Artisan Partners Asset Management Inc. Class A

Hello, and thank you for standing by. My name is Rocco, and I will be your conference operator today. At this time, all participants are in a listen-only mode. After the prepared remarks, management will conduct a question-and-answer session, and conference participants will be given instructions at that time. As a reminder, this conference call is being recorded. At this time, I will turn the call over to Michaela Taphorn, Director, Investor Relations for Artisan Partners Asset Management.

Thank you. Welcome to the Artists and Partners Asset Management Business Update and Earnings Call. Today's calls will include remarks from Eric Colson, CEO, and CJ Daly, CFO. Our latest results and investor presentation are available on the Investor Relations section of our website. Following these remarks, we will open the line for questions. Before we begin, I'd like to remind you that comments made on today's call, including responses to questions, may deal with forward-looking statements. These are subject to risks and uncertainties and are presented in the earnings release and detailed in our filings with the SEC. We are not required to update or revise any of these statements following the call. In addition, some of our remarks made today will include references to non-GAAP financial measures. you can find reconciliations of those measures to the most comparable GAAP measures in their release. And I will now turn the call over to Eric Holson.

Thank you, Michaela, and thank you, everyone, for taking the time to listen or read the transcript. We appreciate and value your time. We know that we cover the same topics and themes over and over. It is important that our stakeholders understand who we are and the fundamental principles that guide our decision-making. We think it's worth the time to go back over these points. High value-added investing, talent, and thoughtful growth. These are the most important things. That's why we talk about them all the time. Our flywheel is simple. Attract and partner with great investment talent. Provide the talent with the resources, autonomy, and time to generate and compound wealth for clients. Long-term growth for talent, the firm, and shareholders follows. Executing is more complicated, especially because we operate at the intersection of people and markets, both of which are constantly changing. All the more reason to have an articulate approach and process that keeps us grounded and guides our actions. Slide 2 outlines our repeatable process for partnering with investment leaders to develop successful, sustainable investment franchises. An investment team with the franchise traits listed on this slide is a powerful engine of value creation for clients, talent, and shareholders. Over our 25 years, we have developed this process and successfully executed with multiple investment leaders across numerous variables, including inception dates asset class, style, geography, resource model, and culture. It starts with finding the right talent for artisan. We seek unique investment leaders who are passionate about their investment philosophy and who want to operate with an ownership mentality. We are extremely patient in both identifying prospective new talent and the courtship process. The opportunity cost of moving forward with someone is high, We only move forward when we believe there is a high probability of long-term success. Once we bring on new investment leaders, we develop and resource a team, which includes people, research, data, technology, space, and guidance. We focus on building a strong foundation, a cohesive team, a repeatable investment process, and early results. We find the right business leader to find the right clients on the right terms Generally, after teams spend several years developing the foundation, a period of accelerated asset growth will follow. We seek to build businesses diversified by client type, vehicle, and geography. We focus on high-quality, long-duration clients. Eventually, organic growth moderates and a lion's share of future growth comes from compounding wealth for clients. Teams broaden out their investment capabilities and add greater depth of talent. Distinctive and recognizable brands emerge. This is not a linear process. It plays out differently for each team, but we always stack the deck in our favor. We design paths with high probabilities of long-term success. Via our model and culture, we buy time. As duration extends, so too does probability of success. Some investment teams and strategies take more time, due to a change in market environment, client preference, or something specific to the team or strategy. Before leaving this slide, I want to emphasize that the growth portion of the curve does not mean organic growth or net flows. It means much more than that. It means growing as investors, growing as a team, and further developing each of the franchise traits. It may mean AUM growth. but that growth will often be in the form of wealth creation for existing clients. We don't engineer products to feed a large sales force, see what hits, or smooth flows. We are targeted in our approach based on who we are. We operate outside the influence of short-termism, expect lumpy outcomes, and compound long-term results for clients, associates, and shareholders. The next slide summarizes two of our newest strategies, International Small Cap Value and China Post Venture. In September 2020, Beini Zhao and Annan Vasagiri joined Artisan International Value franchise. Subsupported by founding portfolio manager David Samra, Beini and Annan launched the Artisan International Small Cap Value strategy in October 2020. The strategy applies the value-oriented philosophy that David has been refining at Artisan for nearly 20 years to the large and inefficient international small cap space. Since inception, the strategy has returned 45.9% after fees, beating its benchmark index by more than 900 basis points. Also in 2020, Tiffany Hsiao and UNUMG joined Artisan to build a new investment group within our global equity franchise. We have worked with Tiffany and UNUN to build a team of five professionals, open a new office in Hong Kong, develop custom investment technology, access the China A-share market, and execute on early private transactions. As of the end of the quarter, since inception, the strategy had returned 11.2% after fees, beating its benchmark index by more than 500 basis points. While each of these new groups sits within an established investment franchise, each is building the strong foundation I described on the prior slide. These strategies also represent the high-value added space where we expect to continue to find opportunities for thoughtful growth consistent with who we are. Emerging and other less efficient international markets and private asset classes, especially those that can be paired with public assets, where we have a proven track record of success. Turning on to slide four, on July 1st, our sustainable emerging markets franchise marked its 15th anniversary at Artisan Partners. Including time at a prior firm for more than 20 years, Maria and her team have employed a consistent investment philosophy, identifying companies with sustainable competitive advantages and unique access to growth. Assessing sustainability has been part of the team's process since inception, but they take a differentiated approach to the concept. They look for companies committed to profits and progress. They acknowledge the realities of emerging markets and evaluate companies individually, but they focus on the long-term direction and degree of change. They dig deeper into ESG by assessing a company's ability and commitment to bring continuity to shareholders employees, customers, and communities, what they call the capacity to endure. They don't use negative screens or exclusion lists, which overlook positive change and forward-looking management. As the quantity and quality of ESG information has improved, the team has evolved the sustainability assessment. They now combine quantitative, incident-based reporting with their own qualitative assessment based on interviews, site visits, company files, and other ESG sources. The team's commitment to its core principle and dedication to continued improvement has paid off for clients and the firm. Over the trailing five years, the team has generated average annual returns of 14.8% after fees, beating the benchmark index by more than 175 basis points per year. The team is strong and the process is proven. The Artisan Sustainable Emerging Markets Franchise is poised for future growth. Our aggregate growth outcome is on slide five. Building and maintaining sustainable investment franchises results in long-term growth. Nearly all the growth shown on this slide has resulted from investment returns generated for clients. That's what we expect. Attract and retain great talent, developed investment franchises that compound wealth for clients. Long-term growth for the firm and shareholders will follow. Our purpose is to generate and compound wealth for our clients over the long term. Our clients use the dollars we compound on their behalf to achieve their objectives and goals. Over nearly 25 years, our U.S. mid-cap growth strategy has compounded client assets at a rate of over 15% per year after fees, generating nearly 5% per year of alpha over the index. Those results over that time period in a daily liquidity strategy stack up well against any investment strategy or asset class. Most importantly, it has worked for clients. Since inception, net of contributions, clients have taken over $10 billion out of the strategy. That gets recorded as cumulative net outflows of over $10 billion. But in fact, it represents considerable success in fulfilling our goal as an organization. Today, the Mid-Cap Growth Strategy has approximately $18 billion AUM, with a strong track record, a stable investment team, and a proven investment process. This is a high-quality outcome for our clients, our people, and our firms. And if measured solely by net flows, a different conclusion may be made. Our outcomes are not linear. They can't be engineered on a quarterly basis. But we have a repeatable process for developing investment franchises, compounding wealth for clients, and generating successful outcome for shareholders. We will continue to apply that process with both our existing investment franchises and new talent and teams we add over time. I will now turn it over to CJ to discuss our recent business and financial results.

Thank you, Eric. I'll begin on page 7 with AUM, which ended the quarter at $175.2 billion, up 8% compared to last quarter, and up 45% compared to the June quarter of 2020. The change in AUM over the quarter reflected $11 billion of investment returns and $1 billion of net client cash inflows, representing a 3% annualized organic growth rate. For the first six months of the year, strong investment returns contributed $15 billion to AUM. Net client cash inflows were $2.5 billion, also representing a 3% annualized organic growth rate. We believe investment returns, including returns in excess of benchmarks, will continue to be the driver of growth in our business as demonstrated this quarter and for the six-month period as well. Average AUM was $170.5 billion for the quarter, up 5% sequentially and 56% compared to the June quarter of 2020. Year-to-date, average AUM was up 49% compared to the first six months of 2020. Changes in AUM by generation are on page 8. Our third-generation strategies continued to achieve impressive growth. For the quarter, AUM and third-generation strategies grew 14% as a result of investment returns and $1.9 billion of net client cash inflows. For the six-month period, AUM and our third-generation strategies grew primarily through net client cash inflows of $4.3 billion, representing a 31% annualized organic growth rate. And despite the measures we've taken to manage capacity in two of these strategies, we believe we will continue to see growth in our third-generation strategies. AUM in our first- and second-generation strategies grew through strong investment returns over the quarter and year-to-date periods, which more than offset modest net client cash outflows across both periods. Net client cash outflows were significantly driven by client rebalancing after several strong years of investment returns. Financial results for the quarter and year-to-date periods are presented on the next two pages. Our complete GAAP and adjusted results are presented in our earnings release. My comments will focus on our adjusted results. Starting with quarterly results, revenues grew 5% compared to the previous quarter on higher average AUM and one additional calendar day in the quarter. Revenues were up 50% compared to the second quarter of 2020, also primarily due to higher average AUM. Adjusted operating expenses decreased 1% sequentially as lower seasonal expenses in the second quarter more than offset the increase in variable compensation and distribution-related expenses due to revenue growth. Year-over-year, quarterly adjusted operating expense increased 32% as variable costs increased with higher revenue and fixed compensation costs grew as a result of a higher number of full-time employees. Our adjusted operating income grew 13% sequentially and 80% year-over-year, and our adjusted operating margin improved to 45.3% this quarter. Adjusted net income for adjusted share also grew 13% compared to the first quarter and 80% compared to the June 2020 quarter. Year-to-date financial results reflect the same themes as the quarterly results I just highlighted. Year-to-date revenues increased 47% compared to 2020, primarily due to an increase in average AUM. Year-to-date adjusted operating expenses increased 30% in 2021, as variable costs increased with higher revenues and compensation costs increased as a result of an increase in the number of employees. Our adjusted income grew 76%, and our adjusted operating margin for the six-month period was 43.6%. Our balance sheet continues to remain strong and support our capital management practices. We maintain approximately $100 million of excess cash to fund operations, seed new products, and make continued investments in new teams, operational capabilities, and technology. In addition, our $100 million line of credit remains undrawn. Dividends are presented on slide 12. Our Board of Directors declared a quarterly dividend of $1 per share with respect to the June 2021 quarter, which represents approximately 80% of the cash generated. That concludes my prepared remarks, and I will now turn the call back to Eric for some additional commentary.

This is Eric again. Before CJ and I take questions, I want to take a minute to discuss the changes we recently announced to our Board of Directors. Stephanie DiMarco, who joined our board in 2013 in conjunction with our IPO, will become chairperson of the board, and Solani Multani will join our board bring the total number of directors to eight, seven of whom will be independent of management. Our board and corporate governance have evolved since our IPO. Over time, we have added new and diverse perspectives, individuals who broaden the board's experience, skill set, and ability as a governing body. We have also retained strong representation from individuals who experience with Artisan dates back to the founding of the firm 25 years ago, individuals who are deeply enmeshed in our history and culture as an investment firm, deeply committed to our talent-driven, patient approach, and who have seen firsthand the power of our model and the results it can generate over extended time periods. Independent governance and transparency as a public company makes us stronger and distinguishes us from many of our peers. At the same time, we are able to maintain the long-term mindset and willingness to be different, more often associated with private firms. These earning calls are a good example of both our transparency and our commitment to long-termism and remaining disciplined to who we are as a firm, whether private or public. Ultimately, what matters is not a company's legal structure, but who we are and aligning our governance, operation, and transparency to support our purpose as an investment firm and increase the sustainability and duration of what we do for our clients, our people, and our owners. I will now turn it over to the operator to take questions.

Thank you. We will now begin the question and answer session. If you would like to ask a question, please press star then 1 on your touch-tone phone. If you're using a speaker phone, we ask that you please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Today's first question comes from Alex Blasney with Goldman Sachs. Please go ahead.

Great. Good morning, everybody. Thanks for – good afternoon. Thanks for taking the question. I wanted to start maybe with a couple questions around your approach to capital management in light of what obviously has been a, you know, fairly challenging share price for, you know, the last, you know, six to nine months or so. I guess when you think about some of the drivers, at least in the public markets, of value, organic growth definitely comes up as one of the more important ones. And I know, Eric, you guys don't target flows specifically, but Artisan does have a positive organic growth backdrop, pretty clean balance sheet, obviously good long-term track record, yet the stock obviously has been sort of challenged here. Given the free cash flow yield is in the kind of high single digits now, any room to pivot to a more aggressive share repurchase as you think about long-term value for shareholders?

Yeah, Alex, this is CJ. You know, I don't think there's – I know there isn't any change in our mindset or the board's mindset around our capital management policy. We've been pretty consistent, transparent, and we like the predictability of our current policy, so I would not expect – any changes, specifically, I think you're referring to whether we do stock buybacks or not. So I would not anticipate that you should expect that.

Okay. And then I guess when you think about building out some of the new strategies, I was hoping you could expand what you guys are doing on the private market side of things, both in terms of product development and how you think about distribution of that product down the road.

Yes, certainly, Alex. This is Eric. Obviously, with the launch of the China Post Venture, which specifically adds the investment degrees of freedom to include both public and private, the mindset with that strategy and some of our other strategies is to leverage investment degrees of freedom and broaden the use of private securities where appropriate. So we see this as a continuing trend in the industry. We see it as a continuing theme inside of Artisan. And we expect to build out more infrastructure and support around this effort, as well as incorporate more private securities across other investment teams, and it also heavily influences how we look at future teams and teams' ability to broaden the universe. It's very obvious in the U.S. on the number of securities going from over 8,000 to under 4,000 of publicly traded. We've seen the growth of private securities the private company universe as companies have stayed longer private. And especially the late-stage private companies have a lot of characteristics that you see in the early-stage public companies. So that blending is occurring. We always take it as an investment-first approach. So The support model around privacy is very important, and it needs to be acknowledged that it is different than the public markets. And the resources to creating a network, providing access to management, and being able to compete to put capital to work in companies that fit our philosophy and approach for strategy will require time and effort. It's a multi-year investment and focus to get to those – to access those markets. And as we build that out, we are looking at how to marry that with the right vehicle and right distribution model, which we're spending more time on today. But we are very optimistic given the early success we've had with China Post Venture. Great. Thank you.

And our next question today comes from Bill Katz at Citigroup.

Please go ahead. Okay. Thank you very much for taking the questions this afternoon. In terms of just sort of building off that last question, could you maybe step back and say where are you in terms of pipeline of discussions with other teams? You know, what's the priority of that versus maybe the opportunity to enhance the product set on the private side across maybe your existing footprint? And then when you say it takes a couple years to build this out, is that sort of even with the existing teams, or is that sort of as you add teams on? Sorry for the nested question. Thank you.

Yeah, obviously, you know, right now we view there's quite a bit of opportunity in the marketplace for artists and with regards to our existing teams as well as new teams in the marketplace. With the breadth of strategies we have today in-house, we are spending quite a bit of time of how to build out existing teams, resources, and functionality to capture investing in private markets or in other areas that broaden out the degrees of freedom, which we That is typically our highest priority and consumes the most amount of resources is supporting the known versus the unknown. And that has paid off for us over the years. And you've seen that with the highlighting of two teams that are embedded in two mature teams highlighted on the call today. We are fielding quite a few teams that we're meeting with. Some would go into privates. Others would be in other asset classes. That would be a lower percentage of time versus our existing teams. And I would say the one- to two-year comment, Bill, is more around our existing teams as you transition transition from public to incorporating privates, you know, it requires resources and networks that need to be built out. With regards to new teams, you may have that skill set embedded with the people that you bring in. You know, for example, the China Post Venture, you know, Tiffany Hsiao and her team brought a very strong network and ability to interact and move forward in privates. And, you know, we launched day one with that strategy, incorporating privates. So hopefully that answers your question.

Very helpful. Second question, just sort of staying on your sort of the discussion between the interplay of sort of AUM growth and flows, you've been pretty transparent in terms of some of the building capacity issues. Can you sort of step back and give us a sense of where you think you are as you look across the platform in terms of related capacity constraints? And then on those mandates where you've actually made some announcements, can you talk a little bit about, like, the residual capacity in the separately managed account or separate account segment?

Yes, certainly. I mean, we've made some announcements around soft closing, various strategies, and I guess just to be clear, soft closing, in my mind, is a glide path to managing long-term capacity. It really, as an investor, takes a longer time horizon and really understands our business model. You know, this should be viewed as increasing the probability of long-term growth. You know, as we illustrated on slide five, I mean, and really highlighting our sources of growth, we find this has the highest probability of of projecting growth out in the long term. And, you know, in our view, I mean, really looking at short-term growth over the next one to two years is highly unpredictable. There are many factors that go into, you know, the pipeline and how decisions are made and when the timing of those dollars occur. And we just don't view the, you know, the soft close or the announcement as an on-off switch. You know, given that we are in a relationship business and really the prospects that look at our strategies take months and years to analyze, you have to manage those relationships and communicate over time of, you know, where capacity is at. And so these announcements signal that we're managing capacity And each strategy is slightly different. In some cases, we might manage the separate account business. In other cases, we might manage the pooled vehicle so that we maintain a diverse asset base. And the outcome of soft closing could be an influx of dollars coming in in a shorter time period. It also could mean just a grandfather list of clients that have set dollars over certain time periods that may take years to come in. You know, regardless, the impact on the short term is really hard to predict. But over the long term, it's really compounded growth quite well. And so you'd have to go strategy by strategy, Bill, on separate account or pooled vehicle for each of these.

Okay. And if I could just slip one more in. Thanks for the goodwill of taking all the questions today. Maybe one for CJ. As you sort of contemplate, I know there's a lot of moving parts to this, as you contemplate maybe the glide path around expense outlook for the second half of the year, can you give us a sense of maybe the exit pacing, particularly for some of the non-comp segments?

What do you mean by the exit pacing?

Well, just how you sort of see the second half stacking up, sort of the economy reopens and maybe travel, entertainment, sort of discussing things that may have been a little depressed given COVID.

Yeah, yeah, yeah. I mean, you're really seeing the impact of COVID in that G&A line, and we're currently realizing about $2.5 to $3 million of quarterly expense reductions as a result of not being in the office and not traveling, and it's hard to tell. I mean, we would have expected that after Labor Day that things would have slowly started back to normal, but that seems to be delayed now with the Delta variant, and so hard to predict when that would come back, but we would expect that when it does come back in full, that that $2.5 to $3 million per quarter will make its way back into our expense base.

Trevor, thank you, guys.

And our next question today comes from Dan Fannin with Jefferies. Please go ahead.

More thanks. I was just looking at the third-generation funds and kind of the vehicles that's broken out on slide eight and the variance or the divergence between the third generation and the second generation. I'm just curious if there's anything structurally why the SMA vehicles wouldn't be a bigger component as that line of products matures over time.

Yeah, the third generation leans a little bit more in degrees of freedom. And when you look at emerging markets or the use of privates to have a broad array of separate accounts that have the country openings or the ability to operate in more illiquid segments tend to tend to bias our asset raise into pooled vehicles with a more uniform investment policy statement around it versus individual IMAs and reliance on the client to be able to handle the breadth of securities or regions that we're going to operate in. So as you up degrees of freedom, And you see that into maybe even the hedge fund or the private equity space. You see a higher use of a pooled vehicle, whether it's a private fund that used it or a CIT. So it's really a reflection on the breadth of those strategies.

Okay, that's helpful. And then one more just on capacity, given the strength in beta and your AUM growth, is there – If you look at the front line of today, are there funds or strategies that are on watch that maybe are closer than others that, you know, as you look out over the next six, 12 months, you know, potentially could be part of that soft close component that you've done more recently?

I think we've talked about the small cap growth as one of those that we've been managing capacity and keeping an eye on the net flows. is probably one strategy that is not formally stated. Otherwise, everything else is in the open market there.

Great. Thank you.

And, ladies and gentlemen, as a reminder, if you'd like to ask a question, please press star then 1. Our next question today comes from Kenneth Lee with RBC Capital Markets. Please go ahead.

Hi. Thanks for taking my question. Wondering if you could just share with us your latest thoughts around the potential, any potential to expand distribution partnerships over time. Thanks.

We've made one proposal. in Australia to go deeper into the high net worth financial advisory. We've built a very strong institutional presence in Australia, and we've gone a bit deeper into that marketplace. With China Post Venture, we've built broadens our distribution into the high net worth marketplace in a more meaningful way than prior to China Post Entercoming. It just sparked interest from clients that we haven't normally interacted with. With regards to that segment, we'll build that distribution capability in-house. And as we bring on more alternative-oriented strategies like China Post Venture. We will resource in-house that distribution. Similar to how we attacked the intermediary market when the broker-dealer market was growing years ago or when the defined contribution was growing, we brought in some individuals to focus on DC, and then it got incorporated into our broader distribution. And as we up the number of alternative-oriented strategies, we'll build that capability in-house more than relying on pure partnerships. And, you know, we continue to expand out on some of the high net worth and financial service companies outside the U.S. to get leverage of our global products. But no specific distribution partners to call out today.

Gotcha. Very helpful. And just one follow-up, if I may, and this is just a follow-up to our previous question. Are there any particular white space investment strategies that outside of private assets that you could highlight as potential areas that Artisan could explore?

Thanks. The privates are a pretty broad trend. When you look at the ability today of leveraging a really strong public oriented investment background, say, you know, Tiffany's, you know, history and ability to now extend into a certain percentage of privates. You can really look across, you know, credit, real estate, and infrastructure, or I guess any real asset, and the blend of public-private provides a really strong opportunity for for Artisan that's navigated in the high value added public strategy arena and then being able to extend a percentage of each of those strategies into privates. It allows us to look at an array of asset classes that may have been more traditional in the private space now with the blending it opens up our opportunity and the ability to onboard Tiffany and the China Post Venture to transact on private companies now in that strategy and to raise dollars to match that is a great signal to the marketplace that we can operate in this broad white space of the blending of public and private. across multiple asset classes.

Great. That's very helpful. Thanks again.

And, ladies and gentlemen, this concludes today's question and answer session and today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.