really excited about the opportunity to partner with [ Super state ] bring our great investment management capabilities to bear with their understanding around blockchain and the infrastructure that they have and to partner and learn with each other. Where these products go? I think -- look, it's going to be an important offering in the product lineup. But to what end and to what size, I don't think we know yet. So this is just the beginning and an opportunity for us to really learn and benefit from a lot of what they have already built [indiscernible] just the transparency, the settlement dates, all of these things are going to, I think, really reshape the landscape of settlements and trades. And so this fund is about a $1 billion fund. It's an exciting product launch. This is, again, one aspect of technology where we would say we want to find great partners that we can learn from, and that we can bring our capabilities to [ bear ] with their capabilities. and grow from there. I think it's one of a number of partnerships launched now.

And more broadly, is tokenization in your view, ultimately like a distribution innovation? Is it [indiscernible]? Is it a completely new product category?

I think it's probably mostly in operational innovation. Will it be a new product capability? Sure, it is just even in the launch of this product, another strategy that is available to people but through an operational lens.

Okay. Great. [indiscernible] to leave it there. Thank you so much, Allison. Appreciate it.

Thank you.