Virtus Investment Partners, Inc.

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Good morning.

My name is Michelle, and I will be your conference operator today. I would like to welcome everyone to Virtus Investment Partners quarterly conference call. The slide presentation for this call is available in the Investor Relations section of the Virtus website at www.virtus.com. This call is being recorded and will be available for replay on Virtus' website. At this time, all participants are in a listen-only mode. After the speaker's remarks, there will be a question-and-answer period, and instructions will follow at that time. I will now turn the conference over to your host, Sean Bork.

Thanks, Michelle, and good morning, everyone. On behalf of Virtus Investment Partners, I'd like to welcome you to the discussion of our operating and financial results for the fourth quarter of 2022. Our speakers today are George Elward, President and CEO, and Michael Angerthal, Chief Financial Officer. Following their prepared remarks, we will have a Q&A period. Before we begin, please note the disclosures on page two of the slide presentation. Certain matters discussed on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, and as such are subject to known and unknown risks and uncertainties including but not limited to those factors set forth in today's news release and discussed in our SEC filings. These risks and uncertainties may cause actual results to differ materially from those discussed in the statements. In addition to results presented on a GAAP basis, we use certain non-GAAP measures to evaluate our financial results. Our non-GAAP financial measures are not substitutes for GAAP financial results and should be read in conjunction with the GAAP results. Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in today's news release and financial supplement, which are available on our website. Now I'd like to turn the call over to George. George?

Thank you, Sean. Good morning, everyone. I will start with an overview of the results we reported earlier today before turning it over to Mike to provide more detail. The fourth quarter remained challenging, consistent with the trend throughout the year. In addition to a volatile market and heightened uncertainty, OPEN END FUND FLOWS INDUSTRYWIDE WERE PARTICULARLY NEGATIVE, MOST NOTABLY IN DECEMBER, AS INVESTOR SENTIMENT-DRIVEN ACTIVITY RESULTED IN AMONG THE MOST ELEVATED FUND NET OUTFLOWS IN WHAT WAS ALREADY HISTORICALLY DIFFICULT YEAR. WHILE WE HAD NET OUTFLOWS IN THE QUARTER DUE TO HIGH REDEMPTIONS, WE DID HAVE A MEANINGFUL INCREASE IN SALES ACROSS PRODUCTS AND ASSET CLASSES, POSITIVE INSTITUTIONAL NET FLOWS, A HIGHER AVERAGE FEE RATE, WHICH HAS BEEN RESILIENT DESPITE INDUSTRY TRENDS, continued solid investment performance, and significant balance sheet flexibility and a net cash position at December 31st. We have built our organization to navigate challenging environments like these in our position for market stabilization and recovery with increasingly well-diversified products and capabilities that can attract assets across market cycles and changing investor preferences. We continue to be focused on the execution of our strategy and building out capabilities to position us for future growth as the environment improves. Turning now to a review of the results, total assets earned in management increased 3% to $149 billion, primarily due to market appreciation, partially offset by net outflows. Sales increased 27% to $7.3 billion, with increases across all product types and most asset classes. Institutional sales doubled to $3 billion, benefiting from a large inflow into an existing mandate, contributions from non-US clients, and the issuance of a new CLO. Retail sales also increased, with open-end funds up 5% due to higher sales of equity, fixed income, and alternative strategies, and retail separate accounts rose 4% due to investment-grade fixed income. Net outflows were $3.4 billion, essentially unchanged from the prior quarter, and again, primarily due to elevated redemptions. Net outflows were primarily in mutual funds, consistent with industry trends, It also included net outflows in the intermediary distributed retail separate accounts, while institutional and private client generated positive net flows. Byproduct, institutional net flows were positive $0.8 billion, reflecting a meaningful increase to a domestic large cap growth equity mandate and $300 million from the issuance of the CLO. Institutional net flows have been positive in eight of the last nine quarters, and considering the challenging environment, we are pleased with this consistent level of activity. Fund net outflows of $3.8 billion were elevated in line with market trends and were particularly negative in the month of December. Retail separate account net flows were again negative due to higher redemptions reflecting retail investor sentiment. In terms of what we saw in January, mutual fund net flows, while still negative, improved meaningfully from the fourth quarter and represented the best month of flows since September of 2021, including improvements in both sales and redemption rates. In particular, we saw positive net flows in our international and global products, as well as certain of our small-cap and fixed-income products. The institutional pipeline remains strong, with known wins exceeding known redemptions over the next two quarters. Our fourth quarter financial results again reflected the impact of market declines over the course of the year. Operating income as adjusted was $56 million, down from $65 million sequentially, and the related margin of 31.8%. declined from 35% due to lower revenues and relatively stable operating expenses. Earnings per share as adjusted decreased 10% to $5.17, reflecting the impact of the decline in average assets under management. Turning now to capital, given our solid cash flow generation and balance sheet, we continue to return capital to shareholders while maintaining appropriate levels of working capital and leverage. During the quarter, we repurchased 10 million of our common shares, totaling $90 million for the full year, and we reduced shares outstanding by 4.3% in 2022. We ended the quarter in a net cash position of $77 million and continue to have significant flexibility in managing our capital needs, with total cash on hand at year end of $338 million, $175 million under on Revolver, and $128 million in investments, providing ongoing flexibility to invest in the business and continue to return capital to shareholders. Before I turn the call over to Mike, I would like to provide a brief update on our agreement to add AlphaSimplex, a leading provider of liquid alternative investment solutions, as an affiliated manager. As we've discussed previously, AlphaSimplex will enhance and diversify our investment offerings, provide additional product and distribution growth opportunities, and expand our presence in the alternatives category. The transaction, which we expect to close near the end of the first quarter, will be funded with existing balance sheet resources that include our undrawn credit facility. We expect it to be immediately creative to earnings consistent with the 10% level we previously provided. Given the time of the close, the first quarter outlook Mike will provide for various metrics will not include the impact of the transaction. We will update you on the modeling for AlphaSimplex and its impact on our outlook on the next call. With that, I'll turn the call over to Mike. Mike?

Thank you, George. Good morning, everyone. Starting with our results on slide seven, assets under management. At December 31st, assets under management were $149.4 billion, up 3% from $145 billion at September 30th. The sequential change reflected $8.8 billion of market appreciation and $3.4 billion of net outflows. Average assets under management in the quarter were $148.6 billion down 5% due to market performance and net outflows. Our assets under management remained well diversified by product type and asset class. Institutional represented 34% of total AUM at December 31st, with U.S. retail funds and retail separate accounts at 32% and 24%, respectively. By asset class, equity was 55%, Fixed income and multi-asset strategies were combined 38%, and alternatives were 7% of AUM. We continued to generate strong relative investment performance across strategies. At December 31st, approximately 57% of rated fund assets had four or five stars, and 90% were in three, four, or five-star funds. We had nine funds with AUM of $1 billion or more that were rated four or five stars, representing a diverse set of strategies from five different managers. On a five-year basis, 75% of our rated fund AUM was outperforming the median performance of their peer groups. In addition to strong fund performance, as of December 31st, 87% of retail separate account assets and 61% of institutional assets were outperforming their benchmarks over five years. Also, 57% of institutional assets were exceeding the median performance of the peer groups on the same five-year basis.

Turning to slide eight, asset flows.

Total sales increased by 27% to $7.3 billion, reflecting growth in each product, particularly institutional. Byproduct institutional sales were $3 billion, up from $1.5 billion in the third quarter due to a significant additional funding into a domestic large cap growth equity mandate in addition to the $300 million CLO issuance. Fund sales of $3 billion increased 5% with particularly strong growth in alternatives, domestic small cap, and global equity. Retail separate account sales of $1.2 billion increased 4%, largely driven by investment-grade fixed income. Total net outflows were $3.4 billion, primarily due to open-end funds. Reviewing by product, institutional generated positive net flows of 0.8 billion with meaningful contributions from non-US clients. Strength in non-US came from multiple affiliates and included both new mandates and fundings to existing accounts. For open-end funds, net outflows were 3.8 billion up from 2.8 billion in the third quarter due to elevated redemptions and consistent with negative retail trends. In retail separate accounts, net outflows of 0.4 billion compared with 0.2 billion in the third quarter with investment grade generating positive net flows. In our private client business, net flows remained positive as they have for 16 consecutive quarters. Turning to slide 9, investment management fees as adjusted of $156.1 million declined $7.9 million, or 5%, reflecting the 5% sequential decline in average assets under management. The average fee rate of 41.7 basis points compared with 41.5 basis points in the prior quarter. The fee rate increased modestly on a sequential basis for each product category. And on an overall basis, the fee rate has remained in the 41 to 42 basis point range over the course of 2022. Performance fees in the quarter were 0.5 million up from 0.3 million in the prior quarter, favorably impacting the fee rate by 0.1 basis points in both periods. Looking forward into the first quarter, we believe the range of 41 to 43 basis points remains reasonable. Slide 10 shows the five-quarter trend in employment expenses. Total employment expenses as adjusted of $88.3 million decreased sequentially from $88.7 million. Lower profit and sales-based compensation was partially offset by market valuation adjustments in investment-related compensation utilized in deferred plans. These valuation adjustments are hedged and fully offset by a corresponding amount included in other income. As a percentage of revenues, employment expenses were 50.1% up from 47.8% in the third quarter, primarily due to lower revenue. For the first quarter, the fourth quarter ratio would be a reasonable level to expect, though I would note It will be subject to variability based on market performance, profits, and sales. For modeling purposes, the first quarter will also include seasonal employment expenses, which are incremental to this outlook. Turning to slide 11, other operating expenses as adjusted were $30.8 million and compared with $31.1 million in the prior quarter, which included approximately $1 million of costs associated with the Alpha Simplex transaction. Excluding these transaction costs from the prior period, other operating expenses as adjusted increased by $0.7 million, or 2.3%, largely due to higher sales and marketing activity, which continues to normalize, as well as efficiency and distribution initiatives. For the first quarter of 2023, we anticipate other operating expenses as adjusted will be at a similar level as the past three quarters. We continue to closely manage all discretionary expenditures and initiatives. While our expenses have been impacted by inflationary pressure, increasing costs of contracts with key vendors, service providers, and suppliers, as well as by the ongoing resumption of sales activity toward more normalized levels, Our focus on discretionary spending has generally offset those increases, allowing us to maintain other operating expenses at a relatively stable level over the past several quarters. In addition, our expense management efforts have supported our ability to continue to invest in select strategic initiatives that we expect will benefit future operating leverage and expand our growth capabilities. Slide 12 illustrates the trend in earnings. Operating income as adjusted of $56.1 million declined $8.8 million or 14% sequentially due to lower revenues. The operating margin as adjusted of 31.8% compared with 35% in the third quarter. Net income as adjusted of $5.17 per diluted share declined 10% from the prior quarter. Regarding gap results, net income per share of $4.77 increased from $4.25 per share in the third quarter and included $1.53 benefit from the fair value adjustments to affiliate non-controlling interests and 78 cents of net realized and unrealized gains on investments, partially offset by $1.03 of CLO issuance expense 50 cents of negative fair value adjustments to contingent consideration, and 41 cents of discrete tax adjustments. Slide 13 shows the trend of our capital, liquidity, and select balance sheet items. Working capital was $181 million at December 31st. down from $195 million at September 30th as an investment in our new CLO and return of capital to shareholders exceeded cash earnings. Contingent consideration, which includes estimated revenue participation at earn-out payments, was $128 million at December 31st, down sequentially from $134 million. This amount will vary over time based on changes in the underlying related revenue streams. During the fourth quarter, we repurchased 53,320 shares of common stock for 10 million, and over the past year, we have reduced shares outstanding by 4.3%. At December 31st, gross debt to EBITDA was 0.8 times, and net cash of 77 million increased from 47 million at September 30th. First quarter 2023 cash obligations include payment of annual incentives, seasonal employment expenses, a revenue participation payment, and as mentioned, we expect to close on Alpha Simplex near the end of the quarter. With that, let me turn the call back over to George. George?

Thank you, Mike. We'll now take your questions. Michelle, would you open up the lines, please?

Thank you. As a reminder, to ask a question, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again.

Please stand by while we compile our Q&A roster. And our first question comes from the line of Samit Moody with Piper Sandler.

Your line is open. Please go ahead.

Thanks. Good morning, guys. So nice to hear retail flow starting off well for the year. Sorry if I missed this. Can you guys talk about what you're seeing on the institutional and SMA channels as well in January so far?

Sure. So for mutual funds, so we commented on the month of January and after really challenging 2022, particularly December, it was very nice when we closed out January that in terms of the level of even sales rate or redemption rate, AS WELL AS IN TERMS OF OVERALL DOLLARS, AS I NOTED, IT WAS THE BEST MONTH TO SEPTEMBER OF 2021. SO THAT WAS REALLY GOOD TO SEE, PARTICULARLY SEEING SOME CATEGORIES LIKE INTERNATIONAL AND GLOBAL ACTUALLY AS A CATEGORY IN THE FUND SET KIND OF BE POSITIVE, AS WELL AS THE SELECT AREAS OF STRENGTH WITHIN SOME OF THE SMALL COPS, BUT NOT ALL OF THEM, AND AS WELL AS SOME OF THE FIXED INCOME. AND THOUGH I HAVE MORE OPTIMISM FOR FIXED INCOME LATER ON IN THE YEAR, HOPEFULLY. INSTITUTIONAL PIPELINE REMAINS STRONG. That's been a lot of area of focus for us where we put our attention and our resources and several of our initiatives are related to maximizing that. So we're really happy to see the consistency of what's in a lumpy business, though still generating strong levels over the nine quarters. We've noted eight have been positive. Pipeline is good. The non-U.S. concentration continues to get a little bit better. So that was something we were underweight several years ago, but they've now become, significant contributors, and that's across affiliates and across strategies. So that's great to see. On the retail separate account side, given the nature of that business, particularly the intermediary sold channel, where some of the strategies are really sort of either done model only or through other provisions, we don't have as much real-time access to some of that information. But generally, because that business is concentrated in our equity strategies, particularly in you know, growth and smaller cap, mid-cap kind of strategies, it's going to go with a broader market. So I think what you saw in the fourth quarter for that, it was really just reflective of the sentiment on those equity strategies. And while we have a smaller piece that's in fixed income, that's where you kind of saw a little bit of an uptick in the January comment.

Great. Thanks.

Really helpful. And then On the AlphaSimplex transaction, what was the AUM to end the year for that? And can you maybe talk about some of the demand you're seeing on the institutional side, you know, specifically for them and how that's been going to start the year as well?

Yeah, so for AlphaSimplex, you know, until we close, we're not going to make comments on their business or their business results. Obviously, they're part of another company. So we're not going to comment on that. But we're continuing to do a lot of work related to the preparation of the integration. Very excited about having them as an addition to the family of boutiques. It's a great team over there. We spent a lot of time internally here thinking about ways to leverage their capabilities and their expertise. Again, they're in the alternative space, though, in the periods in the beginning of the year, last year, where traditional strategies were underperforming. They were outperforming. So, again, they'll be meant to be more kind of cyclical to some of our more correlated strategies. but we're really excited about the opportunity for us to sort of apply what they can do across a whole host of things. And they're still, in our view, you know, best in class in terms of what they do.

Got it. Great. And then last one for me on the ETF side of the business, just I know the AUM has been pretty stable over the last few years. Can you just maybe update us on the growth strategy more long-term? Are you focusing on growing that kind of organically or kind of more M&A opportunities over the next year or two as they present themselves.

Yeah, I mean, we always focus on making sure that we have an organic growth strategy for products. And in the ETF space, including with some of our product introductions, you've seen more in terms of the active fixed income ETF. So that continues to be an area where we've had some existing strategies. We actually launched one in the quarter, right, the Stone Harbor ETF. So that continues to be an area of product introduction. And one of the things we actually were working on throughout the latter part of last year was really kind of sort of optimizing ways to more fully incorporate them into our overall retail distribution. They've been part of it. The data on ETFs is a little more challenging than the data on open-end funds. So we actually feel that we're, in addition to building out our products, I think we've made a few further refinements in terms of leveraging our existing retail resources to be even more effective in bringing those to market. And again, I do think that's an area where investors will increasingly be looking at ETFs. And again, for us, It may be more in some of the active strategies as opposed to the passive strategies, which we will continue to do.

Great. Thanks, George. Okay. Thank you.

Thank you. And one moment for our next question.

And our next question comes from the line of Michael Cypress with Morgan Stanley. Your line is open. Please go ahead.

Hey, good morning. Thanks for taking the question. Maybe just on fixed income, just curious to hear your perspectives and views on the prospects for potentially a strong year of flows into fixed income just given the higher interest rate backdrop. Which strategies at Virtus do you think would be well-positioned to capture that? Maybe you could talk to which strategies have pretty good performance right now in your view on the fixed income side that could stand to benefit.

Yeah. My general view is that, and particularly going into this year, is that this could be a good opportunity for credit strategies, for fixed income strategies. I am not going to make any predictions because every time I turn on the TV, I see slightly conflicting thoughts around where the market's going to go. I do think there is that opportunity for those strategies. I do think there's some broad opportunities because, again, not all investors are going to be approaching it the same way. So I do think there will be opportunities on our shorter-duration products, particularly one of our flagship products, the multi-sector short-term bond fund, and low-duration is a related kind of product. I think those are opportunities there. I also think that emerging market debt, which has been an area where people have obviously not been gathering money, that's a very cyclical area, and depending on your global views, there could be good opportunities there as well. So I really do think across the continuum of fixed income products, I think as people are sort of reevaluating what is the right diversified set of a portfolio and what should it look like going forward, you know, is 60-40 make sense? You know, if it's not 60-40, what should it be? I do think there's going to be increasingly be opportunities, particularly for those things in the fixed income space, that have very targeted approaches, like the loan types of products, like the EMD, or something that just really works the relative valuation of the sectors, which again, is the whole suite of our new fleet products.

Great, and just on the international distribution, I was hoping you could update us on the build out there, how that's progressing, and how much that contributed in terms of AUM and flows, and maybe talk about some of the initiatives from the sales and distribution team standpoint.

Yeah, no, we continue to be very happy about that. And I might give a little color around the relative contribution. But as I noted, we continue to be increasing that business, which for us, non-U.S. clients have gone from roughly 0 to 5%, 10% to 15%-ish as we stand here now. Did give some attribution for the quarter that we had that contribution. So a lot of things that are going on there is the non-US has been a great opportunity for many of our managers because previously they hadn't been big participants in it, right? So there's a lot of open opportunity for various managers. So over the last year and a half, two years, you know, we have commented several times on large mandates outside the US, mandates for multiple affiliates, large mandates for multiple affiliates in the same quarter. And so that's been an area that we have been focused on, and one of the attributes of the Stone Harbor transaction was that brought along some additional high-caliber non-U.S. institutional distribution resources that have done a tremendous job of getting themselves ready and prepared and have been very active in marketing our managers to markets where we may otherwise not have had the ability to market readily. So some of the initiatives we've had behind that are to really sort of support that, maximize that. There's a different, obviously, regulatory environment in some of those areas. So we've been focused on streamlining some of the ways that we can sort of maximize the footprint that we can have there and then the resources that are supporting them. But we've been happy with that. Mike, the attribution on the contribution?

Yeah, and I think you highlighted it, but just to put a finer point on it, we've had Where in the past we've had maybe one affiliate or two affiliates contributing selectively internationally, we had four or five affiliates deliver both new mandates and additional fundings to existing mandates. And George alluded to the pipeline. That trend continues in the pipeline where we're seeing it across affiliates and across geographies. it really is gratifying to see that investment bring us to a level of consistency, especially in this market environment.

Great. And maybe just last one for me, maybe coming back to your point earlier, George, that you're looking to build out capabilities to position the firm for growth. So I guess as you look at the firm today, how well positioned is it relative to the opportunity set and where you'd like to see that? Where might there be opportunities to further

extended to either from a footprint or a product set opportunity how are you thinking about that either organic as well as inorganic and maybe you can update us on some of those conversations how those are progressing today versus a year ago sure so on the organic side so when we think about the the product offering set again we feel very well uh represented in terms of traditional active right our and then our area of focus um on the inorganic side, the last two, have really been in the non-correlated or less correlated alternative types of strategies. So we still think that there's opportunities there. The other areas where we see an opportunity and where we continue to have a focus is taking advantage of the individual strengths we have amongst our affiliates with more multi-assets as well as more model-based and more collective types of products. Again, we have been provided the building blocks for World Diversified Portfolio, but while we do provide some comprehensive solutions, I think there's great opportunities and some of the recent resources that we've added will allow us to sort of accelerate some of the work we want to do in that area. So we do think that that is a good opportunity. I already alluded to AlphaSimplex. I do believe that there is a much broader application of their capabilities. that we can utilize across our product set because, again, most of our managers are active, you know, fundamental managers, and they bring to that, you know, some quantitative capabilities. And we also separately brought in a team, the Verge Systematic team, that also provides those capabilities. So I see great opportunities there. On the market side, the non-U.S., again, is a high priority for us because it's a – fertile playground for us. We haven't had a lot of resources there over 10 or 15 years, so we think that that is a good priority for us, and that would also include the UCIPS and the global funds. So we've been in the process of building out those products, and some of those resources will actually dovetail into both institutional as well as our UCIPS products, but we've actually been... Most of our product introductions recently have been focused on ETFs and use hits, actually not on the open-end side. So I think all of that is part of the comment that I made in terms of the increasingly diversified set of offerings that we have as the market environment becomes a little more or less uncomfortable. So we feel good about that. In terms of the inorganic, again, while our growth strategy is not predicated Upon doing M&A, we continue to make sure that we're in active dialogues. Those dialogues continue. So we've been as active as we've always been. We're very selective in terms of what we do. Does it make sense strategically, either from an addition of a capability, broadening of a market, or some other kind of scale enhancing or otherwise strategic value enhancing transaction. So continue to be active on those. Again, our focus is always on the organic, but as you have seen, we are quite busy on the inorganic side as well.

Great. Thank you.

Thank you.

Thank you. This concludes our question and answer session, and I'd like to turn the conference back over to Mr. Elward.

Great. Well, I just want to thank everyone today for joining us, and certainly we encourage you to give us a call if there's any other further questions, and enjoy the rest of your day. Thank you very much.

This concludes today's call.

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