Welcome to Franklin Resources Earnings Conference Call for the quarter ended March 31, 2024. Hello, my name is Sylvie, and I will be your call operator today. As a reminder, this conference is being recorded. [Operator Instructions] I would now like to turn the conference over to your host, Selene Oh, Chief Communications Officer and 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 are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a number of known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from any future results expressed or implied by such forward-looking statements. These and other risks, uncertainties and other important factors are just described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including in the Risk Factors and the MD&A sections of Franklin's most recent Form 10-K and 10-Q filings. Now I'd like to turn the call over to Jenny Johnson, our President and Chief Executive Officer.

Thank you, Selene. Hello, everyone, and thank you for joining us today to discuss Franklin Templeton's results for the second fiscal quarter of 2024. I'm joined by Matt Nicholls, our CFO and COO; and Adam Spector, our Head of Global Distribution. We'll answer your questions in just a few minutes. But first, I'd like to review some highlights from the quarter. In terms of public equity markets, 2023 was, to some extent, a tale of 2 markets, the Magnificent Seven and the S&P 493 with the former contributing the lion's share of returns. So far in 2024, in the public equity markets, we've seen a significant dispersion emerge in performance among the Magnificent Seven, leading to a better environment for fundamental research to capture alpha and when augmented by robust risk management can deliver compelling portfolio results for clients. Given the current backdrop, we believe equity allocation should, in general, tilt towards sectors and regions that are being overlooked due to the heavy concentration in the largest companies. In addition, the theme of artificial intelligence will likely continue to be a significant stock driver, both positive and negative for the haves and have-nots over time. Meanwhile, on interest rates, consensus estimates currently indicate a notable decrease in the number of expected cuts for 2024 by the Federal Reserve from 6 to now 2. Fed speak increasingly signals openness to delaying rate cuts to later in the second half of this year on the back of improving economic growth and slower disinflation. Against this background, while cash may continue to look attractive in the very near term, fixed income opportunities will likely provide a better total return option over high-yield and cash equivalents as the cutting cycle commences. Looking at private markets, secular trends and macro tailwinds continue to create opportunities…

[Operator Instructions] One moment for your first question which will be from Craig Siegenthaler at Bank of America.

First, we have a big picture net flow question. Lots of ins and outs in the $7 billion, especially with the $14 billion and from -- Great-West. So how should we think about the core net flow run rate if we back the $14 billion out of the $7 billion of long-term net flows?

So Craig, thanks for the question. Let me -- let me answer that question in first, kind of how we're positioning ourselves, and I will -- I promise you, I will get to those points and Adam can add some additional cover -- color. So -- the way we're positioned the firm, I think of it as in 4 key secular trends that has driven our acquisition strategy and what we think will drive flows now and in the future. So the first obviously is our movement to alternatives. We think that it's not going away, private credit is here to stay, banks are going to lend the same way that they've done in the past, private equity is here to stay. And so if you look at our breadth of capabilities from Lexington, Clarion, BSP, Alcentra we think we have the broadest alternatives capability of any traditional asset manager. And from a flow standpoint, obviously well known in the institutional space, what's really important is that the -- in the wealth channel, there's a desire to go from about a 5% allocation to a 15% allocation. And what's significant there, if you just take the 4 biggest wire houses a 1% increase in allocation is $130 billion. And what we're excited about is that as we mentioned in the prior comments and opening comments, Lexington's that fundraise was in the wealth channel. And believe me, that was years of learning starts and stops in blocking and tackling, learning about education, educating our own team, educating the advisers who are selling to be able to be successful in that. And we think we can take that same strategy with any of our alternatives. The second -- I'm going to name 4 of them. The second is just customization. You're seeing…

We're looking forward to seeing your AI announcement later this week. We have a follow-up on outflows. Over the last 8 quarters, we added it up, Franklin had a $13 billion of all inflows. And I know this excludes realizations too. If we add up Lexington $10 million and Benefit Street $5 million. Combined, they add a $27 billion. So all flows look to have been maybe negative $14 billion excess 2 flagship fundraises. So a similar question, but [indiscernible] on the alts business, how should we think about the [indiscernible] net flow trajectory just given that dynamic?

So I think it's -- there's a little bit of noise in the alts numbers. If you just look in calendar year 2022 and 2023, we talked last time about how we raised $40 billion in the private markets. But the reality in our alternatives business, we raised $55 billion, and 80% of it was private markets. But the net change in AUM, you saw $40 billion added to the private markets AUM net, net of realizations, distributions, market, everything. But $16 billion negative in the liquid alts portfolio, which represents about 6% of our alts portfolio now. So that's where you're shifting from much -- the good news is it's the higher fee private markets that have had -- that had solid inflows in that window, but it was a little bit masked by the lower fee liquid alts. Now fast forward to this -- I'll go this fiscal year. So the first 2 quarters, first of all, we said that we would be raising between $10 billion and $15 billion. That's our goal for the year. We're on track for that. We've raised about $7.3 billion in the private markets and another just under $2 billion in the liquid alts. But if you net out distributions, realizations, FX and market, and to be honest, market -- the only negative market was real estate with Clarion and the others were all positive. We'd say it nets to flat. So again, kind of a gross number there. But if you take away the distributions, realizations and FX, FX was actually pretty significant. Matt could probably give you more details on this, but we netted flat so far in the -- in this fiscal year.

Yes. Craig, just for perspective, I'd say, for the last quarter that we're just reporting on, realizations and distributions was $2.6 billion, for example, and we had negative FX of another $1 billion. But we do -- we get these questions, and I think we're going to try and improve our disclosure on this to try and help the question around this. Now we've got the bulk of our alternative assets together. Remembering in previous quarters, we've always said, when we were much smaller, we've always said, look, realizations and distributions just not -- they're just not significant enough to report and break down the explanation of AUM, but they're now getting to the point where we're going to start providing that level of detail. But just for information, the last quarter, again, the one we're reporting almost $2.6 billion of realizations and distributions and $1 billion negative FX.

And Craig, the only thing I would add is that the other thing we've been able to do really is to work more closely with our distribution partners on the wealth management side over the last few quarters and we're able to secure calendar spots further into the future than we ever thought was possible. And I think that speaks well to our future fundraising as well.

Next question will be from Glenn Schorr at Evercore.

So I wanted to talk about fixed income a little bit. So I see pension-funded status is much, much better and rates are higher. I like the $8.3 billion in flows in the quarter, but I don't know how much of that came from Great-West or something else? So maybe you could talk about that. And then bigger picture, is this -- do you feel this is the beginning of a broader trend, the long-awaited fixed income flows, maybe you can give us a little bit of insight from whether it be RFPs, client combos or the consultants on -- if we're at the [indiscernible] of some larger flows into fixed income?

Yes. Thanks, Glenn. So interestingly, let's face it. As long as people believe rates have peaked and potentially will come down, they're going to go longer duration, right? So the only thing is you're now starting to hear the noise for the first time where actually people think rates may be longer -- higher for longer and somebody was even talking about a potential rate increases. So that could slow things. But let me give you what we're seeing. So we obviously had positive flows, but just looking at the pipeline, and the pipeline doesn't include any Great-West Life. If you add -- well, about 70-plus percent of the growth in the pipeline, is fixed income, and that crosses Western, Franklin and Brandywine. If you actually add BSP because I always think private credit really should be thought of in the fixed income because the decisions around that are often how you're thinking about your fixed income portfolio. The growth in the pipeline, 97% of it comes from fixed income. So 6 of our top 10 gross selling funds in the last -- this past quarter were in fixed income, corporate bond, core bond, multi-sector, munis, highly customized [indiscernible]. So definitely demand in the last quarter. But if you actually look at the pipeline going forward, the institutional pipeline, you see very strong demand for fixed income.

And I would say that it's also pretty broad-based. If you take a look at that funding pipeline, it's really across all 4 of the fixed income firms we have, which all have very significant pipelines right now. And if you take a look at the products we're offering, we're positive in core in high yield and munis was our best-selling segment. So really broad-based fixed income appeal, not just one product.

Yes. And they're also -- last thing I'd say on that is they're also positioned differently in terms of their view on where rates are going. So that means where we've had some performance weaknesses. It's being offset not always fully but being partially offset by strength in other parts of the franchise.

And on the institutional business that you asked about is strong, we're also positive in ETF and SMAs, muni ladders, to lots of different fixed income vehicles doing well for us.

Just [indiscernible] follow up on that same topic is have allocations changed a lot? In other words, I hear you on the flows. That's a very bullish commentary for the forward look. But if you took a snapshot of a year ago and 2 year ago allocations to where we are now and maybe 2 years forward, do you think we'll see a major equity fixed income shift? Or I know it's a lot broader than that. But like will fixed income allocations be a lot higher 2 years out?

Again, I think it depends on your view on rates. And as I think Adam or Matt mentioned, you -- our fixed income teams are all kind of spread out as far as their view on where rates go. The frankly, guys probably think a little bit higher for longer Western is probably more aggressively positioned for rate cuts. So I think it really depends on your views. I do think if rates stay higher for longer, it has impacts on returns on equity markets as far as expectations, private markets as well. So Glenn, I think -- again, I think it's going to depend on where people -- where they think they should position our portfolio. I don't know, Adam, do you want to add anything?

Yes. I think it depends on the client, right? You mentioned more fully funded pension plans, right? If we get a wave of more immunization going on, we're going to see that drive fixed income flows. At the same time, really in every channel around the world. What do we see is a move towards alternative. That money is coming out of all of the other traditional buckets. So I think both of those are kind of competing with each other and pushing fixed income allocations in the opposite direction.

Next question will be from Dan Fannon at Jefferies.

I guess, Matt, maybe we could start with some expense questions. So curious about what the delta was in comp versus your guidance and then as we think about the seasonal impacts of some of this quarter, how much do you expect to roll off as we go into 2Q? And then maybe update us on kind of the full year outlook for expenses.

Yes. Thank you, Dan. Yes. So a couple of things on expenses around the second quarter, I'll get to the comp and benefits in a second. I'd just like to say that notwithstanding the higher resets around compensation calendar resets around compensation that I'll talk about in a minute and meaningfully higher markets. If you exclude Putnam, which was the main addition we had in the quarter, our expenses would have been flat. So notwithstanding higher performance fees than we expected, higher calendar resets than we expected and higher markets than we expected. Our expenses for the quarter would have been flat when you exclude Putnam. So hopefully, that demonstrates some discipline there. In terms of your specific question around comp and benefits for the second quarter. The difference is, I said it's around almost half of it is the performance fee, a little bit less than half is performance fee increase relative to where we thought it would be. And then there's these high -- I would say, we were expecting Canada resets their composition, but they're just higher than we thought they'd be. So things like the 401(k), mutual fund units in compensation -- deferred compensation plans, vacation accruals. They were all -- when you add all those things up, plus the performance fee delta, it adds up to about $30 million. So when you add the $30 million to, I think I guided [ $815 million ] on the call, that gets you to pretty much where the [ $844 million ] is where we ended up -- where we ended up. So that explains that part of your question. In terms of the annual guide, last quarter, we guided to $4.6 billion, and that's excluding performance fees, but including the double rent that we've talked about around our New York City consolidation exercise. And I would increase that just slightly to probably $4.6 billion -- $4 billion to $4.65 billion, a very narrow range. So less than 1% higher, and that's really driven by the higher markets that we've experienced. If markets come back down again. as we've been experiencing very recently in the first part of this quarter, it wouldn't surprise me if our annual guide remains flat. But right now, [indiscernible] remaining equal, we expect it to be just slightly higher for the annual guide.

Great. That's helpful. And then maybe just a follow-up on that with regards to the effective fee rate I think you had talked about it coming into the mid 38s as the year progressed. So I guess, given where mix is AUM levels, all the dynamics that go into that, how do you see that trending?

Yes. Thank you for the question. So the EFR for the quarter dropped to 38.5. And I believe that's exactly how we guided for the quarter. And we're able to do that because we had a pretty good feel for the mix that we're coming in, in terms of flows. And I think I also pointed out that we were 1 basis point higher than usual, let's call it, or the effective fee rate for the last quarter was inflated by 1 basis point based on Lexington catch-up fees. Going forward, on an annual basis, I would say that our EFR should remain in the 38s probably in the mid-38s, it will be slightly higher than that, driven by episodic alternative asset fees, as we've experienced over the last 12 months and highlighted those clearly, I think, in our results. And it can -- and the other thing that will help it be higher is a larger percentage of alternative assets and a higher percentage of equities. With the public markets going up as much as they did in the first quarter, obviously, as a percentage overall, our alternative assets came down a bit, so that brought the EFR pressure down slightly. And then we had quite a few successes as Jenny mentioned in her remarks, in ETFs, Canvas, separately managed accounts. And all these things are lower fee rate businesses. It's less about fee erosion per se. I'd say, it's just more about the business mix. So for the next quarter specifically, we expect EFR to probably be even in the high 37, so let's say, high 37 to 38, but this is because of the success that we didn't anticipate as much success with Putnam because the overall Putnam business is a lower effective fee rate. They're kind…

Next question will be from Ken Worthington at JPMorgan.

On the institutional pipeline, when you win an institutional fixed income mandate, are you getting a bunch of cash? Or are you getting a portfolio of securities that you transition and then remanage and do you get a sense of where the assets are coming from? If it's going into fixed income, is it investors going from rates to credit? Are they going from equities to fixed income? Are they going from cash to fixed income? Or are they just switching managers because of performance? So any view on what you've seen in this pipeline that's driving the fixed income success you're having?

You might not like the answer, but the answer is yes. I think we're seeing all of those things, right? So often, people will switch managers because of performance. We see people beginning to extend duration out. Those are usually funded by cash. We should see some of the plus sectors being added to those are funded in a mix of different ways. And then, of course, on the retail side, it's typically a sale of a fund, so you really don't know where that's coming from. In terms of how folks fund things I would say that's a mix. We see 3 different ways. We see it being funded in cash. We see people using a transition manager and then sometimes we'll see folks fund to us with securities and ask us to get to the new point by a certain time. The other interesting thing we see in terms of how accounts are funded is actually outside of fixed income on the Canvas side, where we see significant use cases for Canvas as a tool to aid in the funding of accounts for taxable accounts we're able to do that in a much more tax-efficient way.

Okay. Great. And just on ETFs, how are you thinking about ETFs outside the U.S.? You're having nice success in your franchise within the States. How are you thinking about leveraging the brand? Or are you thinking about leveraging the brand you have and the ETF franchise that you've already built?

Yes. Our ETFs outside of the U.S. have grown in 2 important ways. One, I don't think this was the point of your question, but our single country ETFs, so ETFs that focus on the country, even if they're sold in the U.S. That's been a huge success for us. We were able to price those very competitively. But also in terms of ETFs that we're selling outside of the U.S. regardless of investment mandate, we've seen real growth there in Canada and in EMEA, in particular. Some of that is the single country flow. As Jenny mentioned in his remarks, we've seen some of the more sustainably oriented products go quite well. Green bonds, Paris-aligned, S&P 500 would be 2 that are examples of that. Outside of the U.S., we continue to see a mix of active, passive and smart beta. Passive is still the most significant portion of the market, but active has by far the highest growth rate. And just to put things into context, I believe that if you look at our flow for this quarter, about half of it or so was from outside of the U.S. in terms of our ETF business. So really trying to expand that to the best we can and seeing very good results.

Next question will be from Alex Blostein at Goldman Sachs.

Jenny, I was hoping to dig into your comments from the prepared remarks when you talked about being quite busy over the next 12 months with respect to private markets. Could you, I guess, expand on that a little bit? And I'm assuming wealth is going to be part of the answer. So when you think about the opportunity set in the wealth channel and lots of other folks coming in, with offerings already and it seems like that part of the market is getting a little bit busier. What are you guys doing to make sure you don't miss the window and opportunity there?

Yes. So I mean we're in the market with a few different things. And as Adam mentioned, we are getting on calendars. This stuff is laid out, we've probably surprised early on to learn this. I mean sometimes up to 2 years in advance. So the areas that we're talking -- Lexington obviously, has capabilities beyond their traditional Fund 10, where they've got middle market and co-invest offerings. In the case of real estate, Clarion's top 3 biggest funds are all perpetual. So they're always fundraising, although we definitely see kind of muted demand for real estate. They've got terrific performance. They've got terrific performance. And so I think when things shift back, Clarion should do very well there because they have very little exposure to office. In the case of the private credit real estate debt is really interesting, and we're talking to several clients about that. Obviously, CLOs, structured credit, special situations. And then actually, we've been successful. I never know how much I can talk about, but in our -- in Venture, our Franklin Venture Group is in the wealth channel right now raising money and first fund raise there, and it's going very well. So you just had 2 between BSP and Lexington closed their flagship funds. So then you're in -- that they're digesting and investing in those cycles. They're doing more of their niche type strategies, but they're in markets with those. And they'll -- as soon as those are deployed, I think Lexington's probably deployed 60% of their LEX 10, they'll come back into the market for another flagship. But in the meantime, they've got their middle market and co-invest. And I cannot emphasize enough the -- in the wealth channel, it's 50% the right product and 50% where you got the heft on the distribution side. And I think that is often underestimated. Our 350-plus client-facing wholesalers, internal, external specialists included can sell to an adviser's entire book. If you don't have the breadth of capability that we have, that's incredibly expensive because let's say you're just an alternatives manager, you're only selling to 5% to 10% of that adviser's book. And so it gets really expensive to build the breadth of capability that we have. And the years of investment that we've done in the Academy, again, our Academy is global, where we've now been able to bring alternatives by FT, which is a website that has tons of training on how advisers should think about alternatives in their portfolios to supplement just that wholesaler being out there in the field, I think, has been really important. So very much focused on the wealth channel, really excited about it. I think we have a great suite of products to be able to meet the needs in that market and the distribution capability and expertise to be successful there.

I got you. Okay. All makes sense. And then clarification for you guys on the pipeline. It sounds like there's a bunch of things in the institutional pipeline, as you discussed earlier. Is it -- could you guys help us just size the fee rate of the institutional pipeline, excluding Great-West as you described it? And then I guess is it fair to assume that the remaining piece of Great-West that's going to come in will be coming in at a much high fee rate? So kind of north of that teen-ish basis points, just given that the back end or what's come through came at a pretty low fee rate?

And the pipeline is -- the fee rate is slightly up from last quarter. But look, any time you want it's institutional, so that's lower fee than your traditional EFRs. And then number two, it's heavily weighted in the fixed income -- well, the new stuff is heavily weighted in fixed income, but probably overall pipeline, I don't know, Adam, a 60-plus percent probably fixed income. So I never know if we give guidance on the actual numbers in the pipeline, but it's -- [indiscernible] Matt, have we given guidance there?

I would say it's consistent with our institutional fee rate.

Got it. Okay.

It's in the mid- to high 20s, Alex, and then -- but it can be -- it's gone from anything from the mid- to high 20s to our overall effective fee rate. depending on the quarter and depending on the type of the -- the nature of the pipeline in a particular time. And then the -- to answer your second question, yes, the additional flows we expect to come in will be higher on average on the rest of the Great-West Life flow. And that's expected over the next 12 months. As we've said, we'll, of course, put that detail into our monthly flow. So you can see that, and then we'll provide detail on the effective fee rate when we have these calls and provide updated information.

Next question will be from Bill Katz at TD Cowen.

Okay. I apologize on London weather. So in terms of if I start with your reported net flows of 6.7 and I back out the 3.1 of dividends reinvested, which the industry doesn't include, I get down about 3.5. If I back out the initial capital from Great-West, that's minus $10 billion. If I then back out the $1.4 billion from the 3 alt managers you highlighted, I get to about $11 billion. And then if I back out the Canvas, ETF and the SMA, I think that gets about minus $18 billion for what I would consider to be a long-holding business. A, is that math correct? And B, if it is, what's the go-to plan here to sort of stabilize that part of the business?

So I'm not Matt Nicholls, I can't do the math that quickly. He probably could. So I couldn't quite follow all of that. But I will tell you that the growth areas where some of the things you wanted to pull out alternatives, ETFs, Canvas. I think we said consistently that those are our growth focuses and that they're growing a little faster than the rest of the business. If you take a look at the more traditional business and you look at our outflow rate our decay rate, it's really been stable to improving. So I think over the last few years, we've been able to do a very good job at protecting ourselves on the downside. And as we said earlier, I think Jenny pointed to a notion that we talk about in terms of core sales, which is our smaller sales, which are up pretty consistently at about 14% on average. So stable outflows, increasing quarter sales we're feeling pretty good about the traditional part of the business.

And I'll just add, look, we've been very open and honest that we've been underrepresented in the retirement channel. As I mentioned on the last quarter's call, we were ranked 14th on Empower's platform, and it's similar in some of the others. And with this acquisition of Putnam and the relationship and the absorption of their retirement team as well as their target date products, 1/3 of retirement flows go to the qual side investment plans, and they've got phenomenal performance of their target date products as well as stable value, we think we are poised to -- and again, if we just take our market share, it's a massive increase -- the retirement channel is still a very traditional asset-oriented channel, traditional mutual funds, equities and fixed income. And we just think with our distribution capability, not just to benefit from Empower, but taking that to all the different retirement platforms and gain more market share there.

And then the last thing I'd just add, Bill, is that this area you're trying to get to, which we actually have a little bit -- it's not really 18, but we think of it as I think it's more like 10 that we got to. But when you get to those numbers, it's very concentrated in areas where performance is even more important than usual, let's call it. And in those areas, performance has begun to improve, certainly on the equity side, in particular, quite significantly. So we've seen quite a slowdown in those outflows. On the fixed income side in the couple areas, we've had some weaknesses there, as you know, but we've seen some improvement there, too. So it's a fairly concentrated situation you're referring to and one that as performance improves, you see a correlation of slowdown in outflows.

And Bill, I would add that it's sometimes difficult to separate investment product from the vehicle itself. We have a number of businesses where an investment team is positive, but they're positive because their SMA, their usage, their ETFs are all positive, and the mutual fund might be negative. So is that the core business, they're not, right? At the traditional asset class, they're gaining flow, but they're gaining it because of the vehicle choice, not necessarily because the mutual fund is positive.

That makes some sense. And just a follow-up on all of that, Matt, maybe for yourself, just your base fee rate, it just seems like it's bouncing around a little more than I would envision just given the sheer sizing of the platform today. So can you help me understand if you're going to be sort of in that 37% range plus for the next quarter. And then you sort of bounce back into the fourth? Is that input to a very high level of flow in the alts managers. And if that's the case, is that just vehicles that are just turning on from capital to raise? Or is that from new money coming in the door? And if so, where might that be?

Well, remember, the annual guide I gave included the first quarter or so where we had an elevated EFR for the reason that I explained around the catch-up fees and so on. I think we were pretty close to 40 basis points at one point. We've been trying to be quite clear about that. So when you normalize that out, you get into the 38. And then the only thing that's driving it down periodically from quarter-to-quarter is the areas of growth. And when you add those areas of growth up and you just a second ago, Bill, when you went through your analysis on the traditional side of the business versus other areas of growth. When you start adding up ETFs, Canvas, SMAs and then the flows from Putnam, the overall Putnam -- remembering that it's not just the flows coming from Great-West Life from Putnam, it's the $160 billion, which is 17% higher than when we announced transaction of AUM that's at a multiple basis -- multiple point lower than the EFR of Franklin. So the fact that we've been more successful in that has -- that's what's driven the EFR down a little bit. But what we'd expect is that going into at least fiscal 2025, what we experienced at the beginning of fiscal 2024, depending on what products we have and everything that Jenny just read through or not, there's a possibility that it could step back up again into the higher 38 based on the episodic alternative asset fees. But that's just an exclamation around why it could go up a little bit more and down a little bit more than usual. It's those offsetting factors. It's basically a form of business mix plus the episodic activity out of alternatives. Bill, I'll also answer because…

This concludes today's Q&A session. I would now like to hand the call back over to Jenny Johnson, Franklin's President and CEO, for final comments.

Great. Well, everybody, thank you for participating in today's call. And once again, we would like to thank our employees for their hard work and dedication delivering this quarter. And we look forward to speaking to all of you again next quarter, and everybody stay healthy.

Thank you. Ladies and gentlemen, this does indeed conclude today's conference call. You may now disconnect your lines.