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

Great. Good morning, everybody. It is my pleasure to welcome Céline Dufétel, CFO of T. Rowe Price. Over the last few years, T. Rowe has been making significant investments to expand the firm's product and distribution capabilities as the landscape for asset managers clearly continues to evolve. These investments are paying off, with T. Rowe still being 1 of the few traditional managers with positive organic growth over the last couple of years. In addition, the firm maintains a very strong balance sheet with significant amount of excess cash and discretionary investments on the balance sheet with no debt. Céline is going to go through a brief presentation, in hopes you should have slides on the screen there, and then we'll jump into the Q&A portion of the session. Céline, welcome. Over to you.

Thanks, Alex. Pleasure to be here. So I'm going to spend the next few minutes going through a few slides, which you should have access to, and I'll make sure to point you to where I am in the document, and then I'll hand it over back to Alex for Q&A. Before we begin, though, it's important to note that this presentation contains forward-looking statements, and I would like to call your attention to the disclosure slide, which is Slide 2. So turning to Slide 3. Our vision remains unchanged, which is to execute on our long-term plan to be a premier global and diversified active asset manager, with strong positions in the solutions and in the retirement spaces. And in order to enable our continued success, we strive to remain a destination of choice for diverse top talent, but also continue to modernize our operations and our systems and drive strong financial results. Well, we have a very thoughtful multiyear strategic plan that we're executing on. On Slide 4, we acknowledge that there are a number of challenges and trends that our industry, in particular, active asset managers are facing. None of these are new, but they're certainly important to be mindful of them in the context of our long-term organic growth story. Obviously, we continue to battle the passive trend, including its impact on fees, and feel that our best defense there is investment performance. We also continue to see distributors consolidate their relationships, and we certainly see ESG, particularly in EMEA, continue to be an ever more prevalent trend. Despite some of these headwinds and challenging environment, we remain very focused on delivering strong performance and financial results in addition to executing on some of our strategic priorities, and I'll give you an update on where we are on those today. Turning to Slide 5. As I mentioned, as an active asset manager, we feel that strong performance is our best defense against the shift to [ passive ]. So you see here that we've expanded our performance disclosures to include comparisons to passive peers as well as AUM-weighted results to provide even greater transparency around what's happening across the platform. Overall, our long-term performance remains strong. International equity and Target Date have had particularly strong years for us, while U.S. equity has been a bit more mixed and fixed income, a bit softer, although continuing to improve. So to give you a little bit of color. In international equity, we've continued to see strong performance from our growth-focused strategies, especially global-focused growth, global growth equity, international small companies and Japan equity. Within multi-asset, our retirement strategies continue to perform very well, with all of our portfolios outperforming their passive benchmarks in the third quarter. Our actively managed underlying funds and tactical positioning continue to contribute to our outperformance, which remains very strong versus our active and passive peers as well as our benchmarks. U.S. equity, as I mentioned, has had a little bit more mix, and these are, obviously, all numbers through the end of the third quarter. Some of our small-cap strategies, including new horizons, small-cap stock and small-cap value, had performed well versus their respective benchmark. Consistent with our bottom-up approach though, stock selection was the primary driver of relative performance in each case. The value fund also performed well, as did several sector strategies, including communications and technology, global technology, natural resources and health sciences. There are some strategies that underperformed in the third quarter, including large-cap value equity income fund, mid-cap growth, but recognizing that the environment changed a lot since the end of the third quarter when you think about where we are now, and our 3 large-cap value strategies, as an example, are doing very well in the current rally. Lastly, fixed income had a tough start to the year, but saw a bounce -- some bounce back in the second and the third quarter. And we continue, overall, to improve our overall fixed income results, and this continues to be a strong area of focus for us. Turning to Slide 6. You can see that our financial results, through the end of the third quarter versus the same period last year continued to be strong. We've seen solid growth in revenues this year, obviously, supported by the strength in markets. We've continued to invest in our business for the long term, with expenses up 6% through the end of Q3. And you'll remember that about 30% of our expenses are market-driven, which certainly played a role here. Revenue growth has outpaced expense growth, preserving the firm's strong margin, and adjusted EPS was up 11% to $6.69 per share. The balance sheet remains rock solid, and we've continued to grow the dividend, while preserving strong free cash flow and maintaining our opportunistic approach to share buybacks. Through September 30, we had expended nearly $1.2 billion to repurchase 10.8 million shares at an average price of $108.77. While there's a lot of positives on this page in terms of the financial results, it's important to acknowledge that flows through Q3 were not as strong as we would have liked them to be. While the second quarter was actually our strongest flow quarter on record, largely driven by a handful of sizable institutional wins, Q3 saw a bit of the opposite with some lumpy institutional losses that brought down the aggregate number, particularly within Target Date. It's important to note that in some of these losses, M&A was a factor. Meaning that 2 companies merge in, and that impacted our owned side of that. And the CARES Act also was, to some extent, part of the equation, although to a lesser extent. And you'll probably remember that the greatest -- the impact with the provision in the CARES Act with the greatest impact is the one allowing participants to withdraw up to $100,000 into their 401(k) plans. And that is a provision that has come to end at the end of December. So we do not anticipate that to be a factor in 2021. Finally, on this page, I would just acknowledge that the fee rate has contracted slightly versus last year, largely in part due to the impact of money market fee waivers and then some ongoing migration from mutual funds to lower fee vehicles, such as our collective investment trust. Turning to Slide 7. You can see a quick snapshot of some of our capital return metrics for the last 5 years. Most notably, we've seen a 10% decline in our shares outstanding and have repurchased more than 47 million shares at a weighted average price of just over $90 a share. And as I mentioned earlier, in addition to meaningful buybacks, the company has a strong track record from a dividend perspective having raised its dividend for 34 consecutive years. Turning to Slide 8. In addition to the strong long-term investment performance and financial returns, Slide 8 highlights some of the progress that we've been making against our strategic priorities in 2020. Within investments, we recently announced the forthcoming formation of T. Rowe Price Investment Management, or TRPIM, which I'll spend a little bit more time on in the following slides. We also executed on our product road map, including the launch of our first 4 U.S. equity active ETFs, and continue to make progress on our ESG integration and research process. Within distribution, we have further progressed our efforts outside the U.S., where we continue to see particularly strong momentum in Japan. In the U.S., we continue to invest for growth in the broker-dealer channel, which has been rewarded with kind of continued net flows and share gain and is an area where we expect to have further growth opportunities in the future. Our technology and operations teams have also had a very busy year, supporting all of the activity, but also from the technology side, making sure that about over 97% of our associates globally could work from home. We also made some nice strides in our modernization journey across our tech portfolio. So I'm going to spend just 2 slides on T. Rowe Price Investment Management, or TRPIM. So turning to Slide 9, and then we'll talk more about our strategic priorities going into 2021. As we announced on November 19, we plan to create TRPIM and implement the new adviser in the second quarter of 2022. We're convinced that, over time, having 2 distinct investment platforms, T. Rowe Price Investment Management and the current platform, T. Rowe Price Associates, or TRPA, 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 and our long history of building high-performing investment management teams, leaves us confident that this move will maximize our ability to generate alpha for clients over the long term. So we plan to transfer 6 strategies, representing $167 billion in AUM and move the current portfolio managers 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 will have a small presence in both Philadelphia with our U.S. high-yield team and Washington, D.C. In many ways, it will operate like a new investment division, leveraging shared function, though 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 long-term orientation. The key difference is it will generate its own investment insights, which, obviously, will not be shared between the 2 entities. So turning to Slide 10. 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 styles to facilitate idea generation and knowledge transfer. We've built a centralized research team on each platform based upon our belief and having analysts with deep sector expertise. Importantly, we've retained our ability to collaborate with fixed income by incorporating our U.S. high-yield team into TRPIM. So T. Rowe Price Investment Management will have dedicated ESG, quant and trading functions, and the strategies from both entities will be supported by the same distribution teams and shared services functions, including portions of our equity data insights and our corporate access team. It's also important to note that multi-asset products will continue to be able to select strategies from both entities. Now from a financial perspective, we began to incur additional expenses for this transition in 2019 and have continued to do so in 2020, including compensation for incremental headcount and onetime technology and recruiting costs. 2021 will be the last year of this phase-in of significant additional costs, and those assumptions were factored into the expense guidance of 6% to 9% that was provided in our third quarter earnings release. Notably, the nonrecurring items are not material enough to make an impact on the financials when they will go away. So turning to Slide 11. TRPIM is one of the many strategic priorities that we will be executing on in 2021. On Slide 11, you can see some of our other investment capability priorities. We will be advancing our product road map, including the launch of a health care innovation strategy, which will invest in companies seeking to improve health and span of life. One of the most -- questions that we get a lot is what's next from an ETF perspective. So you'll see that, in 2021, we plan to continue to expand our capabilities and launch our first fixed income ETFs, while continuing to build momentum for the 4 U.S. equity active ETFs that we've already launched. ESG also remains a critical focus area for us, both from a capability and from a -- product overall capability and in a specific product standpoint. We have plans to launch our first impact strategy next year, which will be called Global Impact, and we'll continue to integrate our proprietary Responsible Investing Indicator model, or RIIM, across our platform. We also continue to progress our equity data insights capability, which looks to improve investment outcome through data-driven insights. So I'm going to turn to distribution. On Slide 12, you can see our distribution priorities for next year. Nothing that is, I would say, truly new news on this page, but we continue to build upon our momentum in APAC and in EMEA, including, in EMEA, amplifying our ESG efforts. Within our U.S. intermediary channel, as I mentioned earlier, we continue to invest for growth in the broker-dealer space and continuing to add additional headcount in support of that next year. And then finally, we continue as well to improve the client experience, while driving efficiencies in our U.S. direct and bundled DC, bundled recordkeeping business. And then finally, on Page 13, within technology and operations, our 2021 priorities are broken out here across 4 buckets: continuing to modernize our infrastructure; enhancing the client experience; making sure that we can enable distribution; and of course, support alpha generation. We view technology as an enabler to many of our strategic objectives across the firm. And we expect to continue our modernization journey through 2021 and beyond. And I often get the question, when will it be done. Well, in technology, you're really never fully done. So we plan to continue to make ongoing investments in our technology platform. So with that, I will hand it over to Alex for Q&A.

Perfect. All right. Thanks, Céline. Thanks for that overview and that update. I wanted to start off with TRPIM and the creation of this separate -- or second. And you went through a couple of points on that already. But I guess if you were to just summarize it to the public shareholders. What are some of the biggest ramifications from that move to the public investors into your stock? And clearly, some of that comes down to freeing up capacity at a corporate level. So clearly enables you, I guess, to continue to deliver really good performance. Anything else we need to think about? Anything is on the expense side, since you mentioned that a lot of this buildup was in last year's numbers? Obviously, this year's numbers and '21 is going to be the last year we have to spend on some of these initiatives. So should we take that as a -- there's going to be kind of some free-up of the expense spend? Or will that just be essentially pivoted towards some other growth areas?

Yes. I mean, look, at the heart of our decision is supporting our continued ability to drive strong, long-term investment results for our clients. And that's what should matter most to our stockholders, right? Because that's what continues to enable our organic growth and our continued success. Also, notably, while we do not have any plan... Sorry, can you hear me?

Yes. I hear you great now.

Okay, okay. Apologies. From an expense perspective, we basically have been working on this for a while, right? And so have already absorbed some of the additional headcount that are associated with it, and we'll kind of finalize that in 2021. In terms of what will be next on the investment horizon, I've mentioned this before to you, Alex, but my hope is always that there will be good things to invest in because it means that we're continuing to have success, whether it's new strategies or it's continuing to expand our distribution capabilities.

Got it. All right. Let's talk a little bit about organic growth. Obviously, you and everybody knows that, that's probably the single most important thing for investors in the space. So clearly, the flows have slowed down, as you pointed out, this year, not surprisingly given the environment that we've been in. I was hoping we can zone in on the Target Date channel specifically.

Sure.

$300 billion in assets. Obviously, it's a very important source of flows for T. Rowe over the years. You talked about some of the idiosyncratic dynamics that impacted the flows in that channel. I was hoping to specifically zone in on the CARES Act. Obviously, the penalty-free withdrawal was a headwind. Hopefully, it's done by the end of the year. But what's happening with respect to contributions on the employer side and employee side? Obviously, unemployment rate is still very high, companies still looking for ways to save money. So has that impacted flows in Target Dates this year? And is that a risk, at all, as you're thinking about '21?

Yes. So interestingly, not much actually is the answer. So I've mentioned this before, we have a full look through when it comes to our record-keeping platform. So we have a little bit more insights than we do in our investment-only and IODC assets. But what we've seen on the record-keeping side is less than 10% of employers making some sort of change to their contribution and about 1/3 of those reinstating them in 2021. So when you think about headwinds, I would say that the people taking distributions, the CRDs, the CARES Act distribution, was more of an impact than a change in employer behavior. Of course, who knows exactly where that heads in 2021 if there are other sectors, there's more industries, right, that feel like they have to take these types of measures. I will say, Alex, another thing that was a factor in the Target Date flows this year. It's just that we saw kind of, I want to say, kind of panic behavior in the market drawdown in March. And you saw people just selling out their Target Date or their U.S. equity position in their 401(k)s and going to stable value or money market, unfortunately, at a very bad time for them. But that also had an impact on the year.

Got it. Understood. And I guess outside of the Target Dates, when we look at the collection of other channels of the subadvisory business, separate account business, some of the others, it actually feels like flows in that part of the model, so kind of like non-Target Date, nonmutual fund part of the business at T. Rowe, is actually doing quite well. So maybe spend a couple of minutes on where you're seeing momentum in flows across those channels, both products as well as some of the kind of channels or geographies?

Sure. Well, from a vehicle standpoint, we've had success, for instance, in Japan with our ITMs. That certainly has helped in the other category, right, in terms of other vehicles that you see. We continue to see traction, too, in the commingled investment trust, right, and kind of more demand for that and for the mutual fund format for some of our DC assets. And then we had some nice separate accounts, just institutional wins this year. But as you know, with institutional clients, some of that can be a lumpy win, a lumpy loss, right? So we acknowledge that some of that is -- we had some of that this year.

Got it. And I guess, speaking broadly across the platform, I was hoping we could spend a minute on the asset allocation dynamics, generally, you're seeing in the space. And really, the core of the question is: 2020, seen tremendous amount of volatility, needless to say. Equity markets are now back at near all-time highs, interest rates are at all-time lows. Presumably, that will create more sort of churn with respect to how portfolios are being adjusted, whether it's kind of an order rebalancing perspective or people making sort of [ proactive ] decisions. I guess, what do you see that -- how do you see that evolving over the next 12 to 18 months? What does it mean for T. Rowe? Any rebalancing dynamics specifically that we need to be mindful of given growth in equities and particularly growth stocks, obviously, [indiscernible]?

Sure. I mean obviously, we have a very diverse client base, right? When you think about retail investors individually or investors in their 401(k) plan and then you've got institution or subadviseries. So you've got different dynamics depending on the type of client that you're interacting with. But I think it's fair to say that certainly in some balanced portfolios, where we have U.S. equity representation with equities being up, you can see some trends rebalancing away from that or earlier sort of rebalancing away from growth. So we're conscious of that. But at the same time, as we've got a broad platform. We've got broad capabilities. And so, I think, we're well equipped in different environments to still be a destination of choice for clients.

Yes. Let's hit on another important topic when it comes to asset management, especially recently. Consolidation. We've had this conversation many times, right? And obviously, combining these type of businesses is very difficult. And generally, T. Rowe, obviously, stayed out of majority of things that have kind of been out there. Maybe give us an update on what you think consolidation in the industry specifically will mean for T. Rowe? And whether or not there's something that you would be interested in participating, obviously, at a right price at a right time and all that?

Yes. Well, I think there's -- well, there's 2 types of consolidation -- or several types, I would say. There's been consolidation amongst asset managers, there's been consolidation amongst distributors and then we've seen a handful of sort of vertical integration deals. And so they all sort of have different goals and different potential impacts. What I will say is, we are seeing some of our distributors consolidate and get bigger, right, which means potentially fewer larger clients for firms like us, which you can argue is kind of good and bad, right? It's good. It's good, large, successful relationships for us, but it's also more assets concentrated, right, with these distributors. From a -- from our industry perspective, from an asset management consolidation perspective, we've talked about this before, but I think there's been some deals that have been done on the premise of scale and cost takeout that have really struggled to deliver value were to be embraced, right? We are very much at scale, right? We have a lot of scale in our platform, so much so that we are creating TRPIM, right? So we're sort of in a different place. So we don't think that M&A for scale purposes is something that would make any sense for T. Rowe.

Got it. Pretty consistent message there, but I figured I'd check anyway. Let's shift gears a little bit. I want to spend a couple of minutes on pricing and fee rates. Other than the mix shift, which obviously plays a big role in what we see as the output on T. Rowe story, can you talk about any notable pricing changes you've seen with respect to your key product categories? Just again, wondering with equity markets near all-time highs or, I guess, at all-time highs, do you expect industry pricing pressure to, perhaps, accelerate somewhat? And sort of what's your response to that? And maybe as some -- kind of a subpoint to that, I figured we can hit on money market fee waivers as well. That was a little bit of an impact on that in the third quarter. But once you kind of reprice the whole money market suite, what's sort of the ultimate impact that it could have in terms of revenues of T. Rowe?

Yes. So we didn't have a lot of major pricing changes this year other than the restructure of our Target Date funds from bottom-up pricing to top-down pricing, which we executed earlier this year. As you know, I think, I've mentioned this in the past, we have a product steering committee that reviews all of our pricing decisions in quite some detail, and we want to make sure that we continue to be competitive, right, price competitive. We don't we don't think we need to be necessarily the lowest offer. We certainly don't want to be the highest either. We want to be well priced and certainly in relationship to the alpha that we're able to bring and generate for our clients. I do believe we'll continue to see pricing pressure. I don't know that it's accelerating or dramatically changing. I think it's an ongoing theme, and it will be with us for years to come. In terms of the money market, so we went from $2.7 million in Q2 to $6.4 million in Q3, and we could probably go up a little bit more. If you go back to the financial crisis, the maximum was close to $50 million at its peak, just to give you a sense. Money market AUM was lower then, but you have to keep in mind that some of the contractual waivers have been in place since then and already embedded in revenue. So I mean, that will have some impact on 2021.

Got it. That makes sense. We have a couple of minutes left. So I do want to hit on expenses real quick. So you guys introduced guidance for '21, 6% to 9%. You talked about it obviously earlier this morning. Can you help us unpack this a bit more? In other words, how much lower was your 2020 expense base due to some of the COVID-related items? And how much of that normalization in expenses is embedded within your '21 guidance, right? So obvious things like travel, entertainment and things like that. So what's baked in? How much did that benefit the expense base in 2020, to kind of help us level set?

Yes. So like everybody else, we had a drop, obviously, in our T&E expenses as well as some of our maintenance for buildings and things like that. So that brought down our expenses a little bit this year. We also, back in -- at the end of Q1, made the decision to kind of manage our expenses a little bit more because, at that point, there was so much uncertainty in terms of how the year was going to unfold. So as we looked to plan for 2021, we factored some of those costs coming back in terms of travel and entertainment and buildings, but not to a full normal run rate just because of uncertainty, at least in the first half of the year.

Yes. And I guess, how do you think about some of the structural changes on the expense side that could come out of this crisis, right? So using more digitization and doing more things like this, right, and not spending money on travel, et cetera. So is that something that you think could become more permanent in T. Rowe's expense planning? Or is that essentially going to be used to reinvest into other growth initiatives?

Yes. Look, I think the way that we interact with clients and maybe also with management, right, will evolve. There probably will be more of this and maybe a little less time wasted on travel in the future. And it's -- in some ways, it just enables you to reach more people and do more, right, in the same amount of time. I don't anticipate that it will have a meaningful impact on our expense base, in part, because it's only a small part of the expense base, in part because, perhaps, other things will replace it. But I do think that, certainly, in how we work and how we interact with clients, some of the things will remain.

Got it. We have a couple of minutes left, so I do want to make sure we get to do some of the webcast questions. So I'll take one. It's also around capital, obviously, a significant amount of cash on the balance sheet. You talked about some of the M&A with respect to the asset management side of the business. But anything else that you would consider acquiring, anything on the fintech side, that might be interesting? And broadly, how are you thinking about deployment of that cash that continues to appear on balance sheet?

Sure. I mean, from an M&A perspective, so my earlier point was really around the scale kind of cost take-out-driven transactions that we don't think would make sense for the firm. On the flip side, though, we have a clear strategic road map. We have new capabilities that we want to build. And to the extent that we found in a potential inorganic opportunity to acquire those capabilities, and if we thought it was a real high-quality firm and culture that was compatible with ours, we would consider it. And that could include things in the technology space, right, when I think about technology, I think about, in particular, our direct-to-consumer business, right, the individual investor and the record-keeping business, but also how we support financial advisers. We have a number of services that we offer advisers today that we're always looking to scale and kind of further use technology to reach a broader set of advisers. So it would be a possibility for the firm.

Got it. Great. Well, we're pretty much out of time. So I want to thank, Céline, on behalf of myself, my team and Goldman Sachs broadly for joining us this morning to give us an update, and hope you have a productive day in meetings, and we hope to see you next year.

Thanks for your time.

Great. Thank you.

Bye.