T. Rowe Price Group, Inc. (TROW) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the T. Rowe Price Analyst Call. [Operator Instructions] As a reminder, this call may be recorded. I would now like to introduce your host for today's conference, Meghan Azevedo. You may begin.

Thank you. Good morning, everyone. My name is Meghan Azevedo with T. Rowe Price Investor Relations. Thank you for joining us to discuss today's announcement of the formation of T. Rowe Price Investment Management or TRPIM, as you may hear us refer to it. For the next 15 minutes or so, members of our management team will take you through a short slide deck. And from there, we'll have about 45 minutes for Q&A. [Operator Instructions] We will certainly do our best to answer as many as possible and may group them together if they are overlapping themes. Before we begin, I'd like to remind you that this presentation and other statements that T. Rowe Price may make may contain forward-looking statements with respect to T. Rowe Price's future financial or business performance, strategies or expectations. T. Rowe Price cautions that forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time, and actual results could differ materially from the forward-looking statements. We ask all investors to carefully consider the risks described in our 10-K and our other public filings before investing. With that, I am very pleased to introduce Rob Sharps, our Head of Investments and Group CIO. Rob?

Thank you, Meghan. Welcome, everyone, and thank you to you all for joining us. This morning, we are pleased to discuss an exciting and important initiative that we've been hard at work against for quite some time. At this point, we're far enough along that we're comfortable sharing our plans and addressing any of your questions. This morning's presentation will feature some prepared remarks and perspectives from Steph Jackson, currently Associate Head of U.S. Equity; Eric Veiel, our Co-Head of Global Equity and Head of U.S. Equity; and Céline Dufétel, our Chief Financial Officer. After their prepared remarks, Steph, Eric, Céline, Meghan and I will take your questions. With that, I'd just like to kick things off at a high level and explain what we're doing. In the second quarter of 2022, pending necessary approvals, it's our plan to transition 6 of our existing investment strategies to a new, separate but wholly owned SEC registered investment adviser that we will call T. Rowe Price Investment Management. We're convinced that, over time, having 2 distinct investment platforms, T. Rowe Price Investment Management and the current platform, T. Rowe Price Associates, both with independent research teams will put us in a position to generate new capacity while retaining our scale benefits and position our investment teams to continue to deliver investment results and succeed. Our ability to draw on deep financial resources, our long history of building high performance -- high-performing investment management teams leaves us confident that this move will maximize our ability to generate alpha for clients over the long term. It's important to note that we're still one T. Rowe Price. Both platforms will carry forward key aspects of T. Rowe Price's unique culture, including a dedication to investment excellence, putting clients first, collaboration, mutual respect and a long-term orientation. Steph Jackson will be Head of T. Rowe Price Investment Management and will join the T. Rowe Price Group Management Committee. Steph's leadership and experience in developing investment talent make him well positioned to lead T. Rowe Price Investment Management in partnership with several senior portfolio managers. With that, I'd like to turn it over to Steph to share more of the details of our plans.

Thank you, Rob, and good morning to everyone. I want to share with you several aspects of the new entity, including its structure, investment capabilities, investment and organizational leadership and other important aspects of both investment platforms, T. Rowe Price Investment Management and T. Rowe Price Associates. At the foundation of T. Rowe Price Investment Management will be the cultural tenants that have made us successful since our firm's formation over 80 years ago, a client first mission, focused on investment excellence and built on a culture of collaboration, trust and mutual respect and a long-term time horizon. We are transferring 6 strategies representing $167 billion in AUM and with the current PMs planning to move to TRPIM. The entity will have over 100 associates, including separate investment and trading personnel and a dedicated and experienced leadership team. To ensure the independence of the investment platforms, TRPIM and TRPA will operate from separate access controlled office space within T. Rowe Price's facilities. The teams will be co-located at existing T. Rowe Price Associate locations in Baltimore, New York and San Francisco. And we'll have a small presence in both Philadelphia with our U.S. high-yield capabilities and Washington, D.C., which will be available to both TRPIM and TRPA. In many ways, it will operate like a new investment division, leveraging shared functions. The key difference is it will generate its own investment insights, which cannot be shared with TRPA. We designed TRPIM to capture common criteria that have made T. Rowe Price Associates successful. We chose strategies that cut across market cap and investment style to facilitate idea generation and knowledge transfer. We have built a centralized research team on each platform based upon our belief in having analysts with deep sector expertise. Importantly, we have retained our ability to collaborate with fixed income by incorporating our U.S. high-yield team. T. Rowe Price Investment Management will have dedicated ESG, quant and trading functions. The strategies from both entities will be supported by the same distribution team and share value-added functions, including portions of our equity data insights and the corporate access team. Multi-asset products will continue to be able to select strategies from both entities. Here's our leadership team. Our team is of a diverse and seasoned group of professionals that hold the culture dear. We bring a diversity of experiences that will inform our ability to facilitate the success of the new entity, and we all have a singular focus on client outcomes and organizational excellence. Here are our investment leaders. All of these highly experienced portfolio managers plan to transition to TRPIM with their strategies. There will be no change in responsibilities. All of these PMs are steeped in our culture of collaboration and investment excellence. And I would highlight that this outstanding group of investors includes 2 Morningstar Manager of the Year winners, Brian Berghuis, and also David Giroux, who will be the CIO of TRPIM. We have constructed 2 platforms, fit for purpose in their own rights, excellent talent, balanced, experienced and tenured. We've been very thoughtful in defining the platforms and selecting the analysts. We considered the needs of the strategies and interest of the analysts. This has been a very collaborative process with the PMs, analysts and the leadership team all working together. As far as additional hiring, this is a great environment to attract the talent we need to combine with our experienced professionals. To be clear, we are very confident in the capabilities of both entities to continue delivering on our primary imperative, strong alpha generation for clients with a long-term time horizon. And with that, I will turn it over to Eric Veiel to talk about how we got here and why this decision makes sense for both TRPA and TRPIM. Eric?

Thank you, Steph. While we're very excited about today's announcement, it's very much a natural next step in a long history of managing the [indiscernible] investment capacity. For decades, we have taken prudent steps to close or limit flows into capacity constrained strategies, always with our clients' best [indiscernible] at the heart of our decision. Going back almost 20 years, we had 5 strategies in U.S. equity, with some limit on their ability to take in new assets. Throughout the half of the '00s and into the last decade, we took other actions to support our efforts, including adding dedicated small and mid-cap analysts, additional associate analysts and associate portfolio managers. Currently, 10 strategies in U.S. equity are closed or constrained, representing almost 30% of our assets under management. We believe now is the time to take the next step to preserve our ability to generate alpha for decades to come at both entities. We've come [Technical Difficulty]

Meghan, please proceed.

Thank you. It sounds like we've unfortunately lost Eric, some of the [ joys ] in this virtual environment. Steph or Rob, I don't know if either of you is able to pick up where Eric left off? Apologies to everyone.

Yes, I'm glad to pick up where Eric dropped off, if that's okay.

Yes. Please go ahead, Steph.

Okay. So basically, as I think Eric was saying, that this has been a natural next step for us and our long history of managing the firm's investment capacity. For decades, we've taken prudent steps through the years to close or limit flows into capacity constrained strategies, always with our clients' best interest at the heart of our decision. Going back almost 20 years, we had 5 strategies in U.S. equity, with some limit on their ability to take in new assets. Throughout the latter half of the 2000s and into the last decade, we took other actions to support our efforts, including adding dedicated small and mid-cap analysts, additional associate analysts and associate portfolio managers. Currently, 10 strategies in U.S. equity are closed or constrained, representing approximately 30% of our AUM. We believe now is the time to take the next step to preserve our ability to generate alpha for decades to come at both entities. The market continues to change and evolve, and so do we. Factors we influence are performance which we don't want to change. Even with strategies closed, our performance created the equivalent of a 2% inflow and our growth strategies over a 5-year period through September 2020. Beginning in 2015, outperformance has led to an increase in AUM of about $55 billion for our U.S. equities, offsetting $45 billion [indiscernible] [ flows. ] In our growth franchise, $26 billion of alpha has far outpaced the $7 billion in inflows -- or in outflows rather, generating a 2% organic growth rate in AUM. The factors we don't control, the universe of investable securities is shrinking. Since 2006, the number of companies in the Wilshire 5000, with market caps of less than $9 billion, has decreased by over 1/3. As technology and disruption increase, secular headwinds in many industries, the number of durable growth companies in which many of our PMs invest is also more limited. It's creating another factory that is shrinking the market of potential investable ideas.

[indiscernible]

Yes, Eric?

Yes. Thank you very much. So now we can say this is what happens when T. Rowe Price does its very first-ever analyst call. We get our -- to have our first glitch. So thanks for filling in for me, a little demonstration of the collaboration that makes T. Rowe great. I am using a landline now, so we should be in great shape. I'll just bring home 2 final slides here. First, much careful thought has gone into this decision, and we are confident that creating additional capacity organically is the right next step for our clients and our firm. More capacity will give our portfolio managers, over time, the opportunity to continue to select the right securities in the right amounts at the right time while adhering to proper risk management and regulatory rules. Building a new research platform also capitalizes on a core competency of our firm, identifying and growing top investment talent. Somewhat immodestly, I think this is something we do really well. And the market is rich with top talent right now as many competitors in the sell-side consolidate and/or deemphasize fundamental research. By creating a second independent research platform, we'll also reduce communication complexity across a large single platform. In addition to these direct benefits to our research process, there are additional benefits. We'll preserve multi-asset access to our alpha-rich small and mid-cap strategies. The U.S. high-yield team will get enhanced corporate access and insights from our equity team and will increase career opportunities for investors at both facilities -- at both entities. Before I turn it over to Céline, let me just talk about what we expect next and what you can expect. T. Rowe has a long history of telegraphing key decisions like portfolio manager changes or leadership transitions well in advance. This announcement is in keeping with that tradition as we are still about 18 months away from implementation. While we have the majority of our 2 platforms staffed, thanks to our deliberate 2-year ramp-up of analyst hiring, in 2021, we'll complete that hiring. Over the course of 2021, we will also finalize our technology and operations work. We anticipate requesting the necessary approvals for the adviser change in the second half of 2021. In anticipation of these approvals, we will begin the transition to the 2 adviser structure, including relocating our teams and testing our processes. During this time, associates will still have access to current systems and investment talent. Ultimately, we can control when we make the final decision, but we believe we are well on track to make the adviser change in the second quarter of 2022. And with that, I will turn it over to Céline to close up.

Thank you, Eric, and thank you all again for joining us today. As you heard, we are well positioned to execute this transition and sincerely believe that this is the next logical step in enhancing our structure to best position us to continue to perform for clients over the long term. While we haven't been an acquisitive company, I'd also highlight that the acquisition of our Philly-based high-yield team in 2017 provided us with a critical component for T. Rowe Price Investment Management. Our firm, including our Board of Directors, our senior leaders and, very importantly, the portfolio managers of both T. Rowe Price Associates and T. Rowe Price Investment Management are fully committed to and enthusiastic about this effort. Now with that said, I'm sure you're all wondering what this means for financials. So we began to incur additional expenses for this transition in 2019 and continued to do so in 2020, including compensation for incremental headcount and onetime technology and recruiting costs. 2021 will be the last year of the phase-in of significant additional cost, and those assumptions were factored into the expense guidance of 6% to 9% that was provided in our third quarter earnings release. The nonrecurring items are not material enough to make an impact on the financials when they will go away. We will continue to report our financials as 1 T. Rowe Price, and we will not be providing separate disclosures for AUM flows or the financials of T. Rowe Price Investment Management. And I'll now turn it back to Meghan to begin the Q&A.

Thank you, Céline. [Operator Instructions] Our first question, Rob, I'll throw this one to you. Does this announcement in some way validate kind of the affiliate or boutique model? Can you talk a little bit about that?

Yes. Thank you, Meghan. I certainly don't think so. As I said at the outset, we're still 1 T. Rowe Price. It is the same comp model, the same culture, the same key tenants. And I'd also draw the distinction that T. Rowe Price Investment Management will be leveraging a central research model, serving multiple different strategies across the market cap spectrum and across the style spectrum. So I don't think in any way, shape or form this is the formation of a stand-alone boutique. I think this is the replication of something that we already do within TRPA and kind of really should serve to extend our ability to generate alpha and deliver excellent investment performance over time by continuing to do much of what we've done in the past.

Great. Thank you, Rob. A couple of questions here on the compensation structure and how that will work for the investment professionals within TRPIM. Eric, do you want to answer that one?

Sure thing, Meghan. Happy to do it. We were very careful and deliberate in designing TRPIM and TRPA to have identical incentive structures, identical performance evaluation metrics for analysts, for portfolio managers, for leadership, aligning incentives across the organizations to be equal. It was a critical part of the work that we did and is something that we believe strongly in.

Great. Thank you. Let's talk a little bit more about capacity. Definitely a lot of questions here, kind of twofold. The first is, how does this decision and this move unlock additional capacity for both advisers? And kind of what does that look like? And what are some of the things we're able to unlock as a result of this decision? And then secondly is, how does that impact kind of the organic growth outlook for the firm over time?

Meghan, this is Rob. Do you want me to take a stab at that?

Sure, Rob. That would be great. Thanks.

So in terms of how it creates capacity, I'd say at the outset, it's simply arithmetic. By disaggregating holdings, we eliminate overlap in terms of calculating the position size limits, whether they're internally imposed position size limits from a risk management perspective or externally imposed position size limits from a regulatory perspective. I'd also point out that the platforms will have separate trading desks. So they won't have to share liquidity, which is helpful from a capacity perspective. And in time, having 2 separate research platforms should help with diverse idea generation. So kind of ultimately, we should be able to generate more and unique investment ideas. So the differentiated thinking coming from each investment platform, I think, would also kind of extend the capacity.

That's great. And I'll piggyback one on that really quick. Do you think that this will give us the ability to reopen certain strategies that have previously been closed?

That's not the objective of the creation of T. Rowe Price Investment Management. The goal here is to allow us to continue to generate excellent investment results and extend the ability to deliver those results. We have no plans to reopen strategies at the outset. We'll use the same framework that we've always used in evaluating whether or not a strategy should be open or closed to new investors. I wouldn't rule out at some point in the future that, that framework might permit us to evaluate reopening one of the existing strategies, but it's not what's behind this. And again, we don't have any expectation that we would reopen any of those strategies kind of out of the gate.

Thanks, Rob. Will the new investment adviser have a different focus from the legacy adviser, such as value versus growth, non-U.S. or small caps as an example?

Meghan, this is Eric. I can take that one first.

That's great, Eric.

And then if Steph wants to add in, please. So we purposely designed TRPIM so that it would have the ability to present strategies up and down the market cap structure and across the style box. We are very much creating a replica of ourselves, which we think is unique in the market and something that's different than what anybody else has done before. We're really proud of the culture that we have, and we've purposely staffed the new entity with a mix of, obviously, very senior portfolio managers, senior analysts as well as top lateral talent and top MBA talent. So we think it will be very much in keeping with what has made T. Rowe Price Associates successful for all these years.

And nothing to add.

Fantastic. Awesome. Thanks, Steph and Eric. That's great. Céline, one for you. How does this, if in any way, kind of change our outlook on M&A? Or would this position us to potentially be able to do different -- to do deals differently in the future?

Yes. Thanks, Meghan. I mean, this really has no impact on our perspective on M&A. We've shared in the past that we've been building our capability to analyze potential deals should they become available, looking at opportunities that would advance our strategy with new or additive capabilities. But we have a very high bar for performance and culture and minimizing disruption and all those things we've talked about over time. So really, the formation of T. Rowe Price Investment Management really is in no way a change relative to that position.