Good morning. My name is Michelle, and I will be your conference operator today. I would like to welcome everyone to the Virtus Investment Partners quarterly conference call. The slide presentation for this call is available in the investor relations section of the Virtus website at www.virtus.com. This call is being recorded and will be available for replay on the Virtus website. At this time, all participants are in a listen-only mode. After the speaker's remarks, there will be a question-and-answer period, and instructions will follow at that time. I will now turn the conference over to your host, Sean Rourke.
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 1st quarter of 2023. Our speakers today are George Aylward, President and CEO, and Mike Angerthal, Chief Financial Officer. Following the prepared remarks, we'll have a Q&A period. Before we begin, please note the disclosures on page two 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 news 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. I'd like to turn the call over to George. George?
Thank you, Sean, and good morning, everyone. I'll start today with an overview of the results we reported earlier before turning it over to Mike to provide more detail. Key highlights of the 1st quarter included a meaningful improvement in open-end fund flows from lower redemptions and a strong increase in sales of equity strategies, positive net flows in retail separate accounts and ETFs, solid investment performance across product types, a sequential improvement in our operating margin, excluding seasonal items, and we continue to have a well-positioned balance sheet with modest net leverage at quarter end. After the quarter, on April 1st, we closed on our acquisition of AlphaSimplex, which expands and diversifies our alternative non-correlated investment offerings and further advances our strategy to offer clients a broad array of capabilities that can appeal across market cycles and through changes in investor preferences.
Turning now to a review of the results. Total assets under management increased 4% to $155 billion due to market appreciation, partially offset by net outflows. Sales declined sequentially to $6.2 billion due to lower institutional sales in the prior quarter, which included a meaningful client funding and a CLO issuance. Retail fund sales were unchanged at $3 billion, with a meaningful increase in equity sales offset by lower fixed income and alternatives. Retail separate account sales increased 12% led by SMID equities. Total net outflows were $1.9 billion, a significant improvement from the prior quarter due to lower redemptions in all products, but particularly in mutual funds, where net flows improved by $2 billion. By product, retail separate accounts delivered positive net flows due to private client, but also included improved intermediary sponsored net flows.
Fund net outflows of $1.8 billion improved from $3.8 billion, with improvements in nearly all strategies and marking the best net flow performance since the Q4 of 2021. Emerging markets, SMid, and large cap equity funds each generated positive net flows. Institutional had modest net outflows of $0.2 billion, down from the positive net flows in the prior quarter. While this business is inherently lumpy on a short-term basis, over the past four quarters, Institutional has generated organic growth in a challenging environment. In terms of what we've seen in April, our Institutional pipeline is as strong as we've seen it and expect the funding to see no redemptions over the next several quarters. As you know, there's a lot of volatility in the timing of Institutional flows.
For open-end funds, trends are similar to what we saw early in the Q1. Our Q1 financial results reflected the impact of our normal seasonally higher employment expenses, absent which we achieved sequential improvements in both operating income and margin as we continued to closely manage expenses while generating higher revenues. Excluding the seasonal employment expenses, the operating margin was 33.2%, up 140 basis points from the Q4 due to lower variable incentive comp and lower other operating expenses. Earnings per share as adjusted at $4.20 included $1.11 of seasonal employment expenses. Excluding those items, EPS as adjusted increased 3% over the prior quarter. Turning now to capital.
We ended the quarter with a modest net debt position as the Q1 represents our highest quarter of cash utilization, given the timing of annual incentives and the revenue participation payment. In addition to those items, we net settled approximately 71,000 shares for $12 million to satisfy employee tax obligations. We did not repurchase shares in the open market in the Q1 given other cash priorities, but we continue to view share buybacks as an important element of our capital management strategy. After quarter end, we completed the acquisition of AlphaSimplex for $130 million using balance sheet resources, including our revolving credit facility.
Our balanced and prudent approach to capital management has positioned us to continue to invest in growth initiatives such as the addition of AlphaSimplex and other recent additions of affiliated managers, while returning capital to shareholders and maintaining appropriate levels of working capital and leverage. I'll turn the call over to Mike. Mike?
Thank you, George. Good morning, everyone. Starting with our results on Slide seven, Assets Under Management. At March 31st, assets under management were $154.8 billion, up 4% from $149.4 billion at December 31st. The sequential change reflected $7.8 billion of market appreciation and $1.9 billion of net outflows. Ending assets under management were 2% higher than average assets under management of $152.4 billion, which increased 3% due to market performance. AlphaSimplex AUM at March 31st was $7.8 billion, a decline from February 28th due to market performance, which was in line with expectations for their type of strategies. That was partially offset by positive net flows, both for the month and for the quarter. Our assets under management are well-diversified by asset class and product type.
At March 31st, equity was 57%, fixed income and multi-asset strategies combined were 37%, and alternatives were 7% of AUM. By product type, institutional represented 34% of total AUM, with U.S. retail funds and retail separate accounts at 32% and 24% respectively. Giving effect to the AlphaSimplex transaction, our pro forma total assets under management are $162.6 billion, with institutional assets increasing to 36% of AUM and alternative strategies increasing to 11%, which is a meaningful change from the 3% prior to the addition of AlphaSimplex and Westchester Capital. We continued to have compelling long-term relative investment performance across products and strategies. At March 31st, approximately 43% of rated fund assets had four or five stars, and 87% were in three, four, or five-star funds.
We had seven funds with AUM of $1 billion or more and 30 funds in total that were rated four or five stars. On a five-year basis, 74% of our rated fund AUM was outperforming the median performance of their peer groups. In addition to strong fund performance as of March 31st, 88% of retail separate account assets and 64% of our institutional assets were outperforming their benchmarks over five years. I would also note that our managers performed well during the volatile 1st quarter, with 55%, 89%, and 60% of mutual fund retail separate accounts and institutional AUM respectively, beating benchmarks for the period. Turning to Slide eight, Asset Flows. Total sales were $6.2 billion, down from $7.3 billion last quarter.
The decline was due to higher institutional sales in the prior quarter, which included a large funding in a growth equity mandate and a $300 million CLO issuance, partially offset by higher retail separate account sales. By product, fund sales of $3 billion were essentially flat as higher sales of equity strategies, which were up 44%, were offset by lower fixed income and alternative sales. Retail separate account sales of $1.4 billion increased 12%, largely driven by SMID cap equity strategies. Institutional sales were $1.9 billion, down from $3 billion in the Q4. That included the large funding and CLO issuance. Institutional sales continued to be well-diversified across affiliates, strategies, and geographies. In the Q1, our 10 largest institutional net inflows represented four different affiliate managers and several non-U.S. clients.
Total net outflows were $1.9 billion, with the improvement from $3.4 billion of net outflows in the prior quarter, largely due to open-end funds. Reviewing by product, for open-end funds, the improvement we saw early in the quarter reversed in March, though net outflows of $1.8 billion improved significantly from $3.8 billion in the Q4. Almost all strategies had an improvement in net flows, and there were positive net flows in SMID cap, emerging markets, and large cap equities. In retail separate accounts, positive net flows of $0.1 billion compared with net outflows of $0.4 billion in the Q4 and were due to continued positive net flows in private client. Institutional had modest net outflows of $0.2 billion.
Turning to Slide 9, investment management fees as adjusted of $157.6 million increased $1.5 million or 1%. Reflecting the 3% sequential increase in average assets under management at a modestly higher average fee rate, partially offset by two fewer days in the quarter. The average fee rate of 42 basis points increased by 0.3 basis points from 41.7 in the prior quarter. The fee rate increased for both open-end funds and retail separate accounts, and on an overall basis, the fee rate has been very stable, remaining in the 41-42 basis point range over the past five quarters. Performance fees in the quarter of $0.2 million compared with $0.5 million in the 4th quarter.
Looking forward, taking into account AlphaSimplex, we believe a modestly higher range of 42-44 basis points is reasonable for modeling purposes. Slide 10 shows the five-quarter trend in employment expenses. Total employment expenses as adjusted of $98.6 million increased 12% sequentially, reflecting $11.4 million of seasonal items related to the timing of annual incentives, including incremental payroll taxes, benefits, and accelerated stock-based compensation expense. Excluding the seasonal items, employment expenses declined by 1% sequentially due to lower variable incentive compensation. Employment expenses were 55.8% of revenue as adjusted, but excluding the seasonal items, they were 49.3%, representing an 80 basis point sequential improvement, primarily due to lower variable incentives.
Looking ahead, we anticipate employment expenses as a percentage of revenues in a range of 49%-51%, though, as always, it will be highly variable based on market performance in particular, as well as profits and sales. Turning to Slide 11. Other operating expenses as adjusted were $29.8 million, down $1 million or 3% from the Q4. The sequential decrease was largely due to lower professional fees and seasonally lower travel and related activity, and also reflected close management of all discretionary expenditures while we continue to selectively invest in key areas to support growth of the business. Looking ahead, we anticipate other operating expenses as adjusted will be in a quarterly range of $31 million-$34 million. For modeling purposes, keep in mind that our annual Board of Directors equity grants occur in the Q2.
Slide 12 illustrates the trend in earnings. Operating income as adjusted of $47.4 million declined $8.7 million or 16% sequentially due to the seasonal employment items. Excluding those items, operating income increased 5%. The operating margin as adjusted of 26.8% compared with 31.8% in the Q4. Excluding the seasonal items, the operating margin improved by 140 basis points to 33.2%. Net income as adjusted of $4.20 per diluted share, which included $1.11 of seasonal expenses compared with $5.17 in the Q4.
Regarding GAAP results, net income per share of $5.21 increased from $4.77 per share in the Q4 and included $0.93 benefit from fair value adjustments to affiliate non-controlling interests and $0.64 of net realized and unrealized gains on investments. Slide 13 shows the trend of our capital liquidity and select balance sheet items. Working capital was $184 million at March 31st, essentially unchanged from December 31st. We ended the quarter with net debt of $47 million, representing net leverage of 0.2x EBITDA. The Q1 is seasonally our highest quarter of cash utilization and included the payment of annual incentives, seasonal employment expenses, and a revenue participation payment of $27 million.
The contingent consideration liability, which also includes estimated earn-out payments, will vary over time based on changes in the underlying related revenue streams. During the Q1, we net settled 70,716 shares for $12.2 million to satisfy employee tax obligations. The AlphaSimplex acquisition in April was funded with a combination of cash on hand and $50 million of debt from our $175 million revolving credit facility, which we have had available to provide short-term financial flexibility and we expect to repay as we generate cash this year. Giving effect to the acquisition, we continue to have a strong balance sheet with more than adequate levels of working capital and modest leverage, providing meaningful financial flexibility. With that, let me turn the call back over to George. George?
Thank you, Mike. We'll now take your questions. Michelle, would you open up the lines, please?
Thank you. Ladies and gentlemen, if you would like to ask a question at this time, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. One moment while we compile our Q&A roster. Our first question comes from the line of Sumeet Mody with Piper Sandler. Your line is open. Please go ahead.
Thanks. Good morning, guys. Just wanted to start with AlphaSimplex. The AUM looks like it closed, implied around $7.8 billion in AUM. That's down about 30 from the announcement at 3/2/2022. I think that was around $11 billion. Just wondering if you could talk about sort of the flow and market dynamics that sort of drove the decline over the last, you know, few quarters considering Virtus Alternative AUM declined around, I think, 8% for that period. Maybe secondly, if any updates regarding that 10% accretion estimate at announcement. Thanks.
Sure. On the first part, I think for the AlphaSimplex assets, the change where we reported their February numbers and then the March ones, that decline is in line with what you would expect with those strategies. If you sort of look at the most comparable index for their strategies, the ESG trend index sort of kind of in line with that. As you think about those strategies, they're very different than some of our others. That moved in line. As Mike noted in his comments, the AlphaSimplex for both the month of March and for the quarter was positive flows. It really is market impact, and again, with the unique nature of those strategies and how they'll perform in market cycles.
I think since our original disclosure back in earlier last year, there's been a lot of volatility in the market. I think particularly near the end of the year, those indices, like in November, you'll see had certain challenges. They're moving in line with the strategies that they manage, from the client perspective, again, in the Q1, they had positive flows. On the second, we're not... Mike, go ahead.
I think thinking about accretion, we did reflect that in some of the modeling updates that we gave for each of the key metrics. You know, you noted that the fee rate ticked up modestly, given the fee rate of AlphaSimplex products is modestly higher than the blended fee rate. We gave their impact on each of the line items, there have been changes both in the assets of AlphaSimplex as well as the existing Virtus business. You know, it's generally in line with how we were thinking about it and the updated metrics will should bring you to the revised and updated figures.
Got it. Thanks. I guess my follow-up here is in regards to that. On the other expense line, you know, $31 -$34 million seems to be what you guys cited, and I know you guys have mentioned on the press release, lower seasonal travel costs in the Q1. Can you maybe just talk about, you know, where you are with the full kind of travel and entertainment expense, ramped back from pandemic levels? I guess is it just AlphaSimplex being the driver between that sort of $31 million run rate you've been at and sort of the new guide of $31 -$34 million?
I mean, I think as you're correctly noting, you know, T&E sort of has two dynamics going on. One, in this Q1, there's just generally less travel given the weather impact on certain half of the country. That was illustrated in the Q1. In terms of just generally where we are in terms of the post-COVID remote area, we had not gotten fully back to full levels of T&E. There's been some changes in terms of how that works, particularly on the retail side. That is a dynamic there. Where we've kind of had the volatility in the last few quarters has been that T&E, as well as other things like professional expenses, which again, can sometimes, you know, move the number a little bit. You know, Mike.
Yeah. Then I think you're right. We've been in a very tight range over the past 4 or 5 quarters. You know, we're down 3% sequentially on other operating. The new revised level does incorporate the bringing AlphaSimplex on. You saw us come in a little bit lower than the prior quarter, but we've now reflected the new range to bring on the AlphaSimplex business expenses, and that'll start obviously fully in the Q2.
Got it. Thanks. Last one here before I hop back in the queue. Just on capital allocation. You know, I know you guys didn't pay down any debt or repurchase shares in the open market in the Q1, and ended the quarter at over $200 million in cash. You know, I assume that $80 million payment for AlphaSimplex comes out of Q2 cash. You know, why not repurchase more stock in a quarter? Maybe how do we think about the kind of balance between the items for 2Q, given all the moving parts?
Sure. Sure. I mean, the first thing, again, stock repurchases, which we've consistently done for many, many years, is a very important part of our capital management strategy. The Q1 had a lot of moving parts. It is our highest utilization-quarter for cash, several competing demands for that. Also anticipating, you know, closing on the transaction, from which we actually did draw a little bit off of our credit facility, in an interest rate environment that was kind of a little challenging.
With the many different priorities that we had and also in the environment that we're in, making sure that we, you know, maintained a strong balance sheet, we did not do open share repurchases, but there were $12 million of net settlements, which, you know, also have an impact on what could have been in terms of shared issues. Again, it's still an important part of our strategy, but at any point in time, we balance a lot of things. As you remember that the Q1, there was a little bit more uncertainty in the market. At that point in time, we thought that was the right thing to do.
Great. Thanks for taking my questions.
No, thank you.
Thank you. One moment for our next question. Our next question comes from the line of Michael Cyprys with Morgan Stanley. Your line is open. Please go ahead.
Great. Thank you. Good morning.
Good morning.
Maybe continuing the conversation on AlphaSimplex. Now the deal is closed, can you speak to some of the ways that you can leverage their capabilities and expertise to accelerate growth?
Sure. Well, we're very excited about having them become part of the family. As we said when we announced the transaction, from our perspective, where we currently have a great diversity of traditional long-only equity managers, expanding some of our capabilities to include those that are less correlated to markets on the equity on the fixed income side was very attractive to us. You know, they currently have very compelling offerings. Primarily they have institutional clients, but also including a fund that they are currently the manager of. I think the opportunity set from our perspective is that there is probably a broader range of channels and clients that could utilize their strategies in a well-diversified portfolio.
The conversations that we've been having, you know, with them and internally are how do we make those capabilities available to a broader array of potential investors in those? That would include, as you kinda think about taking capabilities that they currently have and offering them in other types of vehicles that could be more attractive. I also just think there is just a vast amount of untapped opportunity in terms of what they're capable of. Looking through some of the history of other aspects of the business that they've been involved in, we think there's an opportunity in terms of bringing what they currently have to markets where we have additional strength and focus, and then taking just their intellectual property and expanding that into other capabilities, again, through multiple vehicles.
It's supporting what they do really well, which is on the institutional side in the U.S. Anything we can do to help them there, but then bringing them more outside the U.S., which as we've noted for the last few calls, has been a really important area of growth for us. I think we kind of look at the in the institutional pipeline where we gave a little bit of forward-looking statement, undercurrent of that is a lot of that growth and optimism is all coming from outside the U.S., and we view that as a great opportunity, not just for AlphaSimplex, but for all of our managers.
Great. Thanks. Maybe speaking of the institutional pipeline, maybe you can elaborate a little bit more on the type of strategies that you're seeing in there. You mentioned it's quite robust. Maybe you could elaborate or help quantify the size of the pipeline today, how much of the fundings you're seeing or expect to come through here, in the Q2.
Yeah. I think as Mike noted in his comments, I mean, what's sort of interesting, even looking in the Q1, right? If you look at the 10 largest inflows, it really did span multiple managers and multiple capabilities as well as different geographical areas. you know, anytime you're looking at a pipeline, right, Because you work on the wins and you try to prevent the losses, you always have some clarity really on how those wins are gonna look over a period of time. you know, as I indicated, you know, this is, you know, the strongest we've seen it, and it really does go across not only equity managers, but fixed income managers.
Even within the fixed income managers, different ends of the spectrum in terms of what we're, of what we're offering. It really is nicely diversified. The challenge is always the timing, right? Because you can't control, you know, what the timing is of those, of those flows, and that's why there can be some lumpiness within each quarter. Mike, any other additional?
I think you covered it nicely. I think we've particularly seen interest in global strategies, whether they're, you know, global equity, global real estate, emerging markets. We've seen particular interest in those strategies across managers. But it is diverse, and the timing is difficult to project. But we, you know, we're pleased with the traction we've seen there and how that's coming across.
Great. Thank you. Just last one for me on M&A. Now with the AlphaSimplex deal closed, congratulations on that. I guess the question becomes just around, you know, how much time and thinking are you guys spending on incremental M&A from here? What sort of properties are you guys seeing in the marketplace that could make sense? Maybe you could talk a little bit how private valuations have evolved as well.
Sure. As you, as you know, and we often repeat, you know, for us, it's really important that we make sure that our long-term growth strategy is not predicated upon M&A. Obviously, you know, part of our business model allows us to partner with specialized firms that can help us expand our offerings and put it through the different distribution channels that we have. I think, you know, our main focus continues to be on organically leveraging the capabilities that we already have from our great managers. Already highlighted some of the opportunities we see in institutional, particularly non-US institutional, which for us is really an open playing field. A lot of our products, development and growth has been in ETFs and UCITS, so you'll continue to see us do that.
In terms of M&A, we remain very active in all of the activities that are going on in the market. We continue to have those conversations. From our perspective, you know, we look at it in terms of is there a strong strategic rationale and a good fit either on a product addition similar to, you know, say, AlphaSimplex and Westchester, which were both very focused on expanding from traditional long-only, you know, equity and fixed income into non-correlated strategies. That continues to be an area of interest for us. Obviously we continue to be interested in things outside of the U.S., so we'll continue to consider those things.
In terms of valuations, again, there hasn't been actually, not a lot of deals actually closed right around our space recently. There continues to be the disconnect between the public markets and the private market. Every deal is very different in terms of how people approach valuation.
Great. Thank you.
Thank you.
Thank you. This concludes our question and answer session, and I would like to turn the conference back over to Mr. Aylward.
Great. Thank you. I just wanna thank everyone again for joining us and for following us, and we certainly encourage you to give us a call if you have any other questions. Thank you.
That concludes today's call. Thank you for participating. You may now disconnect.