Invesco Ltd. (NYSE:IVZ) Q2 2023 Earnings Conference Call July 25, 2023 9:00 AM ET
Company Participants
Greg Ketron – Head of Investor Relations
Marty Flanagan – Chairman Emeritus
Andrew Schlossberg – President and Chief Executive Officer
Allison Dukes – Chief Financial Officer
Conference Call Participants
Glenn Schorr – Evercore ISI
Brennan Hawken – UBS
Brian Bedell – Deutsche Bank Securities, Inc.
Craig Siegenthaler – Bank of America Merrill Lynch
Alexander Blostein – Goldman Sachs & Co.
Michael Brown – Keefe, Bruyette, & Woods, Inc.
Daniel Fannon – Jefferies LLC
Operator
Welcome to Invesco’s Second Quarter Earnings Conference Call. All participants will be in a listen-only mode until the question-and-answer session. [Operator Instructions] Today’s call is also being recorded.
Now I’d like to turn today’s meeting over to your host, Mr. Greg Ketron, Invesco’s Head of Investor Relations. Thank you. You may begin.
Greg Ketron
Okay. Thanks, operator, and to all of you joining us on Invesco’s quarterly earnings call. In addition to today’s press release, we’ve provided a presentation that covers the topics we plan to address. The press release and presentation are available on our website, invesco.com. This information can be found by going to the Investor Relations section of the website.
Our presentation today will include forward-looking statements and certain non-GAAP financial measures. Please review the disclosures on Slide 2 of the presentation regarding these statements and measures as well as the appendix or the appropriate reconciliations to GAAP. Finally, Invesco is not responsible for and does not edit nor guarantee the accuracy of our earnings teleconference transcripts provided by third parties. The only authorized webcast are located on our website.
Andrew Schlossberg, President and CEO; and Allison Dukes, Chief Financial Officer will present our results this morning. And then we will open the call up for questions. First, however, I’d like to turn the call over to Marty Flanagan, Chairman Emeritus, who retired as CEO on June 30 after 18 years to provide a few comments before we get into the second quarter results. Marty?
Marty Flanagan
Thank you, Greg. And before I turn the call over to Andrew and Allison, I want to say it’s been a pleasure to work with all of you over the years. It’s really been an exciting, challenging [indiscernible] participate in a fascinating industry that has continued to evolve and change, but always seeking to create better outcomes for clients and shareholders. Over the years, I’ve learned from my engagement with all of you, all the key stakeholders, clients, analysts and shareholders, which has been instrumental in the success of Invesco. I’m immensely proud of this organization and the talented people around the world that make Invesco what it is. There’s a tremendous opportunity for the firm going forward.
Invesco has the right strategy, the right team leading this organization into the future while navigating a challenging current market environment. The reality is that the strategies across firms in our industry are not very different. What separates winners and losers are those organizations that can execute effectively across all cycles and market conditions.
Andrew, Allison and the rest of the executive leadership team and our broader senior leadership team, represent the most talented and experienced team Invesco has ever had. They are laser focused on accelerating the growth strategy and making the necessary changes for the benefit of clients and shareholders. This is a team very well prepared and knows how to execute and deliver for all stakeholders. I’m confident in Andrew’s and the leadership team’s ability to achieve the full potential, and I look forward to seeing the firm to do great things in the years ahead. Thank you.
Andrew, I’ll turn it over to you.
Andrew Schlossberg
Thanks very much, Marty, and good morning to everyone. I’m pleased to be speaking with you today, and I look forward to continuing to work with all of you on the call. It’s an absolute privilege to lead a global investment management organization built with such a solid client-centered foundation and which possesses significant potential as we focus on delivering value for clients while innovating to meet their evolving needs. We have exceptional talent, robust investment capabilities, deep relationships with clients and a strong presence in key markets across the globe, all of which positions us well to stay in front of and lead during a period of growth and change in the asset management industry.
At our core, we will be focused on delivering investment excellence for our clients. While we are pleased to have a strong foundation, we are not at all satisfied with our results to date and we are committed to improving our performance by simplifying our organizational model, aligning our expense base, strengthening our strategic focus, being agile and innovative in advancing our use of technology and executing at pace. We believe this will lead to outstanding client experience, attraction and retention of top talent and an enhanced ability to generate profitable growth for the future.
I could not be more confident in the talented, experienced and collaborative team we have in place to take advantage of opportunities in the market and address the challenges confronting our clients and our industry. I want to again thank Marty for his visionary leadership that has provided Invesco, the foundation to capitalize on the opportunities that lie ahead.
With that, I’ll start today’s presentation of second quarter results on Slide 3 for those following along. In the second quarter, financial markets showed signs of recovery even as investors continue to grapple with significant uncertainty. Recovery was uneven across sectors and geographies and while the headline moves and market indices were positive, the underlying client environment continues to be relatively cautious given the uncertain economic backdrop.
Market gains were narrowly distributed, U.S. equity market increases were concentrated in large-cap technology stocks, while non-U.S. equity markets, most notably emerging international and China as well as most long-dated bond index returns were flat or negative. Client actions in the quarter remained risk off, resulting in slower industry growth and long-term assets while cash strategies continue to account for a historically large proportion of client portfolios. We did see an uptick in investor appetite for risk assets in June, providing some optimism for a broader recovery on the horizon.
Across our investment platform, performance is steadily improving in several of our key global equity capabilities and our fixed income performance remains robust across the board. Building on the delivery and quality of investment performance remains a key focus for me and for the management team.
From an asset flow perspective, in the second quarter, Invesco’s diversified business continues to deliver for our clients and prove resilient against market and industry challenges with sustained organic growth in several key capability areas where there is continued high client demand. The largest driver of growth in the quarter was our global ETF business. Net long-term inflows accelerated to $5.7 billion, more than double the growth we experienced in the first quarter and higher than our AUM market share.
Our ETF capabilities have demonstrated the ability to sustain growth through the full market cycle with organic growth in 11 of the past 12 quarters. Our business maintains a revenue profile that is differentiated from competitors with the concentration of strategies, including things like alternative beta, commodities, senior loans and laddered maturity products.
I’m also pleased to note that our business in Greater China returned to organic growth this quarter with $1.6 billion in net long-term inflows. While the higher fixed income redemptions the industry experienced earlier this year have abated, organic growth in China’s asset management industry has remained slower so far this year and overall assets raised by new fund launches across the industry sent to their lowest levels since 2019.
Despite this, Invesco Great Wall raised $1.4 billion from six new product launches in the second quarter, which ranked us fifth amongst all asset managers in China, which is well above our overall number 12 ranking in that market. As the China economy recovers, we are extremely well positioned to capture additional market share in the world’s fastest-growing asset management market. Client preferences for risk-off assets did continue to benefit our fixed income franchise across both institutional and retail channels, including mutual funds and SMAs.
We generated a positive $1 billion in net long-term fixed income flows this quarter, extending our streak to 18 consecutive positive flow quarters. Our money market business continues to show strong growth and market share gains. We brought in $15 billion of net new assets this quarter, and we’ve moved into the top 10 of money market managers in the U.S. institutional channel. We expect our overall fixed income franchise to continue to grow and benefit from our strong investment performance and the greater clarity we expect on the horizon as the interest rate picture becomes more clear in coming quarters.
Within active equity strategies, we did experience net long-term outflows of $4.5 billion in the second quarter, global and emerging market equities, where client demand has been slow to recover, and industry flows remain negative. This accounted for nearly 70% of our active equity net outflows. While headwinds have persisted in the asset class, net outflows for Invesco in developing markets were $1.2 billion. This is consistent with our experience last quarter, but meaningfully lower than last year. I’m optimistic for further stabilization of net flows in these key investment strategies as performance continues to improve and when client demand for risk on assets returns.
As we discussed on our last earnings call, growth in private markets has been more challenging this year due to overall market conditions, and we experienced $1.7 billion in net outflows in these areas during the second quarter. Despite the near-term headwinds, we have an excellent track record in both private real estate and private credit sectors, and we are well positioned to capture long-term growth in these asset classes, particularly in the underpenetrated wealth management channels in both the U.S. and globally.
We expect our private markets and alternative capabilities to be an engine of growth in our future years and Allison is going to provide much more color on that business later in her comments.
From a client and channel perspective, retail and wealth management flows were modestly positive in the second quarter, while our institutional channel had $2.2 billion in net outflows. This is the first outflow quarter in three years. And this comes following an especially strong quarter for fundings in the first quarter, where we had $6.6 billion of net inflows. As Allison will discuss later, our pipeline remains robust and a significant portion of our one-not-funded mandates are in higher yielding equity and alternative strategies.
The longer-term growth of our institutional channels is a testament to our strength of that business and the depth of our client relationships that we have built over many years. As such, I am confident that we will again see robust growth in this channel as client caution abates and as reallocations begin to occur across this part of the industry. Building balance sheet strength, continuing to invest in key growth areas and returning capital to shareholders are top priorities for us.
To that end, I’m pleased to note that in the first half of June, we repurchased $150 million in common stock. We are able to capitalize on an attractive valuation because of the strong balance sheet position that the firm has worked hard to build over the last several years. We are determined to continue to build on that progress. We are also committed to driving a high level of financial performance in Invesco. We will keep our clients and service levels front and center while also striving for accelerated profit growth.
The leadership changes we announced in February have put us in a position to unlock more opportunity for the firm, and we continue to implement related organizational changes in the second quarter. We are taking action to simplify the company and eliminate sources of complexity that were necessary in the past, but may no longer be appropriate today.
This will help us shift investment to our strategic priorities and areas of growth while ensuring our clients continue to receive investment quality and the exceptional service that’s one of the hallmarks of Invesco. The primary benefits of these changes will be seen over time as revenue growth recovers and we take advantage of our further scale. At the same time, we are taking actions that will enhance our near-term profitability and have identified an initial set of cost savings.
Work will continue to identify an action, additional efficiencies and enhancement opportunities and Allison is going to provide further detail on those efforts shortly. Although there is lots of work to do, Invesco is well positioned to take advantage of opportunities and address the challenges confronting the marketplace. I could not be more confident in the team that we have in place to execute on the opportunities that Marty created over his 18 years as CEO of Invesco.
With that, I’m going to turn the call over to Allison for a closer look at our results, and I look forward to your questions.
Allison Dukes
Thank you, Andrew, and I also want to convey my appreciation to Marty for his leadership. Good morning to everybody joining us today. I’m going to begin on Slide 4. Overall investment performance improved in the second quarter with 66% of actively managed funds in the top half of peers or beating benchmark on both a three-year and a five-year basis. This is an improvement from 64% for both time frames in the first quarter.
We have excellent performance in fixed income across nearly all capabilities and time horizons. Performance lagged benchmark in certain U.S. core and gross equity funds. Performance in global and emerging markets equities has been a headwind, but we are encouraged to see steady and meaningful improvement emerging in this asset class.
Turning to Slide 5. AUM was $1.54 trillion at the end of the second quarter, which was $55 billion higher than the last quarter. Technology stock surged in the second quarter, and as a result, QQQ AUM reached $200 billion, an increase of $27 billion as compared to the end of the first quarter. Market increases and additional products, foreign exchange movements and reinvested dividends combined to increase assets under management by a further $15 billion.
Net inflows in the money market products were $15 billion, and net long-term outflows were $2 billion. Despite the net long-term outflows for the quarter, we exited the quarter with strong momentum after more than $2 billion of net inflows for the month of June. We expect that we outperformed most peers on a net flow basis, another data point demonstrating the value of our breadth of capabilities in a difficult environment for our organic asset growth.
Client demand for passive capabilities was strong. And as a result, we garnered $6.4 billion of net long-term inflows in the second quarter. Offsetting the growth in asset was $8.4 billion of net outflows and active strategies. Through growth in our key capability areas, we are recapturing client demand as it moves to favored capabilities led this quarter by growth in ETF and our business in Greater China. Our global ETF franchise delivered a strong quarter, growing at a 9% annualized organic growth rate with $5.7 billion of net inflows.
Our top-selling ETFs included the S&P 500 Equal Weight and the QQQM, which grew to over $13 million in AUM after posting $3.3 billion net influx. Innovation remains a key strength in this area, the QQQM, which was launched less than three years ago, now representing the fifth largest ETF in our lineup.
Currency and commodity ETFs, part of our alternative asset class experienced net outflows of $1.1 billion during the quarter. We delivered net inflows of $200 million from retail clients in the second quarter, an improvement from $3.7 billion in net outflows in the prior quarter. A rebound in Asia Pacific net flows was the primary driver of growth. More specifically, we’ve experienced strong growth in Japan for several quarters now, ending the second quarter with $54 billion of AUM.
Our Henley Global Equity and Income Fund garnered $1.6 billion of net inflows from Japanese clients, making it the top selling retail fund in Japan on both a quarterly and year-to-date basis. Moving forward, we are well positioned in this important market and Japanese markets are experiencing some of the most constructive conditions for risk on assets in many years.
Offsetting growth in the retail channel was $2.2 billion of net long-term outflows in the institutional channel, primarily in the Americas. The channel remains in net inflows year-to-date after $6.6 billion of net inflows in the first quarter. Further, we have a robust and diversified one-not-funded pipeline.
Moving to Slide 6. Net long-term inflows resumed in Asia Pacific with $1.5 billion in the second quarter due to the growth I just discussed in Japan and a rebound to net inflows in our China joint venture. Net outflows were modestly negative in the Americas and in EMEA. Looking at flows by asset class. Fixed income capabilities experienced net inflows for the 18th straight quarter with $1 billion.
Drivers of growth this quarter included China, where we launched an institutional fixed income product and our tax-managed SMA capability, partially offset by net outflows in EMEA ETFs. Net outflows in global and emerging market equities continued to be a headwind in the second quarter with $3 billion of net outflows, including $1.2 billion from our emerging market spot. Encouragingly, this is similar to the net outflows experienced last quarter from emerging markets and below the redemption rates we experienced last year. We are optimistic that headwinds appear to be further diminishing in emerging markets.
Alternative net outflows were $3.4 billion in the second quarter. Public alternatives accounted for $1.9 billion with $1.1 billion concentrated in commodity and currency ETFs as commodities have been out of favor across the industry in recent quarters. Private markets net outflows were $1.5 billion, inclusive of $1 billion of net outflows in direct real estate strategies.
As we move to Slide 7, I’d like to take a few minutes to highlight our global alternative platform, which had $182 billion in assets under management as of June 30. Although market conditions have made it a challenging year for organic growth in the asset class, we have high conviction that alternatives will be one of the key pillars of our long-term success.
Within alternatives, we have a diverse range of capabilities, including $72 billion of public alternatives, spanning commodity strategies, listed real estate and hedged and macro strategy. Real estate is the largest component of our private alternatives platform, with $72 billion in direct real estate AUMs at the end of second quarter. Invesco competes throughout the capital stack by investing in direct real estate and originating real estate debt.
Our direct real estate business offers a range of investment styles, including core and core plus strategies as well as funds with higher return strategies. Our private credit platform is the second component of our private alternatives business with $38 billion in assets under management, anchored by our bank loan capability that holds U.S. and European securities. We have over 30 years of experience managing senior corporate loans, relationships with over 2,000 unique companies and more than 200 private equity firms. More recently, we began to offer direct lending to middle-market companies as well as opportunistic investments in special situations and distressed credit.
On Slide 8, we want to provide a deeper look at our direct real estate portfolio, where we have 40 years of experience investing on behalf of our clients worldwide. Our direct real estate holdings are well diversified by product property type. Commercial office properties comprise about 35% of our AUM. Apartments and other residential properties account for approximately 23%. And the AUM share of industrial properties, about 22% at the end of the second quarter. The final 20% of our AUM is invested in retail and specialty sectors, including mixed-use developments, self-storage and medical.
Focusing on office properties specifically, since the beginning of the COVID-19 pandemic, we’ve been deliberately managing our exposure down, particularly in the Americas and EMEA as market dynamics have shifted with attitudes towards remote work. In the first quarter of 2020, 42% of our institutional open-end AUM and core and core plus strategies was comprised of traditional office properties. At the end of the second quarter, it was 27%, and our exposure in the Americas was reduced by about one-third. Several of our direct real estate funds use leverage but were measured in our approach and the average loan-to-value across our direct real estate funds was approximately 35% as of March 31, 2023.
These figures may fluctuate over time and vary across specific funds. We serve our clients through a range of vehicle types and manage liquidity in accordance with the established bylaws of each fund. Approximately half of our AUM is in institutional separate accounts or closed-end funds with a predetermined life. The remainder in open-end vehicles that manage redemptions on a best effort basis. In our open-end funds, redemption requests go into a queue and are mainly met by net investors into the fund. Investors in our open-end strategies are highly sophisticated institutional investors that understand it may take several quarters to work down a redemption queue while preserving the fund performance for all investors.
Of our full business cycle, we would expect funds to average a redemption queue of 5% to 6% of NAV. This can fluctuate higher in times of market volatility like we’ve been experiencing recently. As of the end of the second quarter, all of our open-end funds were operating according to normal redemption protocols and our real estate teams have successfully navigated market cycles for four decades. Real estate activity has been slower during the first half of 2023, and we would expect activity to be muted in the near term until market conditions improve. In the long run, we expect that investor demand for private market capabilities will grow significantly, and we’re well positioned to capitalize on that growth.
Let’s all move to Slide 9. Our institutional pipeline was $22 billion at quarter end, consistent with last quarter. Although we experienced net outflows in the second quarter, our institutional business remains in net inflows for the year-to-date, and we continue to win new mandates. Our pipelines have been running in the mid-20 to mid-$30 billion range, dating back to late 2019.
So this is on the lower end of that range. We view our pipeline as strong given the market volatility we’ve been experiencing and the $6.6 billion in net inflows that occurred in the first quarter. As we’ve noted previously, some mandates are taking longer to fund in this environment, we would estimate the funding cycle of our pipeline is running in the three to four quarter range versus two to three quarters prior to the market downturn.
Our solutions capability enabled 35% of the global institutional pipeline in second quarter and we’re pleased to see this share increased from 14% last quarter. We embed solutions into our client interactions, and we have ongoing engagements about new opportunities. The pipeline reflects a diverse business mix with alternative and active equity accounting for 40% of the total associated assets.
Now turning to Slide 10. Net revenue of $1.09 billion in the second quarter was $83 million lower than the second quarter of 2022 and $15 million or 1% higher than the first quarter. The decline from the second quarter of last year was due largely to lower investment management fees, driven by asset mix favoring lower-yielding strategies. The sequential quarter increase was primarily due to higher performance fees earned on private real estate mandates, a $4 million decline in other revenues partially offset the increase in performance fees.
A shift in asset mix has had a meaningful impact on our revenue due to the uneven performance across key market indices as well as investor preferences for passive and risk of strategies, including demand for money market products. Total average AUM for the second quarter of $1.49 trillion, with $32 billion or 2% higher than the first quarter. However, $25 billion of the increase was in QQQ average AUMs for which we do not earn management fees. A further $4 million of the increase was in money market AUM.
Meanwhile, average passive AUM ex-QQQ was up $3 billion and average active AUM was flat to last quarter. As compared to the second quarter of 2022, total average AUM increased by $38 billion or 3%. The primary driver was a $58 billion increase in average money market AUM given the risk of investor sentiment of the past 12 months. Average assets in the QQQ were $12 billion higher than the second quarter of 2022.
Average passive AUM, excluding the Qs, increased by $9 billion while average active AUM declined by 5%. We believe that a meaningful portion of the asset mix shift that has occurred is a product of market movements and risk of sentiment, and those pressures should abate as preference for risk assets, returns and conditions improve. That said, growth in investor preference for passive exposure and solutions capabilities is a long-term secular trend, and we continue to reposition our cost base to align with changes in our business mix as we build greater scale in key capability areas.
Total adjusted operating expenses in the second quarter were $789 million, $27 million higher than the second quarter of 2022 and an increase of $40 million from the prior quarter. Included in our second quarter operating expenses were $27 million of compensation expenses related to executive retirements and organizational changes. In the second quarter of 2022 expenses of this nature were not included in our non-GAAP results as they were included in transaction, integration and restructuring expenses. We recognized $13 million of such expenses in the first quarter of 2023. Also impacting second quarter compensation expense with higher incentive pay on $22 million of performance fees partially offset by a seasonal decline in payroll taxes.
As Andrew noted, we are simplifying the organization to position the firm for greater scale and profitability as we grow our revenue base. The majority of the $27 million of compensation expense I mentioned was related to executive retirements and the balance was a result of other organizational actions taken in the quarter. We will action further adjustments to our operating model over the remainder of 2023 and would expect to recognize approximately $20 million of additional costs associated with these decisions in the third quarter. The full benefits from our simplification efforts will be seen over time as we generate revenue growth and margin recovery. To this point, we have identified $50 million of annual run rate expense savings that will be realized by the beginning of 2024.
Work is ongoing to quantify and action additional opportunities, and we will keep you informed on our progress. As we’ve discussed, we managed variable compensation to a full-year outcome in line with company performance and competitive industry practices. Historically, our compensation to net revenue ratio has been in the 38% to 42% range, trending towards the upper end of that range and periods of revenue decline. At current AUM levels, we would expect the ratio to continue to be at or slightly above the high end of the range for 2023, when excluding the cost pertaining to executive retirements and other organizational changes.
Marketing expenses of $32 million, $4 million higher than the prior quarter, indicative of the seasonally higher activity we typically see in second quarter. Marketing expenses were $4 million lower than the second quarter of last year as we are tightly managing discretionary spend in this revenue environment. Property, office and technology expenses were $2 million higher than the first quarter primarily due to higher software costs, partially offset by the end of overlapping rent now that we have completed the move to our new Atlanta headquarters.
G&A expenses of $114 million increased $19 million from the prior quarter. Second quarter expenses included approximately $7 million in spending on our Alpha NextGen program, which was previously included in transaction, integration and restructuring expenses. Going forward, these costs will be reflected in our non-GAAP results. We would expect quarterly average spending on Alpha NextGen to remain at the same level for the next few quarters.
As we mentioned on our last call, we benefited from indirect tax credits in the first quarter, a reduction in credits received drove a $3 million increase in expenses quarter-over-quarter. The remaining increase in G&A expenses related to higher project spending for ongoing technology improvement initiatives as well as normal fluctuation that we can see in G&A period to period after relatively lower spending in Q1.
Looking ahead, we expect G&A expenses in the third quarter to be flat to modestly lower than the second quarter. We’re balancing continued investment in our key growth areas and technology programs while diligently managing discretionary spend, and we are limiting hiring to key growth areas and critical positions. We’ve also been increasing our use of lower cost locations where it makes sense to do so. As an executive leadership team, we are committed to driving profitable growth in the coming quarters.
Moving to Slide 11. Adjusted operating income was $302 million in the second quarter, which included the costs related to executive retirements and other organizational changes. Adjusted operating margin was 27.7% for the second quarter. Excluding the costs related to retirement and other org changes, second quarter operating margin would have been 250 basis points higher.
Earnings per share was $0.31 in the second quarter, excluding those same expenses related to executive retirement and organizational changes, second quarter earnings per share would have been $0.05 higher. The effective tax rate was 24.7% in the second quarter. We estimate our non-GAAP effective tax rate to be between 23% and 25% for the third quarter of 2023. The actual effective rate may vary from this estimate due to the impact of nonrecurring items on pretax income and discrete tax items.
I’ll finish on Slide 12. Building balance sheet strength has been an unwavering priority, and I’m pleased to note that our cash balance increased in the second quarter to $1.01 billion, and that with $1.5 billion of outstanding debt that lowered our net debt to less than $500 million. We were able to achieve this reduction in net debt while also repurchasing $150 million of common stock in the quarter, or 9.6 million shares, equivalent to 2% of the total common shares outstanding. The share buybacks occurred at an average price of $15.65, which we viewed as a very attractive opportunity. The improvements we have made on the balance sheet in the past several years facilitated our ability to take advantage of this opportunity. Our leverage ratio, as defined under our credit facility agreement was 0.7x at the end of the second quarter modestly lower than last quarter.
We are committed to building an even stronger balance sheet, and our goal is to bring net debt excluding the preferred shares down to zero in 2024. We have an opportunity to further address outstanding debt with the maturity of the $600 million in senior notes at the end of January. We ended the second quarter with nothing drawn on our revolving credit facility. To conclude the resiliency of our firm’s net flows performance in a difficult market for organic growth is evident again this quarter, and I’m pleased with the progress we’re making to simplify the organization and build a stronger balance sheet while continuing to invest in key capability areas.
As a firm, we’re committed to driving profitable growth and a high level of financial performance, and we’re confident that we have the right talent, mindset and strategic positioning to do so.
And with that, I’ll ask the operator to open up the line to Q&A.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from Glenn Schorr with Evercore. Your line is open.
Glenn Schorr
Hi. Thanks. Appreciate it. Just a follow-up question on real estate. So obviously not unique to Invesco, but just given higher rate, some problem areas and long-tail workouts across parts of real estate demand is low as you mentioned. So curious if you could just sum up what’s the overall message on the health of the current portfolio? I think you put all that extra disclosure to tell us it’s good. But I wonder if you could just comment that. And two more importantly, what do you think the environment does need to look like for demand for real estate related products to improve? Because that would be a big growth driver for when we get there.
Allison Dukes
Sure. Why don’t I start. I’d say the overall message on the health of the portfolio is, yes, as you said, it’s good. Look, it is in terms of where we are from a cyclicality perspective, it’s been a challenging environment. That’s not unique to us, and that has a lot to do with some of the – just the backup and transactions in that market as rates have increased, the return profile, the ability to put leverage on some of these transactions, it’s more difficult. And that’s caused a back up, a slowdown in some of the transactions, which slows down activity overall.
That said, as we tried to highlight some of the detail we provided, our portfolio is performing very well. And we are long-term, very optimistic about how we’re positioned. And I would say everything is performing as one would expect in an environment like this. And we think we’ve made a lot of good strong decisions to diversify that portfolio, especially managing down the office exposure in advance of some of the downturn of the last year, and we feel good about where we’re positioned overall.
What does it take to see activity pick back up? I definitely think normalization in the leverage markets will help quite a bit. That has been, obviously, with some of the bank challenges that started in the first quarter and progressed into the second quarter. That wasn’t helpful. But as you start to see, I think, some conviction around the rate environment stabilize and you see banks and leverage markets performing at a more normal level. We’ll start to see activity pick back up.
I think demand remains strong. I guess the last thing I would say is, certainly, we saw some challenges as it relates to institutional allocations. When you saw equity markets and fixed income markets declined pretty significantly over the past year that cause a lot of institutions to be overexposed in real estate as equity markets and fixed income markets improve, the denominator effect is less of a concern, and some of the allocations there come back in line with what’s expected. And that’s going to be – that portends well for the future pipeline.
Andrew Schlossberg
And Glenn, I’d just add that as we look forward to opportunities, recall our portfolio is fairly global. So the dynamics are pretty different outside the U.S. than the U.S., and it’s a pretty diverse national footprint as well in the United States. Also I’d say is real estate debt is something we’re hearing increased demand for and have capability there, and we’re going to continue to focus on opportunities in the debt side of the market. And then the last thing I’d say is, while the institutional market is fairly well penetrated, the wealth management markets in the U.S. and globally we see tremendous opportunity where portfolio allocations are less than 1% to things like real assets at the moment.
Glenn Schorr
I appreciate all that. Allison, one other quickie. On the comments on the $20 million in the third quarter and $50 million for – by the end of 2024 and identified efficiency savings. Should we be thinking that it is all falling to the bottom line like or is there a netting effect in terms of the ongoing investments that you’re making? Thank you.
Allison Dukes
Sure. Good question. Thank you. And let me clean that up a little bit. $20 million in additional costs that we expect to incur in the third quarter with $50 million of net realized savings that we expect to be realized in the beginning of 2024, not the end. And so yes, to answer your question, that would be net savings that we would expect to fall to bottom line tax affected, of course.
Glenn Schorr
Thank you.
Operator
Thank you. And our next question comes from Brennan Hawken with UBS. Your line is open.
Brennan Hawken
Good morning. Thanks for taking my question. I’d like to touch on sort of at a high level here, Andrew. You referenced changes you wanted to make to simplify the organization. Allison added some additional color in the context of costs. But could you maybe either give us a frame of reference around what you think could help to simplify the organization. And is this – is this an opening salvo and something you intend to approach over the course of many years. And how should we think about maybe like incremental updates on your approach as you get your hands around and get settled into the seat? Thanks.
Andrew Schlossberg
Sure. Thanks, Brennan. Good questions. Maybe just to start at a high level of what we’re trying to achieve. So our aim of simplifying and streamlining the organization, obviously, is to generate better profit growth, but it’s also to improve quality of investment performance. We want to simplify the organization so we can accelerate more quickly strategic execution, and we want to be able to use our scale and leverage that we have in the business. So what we did was we started this process earlier this year. And to answer your question, it’s going to continue through the course of this year and going forward. This is an ongoing effort to continue to reposition our business for where client demand is. A few examples of some things that we’ve been working on and will continue to work on. One is around investment team simplification and quality improvement.
So for instance, we brought together three multi-asset strategy teams into one. We’re further bringing together our fixed income platform around the world. We’ve enhanced leadership, global leadership with our co-CIO structure and fundamental equity. So things like that around investment team simplification, we’ll continue to focus on. We’re also looking to globalize core elements of our client engagement and client delivery. So we combined leadership in the Americas and EMEA.
We established a single marketing organization. We’re globalizing digital platforms, and we’re taking out complexity in our product platform. We combined our ETF and SMA and custom index leadership and reduced our product line by over 150 products. So lots going on in the client delivery side. And then we’re simplifying and reviewing our operating and enterprise models sort of end-to-end looking for ways to take advantage of those front-end changes and move them through the cost base and be more efficient.
And then the last thing I’d say, which I think speaks to what we’re going to continue to do going forward is evolve the culture. And so we’re going to be tightening our execution edge as a team. We’re going to be simplifying our operating and organizational models, which we’ve started, and we’re going to enhance the accountability around profit growth. So you should expect to continue to hear updates from me and Allison regularly about these efforts.
Brennan Hawken
Thanks for all that color Andrew. Much appreciated. For my follow-up question on real estate, sort of following on to Glenn’s question. So you break out traditional office – traditional U.S. office, which is great. But what – how would you defined nontraditional office, I guess? And what would that do to those numbers? And then when we look at the difference in the allocation to traditional office from 20% down to 13% in the Americas over that three-year sorry, 1Q 2020 to 2Q 2023. How much of that were disposals versus price declines in the assets?
Allison Dukes
Let me take maybe the second one first. That would primarily be dispositions. The vast majority of that would be deliberate choices that were made, not declining asset values there. So it’s been a rocky environment but not an entirely terrible one to try to exit and reposition that portfolio. So I think we were I think our timing was good in a lot of ways, we moved quickly, and we’ve been able to, I think, show the results very quickly. So that – there’s a good news story there, not a bad news story. In terms of what’s – I’m not sure I followed your question on traditional office versus not in traditional office.
Brennan Hawken
I guess I was just – yes, I was just trying to understand office like is the overall office exposure actually larger than what you guys define as traditional? Or did you just use the term traditional just to define the office sector broadly?
Allison Dukes
No. It’s not larger than what we would define. If you think about what’s outside of what we would consider traditional things like medical office buildings and things that we would truly consider to be different than mid-rise, high-rise kind of office exposure.
Brennan Hawken
Got it. Okay. Thanks for that.
Operator
Thank you. And our next question comes from Brian Bedell with Deutsche Bank. Your line is open.
Brian Bedell
Great. Thanks. Good morning, folks. Thanks for taking my question. Just about staying with the private alternative platform theme. I guess as we sort of look forward, just a couple of some of the potential bigger drivers within this bucket. So maybe if you could just size the redemptions that you’re currently running at for the open-end strategies that you talked about in real estate. And then the opportunity going forward, particularly in direct lending, to what extent do you think you can expand these strategies given potential pullback in banks? And is that something that’s more of a near-term development or really more to longer term?
Allison Dukes
Yes, I’ll take the first one. I’d say the redemption rates in the open-end strategies. And again, what we tried to do was narrow down the percentage of our portfolio that is an open-end strategy. And with that, normal redemption rates through the cycle would be kind of 5% to 6%. And as we noted, we’d be on the higher side of that. We would be above that range. And it varies though and it varies quite a bit across the different products. So on average, it’s a touch higher than where we are today.
Operating though very normally and very consistent with what we’ve experienced in cycles like this over 40 years in the business. So more than anything, I think what we hope to convey is it’s quite normal and quite manageable. And there are no liquidity issues or concerns across any of those individual funds. I’d say maybe, Andrew, you want to take direct lending.
Andrew Schlossberg
Yes. In private credit, we’ve been building out our capabilities over the last few years in distressed and in direct lending. And demand, both from institutions and emerging from high net worth retail or wealth management continues to – we continue to see it. We continue to have asset raises and focus both in the U.S. and in Europe. We expect to continue to see that demand for the reasons you described. I’d say given that we’re relatively new entrant into that space, and we’re building our reputation it will be a driver, but it will take some time for it to be, I think, a meaningful part of the private markets, enterprise like our private real estate franchise is.
Brian Bedell
Got it. That’s great color. And then just on the cost side, Allison, maybe on the AlphaGen program, it sounds like that $7 million run rate is sort of – it’s a cost number, but I guess is that – should we be considering that to be like a net cost number of savings? And I guess, do we have any idea yet longer term as you get that platform completely on to and integrated with Alpha, any sense of sizing what potential cost savings can come from that initiative longer term?
Allison Dukes
Yes. Great. Thanks for the question, Brian. So on A&G, just a reminder of one thing I’ve said that we’ve had A&G costs for the last year plus in our transaction integration and restructuring expense. And with that, you discontinued after the first quarter, you do see our cost base now fully loaded through our GAAP financials with the cost that we are incurring for Alpha NexGen and some of these organizational-related changes as well. So it is a difference that does cause changes in our overall operating expense base I noted that it was about $7 million in the second quarter and that we would expect it to be at about that level for the next few quarters.
We will be hard at work on Alpha NexGen really through 2024 and into 2025. So we will be providing ongoing updates, but I think that’s a reasonable expectation for the cost right now. In terms of savings, savings will come once we are able to go live. And we do not – we will not be going live until we are in 2024. And then we will be running parallel for some time. And then savings and rationalization really is something that would occur on the other side of that.
So as we get closer to 2025. So we’re ways off from providing you estimates on how our expense base could improve over time. But we are entirely focused on a successful execution right now, and we do expect the cost that we saw in the second quarter to remain in our cost base for some time as we really focus on the execution here.
Brian Bedell
Yes. It’s great color. Thank you.
Andrew Schlossberg
Thanks.
Operator
Thank you. Our next question comes from Craig Siegenthaler with Bank of America. Your line is open.
Craig Siegenthaler
Thanks. Good morning, everyone. Buyback activity was quite strong in the quarter. You paid out 170% of your earnings power. And I think most of the buybacks just came in the month of June. So how should we expect your share repurchase effort going forward to trend. And will it be more consistent than in the past or more episodic?
Allison Dukes
Thanks, Craig. I think, look, as we’ve noted all along, we’ve had several priorities that we’ve been working really hard on making parallel progress on and one of which has been improving the balance sheet overall. And improving the balance sheet is what gave us the capacity and the flexibility to be opportunistic in the second quarter and execute on those buybacks.
And we were pleased that we were able to do so and to do so without any additional borrowings on our credit facility and continuing to manage our net debt down. So – those are the types of things we need to see to put us in a position to be opportunistic going forward. We were not particularly pleased with our price when we were staring at something that started with $14. And so we did have the opportunity in the second quarter to make some progress there. And I think you should expect over time that we’re going to be disciplined and diligent and continuing to improve our balance sheet. But where we see opportunities to return capital to shareholders, we’re going to do so as well.
Craig Siegenthaler
Thank you, Allison. Just as my follow-up, money market flows continue to be strong. You’ve doubled this business in less than three years. Can you just update us on the drivers? And can this trajectory continue even if overall trends like broker cash sorting slows?
Andrew Schlossberg
I’ll make a couple of comments, maybe and then Allison can jump in. We’re really pleased with the growth and it was deliberate. I mean we focused on quality in the cash management, money market side, client engagement and pricing, and it paid off. We saw $15 billion in inflows this quarter. It’s important to remember, 85% of our business is institutional. And we don’t expect that to change. We’re very strong there. We’ve moved into the top 10, and we’re taking market share I think with high yields continuing for some time, it’s going to continue to be a drive on demand, and we expect to continue to take share. Allison, I don’t know.
Allison Dukes
Got it.
Craig Siegenthaler
Thank you, Andrew.
Andrew Schlossberg
No problem.
Operator
Thank you. And our next question comes from Alex Blostein with Goldman Sachs. Your line is open.
Alexander Blostein
Thanks. Good morning everybody. So maybe we can just kind of wrap up the private markets growth strategy through a couple of questions here. I guess when you look at the real estate business, to your point, there are a number of challenges facing over the next several quarters. and in private credit, some of the growth areas, whether it’s direct lending and kind of distressed or opportunistic credit are newer, and you highlighted that it’s going to take a little bit of time for them to contribute. So how are you thinking about organically turning this business into a positive net flow mode over the near term? Or do you think it will require some inorganic opportunities to add more product breadth as well?
Andrew Schlossberg
Yes. So we’re – I’ll start by saying we’re very focused organically. We think the spaces we’re in, in private real estate and in the private debt side of the markets are the places we want to be. We’ll continue to look over time, obviously, to grow that organically. And if things present themselves to extend off of that, we’ll pay attention. But our focus right now is growing them organically. In addition to some of the things that Allison already covered on the recovery on the institutional side of things, which will – we think will happen in time.
The real growth driver for our real estate business is going to be through the wealth management channels. We started that effort several years ago. We’ve seen strong placements for our nontraded REIT strategy, and we’re going to be and continue to be in market with strategies like those, including on the debt side of real estate. And as I mentioned, the penetration in wealth management for the industry is less than 1% with most expectations getting it to 10% to 15%. That will take some time. So we think with an offering like we have in a pedigree, combined with our wealth management distribution strength in the U.S. and in Europe, that that’s going to be an amazing opportunity. We’ve invested in those areas already. So the growth is going to come to us in the next couple of years, and we think it could be meaningful. So those are the areas that we’re going to be focused on in addition to the institutional space.
Alexander Blostein
Got it. Thanks. And for my follow-up, Allison, just around Alpha NextGen, obviously, it’s been taking longer. It’s a complicated transaction, so that’s all fair. But what has gone right, what has gone wrong? Why do you think it’s taking longer than sort of original expectations? And on the other end of that, do you think there’s going to be room for you guys to negotiate fees down at the ultimate kind of end game of this transaction given the fact that it’s taken longer than expected? Thanks.
Allison Dukes
Well, so I would say, look, it’s been a strong partnership with State Street. We’ve worked closely on the execution of this for the last couple of years, and we have been negotiating around the ultimate cost of this, and it is an important partnership on both sides. And I would say both parties have been responsive and thoughtful as to both the cost and the time that’s involved here. So you should expect that’s ongoing, not something that happens on the back end.
What’s gone right or wrong? I think that’s harder to answer. And I guess I would say, in many respects, it is large and it is a bit unturned for both parties. And so we’ve been working together to try to do this in a way that’s very thoughtful and provides the benefits we’re looking for, for our business. So I think if I could say anything, I would say probably everything going harder and longer than you expect in large-scale technology implementations.
And I don’t think that’s unusual, but one that we are certainly making our way through. We feel good about where we are right now. We feel good about the attention of all teams from both parties and the work that’s underway. The fact that it’s taking a little longer than we expected. I don’t see it as a huge negative, but one that is just something that we’re figuring about as we go along on both sides.
Andrew Schlossberg
Yes. The commitment is high from – obviously, from both parties and other related parties that are working on it, we’re really heads down trying to get the execution and implementation done, and we feel good about that.
Alexander Blostein
Got it. All right. Thanks very much.
Operator
Thank you. The next question comes from Mike Brown with KBW. Your line is open.
Michael Brown
Great. Thank you very much. In China, it looks like there’s been a regulatory mandate to limit the fee rates for products there to 1.2%. Has that already begun to impact China, Great Wall? Or is that something that will kind of come through later this year? And then as you look to next quarter, can you just expand on maybe some of the puts and takes we should consider here for the fee rate when we think about next quarter, maybe that exit fee rate, if you will?
Allison Dukes
Sure. Let me start with China. That was just announced in early July, so just a couple of weeks ago. So we are evaluating what that means for our portfolio right now. Our estimates right now is that those fee cuts will impact about $24 billion of AUM, so about 28% of our portfolio there. It’s early, and we are still working through a lot of this in terms of both timing and overall impact. The timing is perhaps here in the third quarter, but certainly into the fourth quarter as we anticipate revenue being on a net basis lower, somewhere between $5 million and $10 million per quarter. Now that’s for all of the JV. And of course, we own a 49% share of that. But with that lower revenue, there’s also lower compensation changes that come with it. So the ultimate impact to net income will be much lower than that. And I think we’ll be able to provide clear guidance around all of that at the end of the third quarter.
Overall, I’d say we actually are really well positioned with that change just given our more mature market positioning in China overall. As a reminder, we’re the 12th largest asset manager there, the largest foreign – and we have a very mature business, having just celebrated our 20th anniversary there. And we actually think this reform is really going to facilitate high-quality development of the overall mutual fund industry in China, and that’s going to just serve to accelerate growth and really better serve investor needs.
So while there is a near-term impact, we actually think this portends well for the overall growth of the industry in China and that we are well positioned to capture some of that growth. To your question around fee rate and what that means, what we expect from an exit perspective going into the third quarter. We’ve definitely seen continued declines in our overall net revenue yield, and that’s really a function of mix shift dynamics. We gave a lot of color on that in the prepared remarks around just the uneven recovery across asset classes and the particular impact of the risk off sentiment in our overall net revenue yield.
I’ll say we are not seeing fee pressure, but we are seeing high demand for some of our lower fee assets even within our passive assets. We see high demand for some of our lower fee capabilities there. As an example, our two largest selling ETFs in the second quarter were the QQQM and the S&P Equal Weight 500. And those would both be on the lower end of kind of our fee range for our passive capabilities.
So on the one hand, we’re incredibly pleased that we continue to capture flows and we’re well positioned in areas of client demand. On the other hand, that does continue to put some pressure on our fee rates. What does it mean going forward? I think we expect the mix shift dynamics to continue. That said, we’re pleased with some of the recovery we’re seeing in some of our active equity strategies, both in terms of market recovery and diminished headwinds as it relates to redemptions and improving sales particularly as we see performance recover in areas like our developing market strategy. So net-net, I think you should expect continued modest pressure, certainly dependent on market recovery dynamics from here.
Andrew Schlossberg
Yes. If I can just go back to China and just for – just to add a couple of comments, a couple of additional comments. I mean, certainly, market sentiment post-COVID has been a little more negative, and it’s been slow. But I think the Chinese government’s pro-growth reforms and the things that policies and actions underway. We’re starting to see some of that demand come back. And I’ll just reemphasize something Allison said, which is our strong position there and our conviction about the Chinese asset management markets growth.
It is very early days in terms of investors’ sophistication and asset classes. It’s very early days in retirement markets and our position being there for 20 years with close to $100 billion in assets under management, good performance, a good reputation and a bit of a moat around competition coming in, really bodes well for long-term success in China, and we’re looking forward to seeing that for the years to come.
Michael Brown
Great. Appreciate all the color there. And then just as a follow-up on the other revenue line that was down again sequentially. I know last quarter was impacted by lower real estate transaction activity. Was that kind of a similar story here this quarter? And any view on the near term there as well. I appreciate all the comments in your prepared remarks on the real estate side, but just kind of interested in that line near term.
Allison Dukes
Sure. Well, some puts and takes in that line item. Real estate transaction fees were actually a little bit higher in that line item in the second quarter as compared to first quarter. But the negative, what was offsetting that was a lower front-end fees. You really just saw a decrease in some of the transaction fees that were driven by a decrease in equity sales. So puts and takes always a little bit of a lot of discrete items in that line item.
Michael Brown
Okay. Is it fair to assume that next quarter or maybe next couple of quarters would be semi similar to that level?
Allison Dukes
I think that’s a reasonable expectation. I mean it moves so modestly up and down. It’s hard to predict that as that’s kind of discrete level. But you can probably look at the average over the last couple of quarters, and that would be reasonable.
Michael Brown
Okay. That’s fair. Thank you very much.
Operator
Thank you. Next question comes from Daniel Fannon with Jefferies. Your line is open.
Daniel Fannon
Thanks for squeezing me in. So I wanted to take a little bit longer view on the fee rate. Obviously, the mix shift trend has been happening for some time. Allison, you mentioned the current dynamics. But as you look out over the multiple year period, how do you see that trend stabilizing, accelerating or kind of continuing? And then as you announced on the cost side, are you adjusting the expense base fast enough to deal with that trend? Because clearly, there’s been some lag effect of expenses in terms of this mix shift. So excluding beta kind of as you think about that fee rate and then ultimately, the expense base, how we should think about the appropriate use of scale and margin in that context.
Allison Dukes
Thanks, Dan. I do think over time, you start to see the decline in the fee rates start to abate. I don’t know where that is exactly, but you can look at where the demand is for some of our higher growth capabilities. And those fee rates, if you look at – let’s take the ETF portfolio and our passive fee rate, that has declined, and that is all available in our disclosures. And that declined to just under 16 basis points in the second quarter, which was down about a basis point. But again, that’s because of what I just pointed to in the growth in some of our capabilities that are in high demand that are around a 15 basis point fee rate.
If you look at some of the areas of our ETF capabilities that we’re trending off in the last couple of quarters, that would be around commodity and currency ETFs that are going to be on the higher side. And once we see in more of a return to a risk on mentality, we would expect that to come back. So I think, look, our passive fee rate, I think it probably is in that 16-ish basis points over a long-term horizon.
China has obviously had some pressure given the fee cuts we just talked about, but that is on the much higher side, much higher than the firm average, and we expect to see continued strong growth in China as the economy recovers there. Our private market capabilities would be on the higher side, too. You kind of take all of that, you think about the barbelling and one would think that, yes, the fee rate starts to even out roughly, maybe diminishes a bit more as we continue to see some of this mix shift, and we continue to see the growth of our passive capabilities. But over time, over a longer-term time horizon, it should start to abate and even out a bit. Scale, getting to scale and our passive capabilities has been something we’ve talked about a lot, something we continue to be very focused on and getting to the second part of your question, aligning our expenses around that.
It takes some time to reposition an expense base that was built to support who the company was seven, eight, 10 years ago to where we think it will be seven, eight, 10 years from now. And it’s really part of the methodical work we are undertaking now as we continue to simplify the organization and continue to look at how we can reposition our overall organizational structure as well as our technology and operational structure to support where the business is going and continue to really scale there and focus on the marginal profitability improvements, we think we can garner as we get to scale in some of those asset classes.
Andrew Schlossberg
And I think as Allison was alluding to on the revenue yield, client demands and broadening of markets, which we talked about in our comments are two of the things that have a major impact on the revenue yield, and Allison pointed some of those. In terms of the scale and the expense space, the scale of the company, we’re certainly going to benefit from our side.
I think as Allison was alluding to, we’re going to continue to look at the different component parts of our business and what’s required from an expense-base standpoint, in an ETF franchise versus a private markets franchise are going to be – are obviously different. So we’re going to continue to look business by business, not just our global scale.
Allison Dukes
And in that, I think the concluding comments as I would say, we feel very confident we can improve operating margin from here. And that remains our area of focus. The challenge and the really fast remixing of our asset base over the last 12 to 18 months, has been a pretty tough challenge to contend with. At the same time, we’ve been making deliberate changes along the way, and we think we’re really well positioned to capture really start to improve operating leverage over time, and make sure that the expense structure of the business is repositioned to really support what we think the revenue environment will be for the next few years.
Daniel Fannon
Thank you.
Operator
I’ll turn it back over to you.
Andrew Schlossberg
All right. Well, we’ll just wrap it up by saying thank you, and we look forward to speaking with everybody next quarter. Have a great rest of the day.
Allison Dukes
Thank you.
Operator
Thank you. That concludes today’s conference. You may all disconnect at this time.
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