Get started. For important disclosures, please see the Morgan Stanley Research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Good morning, everyone. I'm Mike Cyprys, equity analyst covering brokers, asset managers, and exchanges for Morgan Stanley Research. Welcome to our Fireside Chat with AllianceBernstein. We're excited to have with us here, Seth Bernstein, President and CEO of AllianceBernstein. Under Seth's leadership, AB has been a standout with consistent positive organic growth, with strength across active equities, fixed income, as well as a growing contribution from private markets. AB, as many of you know, is a leading global investment management firm with nearly $700 billion of assets under management. Seth, thanks for joining us here.
My pleasure. Thank you for having me.
Great, welcome back. It's good to see you again in person. I know, very bright here with all the lights.
This is totally ridiculous.
All right. Why don't we start out with the current environment? It sucks. Well, maybe we could double-click on that. I'd love to get your perspective here just a little bit more, broadly on the macro. Clearly a different picture than what most of us expected heading into this year. As an experienced executive, you know, having lived through many cycles.
Is that an age reference? It's okay.
Experienced tenure.
I'm over it.
Oh, they dimmed the lights a little bit. Thank you so much.
They take the day. Thank you.
How are you thinking about this period of higher inflation, higher rates, elevated market volatility, and what does that mean? What are the implications for a money manager like AB?
Let's start with the implications up front. I think the implications are pretty clear. It has been, and I suspect it will continue to be a really tough year for money managers generally. Arising from the fact that it's a pro-cyclical business model. It doesn't get a lot more pro-cyclical. Well, if you have a lot of leverage, it does, I guess, but we don't. You rise and you fall with markets. You know, the ultimate underpinnings of the industry remain compelling. You know, you feed on a positive asset which has a positive long-term skew from a valuation perspective as the prices tend to go up over time in equities.
It's an ad valorem in the sense that irrespective of your contribution, positive or negative, in a strong market, you're gonna do better, whether you deserve it or not. The capital needs are de minimis, and it's a pretty high margin business. If you're returning it to shareholders, it can be a pretty attractive proposition. It helps that it serves a public good and as a demographic matter, people need to be saving more. Broadly, I think the industry was complacent that those factors would continue to protect it forever. Of course, the digital evolution data science has changed the game pretty profoundly, and the water's getting hotter in this pot.
We have to figure out whether we have to jump out or not, but, in the sense that active management has to prove its worth every day. The people in this room who are managing money have to be generating better returns than a client can otherwise get by investing in a market-weighted, cap-weighted, index. That is a tough hurdle, and the industry, by and large, has failed to cross that hurdle. The macro environment we face today is unlike any I've lived through in 40 years or nearly 40 years in the business, in that we are coming out of a period of remarkable fiscal stimulus, coupled with the most fluid and relaxed monetary policy any of us have lived through. That's been going on since the financial crisis to varying degrees.
We have to raise interest rates, while at the same time the Fed is going to be reducing its balance sheet, which will more directly impact the back end of the curve. At the same time that the fiscal stimulus is running out, and I suspect won't be renewed, at least in the United States, just given the likelihood of a Republican victory in November. With that sort of backdrop, it's a pretty volatile brew. That's okay. The industry needs corrections or self-repairing. We're now getting to the point with the backup in rates, which has been at a faster rate and more severe than any time in my lifetime, certainly, where it's become pretty interesting again to be a fixed income investor.
Indeed, we are beginning to see clients, particularly offshore, wanting to have Fixed Maturity Fund offerings, because they wanna call the top. Now, I think it may be premature to call the top. I think you need to see the Fed really take decisive action and meaningful changes in CPI. We gotta break the back of the momentum, and last Friday clearly didn't help, and the market's reaction reflects that. I don't think there's news to people in this room about what ails the country from that perspective or the broader global economy. Fixed income is becoming much more attractive. It's gone through a very tough period where even its role in a multi-asset portfolio was in question, certainly by people like me. I think that evolution changes.
I think, with respect to equities. We've already seen the 30-odd% drop in growth from its peak. There's more to go, which I think is healthy. The breadth of this market needs to become wider, and that's important for the ultimate viability of the economy and the global economy. I think it's ultimately a good thing, but it's gonna. You know, there's gonna be a lot of blood on the floor, and there already is.
Well, that's depressing.
Yeah, okay. Well, you asked. I'm just giving it to you. What do you want?
Okay. Well, I guess let's backtrack. Maybe let's shift and talk a little.
Well, where have you hidden? Where have you been able to hide? When was the last time a fixed income investor had a 12% negative return? Right. It's been awfully tight. You all know that. If you don't, you know.
Fair.
You should.
We'll come back to some of those themes. We'll dig in a little bit. First, let's shift and talk about the firm's strategy. You've been CEO now going on five years.
Over five years.
Over five years, okay. Over which period AB has distinguished itself as an organic grower in what has been, a difficult environment for active management, broadly speaking. Can you just update us on the firm's strategy going forward, and what should we expect, that might be different or similar versus the past?
Fine. Happy to. AB had its own sort of near-death experience back in after the financial crisis, which was self-inflicted. As a private client, I felt it in a very real way. My predecessors, I think, did a remarkable job making tough decisions, stripping back everything it could in order to reinvest and rebuild a much more diversified and robust equity business than we had before, and to start a private alternatives business. I took that lead and ran with it. I wish I could take entire credit for it. My mother used to tell me I should 'cause they're gonna blame me when it goes wrong.
What they did and what we've continued to do is to look for teams where we think they have an enduring edge, a different perspective, and pedigree that we can get to scale faster than they can do it on their own or at their current employer. What we do to analyze that is we try to regress their return streams against the factors that underpin them and see if there really is a persistent idiosyncratic return, positive return, because that is the only reason a client is gonna buy my strategy if they're defaulting to passive and more liquid markets anyway. I gotta earn my place in that portfolio. We've done a really good job. We track our teams on those metrics.
Ultimately, my dream would be to pay them on those metrics, but I'm a taker of talent, not a setter of pricing in the marketplace. We've done a very good job rebuilding the equity teams, and I'd like to continue doing that. I think a message there is we will continue to hunt for, you know, teams in little parts of the market, whether it's EM in China, in small-cap spaces, where we feel we could take them to a much more interesting place. I think the competition, unlike in private alts, is much less, and the payback is much faster for us and our unit holders. We will continue to do that. We will continue to diversify the platform into private alts. We've just.
We will close at the end of this month, beginning of next month, our largest acquisition since Alliance's purchase of Bernstein, of CarVal. CarVal. It doesn't double, but it gets us up to roughly $50 billion of private alts, almost all of which is private credit. That's where we wanna be for two reasons. One, I think we're still earlier in the development of that market. Having grown up in fixed income, it's one I've watched both on the private and public side for a long time.
Secondly, our relationship with Equitable and our institutional links more broadly enable us to have a pretty compelling proposition to a management team to say, "We really can get you to scale faster." We have a track record with our commercial real estate debt teams, with our middle market lending team of giving them the autonomy and the resources, the risk control, distribution capability, operational and technology support, to let them grow and be an increasingly important part of our mix. We're gonna continue to diversify. If you look at our forward calendar and our backlog and it's really been except for the really lumpy target date things we win, it's really the largest single source with public equities in our pipeline and continues to be. That's where we're gonna continue to focus.
We have a fixed income business which really is income-oriented. It's been traditionally, despite what I just said, more retail-oriented. We've been very strong in Asia. I wish I could tell you that was visionary brilliance on our behalf. I think part of it was luck and great local management that enabled us to do it, and we wanna continue capitalizing by advancing and building out in China. We've been approved. Let me be clear what I'm saying. The regulator has approved us filing our application. We have not received our approval to operate yet as a fully owned foreign management and funds management company in China. We're hopeful that we will get that. That's despite the noise in U.S., Sino-U.S. relations.
I think it's a once in a lifetime opportunity because China will close this door at some point. I think interestingly, we have a reputation that's much greater in the East than it is here in the West, because of our success in Greater China.
Great.
That's what we're up to.
Why don't we shift and talk about flows? We'll start first with fixed income. Touching upon some of the themes perhaps you were mentioning earlier. AB has a strong high income suite with retail fixed income, particularly non-U.S., a recent source of pressure though as it relates to flow. I guess, what's your view on, you know, what inning are we in? At what point are rate increases gonna be enough to sort of entice investors to come back into the space? And, you know, are any green shoots emerging?
Yeah, there are. As I mentioned earlier, we're beginning to see private banks and others begin to sponsor Fixed Maturity Fund issues, which is when they're ready to call the top. I think it's still a little early, but when you look at pre-fee yield to worst on our global high yield fund, you're in the nines. These are becoming pretty compelling numbers for people to get into. The issue is what are your inflation expectations? I'd note that breakevens, inflation breakevens, actually are down significantly since April. Whether the world thinks the growth in inflation is beginning to base down, the markets are beginning to recognize that.
I still think we're a quarter or more away from that, when there will be decisive evidence that gives people that comfort to invest. Credit defaults have not yet spiked up. That's the other shoe to drop. I think it's less of an issue than it was post the financial crisis for sure. Look, there are weaker credits and weaker standards out there. The fact is there's still an enormous amount of liquidity in the system that will be soaked up over time, but they can continue to fund themselves at the moment. We haven't seen defaults yet pick up in our portfolios. We tend to be more diversified than most of our peers, which enables us to ride that out, but we tend to be long credit as a firm.
Our outflows in Asia have been pretty modest given the rate increase we've seen and certainly relative to history. You know, we have a few days of inflows from time to time there, but it hasn't shifted. I don't wanna give you Muni SMAs in the U.S. have been sort of remarkably consistent for us. They're not as high as they were last year or earlier this year. Seeing brackets around your returns at the end of the first quarter was a pretty sobering experience for most wealthy individuals who haven't seen that before. I think they're gonna see it again in second quarter. I think there's more disruption to go in the muni market, but the muni market's pretty attractive on a taxable equivalent basis and certainly in a credit-adjusted basis.
We've been bucking the trend, and I think we'll continue to for a while. We have a better product, I think, than a number of our peers.
Great. Why don't we shift and talk about equities? You've been one of the few players in the public domain that has been consistently putting up positive flows into active equity products. I think a lot of the strength you've been having there has come from some of your non-U.S. and the growth-oriented products, in some areas where performance has perhaps slipped a little bit, more recently. Perhaps you could break this down to product performance, distribution. How do you see the growth trajectory going forward on the active equity side?
Look, we've been pleased by continuing positive flows in equities, and we had a bit of a bounce back from negative flows in April and May, as I think most people could see in our AUM report. Equity was a driver of that. We continue to see good demand for our growth products in Asia generally and Japan in particular. Part of that is also helped by the weakness in the yen. It's not just us. We did see performance weaken. We had much less of the mega cap stocks in those portfolios. That's actually helping us now. Our relative performance is picking up. That's been pretty good.
We've seen institutional interest, and in fact, demand is switching more to institutional in our value products and in our core products, less obviously in growth. It's, you know, institutional is more episodic, but we're seeing more consultant interest and focus around it. We've seen a modest improvement in investment performance, both in equities and in fixed income over the course of the second quarter. I hope that persists. We've, you know. Look, I think with regard to small cap, which has been an important area for us, that's been among the hardest hit segments. Of course, it has. It has a tech orientation, and it's very long duration.
It's looking a lot more attractive, and so I'm not comfortable yet calling it, but I think you'll see a reversal later in this year, beginning of next year, in terms of demand for equities more broadly. Because ultimately, I think we're gonna head into recession faster than a lot of other people do. Certainly Europe is. I think the sooner we do and the quicker we mark ourselves the market, the quicker the recovery can get started. I do think there's an adjustment underway.
Do you think we need to be kinda heading into the recession for equity flows to recover or kinda?
I think-
Need to be going through it?
I think it'll be the going through it.
Going through it. Okay. Let's talk about distribution. I think your global distribution platform is key element of the success that you guys have been having. Perhaps, breaking it down to the institutional retail side, how does AB differentiate itself when it comes to distribution in the different regions? Where have you made some of the most progress, and where do you still have more opportunity ahead?
Look, Asia has always been a store for us on the retail side. It continues to be very strong for us. I think it's reflecting itself, frankly, in the smaller outflows in fixed income than what we would've historically seen there. It's not accretive from a revenue perspective, but it, you know, it's defensively valuable at this moment in the cycle. U.S. retail has really been growing robustly for us, and we, you know. Our first quarter was our second best or no, it may have been our best gross sales quarter ever, and that was really driven principally out of the U.S., which is really the first time where we've seen that kind of support out of the U.S. Part of it is fixed income in the SMA side in particular, but much more of it is on the equity side.
That's really where the strength. Europe has been plugging along and, but has not been a big contributor to us yet. We continue to do some tactical hiring in Europe to beef ourselves up in Italy and other countries where we see real promise. We're a very small player, so market share gains for us are not that hard. That's been a big driver. With respect to institutional, it took us a long time to repair our relationships with the consultants following 2009-2014. We have gotten an enormous amount of support, and that continues to be the underpinning of what is a more robust institutional pipeline than we've had historically.
On the retail side, can you just maybe spend a moment just talk about how you're servicing and interacting today with the retail wealth intermediaries, how you see that changing, and how do you expect this to look in the future?
I think more of it will be home office-focused. That trend has been going on for a while, for the industry generally. We're certainly equipping our people, when they're out in the field to be much more, thoughtful on how they structure their calling efforts and, utilizing mobile technology to understand who owns what in that office. What's selling, what's not selling, and highlighting specific funds proactively that compare well to existing, fund selections that these brokers have on their platform and have given to where our clients stay. We're much more proactive in that dialogue, training them to deliver that in the course of those meetings. The home office is making more and more of the decisions.
We spent a lot of time in terms of educating them in our approach to managing portfolios, our risk overlays, our ESG integration, and philosophy around managing Portfolios with Purpose, which is our brand of what we do, where we're trying to measure non-financial returns to the portfolios we manage. That has resonated quite a lot in terms of educating people. It's also in regard to retail practice management we've always been good at, and it's one of our key calling cards when we go into the big wirehouses and some of the regionals and helping them train their FAs. We see it as a comprehensive ongoing training program complementing the underlying product performance and communication. I think it becomes more automated over time, more of it centered in Nashville than it's been historically.
Here in New York, most of our salespeople are now located in Nashville or regionally in the offices they're in. That transition has gone very well for us. I guess the final part of our distribution, people look at our private wealth business differently, but it is a distribution channel. It's been critical to the development of our private alts platform, but also now is continuing to prove and grow. It's about $110 billion of assets at the end of the first quarter. So presumably it's lower today, but has been continually supportive of the strategies we've been developing.
You mentioned Portfolios with Purpose. Why don't we talk about that? ESG remains a really important theme for the industry. You guys stand out with about $28 billion in those strategies, I believe. Can you just walk us through how you construct these portfolios and how you differentiate these strategies in the marketplace versus others that are out there?
Yeah. I think we started. Our firm has always been hyper-analytical. That's just who we are. We overthink things. We have too many consultants who now have jobs there. We really were thinking about, first, how do we make all of our investors, irrespective if they are managing Portfolios with Purpose or not, aware of the externalities of these companies' operations, and making sure when they're discounting those cash flows, they're incorporating those negative externalities or positive externalities, again, even if they're not focused as an investment goal or theme around achieving non-financial improvements on behalf of our clients.
I'm very comfortable we've given them now the training through our joint curriculum of Columbia, where we forced all of them, some weren't really jumping up and down to do it, to go through and learn about climate change and its first order, second order impacts, and how to think about these evolving challenges that we're facing and the new opportunities that fall out of that. In addition, we have a research agenda that we develop quarterly with Columbia that rolls forward on a variety of basic research topics. We're not asking them to tell us how to invest. Rather, we're asking them to help us think about fusion and nuclear power and how it evolves and becomes part of a solution rather than part of the problem.
Because even in ESG, there is considerable debate of what is qualified and what is not. In France, nuclear has always been part of the solution. In the United States, we haven't built a plant since the mid-1970s, which is, I think, really problematic because I think nuclear has to be part of the solution. What we won't do is exclude. If a client wants us to exclude a sector, we of course, will comply with that. In our Portfolios with Purpose, we have funds that wouldn't be classified necessarily in your definition of ESG because we're looking to reduce, for example, carbon footprint. It may be that we own Total because they're gonna be generating incremental cash flows and actually reducing their carbon footprint over time.
If you look at the firms that have filed the most green patents that seem to be related to reducing carbon emissions, a vast majority are filed by exactly those companies. Of course it is. It's the companies that have to deal with the real-life issues around the negative externalities of their business. I think for a number of clients who want to think broadly, your impact in improving may be better in a striver portfolio like that than one that just avoids on its face hard asset companies to invest in. As the controversies around DWS and what we're hearing about with the SEC continue to evolve, the industry and the regulators need to sit down and finalize and define what we mean by these terms that we're throwing around so loosely.
Because I worry that clients don't necessarily understand what they're buying, don't understand that there is implicitly a cost to excluding sectors in their businesses. Thirdly, that regulators will use it as an opportunity to pick off companies, who may deserve to be picked off. We want rules to understand how the world works. I think it's an evolving business. I think we've taken a thoughtful approach to it, and I think it will continue to grow. It has resonance with not all our customers, but with a growing piece of our customer base.
If I could just follow up on that point there. You raise an interesting point around, it doesn't resonate with all customers, maybe some, but how do you navigate that from a, you know, broad-based perspective when you think about ESG, different, it means different things to different customers.
Correct.
Which means customization becomes maybe more important. How do you see that? How do you solve for that?
Much easier to do with institutions. Look, doing business in China is a big issue for some of our clients, some of the places we do business. I'm just pointing out there are lots of issues beyond whether it's a green fund or not that get clients agitated today. Institutionally, we can structure around what they want. We need to be totally transparent and measure what we're doing. I think keeping it simple, keeping it focused, and keeping it straight is how we're gonna navigate this effectively. We are not all things to all people. On the other hand, I think we've got 30+ years of transition to a non-carbon-based economy, and it's a rich man's problem to sit here and criticize it and shut down all coal plants.
When you're in India facing 43 and 45 degrees Celsius weather every day, are you really gonna shut those plants down, even though they're contributing to that? No, you're not. We need to just be clear about how we're trying to navigate. Some people will accept it, some won't. We need to make sure that people aren't misled by what we're doing.
Okay. Why don't we shift and talk about expenses? AB has shown some good margin expansion in recent years, including during the pre-COVID periods. I guess, how are you thinking about managing margins here? You know, can you maintain the momentum and pre-tax margins that you gained during the pre-COVID period?
Look, we've asked people to focus on our incremental margin, and our incremental margin in the first quarter was negative. Of course it was. Asset prices declined and our expenses didn't climb proportionately to it. It will be very difficult for us to maintain that progress that we've had. We've been pretty, I think, clear with people who follow us most closely that we're price takers of talent, not price setters of that talent. People in the industry know comp is going down if I may just by a function of where asset valuations are. It also is a function of investment performance, and it's a function of flows.
We're very clear with our people about that, and there is flexibility in our comp to revenue, but it's not necessarily only in one direction, which has been down. We were over 50%, I believe, in the years prior I arrived. We were 46.4% last year. We're gonna try very hard, but I suspect we may, you know, we may see some weakening of that trend this year because we're in a down market. But it, you know, we're a cyclical industry, and our largest single expense is comp.
How are you thinking about managing the trade-offs around managing costs and are growth projects still on the agenda you have as well?
We have five key initiatives that we're really focused on. We're gonna continue to fund them through the cycle. We're gonna try and defer other things. We will defer other things and maybe even slow down some of the things we don't have to do this year or next. Our goal is to continue building out in China. We have to build out our private alts business. We will continue to invest in our distribution platform. We will continue to build out our private wealth business. We will continue to deepen the technology integration across the firm. We're gonna do all that, and we're gonna have to fund that by being much more disciplined in what expenses, discretionary expenses we can take on and make some tough decisions.
Now, you guys were ahead of the curve with the move to the Nashville relocation. How much more runway is there from a P&L perspective with that? Are there opportunities that the firm might look to just as an effort to move the cost curve down?
We initially indicated we were gonna move 1,000 jobs to Nashville. We've upped that to 1,250. It could be higher than that. We have investment teams who are interested in relocating portions of their team down there, and we've already done that with parts of fixed income and parts of equities. I suspect that will continue. We will, you know, the big bet. While Nashville is already a positive contributor to us, it's been accreted. It was accreted last year to $0.02 and $0.06 per unit. The real payday doesn't happen until the leases in New York run off, which is at the end of 2024. The big impact is still out there. We were forecasting between $75 million and $80 million.
We've continued to be comfortable with that estimate. It's the dynamics of how we're getting there is changing.
Okay.
We're still comfortable with that estimate.
Great. Why don't we see if there's any questions from the audience? Over here, a question up in the front.
Thanks. Could I just ask a little bit on the kind of evolution of your distribution strategy for Europe? You know, what's the importance of, say, fund distribution platforms versus going direct to, you know, wholesale channels and others? How do you think about the approach from here?
Look, I think in certain parts of Europe, we'll go to the fund distribution platforms, Italy being a perfect example of that, and Spain. In the U.K., given the concentration, that's increasingly the case, but there's still the big IFA market in the U.K., and the OEICs platforms are very important for us. We'll continue focusing there. I think in Germany, it's more of a mix for us, but ultimately, we have to pick the markets where we're really gonna play aggressively. You know, France is not a market that we have a particular edge. France is a very big domestic fixed income business and tends to be more fixed income-oriented, while Southern Europe is as well. They're much more open to non-local players in that space, and we've had a lot of resonance there.
The U.K., we've always been under-penetrated in, and we've seen some real momentum in the last year and a half that continues with the big, I guess, for lack of a better word, platforms. I'm hopeful that will continue to be the case. You know, we're gonna use a lot of technology, and our goal is not to put people on the ground everywhere.
We've about two minutes left. Maybe with the remaining time, we could talk about alts and CarVal. You announced the acquisition back in March. Maybe you could just update us on your alts footprint here now post-acquisition.
You know, we'll close at the end of this month, beginning of July. We'll have roughly $50 billion of private alts. The vast majority of that is credit. We have really four principal teams. We have a middle market lending business, which was the first that came out of Barclays after the crisis, and we built it a lot. We just hired a small group of people and now built it to about 45 or 50 people based in Austin. That's the single largest piece today. We have a commercial real estate debt business, that was part of our larger real estate footprint. We spun off our equity part of that business. Company is now called Prospect Ridge. We continue to distribute for them, in our private wealth business.
They've had terrific returns, but we weren't making any money on owning it. We started a European commercial real estate business that has attracted real interest. Now my own thought is as markets slow down and the economy is weak and real estate will be hit first, in terms of new development and financing, there will be, you know, prepayments will slow for sure, in Europe and in the U.S. Those may slow quicker. Middle market lending, we haven't seen that yet, but I suspect it will be sensitive to the market as well. CarVal is the final piece of that. CarVal has been around for a really long time. You know, I've known them when I was in high yield 30 years ago.
I've always admired them a lot. They tick off a lot of boxes for us, whether it's in renewables, infrastructure, transportation-based lending, asset backs, distress. I think we have a lot on our table, and frankly, the job really begins now after we close. We don't wanna blow it, we also don't want to multi-boutique. We don't want a lot of locked fixed costs in the system. We wanna keep that investment engine independent, robust, making their own decisions on people and comp, but we wanna manage the rest of the business centrally. Risk controls, platform, sales, and you know, basic corporate structure. That's our goal. It's not that complicated. I don't think we're doing anything big. We have a lot on our plate right now in terms of acquisition.
We'll continue to talk to teams in equities and fixed income and multi-asset that offer sort of differentiated return streams. That's our plan.
Great. Well, I'm afraid we'll have to end it there. We're gonna run out of time. Thanks so much, Seth.
Thank you.