Welcome to Franklin Resources Earnings Conference Call for the Quarter Ended March 31, 2021. Hello, my name is Denise, and I will be your call operator today. As a reminder, this conference is being recorded. And at this time, all participants are in a listen only mode. I would now like to turn the conference over to your host, Celine Oh, Head of Investor Relations for Franklin Resources.
You may begin. Good morning, and thank you for joining us today to discuss our quarterly results. Statements made on this conference call regarding Franklin Resources, Inc, Which are not historical facts or 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 could differ materially from any future results expressed or implied by such forward looking statements. These and other risks, Uncertainties and other important factors are just described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including in the Risk Factors and the MD and A section of Franklin's most recent Form 10 ks and 10 Q filing.
Now I'd like to turn the call over to Jenny Johnson, our President and Chief Executive Officer.
Thank you, Sween. Hello, everyone, and thank you for joining us today to discuss Franklin Templeton's 2nd quarter results. Fred Johnson, our Executive Chairman Matt Nichols, our CFO and Adam Spector, our Head of Global Distribution are also on the call with me today. We hope that everyone is well. We continue to operate our business effectively with over 95% of our employees working from home.
Broadly speaking, we are planning for a return to office in Hemmer. Though our approach will be flexible and shape our local requirements and the status of the pandemic in the countries where we do business. We are encouraged by the number of vaccines that are now being distributed worldwide. So the rollout rates obviously vary by country. The progress is very promising.
Having said that, we have been deeply concerned by the suffering that has resulted from the surge in cases in India and other parts of the world. Our thoughts go out To our employees and clients who have been personally impacted by this terrible disease. Turning now to our 2nd fiscal quarter. Today, we are pleased to report financial results that reflect our continued progress with revenue growth and margin expansion, Resulting in a 6% increase in adjusted operating income to $581,000,000 Our financial flexibility remains strong with cash and investments of $6,200,000,000 at March 31, net of $250,000,000 of debt paid down in the quarter. After only 2 quarters as a combined company, We're experiencing organic growth in a number of key areas.
We're now in more robust and diversified Active Management Business and we're encouraged and excited by our collective potential. Our merger has created a differentiated global firm Valence's scale and specialization and which we believe offers expanded opportunities for our stockholders, Clients and employees as well as the financial professionals with whom we partner. Turning to performance, We're seeing an improvement in performance across a broad base of investment strategies from the prior quarter. More than 2 thirds of our strategy composites out Performed their respective benchmarks for the 4 key time periods. The number of our mutual funds rated 4 or 5 STARS by MarinStar increased over 140 funds this quarter.
Turning next to distribution highlights. We're encouraged by the positive results of our new sales initiatives and efforts to deepen relationships. More Clients purchased both legacy Franklin Templeton and legacy Legg Mason strategies as demonstrated by our larger wins during this quarter. Our expanded distribution efforts drove an increase in gross sales of 32% from the prior quarter across a broad array Funds, vehicles and asset classes led by U. S.
Retail. Long term inflows increased by $15,900,000,000 Or 19% quarter over quarter to $99,400,000,000 excluding reinvested distribution. 2nd quarter long term net outflows improved to $4,200,000,000 compared to $4,500,000,000 In the prior quarter. Importantly, if you exclude reinvest in distribution, net outflows improved by over $10,000,000,000 Our sales momentum continued with positive net flows in the Benefit Street Partners, Clarion Partners, ClearBridge, Finuciary Trust International, Franklin Equity Group, Franklin Tupholton Fixed Income, Martin Curran, Royce and Western Assets. As we said on previous calls, the firm has been focused on expanding our alternative platform and this quarter we did.
Alternative strategies grew by $4,000,000,000 to $131,000,000,000 in assets under management with contributions from real estate, private credit and Retail Alternatives. Clarion Partners and Benefit Street Partners both reached record AUM levels And K2 Alternative Strategies also contributed to positive net flows. Fixed income inflows increased by 27% To $53,500,000,000 from the prior quarter due to positive contributions from a diverse group of fixed income strategies including core bond, core plus And Corporate. We are pleased that Western Asset experienced net inflows of almost $10,000,000,000 in the quarter, its highest Level in over a decade. Equity inflows were $32,400,000,000 consistent with the prior quarter excluding reinvestment distributions.
We continue to see strong interest in our thematic equity strategies and while it's still early days, we're seeing progress and increased interest in our value strategies. As of this quarter's end, our institutional pipeline has increased with a combined total of 1, But unfunded mandate of $13,000,000,000 and it's diversified across all asset classes. Aside from our specific results for the quarter, we are also pleased to release our corporate social responsibility report in April. We established clear goals and priorities for fiscal year 2021, ESG investing key among them and we continue to make important strides To keep our diversity and inclusion efforts at the forefront. Before we open it up to questions, I'd like to thank our And the teams around the globe that continue to do extraordinary work every day on behalf of our clients and firm And they've done so this past year under challenging circumstances.
I am grateful for everything they do. Now your questions. Operator?
Your first question comes from Dan Fannon with Jefferies. Your line is open.
Thanks. Good morning. My question is on flows and just kind of the momentum. If you look at the backlog, which continues to grow, can you talk about the difference in the This quarter versus last and then also on the strength in alternatives, if you could talk about the fundraising, if it's Evergreen or ongoing or if there was some kind of specific closes that maybe drove business strength in this past quarter?
Sure. I'll take it. It's Adam here. Thanks for the question. If you think about what's happening now and how flows are changing, the good news is that they're becoming Far more diversified, which is actually what we've been planning to do.
So we're seeing good flows, equities fixed, alternatives, as well as in our solutions business And geographically diverse as well. The U. S. Remains by far the largest driver of flows, but we're seeing very good flows in Europe And the Americas as well. In terms of alternatives, I'd say 2 things happened there.
At the top end of the market, we saw Really healthy subscriptions into Clarion, K2 and others from the institutional market, but we are also really trying to address The democratization of alternatives and had some very healthy raises for BSP and others in the wires. And that's something that I think will continue throughout this year as we have other retail launches for other alternative products throughout our system.
Great. Thank you.
Okay. Thank you. Your next question comes from Brennan Hawken with UBS. Your line is open.
Hi, good morning and thank you. This is Adam Beatty in for Brennan. Just wanted to ask about some of the exchanges from equity into Multi asset, it seemed like that had a bit of an effect in the quarter. And just the trend you were seeing throughout the quarter or maybe the trajectory, Do you expect a little bit more of that given where the markets have been? And is there anything in terms of Maybe a poll on the multi asset side that either through marketing or distribution where you are accelerating that movement in some way?
Thank you.
Sure. Let me address that in 2 parts. First of all, in terms of the exchange, that is more of a one time thing where we have essentially Reclassified and tweaked how we manage an existing fund, so that caused a reclassification. So that's an accurate Change for this quarter, but not something that you should see happening quarter over quarter. In terms of solutions in general, though, that has become a focus.
What we see At our largest distribution partners is that there is a focus on having their advisors It's more on asset gathering and less on portfolio management, which means that the management teams at our biggest partners Are really looking to firms like Franklin that are full service, offer active sleeves across the entire suite To provide models and solutions, and that's where we're seeing significant pickup in our solutions business and would imagine that would continue throughout the year.
Great. Thanks for broadening the answer. Appreciate it.
Thank you. Your next question comes from Robert Lee with KBW. Your line is open.
Hi, this is Jeff Dresner on for Rob. A quick question for in regards to gross sales for fixed income. There was a large step up there, but then there was A bit of a sharper drop in equity gross sales. I'm wondering if you can provide any color on some of your peers that are showing some more demand on the equity side.
Yes, we're seeing good demand in fixed income and in equity in fixed income. Western just had an absolutely fabulous quarter. I think that's what drove a lot of the top line on fixed income. From an equity standpoint, the great news is that with Are you coming back in the marketplace from a return perspective? We feel that we are quite well balanced in terms of our exposure to value and growth.
The majority of our inflows in equities continue to be on the growth side and things like DynaTek, ClearBridge is large cap growth, But we have very strong product on the value side and we're starting to see a pickup there as well.
Also, if you Exclude reinvested distributions from the chart, the sales are about flat. And in fact, the net flows improved into equities And you execute with
Investor Distributions. Great. Thanks. And if I could just quickly follow with one more. Just in terms of capital management, Maybe your thoughts on acquiring additional high net worth businesses and maybe just a general outlook on the acquisition?
Yes, I mean
Go ahead, Janice.
Go ahead.
We've stated that we want to continue to grow fiduciary trust. And As we're looking at those potential acquisitions, we're usually looking not only for assets and expanding our distribution there, but Geographic benefit, maybe in a location that we're not located as well as capability. So as you know, the last With Athena, we got really a top ESG manager and Penn Trust with a special needs trust. So it is still an area of focus for us and we will continue to look to acquire there.
Thank you. Your next question comes from Ken Worthington with JPMorgan. Your line is open.
Hi. Good morning. The Biden administration has proposed higher dividend and capital gains taxes for the high net worth. If these proposals Do you think they could or would have an influence on your business, either the types of products that are sold or
So we look at ourselves as a firm. Our expertise Is our investment management capability. We want to be flexible in delivering that expertise in whatever vehicle our clients would like to receive it in. So that can be a mutual fund, that can be an ETF, A CIT, separately managed account. So there's no question that there's a lot of discussion out there that The mutual fund has some tax inefficiencies that an ETF doesn't have, and that there is the Potential to see a shift there.
However, you were probably already seeing a bit of that shift as many fee based advisors Preferred the ETF vehicle. So we want to if that happens, you're likely to continue to see an acceleration in that Chip. What we have been hearing for the last couple of years from our distributors is you need to be able to package all of your products in any of these vehicles and be it not stick to it so that you can meet the demands of our varying distribution groups.
And what I would add to that, Jenny, is that we believe we'll see increased demand for our muni capabilities, where we have a really strong capability of both Franklin Templeton fixed income as well as at Western. And in general, as taxes take a larger bite of the apple, active management Comes more and more important, which we think is in our favor as well.
And Jenny, you mentioned the TF Rapper, since you guys control Precidian, is that something that you're seeing benefit them in terms of either Leads or new business inquiries, any flavor there?
So I think the jury is still out a little bit on whether People want a true kind of blind trust for their active management capabilities. I think there's a view that Many of the products, it's okay to have some transparency even on the active side. We do certainly and certainly in fixed income. But I think there are some you take a small cap strategy, you're going to need to have that in some kind of blind trust in the ETF. So I think That Precidian has the opportunity to benefit, but I don't think that it will be at the level maybe when it was launched Where people thought it would that all active ETFs would be in that kind of packaging for an ETF.
Thank you very much.
Thank you. Your next question comes from Michael Carrier with Bank of America Merrill Lynch. Your line is open.
Good morning. This is actually Sean Cowen on for Mike. Can you guys update us on your distribution efforts for placing Legacy Legg Mason products into retail products. And did that have a major impact on the improved gross flows in the quarter?
Sure. One of the two things that I think we need to be successful is cross selling. The other is getting our general specialist model right. So from a cross selling perspective, if you take a look at the 2 organizations pre merger, Franklin had much more of a strength In the regional broker dealer channel, lag was a little stronger in the wires. There were some geographic differences as well.
One of our major, major efforts is to make sure that we take advantage of that Complimentary nature of the two businesses. So if you take a look at what's happened so far year to date, we've cross sold to about 5,000 New advisors, advisors who either owned only legacy Franklin and bought legacy leg product or vice versa. And that cross selling is having a pretty significant impact. Another way to look at that geographically is to think about The presence that, say, Franklin had in Canada or the Americas where Leggs is a little lighter, we're now at about 25% ahead of last Your sales in those regions for legacy Legg Mason. So yes, kind of that cross selling has had a significant impact.
Thank you.
Thank you. Your next question comes from Alex Blostein with OpenSachs. Your line is open.
Hi. This is Sherik filling in for Alex. My question is on the expense guide. In the commentary, it was mentioned as to subject to market conditions. So just wanted to get a sense as to what are the market assumptions and flows estimates that you have Taken into consideration for the rest of the year.
So in terms of the Market, we're assuming a flat market. We don't make any additional market overlay assumptions in our guidance. In terms of the flow trajectory, we're assuming something similar to what we've been experiencing and the improvements that we've been experiencing over the last two quarters. So that's why our guidance remains consistent with what we described last quarter. What pushed it up In terms of the we mentioned $3,750,000,000 to $3,800,000,000 for adjusted expenses.
What's pushed that up slightly It's the, obviously, the continued momentum in the market, but also our performance has improved, our flows Improved and our results have improved. So by definition, that does have an upward pressure on compensation in particular, but we have other offsets in our Cost structure in that regard.
Understood. Yes, just a follow-up on that. So assuming that this flow trajectory and the markets continue to grind higher, What's the sensitivity of this guide kind of go up for the rest of the year?
I think we for the Q3, we feel good about the continued 3.75 to 3.8 will provide further guidance for the Q4 and 2022 when we reach that point.
Got it. Thank you so much. Thank you.
Thank you. Your next question comes from Brian Bedell with Deutsche Bank. Your line is open.
Great. Thanks. Good morning, folks. Just wanted to talk about the fixed income business broadly. Obviously, when you get And you have a backup in yields or a rising long term yield environment.
On retail bond funds, that Since you have at least a temporary downdraft or a spike up in redemption sometimes as the NAV, then the NAVs get hit on that. But Can you talk about for the institutional side, it can be a different dynamic. So can you talk about what What clients are saying about that or what are their concerns about that or what you perceive as client demand, if we do have a spike up in yield For Western, would you see a temporary sort of elevated redemptions on that? Or do you think that's actually For long term splits.
I mean, particularly on the institutional side, I mean, let's face it, Tensions, insurance companies, they need fixed income as part of their portfolio, both from a cash flow perspective as well as to Actually dampened volatility. So we have about 43% of our AUM in fixed income and there are multiple fixed income franchises Within Franklin Templeton. And they all manage differently. So we go anywhere from treasuries, obviously, to private credit with the BSP. And so they all manage differently.
With a rising rate environment, obviously, you're going to have an impact on the duration component of the fixed income portfolio. But If you take Western, for example, only 4% of their AUM is actually in government bonds. So the rest of it, they're doing Managing across sectors, bank loan, high yield, emerging markets. And if you have a rising rate environment, Chances are that's a better economy, economic environment and chances are those the credit component and the sector component outperform. So when you look at we actually did a study at Western and looked back to 2,000 and there were 30 times Where you had a significant short term significant period of rate increase, which defined by Greater than 15 basis points in a month and was extended.
And in that, Western tended to underperform in the short term, But then significantly outperformed in 6, 9 12 months because what ended up and that's versus obviously And that's because the credit sector component kicked in on the performance. So institutional clients You'll understand that and are willing to kind of work through it, at least that's been our experience.
And the other thing I would add is that
as Ray's rise, we as rates rise, we would expect to see Some money coming out of lower fee cash and very ultra short products into more core products, which will have a positive impact for us.
Yes. That's great. If I can sneak in another one on the Schwab, the AdvisorEngine platform integration with Schwab AdvisorCenter that you mentioned, Any view on how that might impact the sales trend through the Schwab Advisory Network going forward from where it's been?
Yes. Our strategy is to as the world has moved on the retail side to more of a fee based Environment with somewhere between 75 about 75% flows kind of go in that direction. It has pushed because there's obviously transparencies on what Client is paying the advisor, push the advisor to be more of a wealth manager. So our goal is to provide additional tools beyond just investment capabilities To help that advisor be a wealth manager, deepens the relationships with that. So, in the case of AdvisorEngine, There are tools within AdvisorEngine and it may be as simple as the CRM system juncture that an advisor that's sitting on the Schwab platform and custody on the Schwab platform may want to use some of those tools for some of the clients or all of their clients.
And They won't use it unless you have integrated to the custody level. So, it remains to be seen how that Plays out, but that's essentially our goal is to just make it as easy for a financial advisor to do business with us and to provide those additional types of services That for example, like Go, which ends up providing goals based investment models, So that you deepen the relationships and hopefully have stickier assets with the advisors.
That's great color. Thank you.
Thank you. Your next question comes from Patrick Davitt with Autonomous Research. Your line is open.
Hey, Greg. The last you answered all my questions. Thank you. I'm
Your next question comes from Craig Siegenthaler with Credit Suisse. Your line is open.
Hi, good morning, everyone. Thank you for taking my questions. This is actually Karim Afifi filling in for Craig. My first question is on flows. I was wondering if you could expand on the reason behind the $6,000,000,000 fixed income institutional redemption.
Was it performance related or did the client want to move the money in house? And also, does this particular client have other mandates with Franklin Templeton? Thank you.
Why clients make particular moves, I think you never quite know. I would say in general, With some large sovereign institutions, we do see a trend to in source some places. I think this was just not the right mandate for them at the right time. That client still does have significant assets with us as an institution, and we feel solid with The overall relationship, we just happened to lose one piece of the overall relationship there. A lot of money, but only a portion of our overall relationship.
Got it. Thank you very much. And if I could sneak one more. Can you maybe comment on the sustainability of retail flows given the large government stimulus and strong equity market, Which may be making current activity levels unsustainable.
Look, I can only tell you what we're doing, not what the government is I'm feeling really confident about what we're doing in sales. We Post merger really brought the best of the 2 firms together. We feel really confident in the field force we have out there. We've got folks In new territories now for 6 months, we're seeing the results of that interaction. We've put a specialist generalist model in place And I see no abatement in terms of the activity we're having, the level of engagement we're having and feel really, really good about where we are From Flow's.
If you look at U. S. Retail, it's by far the largest segment of our overall business. It's the place We've put the most attention post merger to make sure we get the integration right and we're seeing huge benefits from it. So I'm feeling pretty good about the future.
Thank you very much.
Thank you. Your next question comes from Michael Cyprys with Morgan Stanley. Your line is open.
Hi, good morning. This is Stephanie filling in for Mike. My question is around the fee rate. Given the improvement in performance fees this quarter, Do you think the outlook for generating performance fees has improved into the rest of the year? And then just any help on how we should think about the fee rate exiting the quarter and trending from here.
Yes. I mean, look, the fee rate this quarter was supported by A couple of quite large low fee redemptions. We had growth in alternatives. We had good support in equities. So it's solidified where the current rate is.
We feel quite good for the year to say that The high end of our guidance, so 38 basis points, potentially 38 to 39 basis points Is the right way to model it for the entire year.
Great. Thank you. And then just One quick one on cryptocurrencies. Do you see a commercial opportunity in crypto? If so, how are you approaching the opportunity from Types of products or investments that you might be considering?
Thank you.
So I'm not a huge fan of things like Bitcoin because I think Over time, crypto got so big, governments would want to And regulate because they like to control their currency. So I'll put that sort of out there first. That is not to be confused with tokenization both of assets because I think that That will unlock illiquid assets that become interesting and also tokenized coins That help facilitate business model. And that's different. There's nothing backing a bitcoin, but there is Something backing a coin that actually has a functional capability.
So I think there There's a lot of education that's kind of happened out there around tokenization. And I do think that blockchain will completely change Sort of how this how our industry how the financial services industry operates their back office. I think it has, As I said, it has the real capability of democratizing illiquid assets that some would argue might even take some of the premium out of alternative over a long period of time. That would be my answer to that question.
I just had one other thing on the wealth side. Having the capability to field, let's call it, digital assets in general It's going to probably be important for the future. So we are focused on the capability front in that regard.
Yes. Great. Very helpful. Thank you.
Thank you. Your next question comes from Brian Bedell with Deutsche Bank. Your line is open.
Great. Thanks for taking my follow-up. It's on ESG. You have some detail in the commentary on that. Just wanted to See if you're able to assess what the flows were into the ESG dedicated products or what you call a specific focus For the quarter and then the $175,000,000,000 that you mentioned with specific focus, just wanted to fill in on that a little bit.
I think Legg Mason, If I'm not mistaken, is the bigger part of that, not sure if you can go into some color on some of the bigger parts of that 175 That you're including in that. Does it include any exclusionary product, for example?
So let me give you my little You're on ESG why Adam looks up a little more detail on the actual flows in some of those. So first of all, we would 93% of our AUM As ESG factors, I mean, we think it's here to stay. We don't think anybody could be an active manager without ESG and all of our The teams incorporate ESG factors into their investment process. And we think that one of the reasons we're so far along in that is, 1, as an The manager, we think that the data out there is not particularly good and it requires engagement by investment teams with companies to actually gather the data. And number 2, having a large presence in both Europe and Australia, where really these trends kind of started, We had to develop these products way before they became really important in the U.
S. And we think That again, despite the industry coalescing around things like SaaS being TCFD, right now, it really requires engagement of an active manager To do true ESG kind of screening. When you look at Europe, they have Something called Article 6, Article 8 and Article 9. Article 6 is you do the screens, so our 93% of our AUM would qualify in that. In Article 8, we have 25 products there and Article 8 is I have a tilt towards ESG
factors and Article 9 is really impact and we
have 8 funds there. 9 is really impacted. We have 8 funds there. We are seeing good flows into our 2 Paris aligned climate ETFs. Our European total return and our Templeton Global Climate are both reaching $1,000,000,000 Good flows into our social infrastructure fund.
I know ClearBridge U. S. Equity Sustainability Fund that's been in net sales For the last 12 months. So to answer a little bit of your question, we're seeing flows in a broad set of products. And what's interesting, I think, you're seeing is the supply side of ESG is really increasing.
As you hear like Europe, 1 third of their COVID relief fund will go into green bonds, which is doubling the size of the market. Obviously, with the Biden Infrastructure, that gets passed, you're going to see increase there. And so there'll be a lot more supply, which will continue to drive this. And Adam, I don't know if you want to add any additional details to that.
I think, Jenny, you hit on all the high points. I would just say that the great thing about our ESG capabilities is that, yes, we have it in the traditional Asset classes, equities, fixed income, but also in solutions and alternatives. And it's in alternatives in places like K2, Clarion, etcetera, where we're also seeing significant flows and I think that combination of ESG and ALTS is going to be a real winner for
That's super helpful. In fact, if I just back out the one time redemption of the $6,000,000,000 on the India Fund, We would have about $3,000,000,000 of positive flows for the quarter. Is it fair to say ESG funds would have driven on a net basis a significant portion of the positive rate.
I don't think we know the answer to that. You're right on 3.4, there, yes.
Okay, great. Thank you.
Okay. Thank you. That ends our Q and A session. I would like to hand the call back over to Jenny Johnson, Franklin's President and CEO, for final comments.
Okay. Well, thank you everybody for participating in today's call. Through the work that we've done over the past year, we've built a really truly I thank all our employees for their significant efforts, dedication and client focus. And we look forward to speaking with all of you again next quarter. So thank you everybody.
This concludes today's conference call. You may now disconnect.