Morgan Stanley (MS) Earnings Call Transcript & Summary

All right. Good afternoon, everyone, and welcome back to the BofA Securities Future Financials Conference. I'm Mike Carrier. I'm the research analyst that covers the brokers, asset managers and exchanges here at BofA, and I hope you're all doing well. Our next company up is Morgan Stanley. And with us today is Dan Simkowitz, Head of Investment Management. Given the recently announced acquisition of Eaton Vance, it should be a well-timed conversation. Dan, thanks for being with us today. And before we begin, Morgan Stanley is asking me to read this exciting disclaimer. The discussion may include forward-looking statements, which reflect Morgan Stanley management's current estimates and subject to risks and uncertainties that may cause actual results to differ materially. This discussion, which is copyrighted by Morgan Stanley and may not be duplicated or reproduced without their consent, is not an offer to buy any security. With that out of the way, we'll get started. And for the audience, if you have a question, please just submit it into the portal, and I'll ask those towards the end of the conversation.

So Dan, just to kick off, Investment Management is not an area that we spend as much time on. And so I think just for the audience, give them some perspective on -- if you could just give an overview of whether it's the asset, the geographic distribution mix, maybe some of the strategic areas of focus that you've been spending your time on.

Great. Well, thanks, Mike, and thanks for having me back this year and, I guess, thanks for reading the disclaimer as well. So maybe I'll get a little bit of context around asset management and then around the history and the strategy. If you go back 5 years ago, around 2016, I came in with a pretty clear mandate from James and the Board to grow Investment Management. I think if you go back to that moment, it seemed like the right time. Smith Barney had been successfully integrated. Equity Sales & Trading, IBD, were delivering industry-leading returns. And I think the 2 things, focus areas for the firm were rationalizing and improving fixed income and growing asset management. And I think it's pretty clear over the last few years, on both of those fronts, we've done really well. I think the growth focus in asset management and the rationale was pretty clear. I think the Morgan Stanley firm strategy is pretty powerful and simple. It's all around clients. It's all around markets. It's all about giving clients capital allocation advice or execution. And investment management is maybe the purest form of that, a fiduciary form of that. But I think also importantly, from a firm strategic context, it doesn't require any capital to grow and to deliver value to clients. So when we came in, our first focus was to build a leadership team that was focused on clients, focused on growth, but harness the great investment teams that we had in Investment Management, but also try to develop new strategies, new products and leverage the global client franchise that we had. We think the strategy has been very disciplined. The focus has been on areas of asset management that are in secular growth, where we at Morgan Stanley can add differentiated value. So... [Technical Difficulty]

Hey, Dan, are you there? Give us a minute here.

Mike, are you -- are we back?

Yes.

Okay. Bear with me for one second.

Yes. Take your time.

We will -- we have to -- we'll dial in. So just back to where I was. The leadership team was focused on growth, harness the teams that we have and leverage global franchise. The focus has been on areas in the market with secular growth and where we can add differentiated value. So focusing on areas where Morgan Stanley has got is very good. Our clients want us there, and there's low-risk of commoditization. So that's been the strategic focus of the business. And the results have been very strong. I think as you've noted, $400 billion in AUM in '16. And now it's a bit over $700 billion, and at the same time, revenues were around $2 billion in '16, and we've been averaging this year around $900 million of revenue a quarter, so about 70% growth. If you -- there are a whole bunch of ways you could break down the business, but we think about it strategically in 3 areas. First area is high-conviction alpha. And we think we're pretty unique in that, that's both on the public side and on the private side of the businesses. On the public side, concentrated public equities, where we're delivering really differentiated alpha in portfolios. Typically, 25 or 45 stocks within the portfolios. We're generally avoiding the bucket terminology, and the business skews towards global investing. And what's been, I think, a bit surprising but something we were focused on is that if you could deliver consistent long-term alpha, that there's real client demand around the world to complement and supplement the free beta or inexpensive beta that client and asset owners can have. The second part of that alpha -- high-conviction alpha business is our private alternatives business. So that's now up about $110 billion of client capital in private alternatives. It's across private equity, private credit, real assets, which includes infrastructure, real estate, real estate credit. And again, we're seeing, as a lot of the market is, real secular growth in that marketplace. And we can leverage the firm's resources. We can leverage ISG in terms of talent and product development, wealth management and the global franchise. The second part of the business strategically we think of is around solutions and multi-asset products and partnerships. And increasingly, we think you have to go to the asset owner or the wealth management platforms with a solutions mindset. And we go attack that part of the market through multi-asset products, asset allocation partnerships, asset class mandates or thematic mandates. It could be in hedge fund solutions or it could be in fixed income across public and private markets, or it could even be in a geography like China where we can go to the market. I think, importantly, we're going to market there, not just as a product provider, but also as a solutions and a partner and sometimes just as a service provider, where we're not actually earning a fee. We think, increasingly, content and services to CIOs and wealth management platforms are really critical to the overall relationship you have with your clients. And very few firms, we think, in the industry can go into a discussion with CIOs across asset classes, across both the public and private markets, talk to them about whether you want to have internal management or external management, the mix between alpha and beta and do all of that in a global context. And we're -- we leverage all the resources of both MSIM, but also all of Morgan Stanley, to provide that view. And it's extremely valuable, not just to the actual product we may be delivering, but to the overall relationship and the value proposition of Morgan Stanley. And a big part of the rationale for the combination with Eaton Vance is Parametric is a great solutions and outcome provider. But we've also, within MSIM, been focused on hiring really senior talent to go deliver that sort of service level that we think the market now requires. So we hired the former CIO of CalPERS, Ted Eliopoulos, who has a sustainability background that's first-class. We hired the former CIO of the City of New York, Seema Hingorani, who was the founder of Girls Who Invest, who has a diversity focus. And then our Counterpoint equity team recently hired Mike Mauboussin, the real big picture thinker for the issues facing asset managers and asset owners. And then last, the third bucket is Fixed Income. And it sort of is in the middle between the 2. It's got an alpha component when you think about high-yield or loans or EM or go-anywhere mandates, but it's also got a solutions and an outcome element. And we thought that being bigger and having greater scale is really important and filling some of the gaps in that market, and that clearly was a rationale around the announced Eaton Vance combination as well. And I'm sure we'll talk more about Eaton Vance. You've covered it. But pro forma for Eaton Vance across those 3 areas were about 30% in high-conviction alpha, 30% of our AUM and solutions, and about 40% in fixed income. So really great balance across asset classes, the public and private markets as well as solutions. And then we deliver this in a really very broad and global client franchise. And so our geographical mix coming into the combination with Eaton Vance is about 40% of our sales this year have been from Europe, about 25% from EM and Japan, and 35% from North America. And having that diversification on the client side has been really helpful for us to develop new products and optimize distribution to match client demand. So that's a long overview, but that gives you a sense of how we think about strategically the setup of the business.

Yes. That's a good perspective to start with. So if I look at MSIM, so the Morgan Stanley side, you guys have been putting up organic growth, which puts you in, I'd say, a differentiated bucket. There's not a lot of firms out there that have been able to put up positive flows. So when you look at some of the key drivers of the growth that you've been putting up, like what areas have been driving that? And have you seen much in terms of like fee pressure in some of the parts of the business?

Sure. Well, I think the -- again, you mentioned the strong results. It's been both on the revenue and AUM side, as I mentioned, but also on the PVT side. We've tripled PVT since '16. And the flows have been strong across the board, both geographies and asset classes. But I think as we look back on how we're delivering that flow results, I think, first, it's back to strategy where are we positioned and how we position. We are really focused on places where there is secular growth, where there is a sort of we're avoiding commoditization, and we can do so, balance between the public and private markets. I think the second one is just being global, and our client footprint allows us to go where client demand is. Not all the time you'll have client demand in certain asset classes in every geography, so we can match against client demand. And as I said, having 2/3 of the sales outside the U.S. is really, really, really valuable. And then third, really important, is performance. And so in that high-conviction equity business, which is a big part of our growth, we have -- 90% of our AUM has beaten the benchmark over the last 3 years by 600 basis points. So we're not beating it by 50 or 100, but we're beating it by 600. That gets people's attention. As an example, our Global Opportunity Fund, which is managed out of Asia for the last 5 years, has beaten the index by 1,300 bps annualized. And right now, we have 13 funds in the equity side across 4 teams in 4 different countries that are top decile over 5 or 10 years. So this is not just 1 year performance. It's long-term performance, and that's helped us deliver that very strong equity organic growth in the marketplace. And then the second place is alternatives, private alternatives. That's been a focus area for us. We -- our focus is generally in the middle market where we can drive some real alpha for clients. So we're not going to be as large as the mega cap buyout firms. But we're now up to, I think, $110 billion, $115 billion of client capital in that business, and we try to grow it. We grow it through new products, but we also grow vintages. So as an example, our infrastructure 3 fund, the third vintage we raised last year is about $5.5 billion, but it's also about 50% larger than infrastructure 2. And then the other example is we are very focused on private credit market. 3 or 4 years ago, we were managing about $1 billion of client capital in private credit. We're now up to $19 billion of capital that can be deployed for clients in private credit. You asked about fee pressure. We're -- certainly, in the parts of the market that are most commoditized or where maybe performance hasn't lived up to expectations where -- you definitely see fee pressure. But I would argue, in the high-conviction markets, both in the private side, and this is not a Morgan Stanley comment, I think it's an industry comment, both on the private side and public side, clients are focused on value. So some of that value is in alpha, some of that value is in the fee, some of that value is in the service, but you've seen less of it in that part of the market. And then I think there's -- the third part of the market around solutions and fixed income, fees have definitely come down over the last 5 or 10 years, but I think we're at a point of some element of equilibrium in some of those markets around the fee. What's not in equilibrium is the level of service and content and the value you need to put to the client away from the fee, away from the alpha or the actual investing performance. The service requirements out of clients are going up. And so one thing we think at Morgan Stanley, MSIM as part of Morgan Stanley, is we can be there to deliver more of that value, more of that service as clients demand more for us of, frankly, not a higher fee.

All right. That's good color. Maybe shifting over to Eaton Vance and just M&A to go well. I know you guys said on the call, like strategy and culture tend to be 2 of the key points to try to get right. So I guess more on the strategy side, what do you see playing out in the asset and wealth management sectors that make Eaton Vance a good strategic fit in combining asset and wealth can make sense?

Yes. Again, I think if you take a step back, at the Morgan Stanley firm-wide strategic standpoint, asset management right at the core, all about clients, all about markets, all about capital allocation. Very similar to wealth management, it also requires very little capital to run. And so -- and we think, at the firm, we're pretty good at managing both asset and wealth management businesses. So naturally, the focus is can we grow those businesses, and especially when we're presented with opportunities, where either a transaction or a new product can deliver incremental growth versus the existing business, also if we can deliver incremental value to the client. And Eaton Vance, at the Morgan Stanley firm level, was really attractive in that context. At an industry level, though, I don't think we would be the best buyer of a business or an asset that needs a lot of fixing or a lot of repairs or a lot of cost cutting. I think those transactions generally are harder. They take longer to play out, but they still may be the right thing for those companies to do because they may need it to manage negative flows or they may need to do it to cut costs so they can invest in technology or they can invest in international distribution or they can have seed capital to grow the business. We're very lucky at MSIM. We had really strong flow growth, so we didn't need to address a flow issue, but we also have the resources at Morgan Stanley, $100 billion market cap, $45 billion of revenue. We had all the resources in MSIM to go invest in growth. And I think that also made us quite attractive to Eaton Vance. It also meant our leadership team could focus on what we think is our core skill set. And that's around managing talent. It's around new products. It's around clients. It's around distribution. Frankly, it's just around growth. [Technical Difficulty]

All right. Just give us a minute or 2 to get Dan back here. Just give it a minute. We'll get him right back.

And how it plays out. I think the focus of our leadership team was on growth, and then this obviously presents a real opportunity, you cover it, in that they have a set of first-class investing and solution franchises and they come into the combination with MSIM with very good flows. Yet, and this is really critical, it's almost with no overlap with Morgan Stanley. So when we think about it from a client perspective, our clients were telling us, to be a real fixed income partner, you need to be in the loan business. You need to be much bigger in high yield. You need to build a municipal bond business. And on the solutions side, they were really asking us to build capabilities around customized portfolios and to be bigger around sustainability partnerships. And Eaton Vance didn't just address 2 or 3 of those client needs or client builds we're going to have to do. It delivered market leaders in more than half a dozen secular growth areas. It also brought, I would say, a big bonus and a big requirement. On the bonus side, its extraordinarily complementary distribution capabilities. So Eaton Vance, with U.S. wealth management and then the Morgan Stanley international capabilities. And the requirement, which you highlighted, is ultra alignment. So even with secular growth engines and distribution revenue opportunities or -- and filling the gap, if we didn't think the cultures would work or if the overlap is too high, we would not have moved forward. But the overlap is extraordinarily low, and the cultures are really aligned. And we didn't guess on the culture. I think that's important. We have the incredible benefit of the long and deep relationship with Eaton Vance in Morgan Stanley Wealth Management as well as some interaction they had with ISG. So within days of getting the call, we were really well informed, not just on the investment team, but around the culture. And then the other element that we benefited from, which is really idiosyncratic to Eaton Vance, is their top 25 leaders had the vote on the transaction. So we had really extensive one-on-one time with the top 25 members of Eaton Vance before the announcement, and that's quite rare in a transaction like this.