The operator welcomes the participants to the Franklin Resources Earnings Conference Call for the quarter ended June 30, 2023. Selene Oh, the Head of Investor Relations for Franklin Resources, reminds participants that any statements made that are not historical facts are forward-looking statements and are subject to risks and uncertainties. Jennifer Johnson, the President and Chief Executive Officer, is joined by Matt Nicholls, the CFO and COO, and Adam Spector, the Head of Global Distribution, to discuss Franklin Templeton's results for the third fiscal quarter of 2023. The company has been building a diversified company that offers a range of investment expertise and capabilities across asset classes, investment vehicles, and geographies.

Franklin Templeton's corporate model of combining the resources of a global firm with the investment economy of each of its specialist investment managers has allowed the company to meet the demands of its diverse client base and produced strong long-term results. In the first half of the calendar year, the company experienced positive net flows in its alternative and multi-asset strategies, ETFs, SMAs, and the high network channel. Additionally, long-term net flows were positive in both the EMEA and Asia Pacific regions. The company is interested in distribution-led strategic transactions that could further diversify their business and accelerate growth in key markets.

Franklin Templeton has entered into a long-term partnership with the Power Corporation of Canada and Great-West Life in order to offer more choice to more clients. As part of the partnership, Franklin Templeton will acquire Putnam Investments from Great-West for approximately $925 million. The agreement will expand Franklin Templeton's investment capabilities across key asset classes, and is expected to be accretive to run rate adjusted EPS by the end of the first year post-closing. It will also add approximately $150 million of run rate adjusted operating income in the first year post-closing.

In the fourth quarter of 2023, the acquisition of Franklin Templeton is expected to close subject to customary closing conditions. Assets under management increased to $1.43 trillion due to market appreciation and positive long-term net flows of $200 million, largely due to record net inflows of $4 billion into alternative strategies. Multi-asset strategies also saw positive net flows of $2.3 billion, while equity net outflows improved to $3 billion and fixed income net outflows were $3.1 billion.

Client interest in the quarter was strong, with net inflows into multi-sector, core bond, enhanced liquidity, and tip strategies. ETFs generated net inflows of $1.1 billion, and AUM totaled $16.2 billion. Separately managed account AUM ended the quarter at $116 billion and generated positive net flows. Canvas, a custom indexing solution platform, doubled its AUM to $4.5 billion and generated net inflows of $300 million. Investment performance remained strong.

In the 1-3-5 and 10-year periods, 63%, 53%, 67%, and 63% of the company's strategy composite AUM outperformed their respective benchmarks. For mutual fund investment performance, 44%, 58%, 66%, and 51% of the company's AUM outperformed their peers. The 3-year and 5-year performance improved from the prior quarter due to strengthened performance in equity and certain fixed income strategies, while the 1-year decline was primarily due to one fund being overweight utilities and financials and underweight technology compared to the S&P 500. The company's ending AUM increased by 0.7% to 1.43 trillion, while average AUM was flat from the prior quarter. Adjusted operating revenue increased by 3% to 1.56 billion, with adjusted operating income increasing by 8.3% to $476.8 million and adjusted operating margin at 30.5%. The company has a strong balance sheet with total cash and investments of $6.9 billion.

Jennifer Johnson revealed that Lexington has raised 18.2 billion for their fund, with 3.4 billion of that coming in the second quarter. The wealth channel has raised over a billion dollars, which is impressive for a first time fund. The fund can rate up to $20 billion. Private credit is still seen as a great opportunity, as banks have been lending less due to the slowdown of M&A.

BSP is currently valued at $78 billion and has expertise in special situations such as restructuring credit. M&A activity is picking back up and the deals they are seeing are the best since the global financial crisis. Clarion, which has a focus on industrial space, data centers and multifamily, has experienced difficulty with price discovery. The majority of their clients are institutional, meaning they do not need to do fire sales for redemptions.

Adam and Matthew provide additional information about the fundraising success of their alternative firms in the private markets, as well as the products offered in the Wealth channel such as CP Reef, Opportunity Zone, BDCs, Interval Funds, and Venture Funds. They mention that BSP has over $4 billion in dry powder and expect to raise several billion more over the next 12 months. Alexander inquires about the negative mark-to-market in the old bucket of things, which Jennifer speculates may be due to redemption.

Adam Spector and Jennifer Johnson discuss the advantages of Putnam's investment capabilities and their success in the insurance and DCIO markets. They plan to integrate the two distribution teams in order to better serve their clients, with particular emphasis on target date funds, which have seen 4 of the top 10 net flows for the morning.

The cash balance of the company continues to increase, and the company is looking for ways to utilize it. The company plans to maintain its dividend trajectory, pay down debt, and buy back shares to offset dilution. They are also considering M&A opportunities.

The company has been repurchasing shares and has paid down $300 million of debt in July. They have also enhanced their liquidity and financial flexibility by replacing the $300 million term loan with a larger $800 million 5-year revolving credit facility. They are also interested in the infrastructure space around M&A and the alternative asset space in particular, and they plan to repurchase shares in a methodical manner following the closing of the Putnam acquisition. Finally, they are paying attention to generative AI.

Jennifer Johnson discusses the use of AI for her company, which has been doing work in this area for four years. She explains they are using AI for early warning systems, risk management, business intelligence, and intelligent automation. They have a portfolio research assistant summarizing 10-Ks and annual reports, a help desk hoping to respond within 10 seconds, and a pilot to generate a draft fund commentary. They are using both Azure and Amazon to train the models. Initially, it will be an expense benefit and efficiency benefit, but they hope it will generate revenue as well.

Matthew Nicholls of Blackstone Group provided an update on the company's expected fourth quarter expenses, including a 39 basis point EFR rate, $50 million in performance fees, $740 million in comp and benefits, IS&T at $120 million, occupancy in the mid- to high 50s, and G&A in the mid-140s. For the full year, Nicholls expects expenses to be slightly higher than the previously estimated $4.8 billion, coming in at just over $4 billion.

Matthew Nicholls explains that they expect their operating margin to remain stable in the 30% area in the next quarter. He also states that there will be continued meaningful expense discipline going into 2024 and that they are able to find areas of efficiency as a result of the Putnam acquisition. Nicholls then answers a housekeeping question about the exact amount of catch-up fees and offsetting placement fee in expenses.

In the Putnam transaction, the expense cuts are estimated to be $150 million. This includes some modest attrition across the company. The overlap between the two companies is relatively small, so the expectation is that any attrition will be more than offset by other potential operating income and expense reductions. The company is confident in their $150 million estimate.

Adam Spector and Matthew Nicholls discussed the success of the SMA business, noting that clients have been pleased with the stability of the portfolio management teams post transaction. Craig Siegenthaler asked about the funds that are driving flows into the SMA business and the mix of sales across channels. Adam Spector explained that the legacy of the business was strongest at the old Legg Mason, with a significant portion of the assets with Western and ClearBridge, which tended to be stronger in the wires. They are adding new products like their income fund to the SMA platform, which is now available on 6 broker-dealers and a number of RIAs.

Matthew Nicholls discussed the opportunity for growth in the SMA businesses in munis, where there has been a 30% increase in AUM year-over-year. He also discussed the Lexington fund raise, which is ahead of target and currently at $18.2 billion, but is still in the process of fundraising and may have another closing in the next quarter. Catch-up fees are expected to be flat quarter-over-quarter but the exact amount is not being disclosed.

Matthew Nicholls and Jennifer Johnson explain that even without a catch-up fee, the Effective Fee Rate (EFR) would remain around 39 basis points. This is due to the normalized alternative asset fee of around 1% that is applied to the entire AUM. Brennan Hawken then asks if Western is seeing any impact from the improving performance in taxable fixed income strategies on RFP activity or client dialogue, to which Jennifer Johnson responds.

Western has significantly improved its performance in core, core plus and macros, and net flows have increased. The Franklin Income Fund has a yield of 5.75%, which is significantly higher than the peer average of 1.84%, and if there were an income category at Morningstar, it would be in the top quartile. Despite this, there is a build up in late-stage opportunities but a lack of conversion to funded opportunities due to institutions waiting for the interest rate cycle to settle in.

Jennifer Johnson and Adam Spector of Franklin Templeton Solutions discussed the importance of alternative investment capabilities in growing AUM. Johnson noted that the inclusion of alternatives in model portfolios depends on the channel being served. Spector added that the company is able to build traditional mixes as well as alternative only solutions to meet the needs of clients. Johnson mentioned that they are also working with retirement platforms to bring alternatives to retirement accounts.

Matthew Nicholls explains that 80% of the company's performance fees come from multiyear performance thresholds being hit by clients that invested five years ago. Jennifer Johnson adds that the company provides solutions for clients based on their desired outcome, and they even have a team that researches outside managers. Kenneth Worthington asks for clarification. Daniel Fannon then inquires about the performance fees for the fourth quarter and December.

The central distribution team at Franklin Templeton is responsible for globally, all institutional and all Wealth management raising and client servicing. Over the last two years, there has been a gradual movement towards a more coordinated global effort. This is quicker at smaller firms like Martin Currie, while larger firms like Western have their own well-built out global distribution. The central distribution team is raising assets for them episodically.

Jennifer Johnson explains that the Franklin Income Fund has seen $1.5 billion in net flows despite being mischaracterized in Morningstar's moderate allocation category. She explains this is because when interest rates were low, the fund looked for dividend yielding equity, and as fixed income yields increased, it shifted. She expresses frustration about the categorization.

Jennifer Johnson, Franklin's President and CEO, concluded the conference call by thanking everyone for participating and expressing her appreciation for the hard work and dedication of Franklin's employees. She then went on to explain that Morningstar had difficulty building a big enough peer group for the Wealth Channel, but that the team had a tremendous following and loyalty. She also noted that it was harder for financial advisors to buy and hold the income fund for 10 years, which is why they pushed to get it on the SMA platform. Finally, she reminded everyone that the fund would be managed for yield, which is what clients expect.

This summary was generated with AI and may contain some inaccuracies.