Franklin Resources, Inc. (NYSE:BEN) Q4 2023 Earnings Call Transcript

Franklin Resources, Inc. (NYSE:BEN) Q4 2023 Earnings Call Transcript October 31, 2023

Operator: Welcome to Franklin Resources Earnings Conference Call for the Quarter Ended September 30, 2023. Hello, my name is Julie and I will be your call operator today. As a reminder, this conference is being recorded. [Operator Instructions] I would now like to turn the conference over to your host, Selene Oh, Head of Investor Relations for Franklin Resources. You may begin.

Selene Oh: 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 section, 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.

Jennifer Johnson: Thank you, Selene. Hello, everyone and thank you for joining us today to discuss Franklin Templeton’s fourth quarter and fiscal year 2023 results. As usual, Matt Nicholls, our CFO and COO and Adam Spector, our Head of Global Distribution, are joining me on the call. Over the past several years, we’ve made great strides in transforming our business, all in an effort to meet the needs of our clients and shareholders around the globe no matter the market environment. We’ve done this by creating a diversified company that offers a broad range of investment expertise and capabilities across asset classes, investment vehicles and geographies. Today, we’re able to offer our partners and investors the ability to fulfill their comprehensive investment needs across public and private markets and in the vehicle of their choice as one firm with specialist investment managers operating around the globe.

In addition, we have made important investments in value-added services, including technology, digital wealth and customization in order to be on the forefront of innovation in areas increasingly important to our clients. As we look back over our fiscal year, challenging global financial markets and geopolitical uncertainty weighed heavily on investor sentiment. The so-called Magnificent Seven, 7 large U.S. tech companies, have primarily driven all of the gains in global stocks this year. And in our fourth quarter, we saw heightened volatility lead to increasing pressures and declines across equity and fixed income markets. We believe markets, like the one we’re in, reinforce the value of active management with a long-term investment horizon.

So often in these times of uncertainty, where the best opportunities to capture value are identified. In this complex and volatile market environment, it’s no surprise that there’s a tremendous amount of cash sitting in bank accounts and in money market funds, capturing what are the most attractive short-term yields in more than 15 years. Global Money market assets stood at $7.4 trillion as of September 30, the highest asset level since Morningstar started collecting the data in 2007. We have been actively engaging with our clients to understand their needs and address their strategic goals. Many clients continue to look for additional access to private markets, alternative credit, in particular. And as yields have become more attractive, clients have had a renewed interest in fixed income.

We continue to provide insights and taught leadership to help them navigate the latest conditions, including drawing upon the resources of our various specialist investment managers and the Franklin Templeton Institute. Against this backdrop, we continue to manage our global business with a focus on areas of organic growth, expense discipline and strategic transactions. As such, this year, we are pleased with the progress made executing on our long-term corporate priorities by expanding our investment capabilities across vehicles and deepening our presence in key markets and channels. For the fiscal year, notwithstanding 20% lower inflows. Long-term net outflows improved 23% from the prior year. Long-term net flows were positive in several key areas, including alternatives, multi-asset, ETFs, Canvas and the high net worth channel.

In addition, our Asia Pacific region generated positive long-term net flows for the fiscal year. Our EMEA region turned positive in the second half of fiscal 2023 and our non-U.S. regions posted positive net flows in the fourth quarter. One of our strategic priorities has been to increase our scale in key segments of the industry, reflecting long-term client demand. In this pursuit to offer more choice to more clients, we closed the acquisition of Alcentra, a leading European credit manager, doubling our alternative credit AUM. Firm-wide alternative AUM increased by over 13% to $255 billion from the prior year, making Franklin Templeton one of the largest managers of alternative assets. Alternative AUM represents approximately 19% of our long-term AUM and approximately 25% of adjusted revenues, excluding performance fees in fiscal 2023.

Alternative assets management fee revenues increased 36% year-over-year. Furthermore, we were pleased to announce the pending acquisition of Putnam Investments with $136 billion of AUM and our relationship with Power Corporation and Great-West Lifeco, strengthening our presence in the retirement and insurance segments. The transaction will enable us to further bolster our presence in these key market segments to better serve all our clients and remains on track to close in the fourth quarter of calendar 2023. Industry-wide, we continue to see consolidation of asset management relationships. In this context, there are increased expectations for value-added services and we believe we are well positioned as a strategic partner due to the breadth and depth of our investment capabilities, technology, content and capital resources.

As we look ahead in 2024 and beyond, with better clarity on interest rates and markets in general, there will be an increased likelihood of investors moving money from the sidelines. We believe we are well positioned to capture money in motion as clients benefit from the expertise of each of our specialist investment managers, particularly in areas where there is strong client demand such as alternatives, income, fixed income, solutions and custom indexing. Turning now to our specific numbers for the fiscal year, starting first with assets under management inflows. Ending AUM was $1.37 trillion, an increase of 6% from the prior year, primarily due to market appreciation and the acquisition of Alcentra. Investment performance continues to be strong and resulted in 61%, 48%, 47% and 61% of our strategy composite AUM outperforming their respective benchmarks on a 1-year, 3-year, 5-year and 10-year basis.

Compared to the prior year, AUM outperforming benchmarks stayed the same in the 3-year period and declined in the 5-year and 10-year periods. 1-year performance improved significantly due to several equity strategies, including non-U.S. strategies and select U.S. taxable fixed income composites. Long-term net outflows were $21 billion and improved by 23% from net outflows of $28 billion in the prior year. Reinvested distributions were $21 billion compared to $32 billion in the prior year. Our long-term net flows while challenged for the year, continued to benefit from a diversified mix of assets and strong presence in key areas. Multi-assets saw a 66% increase in net flows from the prior year and were positive for all 4 quarters, including nearly $8 billion, driven by Franklin Income Fund, Franklin Templeton Investment Solutions and Canvas, our custom indexing solution platform.

In fact, our flagship Franklin Income Fund celebrated its 75th anniversary in August. The strategy follows a flexible value-oriented investment philosophy, seeking income and long-term capital appreciation by investing in dividend paying stocks, bonds and convertible securities. The fund has successfully delivered uninterrupted dividends across all market cycles ever since its launch in 1948. It’s also a great example of how we’re giving investors greater choice in how they access the strategy, including through SMAs, sub-advice strategies and in an actively managed ETF vehicle around the globe. For the fiscal year, alternative net inflows were approximately $6 billion, driven by growth in private market strategies which were partially offset by outflows in liquid alternative strategies.

Benefit Street Partners, Clarion Partners and Lexington Partners together generated net inflows of nearly $11 billion. We continue to make strides in alternative assets unlocking new opportunities for investors in our firm. Retail and high net worth investors remain under-allocated in alternatives relative to institutions. Client interest was strong for alternative strategies on wealth management platforms under the alternatives by Franklin Templeton brand in the U.S. which was launched earlier this year. For example, we anticipate over 20% of the total capital raised in our current secondary private equity fund to come from the wealth management channel. We continue to focus on client education initiatives through our alternative focused podcasts and webinars partnering with the Franklin Templeton Academy.

Fixed income net outflows decreased by approximately 50% to $16 billion this fiscal year, with net flows significantly improving starting in the second quarter of the fiscal year. In a year when all eyes were on the bond markets and interest rates, we continue to benefit from having a broad range of fixed income strategies with non-correlated investment philosophies. Brandywine Global saw positive net flows for the year. Franklin Templeton fixed income saw positive net flows in the second half and Western Asset had positive net flows in its core and muni products for the year. Fixed income strategies also saw net flows in ETFs and starting in the second half of the year in SMAs. With the addition of Putnam, we will further strengthen our fixed income offering, particularly with ultrashort, stable value and longer duration strategies with strong long-term investment performance.

Equity net outflows were nearly $19 billion. The risk-off environment continued to impact investor sentiment on select equity growth strategies which were partially offset by net inflows into large-cap core, international, smart beta quantitative and emerging market strategies. We believe that emerging markets equities could be a potential bright spot in equities as investors look across broad markets for opportunities. Turning to ETF, since launching our ETF business in 2016, we have provided our clients with a broad range of investment strategies and have achieved significant growth milestones. ETFs generated net inflows of nearly $4 billion in the fiscal year, representing 4 consecutive quarters with net flows of approximately $1 billion and AUM ended the quarter at over $16 billion.

We continue to launch new and innovative ETFs based on client interest. During the fourth quarter, both Western Asset and Brandywine Global launched active fixed income ETFs and we expect to see strong client interest in both strategies. We are a leading franchise in SMAs with $113 billion in AUM, an increase of 13% from the prior year. We saw momentum in our SMA platform with $1.3 billion of long-term net flows in the second half of the fiscal year. This year, we continued to expand our SMA capabilities with launches focused on customization such as tax managed overlay and SMA products of key flagship strategies, including the Franklin Income Fund. Through new technologies, we’re continuing to enable personalized portfolio solutions that seek to improve bespoke outcomes for investors.

A good example is Canvas which has achieved net inflows each quarter since the platform launched in September 2019 and AUM has more than doubled to $4.8 billion since the acquisition closed. This year, Canvas generated net inflows of approximately $1.5 billion and had 20 new partnerships. In addition, it continues to have a robust pipeline. Private Wealth Management AUM ended the quarter at $34 billion with Fiduciary Trust International, generating its 12th consecutive quarter of long-term net inflows. Fiduciary Trust provides personalized solutions to high net worth individuals and multifamily offices with an average client relationship of 16 years. It is a growing client base and a platform well positioned for long-term growth. Since 2010, Franklin Templeton has been the investment manager and sole administrator of Fondul.

In July, Fondul’s largest holding, Hidroelectrica, Romania’s leading energy producer, broke a record as being Romania’s largest initial public offering on the Bucharest Stock Exchange. The listing reflects our ability to provide partnerships with public and private institutions in emerging markets to deliver long-term value for all stakeholders and our enduring commitment to developing the country’s local capital market, promoting corporate governance and transparency. Looking forward to 2024, we will continue to further expand our business and invest in key areas of growth that extend our ability to offer more choice to more clients in more places, including alternative asset management, insurance and retirement channels, customization and solutions for clients, technology-related distribution and private wealth management, specifically Fiduciary Trust International.

We are proud of the work that we have done over the past several years to further grow and diversify our business. It makes us a more resilient organization over the long run and reflects our focus on positioning Franklin Templeton as a premier partner. Finally, I’d like to thank our dedicated employees around the world for all their efforts in this past year to grow our business by always putting our clients first in a continuously evolving industry. Now I’d like to turn the call over to our CFO and COO, Matt Nicholls, who will review our financial results from the fiscal quarter and year as well as provide an update on the Putnam acquisition. Matt?

Matt Nicholls: Thanks, Jenny. Fourth quarter earning AUM was $1.37 trillion, reflecting a decline of 4% from the prior quarter and average AUM was $1.42 trillion, flat from the prior quarter. Adjusted operating revenues increased by 1% to $1.6 billion from the prior quarter and included adjusted performance fees of $98 million compared to $116 million in the prior quarter. This quarter’s investment management fees benefited from $36 million in connection with Fondul and were partially offset by lower catch-up fees of $17 million in secondary private equity. This quarter’s adjusted effective fee rate which excludes performance fees, was 40.2 basis points, an increase of 1 basis point due to transaction-related management fees earned from Fondul.

Adjusted operating income increased 7% from the prior quarter to $512 million and adjusted operating margin increased to 32.4% from 30.5%. The increase from the prior quarter is primarily due to higher investment management fees, the aforementioned management fees earned from Fondul and lower compensation and benefits expense, partially offset by lower performance fees. The specific operating income from Fondul and secondary private equity catch-up fees was $35 million for the quarter. Fourth quarter adjusted net income and adjusted diluted earnings per share increased by 31% and 33% from the prior quarter to $427 million and $0.84, respectively. The increase in adjusted net income and adjusted diluted EPS is primarily due to higher other income, higher adjusted operating income for the reasons mentioned and lower taxes.

Adjusted EPS increased by $0.05 due to Fondul and secondary private equity catch-up fees in the quarter. Turning to fiscal year 2023 results; ending AUM increased by 6% from the prior year, while average AUM declined by 5%. Adjusted operating revenues of $6.1 billion decreased by 6% from the prior year and included an additional 6 months of Lexington and 11 months of Alcentra. Adjusted performance fees of $383 million decreased from $515 million in the prior year. The adjusted effective fee rate which excludes performance fees, was 39.5 basis points compared to 38.9 basis points in the prior year, primarily due to a full year of Lexington and 11 months of Alcentra. While continuing to invest in long-term growth initiatives, we also continue to strengthen the foundation of our business through disciplined expense management and operational efficiencies.

Our adjusted operating expenses were $4.3 billion, an increase of 3% from the prior year, again, including a full year of Lexington and 11 months of Alcentra. Excluding performance fee related compensation and the full year impact of Lexington and Alcentra, adjusted operating expenses were down slightly from the prior year. This led to fiscal year adjusted operating income of $1.8 billion, a decrease of 22% from the prior year, primarily due to lower average AUM, driven by market declines and to a lesser degree, net outflows. Adjusted operating margin was 29.9%, compared to 35.9% in the prior year. Compared to the prior year, fiscal year adjusted net income declined 28% to $1.3 billion and adjusted diluted earnings per share was $2.60, a decline of 28%.

From a capital management perspective, after returning $870 million to shareholders through dividends and share repurchases and funding the acquisition of Alcentra and other acquisition-related payments, we ended the year with $6.9 billion of cash and investments. We will continue to prioritize our dividend which has increased every year since 1982. Purchased shares to hedge our employee share grants and where applicable, review targeted acquisitions to reach our objectives at an accelerated pace. In addition, as we begin in the fourth quarter, we plan to opportunistically repurchase shares above the employee-related equity issuances during fiscal year 2024. Turning to the Putnam transaction which, as Jenny mentioned, remains on track to close in the fourth quarter of calendar 2023.

Amongst other factors, the transaction is structured to maintain Franklin’s — Templeton’s financial flexibility and promote our continuing investments in the business. It also protects our strong financial position in the context of challenging market conditions. At current market levels, the acquisition of Putnam is expected to add total run rate adjusted operating income of approximately $150 million after the first year post closing. Consistent with an approximate 30% operating margin, inclusive of cost synergies and we are ahead of schedule in terms of when we are likely to realize operating income post-close. Assuming this operating income contribution the transaction is expected to be modestly accretive to adjusted EPS by the end of the first quarter after closing.

And now, we would like to open the call up to your questions.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from Michael Cyprys from Morgan Stanley.

Michael Cyprys: Maybe you could just start off on the private market space. You guys continue to raise capital there. Maybe you could just update us on some of the progress across some of the key flagship funds which strategies you think might be entering the market as you look out over the next 12 months. And just on the private wealth channel, I think you mentioned 20% in terms of what you’re looking — expecting to raise or maybe you could just talk about some of the traction that you’re seeing in the private wealth channel, in terms of fund placements and new products you might be able to bring on the channel.

Jennifer Johnson: Right? Adam? Adam is going to take this one.

Adam Spector: All right. Thank you, Jenny. We’re seeing strength really across the board. I would say the folks — the place where we’re seeing a lot of interest is — like others is in the private debt area. They’re particularly in the real estate-related debt. We’re seeing good growth. We’ve had a good year in our CLO business. We’re out with special situations and new BSP flagship fund, that’s all really good. Alcentra is beginning to be integrated more into our distribution force. We’re feeling really positive about that as well. Lexington is continuing their fund raiser for Fund 10 and we’re just beginning to do some other things there. You mentioned, Michael, the 20% raise that will come from wealth management for Lexington.

We’re starting to see greater traction for wealth management alternatives across the board. We spent the year really building out our capabilities for U.S. wealth management alternatives and we’re now taking that model and using it in Europe. In general, one of the things we’re seeing that’s quite positive in wealth management alts is the fact that we’re now getting on to calendars of 6 month, a year in advance. And once you’re in that flow, we think the fundraising really will continue. That’s the quick overview.

Michael Cyprys: Great. And just a follow-up question, maybe for Matt. I think in the release, you mentioned the transfer agency functions globally have now been outsourced. You did that in the U.S., now you took that around the world. I think also you’ve outsourced fund administration in the U.S. So maybe you could just talk to what’s next as you think of about simplifying the business, enhancing efficiencies, what steps might be able to take over the next year or 2? How meaningful might they be? And just curious, any sort of benefits or lessons learned and takeaways that you could speak to on the transfer agency outsourcing.

Matt Nicholls: Yes. So you mentioned 3 key things there. One is the steps we’ve taken to outsource fund administration, transfer agency and aspects of our technology. What we’ve been working hard on over the last year or so is what next in terms of our investment management platform in terms of technology. That includes both middle office and back-office functions. And I’d say that we’re pretty deep into it and you can expect more updates from us throughout 2024.

Jennifer Johnson: Well and I would just add, Mike, as you know, we’ve done a lot of acquisitions. And I think one of the reasons they work well is, we take our time on some of the integration. And so there’s opportunity, obviously, we’ll be integrating Putnam into the — into our environment. And even some of the Legg Mason SIMs are — have an opportunity to integrate which we think will simplify the environment.

Matt Nicholls: Yes. And in terms of the financial impact, Mike, I would just caution you on that. These things take time. As Jenny mentioned, there won’t be any additional change in 2024. That’s a step change in terms of our expense, in terms of our expenses around the operation. But I think going into ’25, ’26 or longer term, not only do we have the opportunity to be more efficient across the organization, bringing things closer together in an effective way but also, it’s an opportunity to modernize, to reduce CapEx, to make sure that longer term, we’re in a position where we can scale at lower expenses with the right partners.

Operator: Your next question comes from Craig Siegenthaler from Bank of America.

Craig Siegenthaler: My question is on the SMA business. And I think you said, ask one question but maybe I could tuck another one in on the SMA within here. But — what I’m looking for is more details around the components and the growth trajectory. So now that the Franklin Income Fund which is one of your flagship is in the SMA wrapper, I’m just wondering, are there other flagships at Franklin and its affiliates that would make sense also launching into an SMA wrapper? And then — kind of my 2-parter was, you’re generating about $700 million of flows per quarter in the SMA wrapper. Do you think this is a level that could increase significantly from here?

Jennifer Johnson: Yes. So I mean, you’ve got to remember, SMAs exist and the reason we’re taking off so much is that in the retail channel, where the world went fee-based, it is difficult for a financial adviser whose client fees, they’re being charged every month for advice to buy and hold a mutual fund, right? So if you can deliver the same kind of product in an SMA with the holdings basically on the statement, it looks like the advisers being much more active on that. And so we view ourselves as being vehicle agnostic to how we deliver what is our expertise which is our investment capability. And — so you take, for example, the Franklin Income Fund. The Franklin Income Fund now is — we have an ETF version, an SMA version and we’re seeing growth in both of those.

So any of our products can be delivered in SMA. Today, we have munis. Munis are actually — have a good growth area in the SMA muni ladders. And so the way we are thinking about our business is, I always say it’s like a 3-legged stool. It’s product capability, geo-global distribution and vehicles. And the vehicles can be mutual funds, communal trusts, ETFs, SMAs, things like Canvas direct indexing. And we should be flexible about how we deliver those, in whatever market we — whatever market we’re operating in. And I think that nobody has won the breadth of product capability that we have to the breadth of geographic distribution, both on the retail and institutional side. And while we may have been late to things like passive ETFs, we were early actually in the active ETF space.

And so being vehicle-agnostic is very important. Now the challenge is on the SMAs, is that you have to get approval at the gatekeeper level and then you have to go out and train individual advisers. So it’s a bit like alts in the complexity. But once you do that, then you just get consistent flows coming in. So the long answer is basically, we see any of our flagship funds as being able to be delivered through the SMAs platform.

Adam Spector: And I just might add that emerging markets is another area where we’re seeing significant SMA growth in addition to the munis that Jenny answered. And while a lot of the growth is in SMAs, having a product available like the income fund in SMA, in ETF, a mutual fund across border fund being vehicle-agnostic, really, that just take broader access to different platforms.

Operator: Your next question comes from Brennan Hawken from UBS.

Brennan Hawken: Curious about the expectations for expense growth into next year, Matthew. Maybe if you could give us an update there.