Franklin Resources, Inc.

Good morning and welcome to Franklin Resources Earnings Conference Call for the quarter-ended December 31, 2018. Statements made in this conference call regarding Franklin Resources, Inc., which are not historical facts, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a number of known and unknown risks, uncertainties, and other important factors that could cause actual results to differ materially from any future results expressed or implied by such forward-looking statements. These and other risks, uncertainties, and other important factors are described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including in the Risk Factors and MDNA sections of Franklin's most recent Form 10-K and 10-Q filings.

Good morning. My name is Brenda, and I'll be your call operator today. At this time, all participants are in a listen-only mode. If you'd like to ask a question at that time, please press star 1 on a telephone keypad. The confirmation tone will indicate your line is in the question queue. If anyone should require operator assistance during the conference, please press star 0 on your telephone keypad. And as a reminder, this conference is being recorded. At this time, I'd like to turn the conference over to Franklin Resources Chairman and CEO, Mr. Greg Johnson. Mr. Johnson, you may begin.

Thank you. Good morning, and thank you for joining the call today to discuss this quarter's results. Ken Lewis, our CFO, is here with me as usual to discuss our financials, and we also have Rich Byrne, President of Benefit Street Partners, available to address any questions on the alternative credit market as we're set to close on the acquisition this Friday. Market volatility clearly impacted our financial results this quarter. In fact, the net effect of the mark-to-market which is predominantly unrealized losses and other income, was more than $83 million this quarter. Fortunately, this environment has been more conducive to the success of value-oriented investment strategies, including many of ours. We are pleased to see our relative performance continue to improve, with net sales improving notably in several of our flagship strategies this month. Lastly, we remained active with our capital management program and returned approximately $460 million to shareholders through repurchases and dividends in the quarter. We'd now like to welcome any questions that you have.

Thank you. We'll now be conducting a question and answer session. If you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue, and you may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. We ask that you please limit yourself to one question and one follow-up question during the Q&A. One moment while we hold for questions. Our first question comes from the line of Patrick David with Autonomous Research.

Hey, good morning. Thanks for the question. It looks like in the paired remarks, you're guiding to expenses being down in 2020. Could you walk us through the puts and takes of that? versus investment need and how you can get comfort that the expenses can come down after being up in 2019.

Sure, Patrick. This is Ken. So we've been working the last couple of months with all the business units to identify areas where we can leverage efficiencies and kind of fund all those investments you referenced. The result of that exercise is that we do think through cost-cutting initiatives that we will implement this year that we'll be able to get the run rate expenses to be at or below the 2018 levels and still make those investments, those strategic investments that you referenced.

Okay, great. Thanks. And in that vein, I guess, is there a chance that some of that could bleed into the 2019 so that the lower end of the 2% to 3% guide could come down again?

I do think, yeah, I think that's true, and I think we are trending on the lower end of that guide right now. I think I would say to you that as we go through the cost-cutting initiatives, there will probably be execution costs that will be non-recurring, and we'll be able to give you a better handle on that as we go through the process next quarter. Thank you.

Our next questions are from the line of Daniel Fannin with Jefferies.

Hi, just a follow-up on that. I guess I thought last quarter the comments for fiscal 19 was closer to flat in your comments about, you know, you guided up and said it could be towards flat. So I just want to clarify, is your fiscal 2019 guidance a plus 2% to 3% a change from what you had before?

No, I'm going by memory of the comments last quarter. For sure, the guidance remains the same at 2% to 3%. We gave that guidance. But I think when we talked about this quarter, because of the seasonality, I think that's where we made the reference to the flat. But for sure, the annual guidance was up 2% to 3%. And it hasn't changed. And we're tracking to the lower end of that right now.

Got it. And then just on, you know, you kind of referenced increased growth sales in the quarter. you know, we're seeing it, I guess, more in some of the U.S. products. Can you talk about that momentum and kind of maybe a little more specifically where you're seeing it at some of the products and maybe some of the channels that there is actually, you're seeing some of that traction actually pick up?

Yeah, I mean, I think the big driver, you know, tends to be in flows is the global bond. And If you look at the performance and just recently the one-in-three year moved into the top quartile and also the fourth quarter, which as we know was a very tough quarter for about every segment where MSCI was down 13 and S&P down 15. We had a positive absolute return for global bonds. So I think that gives a little bit of near-term momentum there. you know, that we saw kind of, I think as there's more uncertainty, as I said before, as people get a little more nervous, that tends to be, you know, a better selling product. And we're certainly seeing that, you know, I would say that one, you know, has had the biggest turnaround in flows. And we're seeing that through, you know, through this current month as well. You know, the other would be the income fund, which is something we put a a press on, and that's really a U.S. retail product, but we saw a pickup in sales there. We're just getting that message out. We had a big anniversary kind of sales push on that fund. But those would be the two primary drivers, and we saw a pickup in the muni gross numbers as well over the quarter in the U.S.

Great. Thank you.

Our next questions are from the line of Craig Siegensaller with Credit Suisse.

Thanks. Good morning. Just first on excess capital, what is the level of working capital, regulatory capital, and seed within the $7.8 billion, just so we can back into sort of true excess here?

That's approximately $3 billion. $3 billion, so that would be $4.8 billion net.

Well, $3 to $4 billion, so $3 billion, $3 to $4 billion net.

Okay. And just as my follow-up, you know, what is the potential for another special dividend here? And I actually think you may have another board meeting coming up in February. So what are your thoughts around that, just given all that excess capital?

You know, I think, as we've said before to this question, you know, that decision is Is the board decision as hard to handicap what they think? You know, we feel that – we continue to say this. We feel that, you know, having a strong balance sheet is strategic, and, you know, having dry powder for potential acquisitions is always a consideration. So all of that will be weighed at the February board meeting.

And, you know, I just think, as you know, I mean, this is an industry that's undergoing – quite a bit of change and, you know, excess is not a word we use on the balance sheet. It's a word that the market tends to use, but we think that capital can, you know, if it's used appropriately, you know, can be very strategic and add a lot of shareholder value as things change and opportunities arise in what, you know, could be a pretty volatile period for the industry.

Our next questions are from the line of Michael Carrier with Bank of America Merrill Lynch.

Thanks, guys. Rick, maybe first one for you. You mentioned in some of the commentary just some of the traction that you're seeing over multiple years of initiatives on the fee-based side of the business in U.S. retail. Maybe just can you give us an update on what kind of traction you are seeing in terms of the platforms, the number of products, and then maybe an update just how much of your business is on the fee-based side relative to, say, maybe the brokerage and how that has shifted? you know, over the past few years as these initiatives have been in place?

Yeah, I mean, I think the, as we said before, I think an area of significant investment for us in the last few years has been really transitioning the U.S. retail distribution to be better equipped to service a fee-based environment. And that not only required, you know, adding a lot of different skill sets into the group, but also pricing and changing and adding classes of shares and changing products as well. And also, we created a specialized New York Stock Exchange channel dedicated. And I think those kind of changes take a little bit of time, but we are seeing results. And even the New York Stock Exchange channels, we were up 26% in sales quarter over the prior quarter. And those kind of changes can be disruptive, but I think they're somewhat settled now. I think another area that we think is going to be important, we've talked about solutions. We put a big investment in solutions, and I think today we have what we consider one of the best in the industry, which is as far as product development and where we think incremental growth can occur. Within our multi-asset group in solutions, we now have 11 model funds, which use underlying FT funds, but also because they can incorporate some lower-cost indexing and passive into that. It gives us a much more competitive, outcome-oriented solution-type product, and we have 11 of those that are just rolling out right now, and we're seeing a lot of interest there. I don't have the exact number between the break, but I think as far as we look at the world, probably 70%. you know, is going into fee-based versus brokerage today. So that's where we need to be. And what we measure is the, you know, the effect of or how important it is to get products on the shelf, on the platforms. And we have very, you know, specific metrics, you know, try to do just that. And we've seen, you know, a very strong pickup. And that goes to ETFs as well, where, you know, I'd say one of the big changes in the last year is because we've been out there long enough now uh... you know with some of those e t f funds having those types of of of uh... consultants in place and product managers that we're able to get uh... approval you know into the uh... york stock exchange firms and that'll help that as well so i i think it is that it is a big transition it's going to continue to happen you know with some funds that may not fit the fee based world others that we have to continue to to modify pricing on them and maybe adjust but uh... I think we have better momentum or good momentum there now, and hopefully that's going to continue.

Okay, that's helpful. And then, Ken, just a quick follow-up on the capital return. You guys have been active kind of across the different ways that you can return capital. Just on the buybacks, given that the pace has been elevated, any update, just how we should be thinking about the rest of 2019, just in terms of the pace?

Yeah, it's pretty much our same policy that we've had and practice that we've had going forward. So, you know, obviously we think the stocks will good buy at this price, so we'll be active in the market. But, you know, having said that, we're going to be both systematic and opportunistic, take advantage of things like, you know, volume dips and then, you know, hold back if we see any kind of opportunities in the M&A world or any other need for capital. So kind of more of the same. You know, I don't know that I would think we would, you know, the volumes would be elevated from this level, but, you know, we're just going to continue to be opportunistic.

Okay. Thanks a lot.

Our next questions are from the line of Bill Katz with Citi.

Okay, thanks very much. Ken, staying with the margin discussion for a moment, could you sort of maybe drill down in terms of where you think you can get some of those incremental savings versus talk to some of the incremental areas of spend?

I think across the board, I think every function is looking at their operations and trying to identify areas where we could reduce costs. It's just simply – You know, looking at kind of, you know, what we do and how we do it, the world's changed. So, you know, there's probably a lot of outdated procedures that we don't need to do it, do the same way anymore. And obviously we've been building over the years in low-cost jurisdictions, so leveraging that, and that crosses every function. So it's really an enterprise-wide effort. It's hard to say. one particular area versus another. Um, but, um, I think that the key levers are the low cost jurisdiction and then leveraging technology. Uh, and then, you know, we've kind of been very, um, bored with, you know, with our strategic, strategic investments are. So we would continue things like solutions, um, uh, and other strategic investments and fund them with these savings.

Okay. And just as a followup, uh, Greg, you mentioned, uh, It's a rapidly changing backdrop, and from that I'm sort of implying that maybe a little bit more interest in M&A. Could you talk a little bit about from here what areas seem to make the most strategic appeal to your mind?

Well, I think, again, as we've said before, I think it is a changing landscape for distribution and how we look at the world, and I think if that means – You know, there's opportunities to tie up with distribution in some cases or own portions of distribution. I think that would be different than our traditional way of thinking about a purely independent asset manager. And I think you're seeing some of that happen in places around the globe. You know, that would be one that we think could be strategic for us. You know, I've said the high-yield business, the ETF business, all businesses that we want are – I said high yield. The fiduciary trust would be one that we'd want to grow and scale up. Having that direct relationship with the investor, I think, would be important as well. So those would just be a couple. But distribution and building high net worth would be certainly two priorities for capital.

Just a quick follow-up. Since you have them online, I was wondering if you could get an update from the team at Benefits just in terms of what they're seeing in terms of the credit backdrop and allocations given some of the tumult through the fourth quarter? Sure.

Rich, are you there?

Yeah, thanks, Greg. I'd be happy to take that. The fourth quarter, as you know, with the drawdown in the S&P, we saw outflows out of loan funds and bond funds. Some of that you know, that translated into the liquid markets and pricing, less so in our private debt business is usually a delayed effect there. Maybe for the purpose of your question, note that almost all of our capital is locked up capital. So, you know, if your question relates to, you know, any redemptions or things like that, that's not really a factor for us. For us, it's just a function of where is the most opportunistic investment opportunity. I know the market has retraced a lot of the declines in the from the fourth quarter into the first quarter. But we're finally starting to see some of that lag has finally taken hold. Pricing and documents starting to reflect a more reasonable risk-reward equation. And just a word about sort of our philosophy. We've generally been fairly defensive in how we position most of our portfolios, particularly around the private debt product. Mostly everything we've been doing is top of the capital structure. Most of that's first lien, low loan to values, and a fair amount of dry powder. So we're looking forward to a more reasonable environment where we can invest. Fundamentals have been still relatively strong. I know there's some headwinds. We'll see what volatility brings us going forward. But for us, this is a buying opportunity.

Thank you.

Our next questions are from the line of Robert Lee with KBW.

Great, thanks. Thanks for taking my questions. You know, maybe sticking with Benefit Street a little bit, I guess a couple of questions there. Number one, you know, maybe can you give us a sense of, you know, where you are in maybe your fundraising cycles? I mean, obviously mostly locked up capital. Did you just kind of come out of a cycle with a lot of dry powder? Are you kind of, you know, have on the drawing board post-closing, there's a fair number of new strategies or existing strategies you're raising for. And then maybe, Ken, I think when you announced the deal last quarter, you kind of suggested that beyond kind of the gap impacts, there could be some other things that kind of start impacting the P&L, either going forward, whether it's contingent payouts or whatnot. Any update on how we should be thinking about those non-GAAP factors going forward, or maybe some of them are GAAP?

Let me start with that, and then hand it over to the Benefit Street guys. Right, so in the guidance we talked about, for this year, we have eight months left, the deal will close February 1st, that, you know, for modeling purposes, we're looking at investment management fees increasing about 3.5%, and And then, you know, a commensurate increase in expenses, not in percentage basis, but in absolute dollar basis. So we still think that in this fiscal year, the acquisition will be neutral in terms of EPS accretion and then accretive after that.

Okay. I mean, are there going to be any – We want to think of kind of the cash impact. Should we assume that's going to be somewhat higher? Maybe there's some tax benefits or obviously intangible amortization, things like that?

Well, those expense numbers include everything. And in terms of cash, we disclosed the purchase price, and that's it. So it's the upfront payment that we disclosed and then the expense number I gave you.

And that's it. Okay. All right. Maybe the follow-up on some of Bill's questions. I'm sorry.

Go ahead. Do you want the Benefit Street folks to answer your question?

Yeah, yeah. That would be great.

Okay. Sure. Well, let me see if I can hit the key parts that you're getting at or follow-up, if you like. Most of the money, as I mentioned and as you mentioned, is locked-up capital and draw-down funds funds. That is our flagship fund in private debt. That's our fund four. We have a senior-only fund in private debt. We have a special situations fund. We're actively investing those funds. When we get to a certain threshold of drawn capital, we usually then start to market our successor funds, which we intend to have successor funds to each of those. So we've been generally on pace on all that. And remember, we also have leverage against the funds that we could use for, you know, additional buying power, you know, if the market opportunity gets better. So, you know, we remain on pace, and that's sort of the nature of how we approach it. Did that answer your question?

Well, I guess I was just curious, I mean, say, since you're not familiar with your firm, you say on pace, are you kind of halfway through investing these, and they have kind of an average investment period of three years, just trying to get a sense of when you could be hitting that next fundraising cycle?

Yeah, as a general rule, we raise our successor fund when we're 75% invested in the current fund. And all three of the funds that I referenced, and I didn't even mention our separate accounts and other capital that we manage, that's also locked up. But we are more than 50% drawn on all the funds that I mentioned. and they all have different drawdown periods and cycles, so it's a little more detail. But we're more than half drawn, and when you get to 75%, you should assume we'd be launching some successor funds.

Okay, great. Fair enough. And maybe if I can, just one quick question. When you think about your own budgeting and modeling going forward and given – a lot of the investments you've made in, whether it's CITs or ETFs or just new products, you know, and obviously have made some and have talked about some kind of, you know, fee adjustments. How are you modeling changes in your kind of overall fee rate? I mean, do you kind of assume, hey, it's going to go down one or two basis points a year or half? I mean, how do you kind of handle that internally?

Yeah, we've... So, you know, we do... a bottoms-up build of all that, and we look at the mix of assets going forward. And with the volatility this quarter, we saw a slight – if you adjust for non-recurring items for the two quarters, we saw a slight degradation in the effective fee rate. And so if you look forward for 2019, we think that the fee rate won't change that much, and it might be slightly lower than – last year but we're not getting a lot of um external fee pressure on that so we're not budgeting some uh you know material um decreases in the effective fee rate going forward um now of course benefit street will change that and for the better um but um you know i think i give you the math for that but without benefit street um you know we don't see significant changes in effective fee rate a slight slight degradation in 19 versus 18.

Great. Thanks for taking my questions.

Our next questions are from the line of Brian Bedell with Deutsche Bank.

Great. Thanks very much. Greg, can you talk a little bit about the investment advisor reception to the improved performance across a lot of different products, especially in the one- and three-year periods? and whether that's actually impacting sales here in January, and also whether that's slowing redemptions. Obviously, December was heightened redemptions for the industry. And then also on the institutional mandate side, any large won or lost mandates in the pipeline? And then do you see delayed fundings given the environment in the institutional space?

I think December, January is always a little bit tricky to draw too many conclusions because of the tax selling in December and then the historical strength of January after that with some retirement fundings, other money going back in the market after tax selling. I think like most in the industry, we sometimes maybe get overly encouraged by January because it looks so good compared to December, and I think that's true again for us. And I think part of that, you know, hopefully is certainly sustainable with better performance over time. And if I, you know, I was just looking at a chart, you know, for us, our top 25 funds a year ago, 6% were in above average, and this year, 78% are above the peer average. So, you know, that's a significant shift in performance that, you know, I think You know, we know that. We have to get that message out and have it, you know, flow through the three- and five-year numbers. But, you know, I think we are encouraged by what's happening, you know, in the market. We've said sometimes, you know, being a predominantly, you know, as far as our mix, having value side that it takes a little bit of a disruption in the market, you know, to get people thinking back again about value. And I think the decoupling from the fangs is another, you know, important shift that's happened over the last few months. you know, that should help these. So we are seeing, as I said before, I mean, I think the global bond is a very strong story in this kind of marketplace. And as people, you know, become more concerned about equity valuations and things and looking for alternatives, it's just a nice fit. So we're seeing, and that one tends to move a little bit faster than, say, your traditional retail value funds, which may take a little bit more time. But clearly, I think, you know, the relative numbers give our sales force something to certainly talk about, and hopefully we'll see that boat. As I've said, the beginning of January looks a lot better than December.

And on the institutional side?

Yeah, the institutional, I haven't heard anything as far as, you know, I think, you know, that may have been the case where you saw delays, but I haven't really heard that. And, you know, if you think the retracement in the market that we've had to date would probably eliminate anybody from a timing standpoint. But, you know, that's just something I'm not aware of, you know, having a delay there.

Thank you. And then just on the capital management, Ken, I think you said, just I just wanted to clarify, was it $3 billion to $4 billion of what you view as net excess capital or cash? Yes. And then maybe, Greg, just to expand on your M&A comments about, you talked about distribution. I guess if you can get a little deeper in that. I think you mentioned high net worth, but if there was anything else that you wanted to sort of own the distribution, and I guess how that fits in with this general trend towards open architecture that's been going on for decades.

Yeah. So in our prepared remarks for your question on the excess, I'll let Greg get the moment. It's 3.3. You said 3.3 billion liquid assets reserved to satisfy operational and regulatory requirements and capital investments in our products.

Right. So the excess capital then is – you said – But we don't use that.

No, that's – we don't use that term, and that's what we need. So the difference is available, is opportunistic when available. Got it.

Got it, got it, got it. And I just, to expand, I mean, I think the world, you know, if you look at, and this is not a statement really for, you know, the U.S. When I mentioned distribution, it's probably more outside of the U.S. and markets that have guided architecture type platforms and may have ownership of, you know, four or five investment managers for those platforms. And it could be, you know, new technology platforms for, fee-based advisors in countries where we may not have a significant share could be a good way to enter that market. So those are the kind – I think it's just a change in how we would say we are – strictly think of ourselves as an independent, pure asset manager in an open architecture world. We do see more guided architecture in certain markets and the strength of banks in certain markets, and a bank may – for regulatory reasons, spinning out their distribution, things like that. I would say we are open to looking at that, where in the past we may have said, hey, we're a pure independent asset manager, and that's not something we want to do. Fiduciary Trust is a very successful high-net-worth manager that we think could be bigger and more meaningful in to our bottom line. It's something that, you know, we want to grow and something that we've talked about and we just believe in the value of advice and that, you know, would be another area that would be on that list. But just like, you know, alternatives, real estate, all those other things are on that list too.

Right, right.

No, okay, that's clear. Thank you.

Our next questions are from the line of Alex Blustein with Goldman Sachs.

Now, guys, just a couple of clarifications at this point. So when I look at your expense guidance, again, for fiscal 2019, does that include any sort of kind of severance restructuring charges that are going to be associated with a cost savings plan and any help to kind of help us break out the actual dollar amount of kind of run rate expenses that you expect to take out and the kind of restructuring costs that will be associated with that?

Yeah, so the guidance does not include any severance or execution costs related to cost reduction simply because we don't know what that is right now. So that's, you know, when we talk to you next quarter, we'll be able to give you a better idea for that even, you know, by line item for the rest of the year what that's going to be. We do expect all of that to be incurred in this fiscal year and not bleed into 2021. And so it'll probably start out slowly next quarter, gradually build with the bulk of it probably being in the fourth quarter. And then in terms of the number, I think, you know, of savings, we're looking to get it, like we said, at or below 2018 levels without regard to benefit streams.

Got it. Okay. And then just a clarification again, another one on the cash and kind of the requirements that you guys have between working capital, regulatory, et cetera. Do you include the upcoming payment to Benefits Trade, which I think was $683 million within that, or that would be on top? So I know you guys don't like talking about the excess cash, but would that be effectively a reduction to that number?

No, that's in there.

That's in there. Got it. Okay. Thanks.

Our next questions are from the line of Brennan Hawken with UBS.

Good morning, guys. Thanks for taking my questions. Just a couple left here at this point. Can you – I know you spoke to the sort of core trends that you expect in fee rate, but could you please quantify performance fees this quarter just so we can try to calibrate at least where we're starting off from a core fee rate basis and then post-BSP deal – It seems as though performance fees are going to be substantially larger. Is that going to lead you to actually break that out as a line item so that we can have greater clarity and maybe avoid some of the noise that might flow into the numbers?

Sure. So your quarter-over-quarter delta for performance fees was about $4 million. And so last quarter they were about $4 million higher than this quarter. And I think if I remember, last quarter they were about $6 million. This quarter they're about $2 million. And then going forward, yeah, you're right. We do expect performance fees to be higher. We haven't made a decision on how we will present that, but for sure we will call it out. We will call it out in the prepared remarks. In terms of the geography of the income statement, we haven't decided what to do there. I'm kind of waiting to see what the magnitude is, but for sure we'll call all of that out.

I think that's a good point, something we're going to look at, just like we're going to look at the other income line and look at the mark-to-market effect of the investments we hold, because that can be a little bit noisy quarter-to-quarter too.

Sure, that's fair. Thanks. And then I'm just curious about on the accretion expectations. I know you said you don't think that there's going to be much change and also fully appreciating that the comments about the BSP funds not really being marked as we see with some of these other alternatives. Certainly attention being drawn to leveraged lending and other similar types of lending activities, which even though explicit leveraged lending is just part of what BSP does, a lot of the other lending activities are very, very similar in structure, et cetera. So, you know, for example, the Fed's SNCC review, leveraged lending was like three-quarters of non-accrual lending and, you know, almost 90% of substandard commitments were and there's been a lot of significant risk flagged in these loans. I know you see the recent volatility as an opportunity, but is there still an assumption of credit losses remaining at zero in your accretion? When you think about if that turns out to be too optimistic and credit losses go up in these products, how much does that impact fundraising and how much could that impact the outlook for accretion from this deal. Thanks.

Well, we are assuming, I'm going to let the Benefit Street guys talk about the risks in the portfolios, but we are assuming very low, consistent with historic results, very low default rates in our accretion analysis.

And I would say, I mean, those are all fair concerns and comments and ones we had well before the fourth quarter. And as we looked at this business and we're late in the economic cycle and credit spreads were narrow, and I think we think, again, we would just say that this is an asset class that's here to stay. I think that having the dry capital puts you on the right side of the trade when other vehicles are forced to sell and have to continue to mark down. You know, those are the kind of things we got comfortable with. I think from fundraising, it's very hard to give you any kind of sense of what that means. I mean, yes, it's going to be harder in an environment where, you know, spreads are rising and there's defaults out there and credit issues. That's clear. But I think that our commitment is to the asset class long term and the fact that Benefit Street has come into that with its eyes wide open as far as, you know, being – on the first lean side and more senior secured. And we know the arguments on that, that there's less junior and recovery rates are going to be lower. But, you know, that's all – I think we feel like we're in the right place in a growing market. And I'll let Rich take it from there.

Thanks, Greg. I think you and Ken hit most of the key points. I guess I would just add a few things. One, I think as the question unfolds, talked a little about marks. Just to be clear, we mark all of, and I assume we're mostly talking about private debt here, we mark our private debt assets quarterly. You know, those are real marks. This is not, you know, there may be a lag effect sometimes, but on a quarterly basis, you'll feel very comfortable that the book is marked, you know, appropriately by third-party valuation firms. Greg mentioned, you know, we're generally at the top of the capital structure. You know, The correction in the markets and the drawdown in the S&P and the outflows, it was really a technical correction. We haven't seen any material, I mean, energy. There were some issues, of course, with oil prices, but we haven't seen a material change or diminution in credit quality across the book. There's always going to be defaults. We've been very fortunate to be running at a very low default rate historically, but Of course, we're going to always model something greater than zero in our books, but nothing that's happened in the fourth quarter has led us to materially change our assumptions around defaults or recovery rates, and we think all of our books are marked appropriately.

Thanks for the call.

Our next questions are from the line of Chris Harris with Wells Fargo.

Okay, thanks. The earlier commentary about M&A and possibly investing in distribution, how do you guys think about the conflicts that might arise as a result of a deal like that?

Well, I think that's why I said that I don't envision this in the U.S., certainly, where you'd have a conflict. But I think the world has changed considerably where it doesn't – in the old days, the thought of having anything direct to a consumer – you know, you could never do if your business was sold through advisors, and today in a fee-based world where you're competing with Vanguard and traditional direct marketers, it's really just you've got to make sure you've got best-of-class funds with very strong track records, and that's going to get you your distribution. So I don't think the conflict is as big, although I would say I don't envision us doing anything in the states that would own distribution. I think it's more... we look at markets that have become more closed and guided, and you look at a Canada that has a closed kind of market as far as distribution goes, or more closed than most, and Europe, which is trending that way too, where you're seeing countries like Italy and others where distribution has co-owners that could be fund sponsors. So those are just the things we're looking at. And I think it's just a change in how we would view our traditional mission and mandate of being independent, one that in certain markets it may make sense to tie up in places like Latin America where banks dominate the markets. And India. India. There's just a lot, I think, of places around the world outside of the U.S. where it may make sense long-term to do that. I think that's just a different – thinking, you know, as far as how we would approach M&A in the past.

Yeah, okay, that makes perfect sense. And then just the one follow-up question I had was on your investment performance. You know, obviously, good thing to see things trending in the right direction there. I know it might be a little difficult to generalize, but when you look at across your asset classes, the numbers in, you know, tax-free fixed income and U.S. fixed income, probably a little bit still below where you guys would like to see them. What is driving that at this point? Is that kind of like a duration thing perhaps? Is that what it is?

Okay. I think it's a few things. I think we tend – that's the one area where we don't worry as much about your total return ranking. I mean, we want to be in the middle because we run those funds – We want to make sure we're providing some of the highest tax-free income out there and have a stable net asset value is kind of how we think about it. And that's important in how we sell those. I think as far as the makeup over the last few years and some of why we've underperformed would be we were on the higher end of credit quality and the lower credit in munis tended to do a bit better. although we saw that reverse in the fourth quarter where many of our funds had very strong performance with stronger credit compared to others. In duration, we don't really switch, and we were on the lower end of duration because of pre-refunded bonds. And again, how we think about running these is more for stability and high income than trying to make duration bets and have a dividend that goes up and down from those duration bets. We think that's what people really want. So we don't worry as much if we're below or above average in that category as we do certainly in equities. We want to make sure that the funds are stable in all types of markets and provide that high current income. Great. Thank you. Thanks.

Our next questions are from the line of Michael Cypress with Morgan Stanley.

Hey, good morning. Thanks for taking the question. I just wanted to circle back right to your comment earlier on fees and pricing. You mentioned modifying pricing on some products. Can you just talk about your approach to that in terms of modifying pricing, your expectations there? Where have you modified? How that's played out relative to expectations? And is this more about gross sales or looking to stem redemptions, how you're approaching that and thinking about it? Thank you.

Yeah, I mean, I think it's just recognizing that being on a high end of a fee, if you're fourth quartile in fees and have top performance, you're not going to get shelf space in the new fee-based world. So I think you have to look at how are we positioned against the universe, and we have to be at least competitive on the fee side. So we've made... a series of modifications and a lot of different products. I mean, they're not dramatic shifts, but we've lowered fees on our international equity funds. We've lowered fees on limited duration fixed income funds. We've changed payouts to be more competitive, you know, for those that are still using the brokerage side on reallowance and things. And, you know, I just think all of that, you know, affects your margin, but that's the reality of where we need to be And then I mentioned that we're excited about these 11 new models, the outcome-oriented growth, growth income, that combine a lot of our traditional funds with some lower fee mixes and then get you to a more competitive overall fee. And we think that that is very attractive in this market as well. So I think it's just a recognition that it's not just a world where certainly the buyer or the consultant or the gatekeeper is looking just at your total return. They're looking at where you are positioned in fees. So we have to, and I think the good news is that we're always, you know, on the lower end of that equation. So don't feel like we have a huge, you know, amount of changes ahead. But we continue to, I sit there and I sit with our group and we look at every fund on a regular basis and go down and see where it's positioned. And we obviously do that with the boards as well. But it just reflects the nature of the forces that all of us are dealing with in this industry. But as Ken said, I think at the end of the day, it doesn't really have a material effect on our overall effective fee rate. And what's going to affect that in the next year is if emerging markets are international equities or equities are up, that's going to have a much greater effect on our effective free rate than any tinkering by individual funds.

Got it. Okay. And just as a follow-up question, maybe more broadly on credit cycle and liquidity, some concerns there around build-up and leverage by corporates with a larger portion going to daily liquidity funds, high-yield bond funds, loan funds, et cetera. Can you just talk about what actions you're taking to mitigate any such risks in your daily redeemable funds?

Yeah, I mean, I think it is a concern and certain, you know, obviously many, you know, academic papers, many journalists have covered this, that liquidity in certain markets, the seniors, you know, secured debt market and floating rate and things like that, that, you know, you do need to be careful about. So I think like most, you know, we look at liquidity and make sure that we feel comfortable and we stress test these things and don't want to be in a position where you're forced selling into a market that doesn't have a lot of buyers. But again, that's not an area where we have a lot of assets and why we think a benefit street structure that is more like a private equity structure can be, I think, a... very effective way to benefit from that dislocation and liquidity with funds that are daily liquid funds. So I just don't think it's a category for us that there's a lot of assets where we would say that's a concern. I mean, we have some funds in those areas, but they're just not significant as far as size.

Great. Thank you.

Our next questions are from the line of Brian Bedell with Deutsche Bank.

Great. Thanks for taking my follow-up. Just one more on M&A, maybe a longer-term view. I know, Ken, you mentioned you do want to preserve dry powder for potential future opportunities, especially if the markets get tough. We are a late cycle, and if we do move into a bear market and recession period for a prolonged period over the next even two to three years, I mean, Greg, how do you think about large-scale M&A where there would be a lot of product rationalization involved and a lot of cost-cutting? I know typically those deals are hard to execute well, and that's why managers kind of shy away from them. But if we do have even a much tougher environment, both from a market-level perspective and an industry-wide organic growth perspective, do you see those deals – starting to form, and would you be interested in engaging in something like that?

Well, I think we never say never, and if we think it can add shareholder value by efficiencies and synergies and costs, that's certainly something we're going to look at. But I think you hit it on the head that the execution, it is very challenging. It's very disruptive and very time-consuming for management to do that, and it's also – a question of the brand and how much you can throw on distribution and get those synergies. So I think it's more of the smaller media managers that will be bought versus the bigger managers that are going to combine, that that's where the difficulties lie. And if you're not on a smaller group that relies on a narrow distribution platform and that goes to fee-based and all of a sudden you're not on that platform, Those are the ones that you'll probably see move in with larger firms, and you're able to benefit by getting different styles and management teams in there. I think the larger ones are very difficult. They look good on paper, but the execution side is just challenging, as you said.

And then maybe just going back to your alternative comment with BSP, and I guess thinking about that, down the road as well, is a shift into alternative assets in a more meaningful way, something desirable for you, or you'd rather just continue to be opportunistic?

No, I think it is. We've stated it's a priority for us to grow that business, and I think the strength and depth of the BSP senior team and access that we think really accelerates that by having Somebody like Tom Gann and his senior team involved in looking at the landscape of alternatives, along with our K2 group that I believe will be very helpful in us looking at other opportunities in that area. And none of these are vulnerable to the passive shifts and pricing wars that we're seeing on the traditional model.

Okay. Great. Thanks very much.

Thanks.

Thank you. We've reached the end of our question and answer session. I'd like to turn the floor back over for any closing comments.

Well, thank you, everyone, for participating on the call, and we look forward to speaking next quarter. Thank you.

This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.