Franklin Resources, Inc.

Welcome to Franklin Resources Earnings Conference Call for the quarter and fiscal year ended September 30th, 2021. Hello, my name is April, and I will be your call operator today. As a reminder, this conference is being recorded, and at this time, all participants are in a listen-only mode. I would now like to turn the conference over to your host, Celine Oh, Head of Investor Relations for Franklin Resources. Thank you. You may begin.

Good morning, and thank you for joining us today to discuss our quarterly and fiscal year results. Please note that the financial results to be presented in this commentary are preliminary. Statements made on 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 the MD&A sections of Franklin's most recent Form 10-K and 10-Q filings. With that, I'll turn the call over to Jenny Johnson. our President and Chief Executive Officer.

Thank you, Celine. Hello, everyone, and thank you for joining us today to discuss Franklin Templeton's results for our fourth quarter and fiscal year. We're also very excited to announce the acquisition of Lexington Partners, and I am delighted to extend our warmest welcome to such a talented team. Lexington's business provides us the exposure to a critical growth area in the alternative asset business, and we cannot be happier with this new partnership. We'll cover more on this transaction in a few minutes. Matthew Nichols, our CFO, and Adam Spector, our head of global distribution, are on the call with me today. We're also joined by Tom Gann, head of Franklin Templeton Alternatives, and Will Warren, president of Lexington Partners, who will be available for questions after our prepared remarks. I'll start by reviewing this year's milestones. Then Matt will go through our financial results for the quarter and the fiscal year, as well as spend some time discussing today's important transaction in greater detail. Throughout Franklin Templeton's history, we have invested in our business to build a truly diversified and resilient organization that performs across market cycles with a commitment to serving our clients, employees, and shareholders. The results that we announced today represent the first full fiscal year since we closed the Legg Mason acquisition, a transformational transaction that created a more balanced business across asset classes, client mix, and geographies. We are pleased to report that the strategic and financial benefits from our acquisition of Legg Mason exceeded our goals, and we have added important growth opportunities. Over the course of the year, we have created a management team consisting of key representation from Franklin Templeton, Legg Mason, and our specialist investment managers. We have maintained our culture while invigorating collaboration and innovation across the firm. Through the hard work and dedication of our employees, we've successfully brought two firms together to maximize our collective potential, one that successfully combines the attributes of global strength with boutique specialization. We've made strong progress, and yet, in so many ways, we're just getting started. Turning to investment performance, there's been an improvement in performance across a broad base of investment strategies. Through September, 71%, 69%, 72%, and 77% of strategy composites outperformed their respective benchmarks across the four key time periods. This quarter, we had 53% of mutual fund AUM in funds with four or five star ratings by Morningstar compared to 43% a year ago. During the year, we focused on updating our global distribution efforts by enhancing our generalist specialist model reshaping client coverage and deepening relationships in each sales region, particularly with the largest global financial institutions. Fiscal year long-term inflows doubled to $365 billion from the prior year. Notably, the U.S., which is our largest sales region with over $1.1 trillion in AUM, was net flow positive for the year. In terms of notable organic growth, we saw positive net flows in our core growth areas, including alternatives, SMAs, wealth management, and ESG-specific strategies. We executed important acquisitions to further grow and diversify our business in alternative assets, customization, and distribution of investment strategies. In terms of other accomplishments, our alternative asset strategies, an important area of focus for us, generated positive net flows in each quarter during the year and grew by 19% from the prior year to $145 billion in AUM, with contributions from a diverse group of strategies, including real estate, infrastructure, private debt, and hedge funds. Several years ago, we announced our intention to create a full suite of alternative strategies, and we've been very deliberate in building our capabilities. In 2018, the acquisition of Benefit Street Partners brought us a leading alternative credit manager. In 2020, we added a world-class real estate manager with Clarion Partners. This focus on alternatives led us to today's announcement of the acquisition of Lexington Partners, a leader in secondary private equity and co-investments. We now have top tier specialist investment managers in all of the key alternative categories with Benefit Street Partners, Clarion Partners, Franklin Venture Partners, K2, and now Lexington Partners. Specifically with the Lexington Partners transaction, I'm excited that Franklin Templeton will be partnering with such an outstanding firm that is led by an experienced and talented team, immediately bringing us scale and capabilities in an attractive and growing global market. There will be no changes to the team or its independent investment management process, and they will continue to operate autonomously as Lexington partners. Upon the close of this transaction, we expect our alternative AUM to approach approximately $200 billion and over $1 billion in revenue, excluding performance fees. Matt will review the additional details of the transaction shortly. Another core growth area is our separately managed account business. We are a top three provider in SMAs with 125 billion in assets under management, which is one of the fastest growing segments in retail. Our SMA business grew by 23% in AUM year over year and generated positive net flows in each quarter during the fiscal year. Our recently announced acquisition of O'Shaughnessy Asset Management and its custom indexing platform, Canvas, will take our existing strengths in SMAs to the next level by enhancing our tax management, factor-based, and ESG customization capabilities. Canvas was launched in late 2019 and has seen strong growth since its inception and now represents $1.9 billion of the firm's total AUM of $6.3 billion as of September 30th. The transaction will bring compelling benefits to the clients that both companies serve across multiple channels. There's no question that investors are more focused on ESG goals than ever before. Increasingly, there are three dimensions to ESG that investors consider. ESG factors as understood risks in a portfolio, how ESG contributes to overall returns, and the overall impact of ESG considerations to society and the environment. As an active manager, approximately 95% of our AUM represents strategies that consider ESG factors as part of the investment process. And ESG-specific strategies representing over $200 billion in AUM were net flow positive in each quarter this fiscal year. All this being said, none of our accomplishments this past year would be possible if it weren't for our employees. We're extremely fortunate to have such dedicated colleagues who are focused on achieving investment excellence, fostering enduring relationships, and delivering superior service to our broad range of investors around the globe. Now I'd like to turn it over to our CFO, Matt Nichols, who will review our financial results from the fourth quarter and fiscal year, as well as take you through the specifics of the Lexington transaction. Matt?

Thank you, Jenny. Fourth quarter long-term net outflows were $9.9 billion, which were partially offset by the acquisition of Diamond Hill's high-yield focused U.S. corporate credit mutual funds, which added $3.5 billion in AUM and closed in July. This quarter included the previously disclosed $5.4 billion 529 plan redemption, which included $4.7 billion of long-term assets, a $2 billion fixed income institutional redemption that had minimal impact to revenue, and $800 million of fixed income outflows from the non-management fee earning India credit funds that are in the process of liquidation. Reinvested dividends were $2.3 billion this quarter. 1% higher average assets under management of $1.55 trillion compared to the prior quarter, plus $69 million of performance fees, generated $1.66 billion in adjusted revenue for the fourth quarter. Investment management fees, excluding performance fees, were 3% higher compared to the prior quarter. Adjusted operating expenses of $1.01 billion for the quarter were 3% lower due to lower compensation and lower G&A as a result of last quarter's upfront closed-end fund expenses. This led to an 8% increase in adjusted operating income of $647 million and an adjusted operating margin of 39%. Fourth quarter adjusted net income and adjusted diluted earnings per share increased 31% to $645 million, or $1.26 per share. These results include favorable discrete tax items of $155 million, or $0.30 per share, for the quarter. Turning to 2021 fiscal year financial results, which benefited from favorable market conditions and a full year of Legg Mason versus two months last year. For the full year, adjusted revenues were $6.32 billion, and adjusted operating expenses were $3.94 billion, an increase of 63% and 65% respectively. This led to fiscal year adjusted operating income of $2.38 billion, which was 60% higher compared to the prior year. Our adjusted operating margin was 37.7%. Compared to the prior year, fiscal year adjusted net income increased 46% to $1.92 billion, and adjusted diluted earnings per share increased 43% to $3.74 per share. which included the impact of favorable discrete tax items of $175 million, or 34 cents per share, for the full year. As planned, we have achieved a run rate of 85% of our targeted merger-related cost synergies of 300 million this year. We anticipate that 100% of these synergies will be achieved by the end of fiscal year 2022. As a reminder, none of these cost efficiencies involved our specialist investment managers or investment teams. Moving on to capital management, we believe our strong balance sheet continues to provide us with financial and strategic flexibility to evolve our business. For the fiscal year ended September 30th, we returned $782 million to shareholders through dividends and share repurchases. During the year, we also pre-financed a large portion of legacy Legg Mason debt with lower cost of debt reflecting our credit profile. Specifically, we issued $850 million of 1.6% senior notes due 2030 and $350 million 2.95% notes due 2051. We redeemed $250 million of 6.38% Legg Mason junior subordinated notes due 2056 on March 15, 2021, and $500 million of 5.45% Legg Mason Jr. subordinated notes due 2056 on September 15, 2021. We ended the quarter with $6.93 billion of cash and investments. We will continue to prioritize our dividend and intend to repurchase enough shares to at least offset our employee equity grants. The remainder of our capacity will focus on continued investments in our business and acquisitions to further diversify and increase our sources of cash flow, while positioning our firm for new growth opportunities as the industry continues to evolve. Consistent with this, we are excited to share the specifics on the acquisition of Lexington Partners that we announced this morning. As outlined in the transaction summary document, Lexington Partners is a global leader in secondary private equity and co-investments, with current fee-based AUM of $34 billion. Since its founding in 1984, Lexington has raised over $55 billion in aggregate capital commitments and currently has a team of 135 employees across eight global offices. It is expected to generate revenue of approximately $350 million and EBITDA of approximately $150 million in 2022. With this acquisition, we now have strong and complementary capabilities in alternative credit, real estate, hedge fund solutions, and PE-related activities. Given the overall size and growth of private equity and the likelihood of further private market expansion, Having a specialist investment manager tied to this sector of alternative assets is a logical step in the diversification of our business. Furthermore, providing access to diversified versions of higher returning investments will continue to increase in importance to meet savings and retirement goals of our broad group of clients. This could also be important in both our multi-asset solutions business and the continued development of our customization capabilities. As Jenny mentioned earlier, this transaction takes us one important step further in creating a larger and more diversified alternative asset business that will result in performer fiscal year 2022 alternative asset AUM of approximately $200 billion, producing approximately $1 billion in annual management fee revenue, excluding performance fees, at a margin of approximately 40%. We intend to continue adding complementary business in both wealth management and asset management, including asset class and geographic expansion. This will be both organic investment through allocating capital into our existing specialist investment managers and via acquisitions. Given our global reach, financial flexibility, business model, and experience in execution, we're able to attract highly talented teams and partnerships looking for a combination of independents, support, and collaboration on a global and local scale to create new growth opportunities in what is a very large and expanding segment of the asset management industry. Turning to financial terms of the transaction, we're acquiring 100% of Lexington Partners for $1 billion in cash at closing, plus a further $750 million in cash over the next three years. We have also structured this transaction to ensure continuity and strong alignment of interest with Lexington's clients, partners, and employees over the long term. Consistent with this, we will be simultaneously issuing grants equal to 25% of Lexington to employees of Lexington subject to five-year vesting and establishing a performance-based cash retention pool of $338 million to be paid over the next five years. The transaction is expected to close by the end of our fiscal second quarter, subject to customary approvals. And now, we would like to open the call up to your questions. Operator?

Thank you. If you would like to ask a question, please press star then the number one on your 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 then zero on your telephone keypad. We request that you limit to one initial question and one follow-up. Our first question is from Glenn Shore with Evercore. Please go ahead.

Hi, thank you. So I like that you're using the cash to buy into good businesses. I think everything's accretive when you're earning nothing on cash, so I'm a big fan of that. If I took all the purchase price pieces and we can't see it all, it looks to me in the range of high teens to 20 times EBITDA. I'm just curious if that's about right and what kind of ROI that kind of comes out to. Thanks.

on whether you take the $1.75 billion or whether you take the $1.75 billion plus the $338 million of additional deferred compensation.

And maybe the 25% of the company also, right?

Yes. Oh, yeah, of course. Yeah. Well, yeah, I mean, all the multiples we just referred to assume 75% of the EBITDA numbers that we just announced. Got it. So pretty simple, I mean, just take 150 times 75% divided by the amount we're paying.

Got it. Okay. And I'm curious, you are piecing, as you went through, you're piecing together a bunch of interesting pieces of the alternative pie. So between Benefit Street, Lexington, Clary, and K2, what's the thought process on how you do or do not integrate i noticed that you're forming and funding a specialist distribution team but you know the historical leg mason never really integrated their their boutique so curious on how you're approaching the the integration of all your alternative pieces thank you so i'll i'll uh i'll start and then have tommy add to it um

So, you know, obviously one of the differences when you acquire alternative managers is there's a lot of things that traditional asset managers can be shared across investment teams that isn't the case. You know, for example, an alternatives manager may want their own legal expertise as they're doing deals and things. And so there's a lot more that sits within the independent specialized investment team in the alternatives world. And one of the changes that we've made with the acquisition of Legg Mason is having more institutional salespeople within the investment groups. So that's already part of an alternatives manager. And what we are working hard to build is we believe the opportunity to democratize alternative assets in the more retail channel is that global distribution of alternatives. Tommy, you want to add anything to that?

No, I mean, I think that's – hey, Glenn, how are you? I think that's exactly it. I mean, I think we see opportunities in alternatives broadly defined. You expect that to continue to grow at a really strong rate. And it's really sort of bringing the power of the platform to bear on the distribution alternatives, both institutional and retail. And the joint venture that we've effectively – created as, you know, is first focusing on retail, and then we'll look to expand it. But, you know, given the $200 billion now in AUM, we can afford to invest more in these types of products and services, which I think is going to be good for everybody.

And, Glenn, just one other point. You know, as we have tried to fill out our, you know, product breadth, we really believe the opportunity of multi-asset solutions, that's where it gets knitted together as well. And that's kind of a, you know, requires the teams to be communicating. You're going to look at risk factors across as you're building additional products around that.

Thank you both. Appreciate it.

Thanks, Beth.

Your next question is from Alex Blostein with Goldman Sachs.

Hey, good morning. Thanks for taking the question. So maybe just building a little bit more on Lexington and kind of what that business looks like. I guess first, pretty impressive growth in their funds over the last couple of integers. Maybe give us a sense what you are assuming in terms of growth for Lexington into 22 and 23 and what the earnouts are going to be based on.

We'll let Will take that answer. Yes.

Thanks. Yes, we've been able to raise significant capital in our areas of focus in secondaries, both our flagship funds, our middle market funds, and then our co-investment business. So there's some structural drivers in each of those businesses that we think expand the market opportunity as we look forward. So we're excited to go after it with our new partners, and that's really it.

Yeah, and I think, Alex, in terms of what needs to be achieved to get to the hurdles on the various contingent consideration, we cannot talk about future fundraising on this call. But if you look at the past history of the company and the timing around some of these things, we do have some growth. built in, but I wouldn't say particularly aggressive growth for the future, given the potential that we think we have together. One of the very attractive things about Lexington partners is, frankly, they were very successful on their own. So the forward-looking growth of Lexington standalone was very attractive to us. And then when you apply the additional growth potential through adding our resources with broader client base across high net worth and other distribution globally, we think it could actually add more to the numbers that we've highlighted today.

Great. Thanks. And my follow-up just around the balance sheet dynamics performer for the deal. The deck says you guys have about $6 billion of cash and investments on a performer basis after the deal. Can you give us a sense how much of the $6 billion is ultimately kind of unrestricted cash. So if you wanted to, you know, do something with it or pay it out, you know, tomorrow, what would that look like? And then how much of future funds do you expect Ben's balance sheet to participate in? So in other words, like the co-investment or seed capital or whatnot, is it going to be a hundred percent based on Franklin's balance sheet and how much of sort of resources do you think that's going to take on future fundraisers? Thank you.

Yep. Okay, thanks, Alex. So a couple of things there. In terms of the sort of unrestricted cash that's available to do other things at the time that we close this transaction, and we're assuming that we can close this transaction at the end of March, that number would probably be something like a billion dollars. So that's question one. Question two on the GP commitment. There is very strong demand for the GP commitment from partners and employees. both at Lexington, and I know that Frankie Templeton, senior executives, and other folks are looking forward to being part of that also. But you're right to highlight the fact that Frankie Templeton will also, from a balance sheet perspective, be committing capital to support the GDP level. So, Yeah, and we have a commitment to that. We obviously can't say what the amount is because it depends on future fundraising. Great.

Thank you very much for the questions. Thank you.

Our next question is from Michael Cypress with Morgan Stanley.

Oh, hey, good morning. Thanks for taking the question, and congratulations on the deal announcement. Matt, just a question for you just around the carry economics. I was hoping maybe you could just elaborate on that. I don't think I heard that. Apologies if I missed it. And then just on the equity that's granted to employees in Lexington, just curious the thought process around why not grant equity in shares of the parent in Franklin Templeton.

Yeah, so what was the first question again? The carry. So carry, we're going to share in something like 20% of carry going forward. The focus for us, and then we haven't acquired any past carry either from previous funds. The focus on us in this transaction was the very attractive management fee stream at a much higher fee rate than our average rate and the growth potential of that. We think, and I think investors believe, and certainly for Lexington Partners, the alignment of interest through allocating the majority of carry to the producers in the company is very important. So that's what we focused on in terms of structuring the transaction. What was the second question?

The second part was just around the equity ownership. Why not Ben's shares?

Good question. So firstly, it may not surprise you to hear us say that we believe that Ben's shares are quite undervalued. So we don't really like to dilute our shares. We don't need to. But the more important answer to the question is that we think that the alignment of interest through providing equity in the actual business that the folks are operating in, you can't get a whole lot better than that. We've got plenty of incentives across the firm to make sure people collaborate and coordinate to create more value. The more that that happens and that we create more revenue and EBITDA, the more Lexington will be worth in this case and the more Franklin will be worth. So we think that the two things align very well in this regard. And frankly, it's probably better shareholder value for Franklin investors.

Got it. And a follow-up question, if I could, just more bigger picture. I think there was reference in the deck about opportunities to extend the Lexington business into private credit and into real estate. I was just hoping you could elaborate a bit more on the opportunity set there, how that might be accomplished, what sort of hurdles there might be with putting through that sort of extension and growth, and just more broadly on the retail opportunity set, if you could talk a little bit about that, because clearly Franklin has strong retail distribution.

Tommy, why don't you or Will take that question?

Will, you can... Well, look... I think that we have tremendous growth opportunities in each of the verticals, and we'll continue to look for opportunities to expand products organically as well as inorganically. With respect to potential fundraising activity targeted at secondary real estate or private credit, I'd sort of push that back to Will.

Yeah, so... As I said earlier, we see structural growth in our core products that exist today, but there are also secondary markets developing in the areas you mentioned in private credit and certainly in real estate. So as the alternatives universe grows, one of the interesting things about this transaction is the ability to consider raising dedicated capital in those areas. So that will be something that we'll look at over the medium term, I'd say.

Great. Thank you.

Your next question is from the line of Ken Worthington with JP Morgan.

Good morning. Thank you for taking the question. So Franklin operates increasingly as a multi-brand and arguably the multi-boutique asset manager model, and you highlighted your intent to continue to acquire more. I guess other publicly traded multi-brand asset manager models command a discount. So some questions on this. So how does Franklin not get perpetually trapped into trading at a conglomerate or multi-brand discount, particularly as you acquire more brands? And then to Glenn's question in your response about solutions being the point of differentiation and knitting together the various products, can you flesh out more how you're thinking about solution-based products and services on the alt side? It looks like, for example, the bigger alternatives are buying insurance companies to leverage their diverse product offerings and create a solutions-based offering set? So more color, if you could, on the solutions roadmap.

Yeah, so first of all, you know, we'd look at it and say that, frankly, large asset managers with the broad capability that we have we think should be selling at a premium, not a discount, because the sum of the parts, if the sum of the parts isn't greater than the discrete parts, then we've failed. So why is that? you look at, starting with just our large partner clients, they are consolidating the number of firms they do business with, and you have to have a broad breadth of capability to be able to make those lists. Number two, if you think about just what's happening today with technology and technology disruption, and I'll just start out with, we talk about You know, as an active manager, if you're not really good at leveraging data science and data analytics, ultimately you're going to have a hard time competing in active management. And data is expensive. Our approach is at the center. We've created, for example, an investment data lake, and our individual teams have data scientists in there so they can leverage that at their opt-in choice. but we can negotiate large vendor contracts and gain independent access to unique raw sources of data. Those types of advantages, if executed well at the core, become a massive opportunity. And then there are things, back to that kind of partner point, when you have a broad breadth of assets, you can do things like we have the Franklin Templeton Academy, which we built for emerging markets and fined that partners in the developed markets want access to that kind of capability to do training of their teams. Thought leadership with the institution or the institute, the Franklin Templeton Institute is something that's sought after by our large partners. And then of course, just a massive global distribution footprint that no individual manager could ever support that kind of capability. And so, we think that that brings a strong premium. On your point on solutions, yes, I mean, you see what's happening in the insurance business. It's, you know, probably that model will continue. You'll see more of those kind of deals, although there's a limited number. Yes, if you have a good solutions team that can bring together and customize, that's an opportunity. And we look at where we can continue to grow that, but we also see it as an opportunity with our existing partners. And I know Matt's dying to add something here.

I would just say kind of the highest level. We don't really see ourselves as a multi-affiliate asset management company from a model perspective. I wouldn't confuse the autonomy and independence of our teams with being a multi-affiliate asset management company. The brand strategy is because a number of our specialist investment managers are known very well for exactly what they do, and we don't want to dilute that in any way. And that seems to resonate in the marketplace, both institutional and through other big distribution channels. That's number one. And number two, while the coordination and collaboration across the firm and some of the things that Jenny mentioned do not in any way dilute the independence and autonomy of our specialized investment management companies, it is really good, the collaboration across the firm. And we're definitely seeing increased opportunities by that collaboration. And it's opt-in collaboration. We don't force it across the firm. And you're seeing in an increasingly competitive environment across the industry that it's really energizing for the company and our specialist investment managers. One thing we all have in common is we all want to grow and we want to compete and we want to win. And we're finding that this is a good strategy for us at least. It doesn't mean that other models don't work really well. Also, we have tremendous respect for our colleagues that have slightly different versions of our model. In our opinion, we think of ourselves almost like as a hybrid of a model that you've referred to. And in terms of the insurance piece, we study these things pretty carefully. We have a pretty meaningful insurance angle ourselves, but it's an area that we're very interested in also. So it's one thing at a time, obviously, as we continue to build new opportunities for the company. Great.

Thank you.

Our next question comes from Dan Fannin with Jefferies.

Thanks. Good morning. I know there's a lot of moving parts as we think about expenses for next year, but maybe, Matt, if you could give us a framework to think about fiscal 22 in terms of either X the transactions, maybe on a core basis, we can think about expense growth, or if you want to talk about them together, that would be helpful.

Yeah, sure. So including Lexington, assuming that we close March 31 or around that date, April 1, say, I would just take the numbers we provided and the margin we provided and just divide it by two. Well, sorry, the margin won't be divided by two, but the revenue and EBITDA would be divided by two. Just assume that's added in. So putting that aside, on a standalone basis, for the first quarter first, because obviously we're very early to give guidance for the year, but for the first quarter, excluding performance fees, we would expect our revenue to be approximately flat for the quarter and expenses to be down in the low single digits, let's say. Because as you know, we do have some run rate expenses rolling through from last year from the merger related synergies. So we've got that happening. So I think I would say that all else remain equal. If markets remain stable, we expect our adjusted operating level to remain current levels and adjusted operating expenses to be down low single digits compared to the fourth quarter. This is all excluding performance fees. As you know, we have had elevated performance fees for the last two quarters with $102 million in the third quarter and $69 million in the fourth quarter. Obviously, that does vary. In terms of modeling on that one, I think there's been a little bit of confusion around how to think of that. I would just think of half of that being on and the other half being not comp. So the other half coming to the parent, if that's helpful.

That is. And just to clarify, when you say that's percentage down for expenses quarter over quarter?

Yes. Yeah. Yeah. So, sorry, low single-digit percentages.

Great. And then just in terms of the core business and gross sales and momentum in the prepared remarks, you talked about onboarding a wide range of product offerings with your largest global financial partners. So you maybe expand upon, I think you talked about Edward Jones last quarter, but maybe some other tangible examples of what products or channels are seeing that. And then also maybe if there are, you've had some one-off redemptions that you've called out before, if there's anything to note for the fourth quarter, I'm sorry, your fiscal first quarter that we should be aware of as well.

Adam, you want to take that?

Sure. So let's talk about the onboarding, and I'll go back to what we said about the merger over a year ago and how complementary the two firms were. And if you think about the U.S., legacy Franklin so much stronger in the regional and independent channel, like stronger in the wires outside of the U.S. Franklin much stronger in retail banking in markets like Germany and Italy, with Lake Mason having a better presence in private banking. Each of those business segments really operates separate platforms. So Leg had its product on one set of platforms, Franklin on the other. Often it takes a little bit of effort and work and sometimes formal agreement to be able to participate on those platforms. Since we had the platforms, we were able over this year to execute a strategy where we brought on legacy Franklin product on the Lake Mason platforms, and vice versa. That means that we have far more funds in the U.S. and outside of the U.S. now available for sale. That process took several quarters to execute, and we're now in the position where we think we can sell significantly more next year because we're able to do that.

And I guess, Adam, in terms of the – the lumpiness, if you will, of numbers going into the fourth quarter, there are a couple of potential large increases because one of the things we haven't talked about since the announcement publicly is the O'Shaughnessy asset management acquisition, which was a very important acquisition in terms of customization capabilities And that's a tremendous team, and we're really excited about what that could bring for us. That may close in our first quarter, and that will add almost $7 billion under management. And then we also announced publicly, obviously, the acquisition of a team, a new team within fixed income in the LDI space that is expected to raise Fairly quickly, again, it could be first quarter, second quarter, but that could be a few billion dollars that we will call out specifically at that time.

And just to kind of put an exclamation mark on it, you know, I mean, I think in the past there are times where we were very concentrated on a few products. You know, today our top 10 funds represent only 19% of our AUM, and of the 14 out of the top 20 funds you know, by flows are not our largest funds. I mean, we are really not only diversifying our client base, but also very much diversifying our product base. And in the case of something like OSAM, you know, we're excited about direct indexing, but we're also excited about the capabilities of that being a wrapper to deliver just our core active strategies as well, you know, down the road, really enhancing the SMA portion of that.

And, Jenny, I would say that the diversification is equally true on the institutional side, where we look at our pipeline there, where no strategy, I think, is kind of asset class is more than 17% of our pipeline at this point. So really diversified on the institutional side as well.

Thank you. Thanks.

Our next question is from the line of Brennan Hawken with EBS.

Thanks for taking my question. Just a couple follow-ups on the 150 million of each dollar. So, Matthew, you said to just divide it by two for the six months. So I'm guessing that that means there's no carry in that 150? Right. Okay, great. And then... Does that also mean that the 25% interest will sort of move with the vesting schedule? So five percentage points of interest going to that team per annum?

No, that will be immediate. So that will run through. We're obviously going to work through the best way to account for the transaction when the process is doing that. But I would look at it on a – sort of an adjusted basis, you can expect to see 75, the impact will be 75% of those numbers that we've highlighted running through our P&L, basically. And then I would just apply, you know, our average tax rate to the EBITDA to get to a rough contribution level in terms of net income. We expect it to be, you know, Probably mid to a little bit better single digits accretion immediately. Okay. On an annualized basis.

Got it. And then when we think about the – I know there's the 338 of performance that have performance metrics tied to them, but are there any other performance or retention components to the 25% In other words, is that transferable? Are there any performance pieces connected? How else is that linked in with Franklin over the long term?

Thanks. Yeah, and that's a really important question, something that obviously Will was very focused on as well as us and the team. And that 25% vests over a five-year period, And there are non-solicit, non-compete, all the things that you would expect around how you retain and incentivize senior employees that are equity holders in the company. So we have all those things. It vests relatively over the five years. And at the end of that five-year period, there are basically options around who can acquire the equity. Franklin, obviously, is one that could acquire it, but there's going to be a lot of demand for that equity internally at Lexington, including through their own bonus pool. So that's something that Will maybe wants to comment on also in terms of the dialogue that we had, and then I'll go back to the contingent piece in a minute. Will?

Yeah, thanks, Matt. I mean, the opportunity to own a significant portion of our own business is something that we understand. You know, the business has grown considerably since it was formed in 1994. And the opportunity through this partnership and structure with Franklin to broaden that ownership is really exciting for our employees. So, you know, I think this is for us a chance to have a really powerful and exceptional new partner and at the same time really bet on ourselves and our ability to continue to perform for our LPs.

Thank you, Will. And then in terms of the performance-based cash awards, Brennan, that you asked about, they don't begin until the second year, end of the second year, and they run all the way through to the fifth year, and they're tied to a number of revenue and AUM-based metrics that we anticipate over that period of time. And then there is time-based payments on this also. that we were very pleased to work on with the team. So we have a billion dollars at closing, and we referenced 750 million over three years, and that 750 million is split 250 million in the first year, 400 million at the end of the second year, and 100 million at the end of the third year. And then the 338, and then the 338 is pretty much even, it's a little bit different numbers, but very evenly split between the second year right the way through to the fifth year. So it's quite well balanced between three and five years.

Thank you for all the details. That's really helpful. Just one clarifying point. Is there a chance that the fee for equity goes to the point

Sorry, Brandon, you're cutting in and out.

We can't hear you.

Yeah, we can't hear you.

Sorry. Can you hear me?

There you go.

Try it again. That's better. Okay, better now? I had to walk a little bit. Is the 25% after five years, does that have a chance to actually increase and Lexington employees participate in more, therefore diluting Franklin? Is that what you had said? I just want to make sure I understood that.

No, I meant within the 25%. Oh, okay. Got it. Within the 25%, it will either circulate within Lexington, it will never go outside of Lexington, other than to Franklin. So it'll either be within Lexington or Franklin will acquire more. Thank you for clarifying that. But we expect it to stay within Lexington for the extended period. Understood. And I guess just to complete the picture, even if, in theory, even if Lexington partners decide to sell some of their equity to Franklin, there is a minimum amount of equity that needs to be held by the partners when they're actively employed at the company. And it takes a number of years to sell down the equity. And that's why we're confident at the circulation point.

Thank you for the thoroughness of the answer. Appreciate that. Thank you.

Your next question is from Robert Lee with KBW.

Great. Good morning. Thanks for taking my questions. First of all, maybe just sticking with some of the payout or earnouts, I want to make sure you understand this. Is the 750 that you start paying, I guess, in year ones through three, is that subject to an earnout or performance, or is that just kind of delayed payments and not really, I'll call it performance-based?

They're just time-based payments. Okay.

They're just time-based. Okay, great. And then just stepping back a second, maybe philosophically, Lexington, certainly there's huge value in having them own a piece of their business over time. Clarion, I believe, employees, partners there still own a piece of their business. And I know something that Legacy Legs struggled with was how to get more – maybe move away from someone from a revenue share, more towards having employees in Western and other affiliates own equity? I mean, does this kind of create any, I don't know, internal pressure or whatnot, whether it's Benefit Street or the other specialist sales to kind of revamp or reshape, you know, their structure and, you know, and how much, how they have equity versus revenue share?

Well, so first of all, you know, the, The nature of which individual investment team structure is often is related to some historical acquisition. And the beauty of the alternatives business is because there's the carry in there, often itself is a great retention tool. And so that's built into all of our alternatives businesses. And then, you know, when we did the acquisition, I mean, there were things that we were able to do in the acquisition of Legg Mason to ensure that incentives are aligned with the parent company and that everybody's rowing the boat in the same direction. And, you know, as we talked about earlier, we've created an opt-in environment where we think there are some really good upsides to the teams by, you know, leveraging the core part of the business. And what we've seen is a real desire. We had recently a CIO forum where the heads of all of our different investment teams got together. And I got to tell you, the engagement was outstanding. Everybody really appreciated it. And the conversations were very, very good. And so I think people recognize the benefit of being part of a greater organization.

But also, Rob, just to add to Jenny's points, if you think of our alternative asset specialist investment managers, They all either have like Clarion's, for example, owns 18% of Clarion's. That's the same sort of partnership structure as we have with Lexington. And Benefit Street Partners, we have basically the equivalent of growth units. It's not equity, but it's very close to equity. And then in many other businesses, we have the same thing where you're basically, as Jenny mentioned, we're aligning interests. It doesn't always have to be with equity. It can be a combination of equity. and cash in terms of how it relates to certain specific growth objectives for that particular business or growth targets for that business. So it's really a combination of things that works well for the specific teams, what we work on with them, and what works for the parent company to make sure we get the right growth going.

Great. And maybe if I could squeeze in one quick follow-up question. I mean, the $30-odd billion of fee-paying AUM, and fundraising was very good, I guess, last cycle. But is there a certain amount of dry powder that's not yet earning fees? I mean, maybe some of those funds are drawdown structures. So is there kind of, as we look forward, is some kind of built-in fee growth already just from what they already have committed?

So, Will, why don't we have you take that?

Happy to take it. The answer is no on existing products. These are commitment fee-paying products.

Great. Thank you for taking my questions. Appreciate it. Thanks, Rob.

Our next question comes from Brian Bedell with Deutsche Bank.

Great. Thanks. Good morning. Thanks for taking my questions. Most of them have been asked and answered. um just a couple clarifications on the deal first and then a longer term question um the um the the aum the 200 billion pro forma includes the 55 um from lexington but um on the 1 billion um of fees on that should we be thinking of it on the fee-paying aum contribution so more like 180 billion then um just to clarify on the 338 million i think matt you said that starts in the second year so that would not impact fiscal year 22 whatsoever? And then what is the adjusted tax rate going forward that you're using?

Yeah, so a couple things. Firstly, could you just repeat your first question? I didn't fully follow what you said.

Yep. The $200 billion AUM is $145 right now. Oh, yeah, yeah, yeah.

Okay, yeah. Yeah, so firstly, that actually doesn't include $55 billion. $55 billion is the amount that's been raised in terms of capital since inception at Lexington. It only includes the $34 billion with an assumption of some modest growth. But we've been growing 20% organically across other alternative asset SIMs. So it includes some growth in those also. So it doesn't add just the $55 billion. It adds the $34 billion and then the assumption of growth. That's how you get to the $200 billion. We feel good about that. What was the second question?

And that $200 billion is at the end of March, basically. Right, yes, exactly. Exactly. Just a couple on the second part of the question is the $338 million, I think that starts after fiscal year 22, and the go-forward tax rate that you're using.

So the first contingent payment, it starts in 2024, actually.

Okay, yep.

So that's that. And then the other question you asked, sorry, I just had so many questions. The billion dollars... You asked, well, I'll get to taxing in a second. You asked about the billion dollars of management fees, and yes, that's tied to the 200, and frankly, it's quite conservative probably, and that's only management fee revenue. It's not anything to do with carry or performance fees or anything like that. We think that's fairly conservative because already at Franklin Standalone, we're probably at something like $700 million of management fees for 2021, for example, and then plus the procurement fees got us already quite close to a billion at that 40% margin that I mentioned to you. In terms of tax rate, I would continue to use the 23% to 24% effective tax rate guidance on all of this. We realized that this quarter was unusual in terms of the reserve that we're able to release So we do not expect any additional large reserves like that to happen, although I should point out on taxes that we've probably been able to benefit from about $150 million of the approximately $600 million of tax benefits obtained through the acquisition of Legg Mason, and we should be able to benefit from about another $200 in favorable tax attributes over the next two years. and then the rest will be over, you know, probably seven years at that point, six or seven years or something like that.

And that's a cash tax rate as opposed to the 23% to 24%. Yep, yep.

That's right.

Exactly, yep. That's great. Thank you for all that. And then maybe just one on ESG, Jenny. You mentioned obviously now you're up to about $200 billion. Maybe just classifying that between what you would consider – like pure sustainable investments versus exclusionary products. And I think before you said you sort of modeled it after Articles 8 and 9 in terms of classification. So I just wanted to verify if that $200 billion is linked to Articles 8 and 9 of Europe and maybe just what your view is of maybe potentially reclassifying, changing perspectives, if you will, in terms of the strategies, even raising that $200 billion.

Well, so, yes, it's Article 8 and 9, so that's the first part. And, you know, if you look at the flows in Europe, I mean, we saw something that says, you know, there's $2.2 trillion in AUM in 2020, and that's going to get up to $53 trillion by 2025. I mean, there's some Article 6 selling, but I've got to tell you the demand is Article 8 and 9. So that's where the growth is. We've got very good products there. I think we were very disciplined. Nobody's claiming greenwashing on our part. We were very disciplined and have a rigorous compliance group reviewing any products before we declare them that way. We have more in the queue that are being reviewed internally. And, you know, we think that what's happening in Europe is going to happen in Asia and the U.S. as well. Adam, you want to add to that?

I was just going to add that if you look at our pipeline, it's pretty incredible. About 20% of our flows are coming from eight and nine products in Europe, and it's about 40% of our pipeline. So while we've got a decent business there, it's just growing and growing more quickly than anything else we do.

That is super helpful. Thank you for that. If you're able to break it apart between sustainable and exclusionary, I don't know if that's possible.

I don't have it on my fingertips. Adam, I don't know if you do.

I can tell you that. Why don't we get back to you with those exact numbers?

Okay. Thank you so much. Super helpful.

Great. Thank you, Brian. All right.

Great. Well, I just want to say thank you for participating in today's call today. We are at time. As you can hopefully tell, we've made a lot of exciting progress over the past 12 months. And yet, you know, in so many ways, we're just getting started. So once again, we'd like to thank our employees for their hard work and remaining focused on our clients and each other. And we look forward to speaking to you again next quarter. So thanks, everybody, and stay healthy.

This concludes today's conference call. You may now disconnect.