I would like to welcome everyone to the Virtus Investment Partners quarterly conference call. The slide presentation for this call is available on the investor relations section of the Virtus website, www.virtus.com.
Thank you, and good morning, everyone. On behalf of Virtus Investment Partners, I'd like to welcome you to the discussion of our operating and financial results for the Q3 of 2022. Our speakers today are George Aylward, President and CEO, and Mike Angerthal, Chief Financial Officer. Following the prepared remarks, we will have a Q&A period. Before we begin, please note the disclosures on page 2 of the slide presentation. Certain matters discussed on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, and as such, are subject to known and unknown risks and uncertainties, including, but not limited to, those factors set forth in today's new release and discussed in our SEC filings. These risks and uncertainties may cause actual results to differ materially from those discussed in the statements.
In addition to results presented on a GAAP basis, we use certain non-GAAP measures to evaluate our financial results. Our non-GAAP financial measures are not substitutes for GAAP financial results and should be read in conjunction with the GAAP results. Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in today's news release and financial supplement, which are available on our website. Now I'd like to turn the call over to George. George?
Thank you, Sean. Good morning, everyone. I'll start with an overview of the results we reported earlier today before turning it over to Mike to provide some more detail, and then I'll provide some additional background on our announcement last week of the AlphaSimplex agreement. The equity and credit markets remained exceptionally challenging in the Q3. Concerns over rising interest rates, inflation, geopolitical tension, and heightened volatility have negatively affected investor sentiment across products and asset classes. Our Q3 results reflected this difficult environment with year-to-date market declines meaningfully impacting assets under management and operating earnings. For the quarter, we had net outflows, primarily due to mutual funds, though we did have a significant improvement on a sequential basis. While retail separate accounts and institutional also had modest net outflows, we did have positive net flows in closed-end funds, Private Client, and ETFs.
Although the environment remains challenging in the Q4, we believe these types of markets highlight the importance of active management. We are pleased with how our managers are navigating these markets, and we believe we are well positioned to provide clients compelling solutions now and as investor sentiment improves. Turning now to review the results. Total assets under management decreased 7% to $145 billion, primarily due to negative market performance in addition to the net outflows. Sales of $5.7 billion declined from $7.9 billion in the Q2, due primarily to two large institutional client fundings in the prior quarter, as well as a generally unfavorable retail investor sentiment. In certain asset classes, however, including international equity, fixed income, and multi-asset, we had increased sales in the quarter.
Net outflows were $3.3 billion, a meaningful improvement from $4.8 billion in the prior quarter. Net outflows were driven primarily by mutual funds, but did include the net outflows in institutional and intermediary distributed Retail Separate Accounts, while ETFs and Private Client again generated positive net flows. Closed-end funds also generated positive flows, which were related to a rights offering during the quarter. By product, fund net outflows of $2.8 billion improved from $4.5 billion due to a lower level of redemptions across strategies. Retail Separate Account net flows, which were modestly negative, also improved as a result of lower redemptions. Institutional turned negative, generating net outflows of $0.4 billion after many consecutive quarters of organic growth. The business is inherently lumpy based on the timing of client fundings.
We still see a strong level of activity in the pipeline, including mandates that funded immediately after the end of the quarter. In terms of what we're seeing in October, the trend for retail open-end funds remains similar to the Q3, which varied with the market. For institutional, we remain pleased with the pipeline and have seen several significant mandates begin to fund, including a global growth mandate. We also priced a $300 million CLO earlier this month. Our Q3 financial results reflected the impact of the market declines that began early in the year and continued in the Q3. Operating income as adjusted was $65 million, down from $78 million sequentially, and the related margin of 35% declined from 39.2%.
Earnings per share as adjusted decreased 16% to $5.76, in large part reflecting the decline in average assets under management. Turning now to capital. Given our solid cash flow generation and balance sheet, we continue to return capital to shareholders while maintaining appropriate levels of working capital and leverage. During the quarter, we repurchased 10 million of our common shares, totaling $105 million over the past year, and have reduced shares outstanding by 4.7% since September 30, 2021.
We also raised our quarterly common dividend, representing the fifth consecutive annual increase. We ended the quarter in a net cash position of $47 million and continue to have significant flexibility in managing our capital needs, with total cash on hand as of September 30 of $309 million, a significant undrawn revolver and $120 million in investments. While we are disappointed with the results for the quarter, they are primarily related to market and investor sentiment factors from which we are not immune. In spite of the markets, we continue to be focused on the execution of our strategy, focusing on building out capabilities to position us for future growth as markets stabilize. Our positioning is underpinned by our increasingly broad range of strategies and product offerings to appeal to clients across changing environments and preferences.
Our extensive distribution reach, including expanded non-U.S. capabilities, which make us an attractive partner for boutique managers, solid investment performance across products and strategies and a flexible balance sheet and strong free cash flow, enabling us to return capital to shareholders while continuing to invest in growth opportunities both organically and inorganically, including our recent agreement to add AlphaSimplex as an affiliated manager, which I will discuss later in the call. With that, I'll turn the call over to Mike. Mike?
Thank you, George, and good morning, everyone. Starting with our results on slide 7, Assets Under Management. At September 30, assets under management were $145 billion, down 7% from $155.4 billion at June 30. The sequential change reflected $6.6 billion of market depreciation and $3.3 billion of net outflows. Average assets under management in the quarter were $157.1 billion, down 8%, largely due to market performance. Our assets under management remained well-diversified by product type and asset class. US retail funds represented 34% of total AUM at September 30, with institutional and retail separate accounts at 32% and 23% respectively. By asset class, fixed income and multi-asset now represent nearly 40% of total and alternatives were 7% of AUM.
We continued to generate strong relative investment performance across strategies. At September 30, approximately 67% of rated fund assets at four or five stars, and 91% were in three, four or five-star funds. We had 9 funds with AUM of $1 billion or more that were rated four or five stars, representing a diverse set of strategies from 5 different managers. In addition to strong fund performance, as of September 30, 86% of retail separate account assets and 63% of institutional assets were outperforming their benchmarks over 5 years. Also, 75% of institutional assets were exceeding the median performance of their peer groups on the same 5-year basis. Turning to slide 8, Asset Flows.
Total sales of $5.7 billion compared with $7.9 billion in the prior quarter, reflecting $1.8 billion from two significant institutional mandates in the prior quarter and continued negative investor sentiment. By product, fund sales of $2.9 billion compared with $3.1 billion, down 8%, as lower small- and large-cap domestic equity and alternative sales were partially offset by modestly higher fixed income and international equity fund sales. Institutional sales were $1.5 billion, a sequential decline due to the two large client inflows in the prior quarter. Retail separate account sales were $1.2 billion, compared with $1.3 billion in the Q2. Overall net outflows were $3.3 billion, primarily due to open-end funds.
Reviewing by product, for open-end funds, net outflows were $2.8 billion, an improvement from $4.5 billion in the prior quarter, primarily due to lower redemptions across all asset classes. Our top two fund strategies for net inflows in the quarter were multi-asset credit and merger arbitrage, both from recent transactions and highlighting the benefit of the ongoing diversification of the AUM profile. I would also note that ETF net flows were positive, as they have been for eight of the past nine quarters. Institutional net outflows of $0.4 billion compared with net inflows last quarter, which included the two large client fundings. In retail separate accounts, net outflows of $0.2 billion compared with $0.7 billion in the Q2. Domestic mid-cap, SMID-cap and multi-asset strategies generated positive net flows.
In our Private Client business, net flows remained positive, as they have for 15 consecutive quarters. Turning to slide nine, investment management fees as adjusted of $164 million declined $11.9 million or 7%, reflecting the 8% sequential decline in average assets, partially offset by a modestly higher average fee rate. The average fee rate of 41.5 basis points compared with 41.2 basis points in the prior quarter, with the modest sequential increase primarily reflecting a higher average open-end fund fee rate. Our fee rates, which are net of asset-based distribution costs, included a discrete $1 million third-party distribution expense that lowered the overall rate by 0.3 basis points. Performance fees in the quarter were modestly lower at $0.3 million, compared with $0.4 million in the prior quarter.
For the Q4, we believe the range of 41-43 basis points remains reasonable. At current market levels, we would anticipate being closer to the low end of that range. Slide 10 shows the five-quarter trend in employment expenses. Total employment expenses as adjusted of $88.7 million decreased sequentially from $89.1 million. Lower profit and sales-based compensation was largely offset by $2.2 million of higher stock-based incentive compensation in the quarter, primarily as a result of improvement in relative investment performance metrics on which certain awards are based. Employment expenses also included a $0.8 million impact from the addition of two new investment teams in the quarter. While those teams only joined recently, we are pleased that we have already seen modest mandates and notable activity.
As a percentage of revenues, employment expenses were 47.8%, up from 44.8% in the Q2, primarily due to these items as well as the market-driven revenue decline. For the Q4, we believe employment expenses as adjusted would be in a range of 50%-52% of revenues, which assumes current market levels and no meaningful improvement or degradation in markets through year-end. We will update you on that range next quarter as appropriate. Turning to slide 11, other operating expenses as adjusted were $31.1 million and included approximately $1 million of transaction costs associated with AlphaSimplex.
Adjusting for the transaction costs as well as the $0.8 million of annual director grants in the prior quarter, other operating expenses as adjusted were essentially flat with the prior period and within the $27-$31 million per quarter range we previously provided, which we believe is an appropriate level going forward. As always, but particularly in this challenging market environment and given the impact of inflation, we are closely managing all discretionary expenditures and initiatives and have taken such actions as eliminating facility costs through lease consolidation, in addition to initiatives underway to provide for future operating efficiencies. We will, however, continue to prudently invest to support growth. Slide 12 illustrates the trend in earnings. Operating income as adjusted of $64.9 million declined $13.1 million or 17% sequentially due to lower revenues.
The operating margin as adjusted of 35% compared with 39.2% in the Q2. As previously mentioned, operating income and the margin were each impacted by discrete items, including the $1 million third party distribution expense, $1 million of transaction costs and other noted items. Net income as adjusted of $5.76 per diluted share declined 16% in the quarter. Regarding GAAP results, net income per share of $4.25 increased from $2.29 per share in the Q2 and included $1.12 of realized and unrealized losses on investments, primarily consolidated investment products, and $0.54 of restructuring charges related to the consolidation of office space, partially offset by $0.73 of fair value adjustments to affiliate non-controlling interests.
Slide 13 shows the trend of our capital liquidity and select balance sheet items. Working capital was $195 million at September 30, an increase from $185 million at June 30 as cash earnings exceeded capital return to shareholders. During the Q3, we repurchased 50,422 shares of common stock for $10 million. Over the past year, we have reduced shares outstanding by 4.7%. During the quarter, as previously announced, we also increased the quarterly common dividend by 10% to $1.65, our fifth consecutive annual increase. At September 30, gross debt to EBITDA was 0.7x, net cash of $47 million, compared with net debt of $12 million at June 30.
I would note that we did not make a discretionary debt paydown in the quarter so as to preserve financial flexibility. With that, let me turn the call back over to George. George?
Thank you, Mike.
Before we take your questions, I would like to comment on our announcement last week regarding our agreement to acquire AlphaSimplex, a leading manager of liquid alternative investment solutions with $10.9 billion in assets under management at September 30. AlphaSimplex specializes in systematic investment strategies that are designed to adapt to changing market dynamics, primarily using liquid futures and forward contracts. They offer a flagship trend following managed future strategy, a multi-strat hedge fund replication strategy, and risk efficient alternative solutions that seek to provide diversification to traditional portfolios. AlphaSimplex's managed future strategy that seeks to generate positive absolute returns over a full market cycle with low correlation to traditional stock and bond markets during periods of dislocation is offered in multiple investment vehicles, including a U.S. mutual fund, the UCITS fund, private funds and separate accounts.
The firm's five-star $3.5 billion AlphaSimplex Managed Futures Strategy Fund is the third-largest U.S. fund in its category, has a strong 1-year investment return and positive flows through September 30, and is in the top decile of the peer group for each of the 3-, 5- and 10-year periods. We are very excited to add AlphaSimplex to our family of affiliated managers, each of which specialize in individual strategies or asset classes. This transaction, like our previous ones, is part of our overall strategy of expanding our offerings of distinctive capabilities provided by dedicated and specialist boutique managers that collectively will provide the building blocks of a well-diversified portfolio as well as more comprehensive investment solutions for clients.
AlphaSimplex will significantly enhance and diversify our investment offerings by adding an attractive liquid alternative capability from a market leader with a 15-year track record that has delivered strong uncorrelated returns over market cycles. The addition will further diversify our asset base, both by product and asset class. On a pro forma basis, institutional AUM would increase to 35% of total, and alternative strategies would double to 14%. AlphaSimplex's strategies will also provide additional growth and distribution opportunities as we seek to introduce their capabilities into different product structures and by leveraging our retail and institutional distribution resources to expand their client base in both the U.S. and particularly non-U.S. markets. In addition, there is a strong cultural fit between AlphaSimplex and Virtus, and their talented group of experienced portfolio managers and researchers are aligned with us on strategic growth objectives.
Like all our affiliated managers, AlphaSimplex will operate as an individual boutique, retaining autonomy over its investment process and maintaining its independent structure, culture, and brand identity. Under the agreement, we would acquire 100% of AlphaSimplex for $130 million at closing, which includes meaningful deferred retention incentives for management. Given our balance sheet and cash flow, the transaction will be funded with existing resources that include an undrawn revolving credit facility. We expect the transaction to be immediately accretive to earnings as adjusted by approximately 10% based on run rate Q3 earnings. We anticipate closing near the end of the Q1, which is subject to regulatory, client, fund board, and fund shareholder approval. With that, we'll now take questions. Michelle, would you open up the lines, please?
Hey, thanks. Good morning, guys. Just a couple here to start on AlphaSimplex. Maybe it's for Mike here, but on the fee rates for both the retail and institutional pieces, are those gonna be in that sort of 1.30-1.40 range for revenue modeling purposes? Can you talk about the expected impacts of maybe comp or non-comp expenses as well? Just some color around those financial impacts would be really helpful.
Crispin Love, what we'll do, we gave the accretion on an overall basis on this call. We'll go through the impact on each of the rows, the fee rate, the expense and the other operating in more detail when we get on the call in the next quarter. We just signed a transaction. We have a good sense of the accretion as George Aylward outlined. We'll go into those line items in more detail going forward. We're pleased with the meaningful accretion that was outlined on the call.
Right. Just like, even without AlphaSimplex, our employment expense ratio and fee rate will vary a lot depending upon what the market environment is. We'll also be able to then update it for whatever the market environment is impacting our ratios as well as the impact of bringing them into the family.
Okay, great. I guess on capital allocation, just the impact there, I mean, just trying to think through the near term impacts, kind of given not just the transaction but the market environment. On the buyback side, is it safe to assume maybe the focus on the purchases continue kind of given this price action? Will you try to accumulate a little capital ahead of the deal closing? On the dividend side, not surprised to see the increase maybe not being as large as prior hikes given the backdrop. Can you remind us how you think about managing that level over the next couple of years? Is it more kind of yield focus or more as a percentage of cash flow?
Yeah, no, it's a great question, and I think you sort of kinda highlighted an important element, which is the environment, right? One of the number one functions of our capital on our balance sheet is to protect the business, and particularly in volatile and challenging times, right? It's been an interesting year, as we sort of say that. We filter that as we make our various decisions around how to manage the capital. Again, we've done it in a way that we have flexibility, and we continue to balance the different alternatives of things we need to do. As you can kind of see through what we've reported, we did continue to do buybacks, albeit at a lower level.
We chose not to pay down debt, again, and that's really, given the backdrop of however the environment is unfolding, as well as other high uses of capital from our perspective, which include organic and inorganic growth, and obviously now we have the announcement on AlphaSimplex. Going forward, again, I think what we've always said will continue to be the case, which is we wanna maintain, with our free cash flow generation, a balance between those three areas. Depending upon the environment, we would then prioritize, slightly prioritize one or the other. Again, I think as we've demonstrated, we've continuously returned capital either through repurchases or through five consecutive increases in our dividends.
When we strategically find a good use of capital via an M&A transaction, we will choose to do. Some we choose not to do. Obviously, we've just announced one. We'll continue to balance all of that.
Great. Thank you. Just one last one for me. On distribution, just at a high level, I just wanted to maybe get an update where you guys are in terms of expanding outside of the U.S. I know AlphaSimplex helps in that regard, but the ultimate goal there, over the long term, can you talk about that and what you expect that to come, either through, organic growth or more likely through acquisition? Talk about that. That'd be helpful.
Yeah. I'll speak to distribution broadly and obviously throw in retail there. I think on the retail side, we continue to see great opportunities expanding our offerings on the retail separate account side. Obviously, we have a very broad range of mutual funds, which we continue to focus in on, but we continue to see opportunities in retail separate accounts, particularly strategies from some of the newer capabilities that we've either recently added or are in the process of developing. That continues to be an area of focus, including certain sub-channels within retail. We see great opportunities continued on the retail side.
Institutional, we think those are actually larger opportunities just because of, from our history, there are certain areas of the institutional market that some of our affiliates have not been able to, fully penetrate. So as you've seen over the last quarters, except for the Q3, we've had successful mandates, particularly outside the U.S., for multiple of our managers and multiple strategies. That is an area that we continue to see great growth opportunities. Those growth opportunities will in part come from some of the additional resource expansion that we had as a result of the Stone Harbor transaction, where individuals with great experience in contacts in that market are now making our other capabilities available.
We continue on that portion of our business and continue to look at areas to grow not only the offerings in terms of institutional separate accounts, but even in offshore fund vehicles for multiple of our managers. Generally, as you sort of see the kinds of products we're gonna be introducing, you'll be seeing more of them on the offshore fund side, on the retail separate account side and ETF side, and probably on the open-end side. That's all really just marrying our product development strategy with where we see the greatest distribution growth opportunities.
Great. Thanks, guys.
Thank you.
Great. Thank you. Morning, guys. Maybe just starting off with AlphaSimplex, a strong track record, clearly, that they have there. Just a question around, in this market environment that's particularly favorable perhaps for their strategy, how do you get comfortable that you're not buying this strategy, this business at the peak in terms of performance in AUM? How do you sort of de-risk that, in your view? And then can you talk about from a distribution standpoint, what sort of actions and steps you guys can take to accelerate the growth of AlphaSimplex top decile strategy and any capacity constraints to be aware of?
Sure. On the first part of the question, I mean, for any transaction, and we have done quite a few over the last few decades, you kind of really ignore the current environment in terms of either being negative or positive, right? Obviously, if we're announcing it now, you should assume we've been in conversations for an extended period of time. Throughout that entire time, they've continued to have positive flows, as I noted in the earlier comments. Really, we looked at that really as part of the strategy which we've actually even discussed on previous calls, which is we truly and fundamentally believe that there needs to be a much more significant component in a diversified portfolio of non-correlated strategies.
We have been looking at those, looking for those that have demonstrated performance, particularly over market cycles. This is really a strategic fit. As we go through any transaction, we're very disciplined about how we sort of approach valuation, because again, we don't need to do M&A for our long-term growth strategy. We choose to do it when there's a great strategic fit, it's part of our plan, and the financial terms are ones that we are very comfortable with in executing that transaction.
On the second part of the question, which I think was really more on the growth side, as sort of alluded to in the comment, I think one of the many things that's attractive about this relationship is I think there is a really strong alignment between our growth objectives and their growth objectives, right? As I just stated, a lot of our growth objectives do include bringing in those more non-correlated strategies and capabilities and really expanding them through the filters of institutional as well as ETF and other offerings. I think that dovetails well with what they've done. We have views around the opportunities that we can have together by leveraging their strategies.
Obviously, there's work to be done, and as we indicated, we wouldn't be closing on this until near the end of the Q1.
Okay, great. Then maybe just shifting over to expenses, just on the comp side, I hear you on the 50%-52% comp ratio range for the Q4, I think it was, if I heard you right. I guess, how should we be thinking about that, into 2023? Maybe a little bit early for guidance there, but I guess just for modeling purposes, why would that not be a relevant range if markets remain at these levels as we think about next year? Would there be other things to be thinking about in terms of cost-saving initiatives that would result in that being anything different from that 50%-52% range for next year?
On the non-comp side, maybe you could talk to some of the initiatives that I think you were alluding to around managing discretionary costs a bit tighter. What sort of actions can you take? How meaningful could that be relative to that guidance range you gave on the non-comp side? Could we actually see that towards the lower end, if not even decline? Thank you.
Yeah. I'll just make a couple comments then Mike will respond as well. As you sort of look at the employment expense, particularly look at it in terms of the relationship between that and revenue, the primary driver of that over the years has been and will continue to be, the markets and the impact of markets on our revenue. As we even give guidance within quarters or from one quarter to another, we do like to stress that it's really kind of important that that will have a big implication. Even in the Q3, right, as you saw the markets in July versus August versus September, there's a lot of variability around that.
I think that the comments that Mike made were sort of anchoring on if there is no change in the market, that that would be the right range, and it could change otherwise. Mike, thoughts on that in the operating expenses as well?
Yeah. Michael, I think George outlined it well. We're certainly impacted by market-driven revenue increases as well as market-driven revenue declines. Just based on where ending assets settled at 9/30 versus average assets in the Q3, we highlighted the expectation for the Q4, and we will update as appropriate moving into 2023. That could shift. I think the view on our incremental margins is still overall in that 50%-55% range that we've historically achieved. When we look at the business and we look at incremental margins, we still believe that'll be the level that the incremental margins come on. The business should be well positioned to revert back to margin levels at previous levels.
I think on the operating expense side, we talked about the $27 million-$31 million range and initiatives underway there. The one most notably is the lease consolidation that we completed at one of our locations that will deliver a savings. There was some restructuring that came through related to that item. We'll continue to invest in other areas and other initiatives, and we're looking carefully at all of them. I think what we're seeing is savings from those areas kind of keep us in that range. We've been in that $29 million-$30 million level. We kept the range the same. We're really offsetting inflationary pressures that we're seeing across the business. We're really focused at a very detailed level.
We're keeping our levels consistent, offsetting inflation, and continuing to prudently invest in the business. We're closing on AlphaSimplex early in 2023. We're continuing to invest in the business. Balancing all that, but being very disciplined, as we always have been, on the expense side to continue to be in a position to drive those incremental margins like I referred to.
Great. Thank you. If I guess maybe squeeze in another question. Just on the institutional pipeline, it sounds like you had some mandates funded in the Q4. Maybe you can just give a little bit more color around how the pipeline overall is shaping up relative to maybe a quarter ago or a year ago. Where are you seeing sort of strengths? Anything you're able to help quantify on that front,
that'd be very helpful. Thank you.
Yeah, a couple of comments and then Mike will add on to that. I mean, as I think all of the institutional business is really lumpy and some timing can be pretty heartbreaking. There were, as we noted in the comments, certain things that came in right on the cusp. If you think about the kind of the backdrop, I mean, the Q3 really was an unsettled backdrop for people to ultimately make decisions. What we have seen, though, is institutional investors are continuing to do what they need to do for the long term and have been much less impacted than the retail side. In terms of the pipeline, Mike, wanna give us some color?
Yeah, I think we've been consistently pleased with the pipeline across strategies and managers and geographies. I mean, we've seen our managers outside the U.S. be considered for mandates and what we know that has been won and not yet funded is significantly in excess of known terminations. We feel good about it. It's a lumpy business, as George noted. Some of the fundings take time to come in. We're pleased that seven of the quarters consecutively before the Q3 were positive, and we feel very positive about the pipeline, the activity, and then George alluded to a CLO, which will also come through in the Q4, which also will generate positive flows.
We're seeing it across multiple affiliates and different product forms and feel good about the continued progress being made there on the institutional side.
Great. Thank you. I just wanna thank everyone for joining us today. As we always do, we certainly encourage you to call us or send us a note if you have any additional questions. Thank you all.