Artisan Partners Asset Management Inc. Class A

Good day and welcome to the Artisan Partners second quarter 2022 earnings call. All participants will be in a listen-only mode. Should you need assistance, please send an all-conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one. Please note that this event is being recorded. I would now like to turn the conference over to Michaela Taphorn with Artisan Partners. Please go ahead.

Thank you. Welcome to the Artisan Partners Asset Management Business Update and Earnings Call. Today's call will include remarks from Eric Olson, 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, the most comparable GAAP measures, in the earnings release. I will now turn the call over to Eric Olson.

Thank you, Michaela. And thank you, everyone, for joining the call or reading the transcript. The first six months of 2022 have been tough. The war in Ukraine, inflation, in June reaching approximately 9%, a 40-year high. Negative consumer sentiment, economic stagnation, whether qualifying as a recession or not. The worst first half for the S&P and persistent high volatility. At Artisan Partners, our AUM declined 26%, from $175 billion to $131 billion. Year over year, first half revenues declined 11%, and adjusted operating margin declined 750 basis points, from 43.6% to 36.1%. As we've experienced before, these times demand discipline to our business and financial model for stability and perspective to capture opportunities for long-term growth. To achieve stability and growth, it's critical that we level set our business and financials and align our interest and resources for growth with all stakeholders, our board, management, associates, clients, and shareholders. Last week, after our quarterly board meeting, We hosted a firm-wide discussion with several members of our board in Milwaukee. The event was attended in person and online by over 250 Artisan Associates. We discussed Artisan Partners' history, philosophy, values, and consistency through time. I wish all of our stakeholders could have been there. our commitment to excellence, quality, and doing the right thing, our patient, long-term approach, and the consistent application of our guiding principles as we have grown and evolved since 1995. Across the firm, we take confidence in our investment track record and proven business success. We are well-positioned to take advantage of the disruption around us. Sharp market drawdowns happened relatively often. Since our founding in 1995, there have been 12 calendar quarters in which the indexes to which our strategies are compared have declined by more than 10%. That averages to approximately every two years, though not evenly distributed over time. On the way down, Higher correlation on the way down, though, creates opportunity for active managers with extended time horizons. Historically, our teams have taken advantage. In eight of 11 12-month periods following a 10% drawdown, our firm-wide asset-weighted performance has exceeded benchmark performance. Across the 11 periods, Alpha averages 297 basis points. Over the following three-year periods, we have outperformed 8 of 10 times, with outperformance averaging 308 basis points. If you reduce the drawdown triggers to 5%, there have been 22 such quarters since our founding. We have outperformed in 13 of 20 subsequent 12-month periods and in 16 of 19 subsequent 3-year periods, with outperformance again averaging 300 basis points. Disruption from shocks, like the TMT bust, great financial crisis, COVID, and now war in Europe ignite macro issues. In subsequent periods, years, not months, dispersion returns, and with it, opportunities for alpha. Every drawdown is different, and statistics never tell the full story, team by team or strategy by strategy. Historically, there has been a rhythm to these patterns. Post-drawdown, dispersion occurred within security universes, allowing conviction-weighted portfolios to differentiate over a longer holding period. Our investment teams have been able to take advantage in the past, and we believe they will be well-positioned to do so again. Market disruption also creates business opportunities. have the advantage. Our disciplined long-term approach and flexible financial model allow us to continue to purposely invest in new investment teams, new capabilities, and new resources. As with past drawdowns, we level set our business commitments with our resources and people to capture long-term growth while scrutinizing expenses to adhere to our financial model. As an investment-oriented firm, for the market environment. Thus, we mitigate the need to pull back on investments, projects, or people as aggressively as others. Consider emerging markets debt. In the first half of 2022, EM bond funds experienced $50 billion of redemptions, the worst outflows in more than a decade. The dollar-denominated EM debt index declined nearly 20%, storm and stampede for the exits. What do we see? Opportunity, money in motion, poor absolute and relative returns from established players, a market ripe for wealth and alpha generation going forward. With that mindset, we have stayed on schedule with our new emerging markets debt team, the M. Seitz Capital Group. not managing for short-term outcomes, but for the long-term investment performance, franchise development, and sustainable growth. Over the last four months, we have launched three strategies and four vehicles managed by the Insights Group. Blended Currency, Artisan Emerging Markets Debt Opportunities, Local Currency, Artisan's Emerging Markets Local Opportunities, and the highest degrees of freedom, Artisan Global Unconstrained. The team's early performance has been gratifying. More importantly, they are establishing the foundation for long-term success. This is not the first time we have launched an investment team or strategy in a difficult environment. We launched the Global Value Strategy in the second half of 2007 in front of what turned out to be the great financial crisis. The strategy declined 13% over its first three years of operation. track record, 289 basis points of average annual outperformance since inception, and approximately $22 billion in AUM. The Global Value Strategy was instrumental in expanding our reach to clients outside the United States and around the world. In 2007, we had approximately four relationships outside of the United States. Today, that number is 229. We began high-value-added credit investing eight years ago with the launch of the High Income Strategy. We are methodically building out the capabilities and offerings of the Artisan Credit Team, led by Brian Krug. And the launch of the MSites Capital Group Strategies is a significant investment in building out differentiated credit offerings. significant amounts of capital. Our proven success with talented investment teams uniquely resourced by our centralized operations and delivering investment strategies designed for long-term asset allocation provide confidence to operate through short-term shocks and noise. With each investment team, multiple dimensions. Slide four shows the hypothetical performance of a portfolio consisting of $1 million invested in each artisan strategy at inception compared to a portfolio consisting of the same dollars invested on the same dates in the corresponding benchmarks. The alpha we generate translates into much more wealth. It takes time. and generate much more wealth for clients. Our business model and philosophy are designed to buy time, absorb shocks, and provide stability for our people, our clients, and our shareholders. We manage time horizons, durations, and careers to buy the time needed to realize the benefits of a disciplined investment philosophy and process. Our financial model and business management team absorb shocks, like the ones we have seen so far this year, and insulate our teams from short-term noise and follow the herd pressure. Our investment teams are genuinely autonomous. We believe in the alpha-generating capability of each of them. We give them the time, tools, and intellectual freedom to stick to their process through volatility and uncertainty. We have managed revenue declines due to market shock. and profitability fluctuations resulting from both revenue declines and expense increases, sometimes at the same time. This is nothing new for us. We have been here before. We will remain disciplined and confident in the outcomes that result from talented people operating in a stable, long-term environment. I will now turn it over to CJ to discuss business and financial outcomes.

Thanks, Eric. I'll begin with AUM on page 7. During the quarter, sharp market declines negatively impacted our AUM. Global equity market indices declined approximately 15% for the quarter and approximately 20% for the year, hovering near bear market territory as of the end of the quarter. Market declines were driven by, among other factors, the continued conflict in Ukraine, a spike in inflation, and sharp increases in interest rates, which drove heightened fears of a pending recession. As a result, AUM declined to $130.5 billion, down 18% compared to last quarter, and down 26% compared to the June quarter of 2021. In response, some clients took defensive actions, turning away from riskier growth equities and emerging markets. Net client outflows were $4.2 billion. growth teams. A small number of clients drove the majority of the increase in outflows, mostly as a result of reallocations away from risk. Average AUM was $143.9 billion for the quarter, down 11% sequentially and 16% compared to the June quarter of 2021. Year-to-date, average AUM has declined 8% compared to the first six months of 2021. Across all generations, AUM was impacted by declining global markets during the quarter and year-to-date periods. There were no material changes in the weighted average management fee for AUM mixed by generations. Financial results are presented on the next two pages. Our complete gap and adjusted results are presented in our earnings release. My comments will focus on our adjusted results. Quarterly revenues declined 11% compared to in the year-to-date period in 2021. Adjusted operating expenses decreased 6% sequentially due to the decline in incentive compensation expense as a result of lower revenues and seasonal expenses. The decreases were partially offset by an increase in travel expenses, which have trended back to pre-COVID levels. Year-to-date adjusted operating disruption, and continue to invest in our business to support future growth. Over the last year, we've invested in new and existing talent, technology, and office space, including the onboarding of the MSITES Capital Group and the launch of the team's three new investment strategies, as well as two additional strategies and existing teams. In addition, we have expanded our distribution capabilities to support the additional capacity created by the new teams and strategies, and expanded our operational capabilities and fixed income and credit with new technologies and specialized talent. These investments were mostly offset by a decline in incentive compensation expense as a result of lower revenues. Adjusted operating income declined 18% sequentially. Adjusted net income for adjusted share declined 19% compared to the first quarter and declined 27% compared to the 2021 year-to-date period. Our financial model was built to flex with fluctuations in global markets. While market declines were sharp quarter over quarter, our financial model allowed us to continue to focus on the long-term rather than react to short-term market swings. We are confident that the investments we've impact of short-term results. Our balance sheet continues to reign strong and supports our capital management practices and our variable cash dividend payout model. Over the past year, we have leaned into new strategy launches, putting approximately $60 million of seed investments into new products. Investing in new strategies is an important component of our future growth. Accordingly, we currently plan of cash generated. Consistent with our capital management policy, our board of directors declared a quarterly dividend of $0.60 per share with respect to the June 2022 quarter, which represents approximately 80% of the cash generated. That concludes my prepared remarks, and I will turn the call back to the operator.

And we will now begin the question and answer session. To ask a question, you may press star then 1 on your touch-tone phone. If you're using a speaker phone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. And in the interest of time, we please ask that you limit yourself to two questions. And our first question today will come from Kenneth Lee with RBC Capital Markets. Please go ahead.

Hi. Good afternoon, and thanks for taking the question. Um, first one is just around, uh, investment capacity, just given the, the current, um, the market volatility and all the various, um, dynamics. How do you think about investment capacity across all your various teams and strategies at this point?

Yeah. Hi, Kenneth. It's Eric. Um, it was the, uh, you know, the current drawdown, um, that we've seen in the marketplace. Uh, we've, uh, Obviously, increased capacity in some of our strategies with the drawdown. The strategies that still remain in high demand, we're going to carefully manage flows. We've always believed that there's been three major drivers of capacity control. One, really around just the pure – you know, rate and speed of which flows come in. And sometimes you see a strategy get a high demand in a short period and you have to manage that flow so it's not disruptive to the integrity of the strategy. Second, you look at channels and regions and so that you want to protect against a concentrated flow that comes in. And likewise, you look at just the aggregate capacity of a strategy. We have that we're in the demand category, but the bulk of the strategies, you know, demonstrated some outflow as well as drawdown in performance, creating capacity. As we look across the entire platform, with the addition of new teams and strategy, we have more capacity than we've ever seen in the history of the firm.

Gotcha. Yeah. And then one about the prepared remarks that you talked about, retention of some of the special dividends for seed investments. I'm wondering if you could just help quantify that amount and perhaps talk a little bit more about the details. Presumably this is going for either newer credit strategies or are there any other strategies that you're looking to seed in particular? Thanks.

Yeah, Ken, with respect to future dividends, our quarterly dividend policy at 80% of the cash generated remains the same. In past years, we have held back a small amount of cash to fund strategies as well as be defensive. So I think last year we paid 95, 96% of the cash generated and with a little bit of a holdback and we're continuing, we're on track to pay about the same percentage. You know, our trailing 12-month dividend yields about 11%. And, you know, even with the holdback, you know, we'll still have an extremely healthy dividend. And so, you know, we're not talking a whole lot of dollars. Probably, you know, somewhere in the $10 million to $15 million range.

Gotcha. Very helpful. Thanks again.

And our next question will come from Dan Fannin with Jefferies. Please go ahead.

Thanks. Eric, I was hoping you could expand upon some of the comments you made. Obviously, your historical performance has been quite strong. Curious about the conversations with asset allocators today and how they weight as longer-term track records and periods of alpha generation versus, you know, kind of where things sit today.

Yes, Dan, thanks for the question. We did highlight on page three of the deck just, you know, our performance during very short periods of a 12-month period and then later in the deck of the longer term. With regards to the shorter period, We used a 12-month period. We looked at three-year and five-year, but it clouded these unique periods. And looking at the drawdown in these 11 periods we highlighted, it does produce an opportunity on the back end of that drawdown that we highlighted on our prepared remarks. I would also highlight the The three periods where we didn't produce as a firm an excess return to the index were back in 2009 where the index was up 60%, a great outcome for clients, and we lagged behind at 59% return. In 2002, index up 30, and we were up 23, and 98, it was 32%. We were up 30. Those are pretty sharp V-shaped recoveries, and the client makes out very well in that absolute recovery, and likewise we do with our AUM moving up. With regards to allocators, I think with each of these crises – people have moved away from a static asset allocation to then a strategic. And I think today we're seeing a little bit more tactical asset allocation, and it's fueled by better services and tools and data and, you know, today product to actually execute on those shorter-term exposures. And we've always moved our business towards the, strategic allocation and looked for longer duration clients and haven't managed in that tactical exposure. So we haven't created what we call engineered products, whether it's in an asset class that's new, like crypto, or in a factor base that you see the ETFs, like a momentum-based factor ETF exposure, or even in a newfound, like, you know, say an innovation energy fund that is maybe a hot theme and you know, that allows us to see through it. I think engineered products, you'd have to pull back quicker because it's a market timing and distribution. We can invest through these periods because our strategies are built for the long run. So it doesn't surprise us that we have maybe a little bit of pause on our inflow. We had about the same gross outflow that we've seen in other quarters. It was really a gross inflow that clients made tactical shifts this quarter, and that makes sense to us. I guess that's our view and perspective on clients' shorter-term allocation and our product mix.

Great. That was very helpful. And I guess, CJ, just to follow up on your comment around continuing to invest, can thinking about 2Q kind of levels for non-comp expenses. Is this fair or reasonable for the back half of the year? And then also if you could expand upon the – you mentioned distribution and some investments there. If there's anything you could highlight in terms of what you're specifically doing, that would be helpful. Thank you.

Yeah, sure. Yeah, we're on target with sort of the guidance we gave in the January call. They were primarily around compensation. You know, we're right on target with the compensation targets that we set out, which was, you know, about $15 million increase on the fixed side of the comp and benefits. And then on occupancy and tech, we gave, you know, those areas to be up $5 million to $7 million this year, and I'd say we're on the lower end of that, but on target, you know, from a quarterly basis. You know, the one area where we did see a little bit of an uptick this quarter was travel. Travel came back pretty robustly this quarter, back to, you know, pre-COVID levels. We see that being close to where we were in the next two quarters, but maybe a little bit lighter in the third quarter, which is typical. So, yeah. and we are on track to achieve those targets. You know, with respect to distribution, it's really been around – the majority of it's been around new investment teams and strategies, you know, the new team and strategies that we've onboarded this year, as well as sort of accelerating, you know, sales in the intermediary space, with some dedicated internal resources to target prospective clients as well as on the digital enablement side. So, you know, we're in the early innings of those investments, but we've made them this year.

Great. Thank you.

And our next question will come from our explosion with Goldman Sachs. Please go ahead.

Hey, good afternoon. Thanks for the question. Eric, I was hoping you could spend a couple of minutes on the opportunity to bring in new teams and new talent in a more volatile environment. Is that a net positive, net negative? How are you guys thinking about it today?

Usually with volatility in the marketplace and then more importantly, I think, robust M&A activity. With M&A activity and with volatility, it's natural for many people to think about their long-term home of where they want to build an investment franchise and where they want to actually reside for their career. And so we continue to have a fairly active dialogue in the marketplace. We also are going to be, you know, putting an extremely high bar in that dialogue given the amount of capacity we've built in the firm and the teams that we've brought on. We've always had a mindset that we – purposely invest in strategies with clear intent that they fit for the long run, and we see those through as opposed to designing strategies and throwing them against the wall and hoping they work. And given the amount of capacity and the number of strategies we've invested in, we're going to focus our investment operation time on those strategies and be highly selective on new teams that we're looking at right now. But the – The activity is still there and quite interesting in the marketplace. It's just key for us to stay disciplined.

I got you. Heard you guys on sort of the commitment to private markets that you've obviously talked for a couple of quarters now, so it doesn't sound like anything's changing there. But I guess from the balance sheet perspective, CJ, I heard you talk about, you know, retaining a little bit extra cash, nothing too material, but a little bit more than you've done in the past to, I guess, co-invest in seed products. What do you think is the right amount of seed capital that you guys need to have on the balance sheet to sort of support the growth, especially including some of the newer initiatives you have in the marketplace?

I'll jump in and then let CJ jump and add on to the response. Really, the uptick in seed capital is really driven by asset class. We've been quite fortunate to launch an array of public equity-oriented strategies and to launch a strategy And that asset class takes a much smaller amount of seed, and we also did it primarily in the U.S. Today we're operating with investments in an array of credit strategies. And on top of that, the demand and interest in the more recent launch of MSITE's capital group is global demand. So we've not only increased the amount due to the asset class, we've also increased the amount due to the distribution footprint of the firm being outside the U.S. As we highlighted, the number of non-U.S. clients, the emerging markets debt and global unconstrained is attracting clients and prospects for both a USIP and a mutual fund. So, yeah. It's hard to normalize that if, you know, we move into another asset class or we go back to launching some equity-oriented strategies, but the current uptick is really around asset class.

Yeah, the only thing I would add is that, you know, we have a disciplined approach to seed capital. You know, we obviously, you know, make seed capital investments to invest in growth, support our investment teams, and then on the back end, you know, our

Cool. Thanks so much.

And our next question will come from John Dunn with Evercore ISI. Please go ahead.

Hi. You guys talked about a small amount of clients reallocating and kind of driving the outflows. Maybe could you talk a little more about the different demand dynamics on both the fund side and then the separate account side?

Certainly. Most of the clients that we look to invest in Artisan tend to have long-term horizons, and really the fund side attracts a lot of institutional clients, whether it's in the mutual fund or a UCEDD or a CIT. So we really don't see much of a difference based on vehicle. We have... more recently seen really clients thinking about their risk exposure. And so much of the flow that we've seen this last quarter was due to either a time horizon or risk perspective. Two clients drove a significant amount of the outflow. One was a a sovereign wealth client that was invested with us for less than three years and had a shift in allocation. In my view, that is not a statement about our strategy given it was only a two and a half year relationship. It was clearly an asset allocation decision there to reweight the portfolio and that client wanted to increase their private asset allocation The other larger client was a superannuation that was with us for over seven years. We outperformed the index over that seven-plus-year relationship, and the client wanted to de-risk. So the trend really, in our mind, is an evaluation of their overall risk exposure, our strategies across the board. you know, lean to high value added strategies to take advantage of risk opportunities. And there's an array of clients that want to de-risk that. And that's what we saw this quarter, which is fairly natural in a, you know, a drawdown like this. And at the same time, there was a pause on inflows, which created the imbalance there and the logic around the outflow. But yeah, The two clients that extrapolate, hopefully it gives a good example of people evaluating time horizon and risk exposure.

Yeah, it definitely does. Thank you. And then the follow-up is there's already three strategies in MSITE. Is that sufficient for the time being, or might we expect some more launches over the next couple of years?

No, over the next few years, that's a very sufficient number of strategies. In fact, that's the most we've ever launched with a single team day one. This team has managed these strategies for years at their previous firm and and build some scale into the strategy. Clearly a mindset would be to develop more around the team given their broad capabilities. But I would expect for the next few years we're going to really be focused on the three launches that we put together over the last couple of months.

Gotcha. Thanks very much.

And this will conclude our question and answer session, also concluding today's conference. We'd like to thank you for attending today's presentation, and at this time you may now disconnect your lines.