Pzena Investment Management, Inc. (NYSE:PZN) Q1 2022 Earnings Conference Call April 20, 2022 10:00 AM ET
Company Participants
Richard Pzena – Chief Executive Officer and Co-Chief Investment Officer
Conference Call Participants
Mike Sykes – Pzena
Tom Brownell – Rock Point Advisors
Operator
Hello and welcome to the Pzena Investment Management reports results for the first quarter of 2022 conference call. My name is Alex and I will be coordinating the call today. If you’d like to ask a question at the end of the presentation [Operator Instructions] I will now hand over to your host, Richard Pzena, CEO of Pzena Investment Management. Over to you, Richard.
Richard Pzena
Thank you, Alex. Good morning, and thank you for joining us on the Pzena Investment Management first quarter 2022 earnings call. I’m Rich Pzena, Chief Executive Officer and Co-Chief Investment Officer. Jessica Doran is not with us this morning, but I did want to congratulate her on the recent birth of her daughter, we all wish her the best. Our earnings press release contains the financial tables for the periods we will be discussing. If you do not have a copy, it can be obtained in the Investor Relations section on our website at www.pzena.com. Replays of this call will be available for the next two weeks on our website. Before we start, we need to remind you that today’s call may contain forward-looking statements and projections.
We ask that you refer to our most recent finance with the FCC for important factors that could cause actual results to differ materially from today’s comments. Please note that we do not undertake to update such information to reflect the impact of circumstances or events going forward. In addition, please be advised that due to prohibitions on selective disclosure, we do not, as a matter of policy, disclose material that is not public information on our conference calls. One of the complaints I hear often for my family don’t worry, I’m not going to offer a long list. Is that I tend to repeat myself. And the truth is they are right.
I’ve been saying the same thing about value investing for my entire life. It just works. It works because people are emotional and not analytical. It works because people blindly project recent events indefinitely into the future. It works because people tend to shy away from considering investments that have known problems. As for me, I’m comforted by the predictability that value investing works because of these very human tendencies. My favorite chart these days is one that shows a 70-year history of the Price to Earnings ratios for the most expensive quintile of stocks along with the cheapest quintile of stocks in the broad U.S. market.
While the expensive stocks PE are fluctuated between 12 times and 85 times and today it’s very near their high point, cheap stock have barely budged for 70 years ranging between 5 and 10 for the entire period. In other words, as we sit here today, I see an environment that is very normal for a value investor. Until it seems to me perfectly reasonable to expect that the return opportunity for value strategies should be similar to what has been earned over the long term. At the same time, given the valuations spreads seems very difficult to imagine that growth strategies or the broad market for that matter are likely to earn returns similar to their long-term histories.
And so we stay the course building concentrated portfolios of deeply undervalued companies, which have gone through a rigorous research process combined into a portfolio that offers attractive long-term return potential, along with a diverse set of risk exposures. Just like we always have. In addition to my enthusiasm for our investment opportunities looking at, I wanted to share this morning — something this morning about two subjects getting primary attention here at Pzena, as well as amongst our clients all over the world. They are diversity, equity and inclusion, and ESG. Let me start with DEI. We’re extremely proud of the leadership roles women play in our organization.
Here are just a few highlights. Our executive committee of six includes two women, our General Counsel, Head of Human Resources, both Co-Heads of our North American distribution team and our Director of Marketing Operations are all women. 57% of our promotions, transfers, and partnership appointments over the past five-years have gone to women. There’s certainly more for us to do in this area. And we continue to strive to increase the diversity in our applicant pool for all loans. On the ESG. We have always beard, environmental, social, and governance factors as being integrated into our investment process.
As such, the primary responsibility for our ESG analysis falls on our 28-person research team. While we have added three ESG specialists to coordinate our issue identification, documentation and tracking of these ESG issues. The entire research team is focused on ESG. Unlike many managers who have taken a quantitative approach, focusing their investments on companies with high ESG scores. We believe a better way to enable our clients to benefit from companies increased attention to ESG issues, and to have more impact as responsible stewards of capital. It’s to focus our analysis on companies that are taking identifiable steps to improve their ESG standard.
We wrote a whitepaper which highlights that ESG improvers actually make for better investments than those with current high ESG scores. We will keep updating this data as it is too short to have complete confidence. But the initial results are encouraging on the business front. I can report that things are going well our net flows, which have a very erratic pattern were flat this quarter. But for the trailing 12 months were about $1 billion in net inflows. And the pipeline is building slowly but surely as we typically see after value cycles take hold. Now for the details.
We reported diluted, fully diluted earnings of $0.16 per share for the first quarter, compared to $0.24 last quarter and $0.24 per share for the first quarter of last year. During the current period, we recognized an additional $5.9 million of expense associated with a change in the estimate of uncertain tax positions due to a change in our interpretation of administrative rulings. Excluding the impact of this expense, diluted earnings would have been $0.20 per share for the first quarter of 2022. Taking a closer look at our results, assets under management ended the quarter at $52.8 billion, up 0.6% from last quarter, which ended at $52.5 billion, and up 7.3% from the first quarter of last year, which ended at $49.2 billion.
The increase in assets under management from last quarter was driven by market appreciation, including the impact of foreign exchange of $0.3 billion with no impact from net flows. The increase from the first quarter of last year reflects $2.6 billion in market appreciation including the impact of foreign exchange, and net inflows of $1 billion. As of March 31, 2021, our assets under management consisted of $19.4 billion in separately managed accounts, $30.7 billion in sub-advised accounts, and $2.7 billion in our Pzena funds. Compared to last quarter, separately managed account assets remain flat, sub-advised account — sub-advised assets reflecting $0.3 billion in market appreciation and foreign exchange impact, and $0.1 billion in net outflows, and assets in Pzena funds increased slightly due to $0.1 billion in net inflows.
Average assets under management for the first quarter of 2022 is $53.1 billion, an increase of 3.1% from last quarter, and an increase of 17% from the first quarter of last year. Revenues for the first quarter totaled $52.8 million, increasing 3.5% from $51 million last quarter, an increase in 15% from $45.9 million in the first quarter of 2021. These variances primarily reflect the change in average assets under management over the respective periods. A weighted average fee rate was 39.7 basis points for the quarter compared to 39.6 basis points last quarter, and 40.4 basis points for the first quarter of last year. Asset mix across our strategies and distribution channels, as well as performance based fees are generally the primary contributors to changes in our overall weighted average fee rate.
However, changes in asset levels may also impact our fee rates as the majority of our separately managed accounts passed management fees pursuant to a schedule in which the rate we earn on the AUM declines as the amount of AUM increases. Our weighted average fee rate for separately managed accounts was 53.2 basis point for the quarter compared to 53.9 basis points last quarter and 54.5 basis points for the first quarter of last year. The decrease from last quarter primarily reflects a shift in assets to certain strategies that typically carry lower fee rates. The decrease from the first quarter of 2021 primarily reflects an increase in assets due to market appreciation.
As the rates we are on the majority of our fee schedules decline as the assets increased. Our weighted average fee rate for sub advised accounts was 28.5 basis points for the first quarter of 2022 compared to 27.4 basis points for the fourth quarter of 2021. 27.0 for the first quarter of 2021. Certain accounts related to one client relationship have fulcrum fee arrangements. These fee arrangements require a reduction in the base fee. If the investment strategy under performs it’s relevant benchmark. Or allow for a performance fee if the investment strategy outperforms its benchmark. During the first quarter of 2022, we recognized the $0.5 million of performance fees related to these accounts. During the fourth quarter of 2021and the first quarter of 2021, we recognized $0.91 million reductions in base fees related to these accounts.
These fees are calculated quarterly and compare relative performance over a three-year measurement period to the extent that three-year performance record of these accounts fluctuate relevant benchmark. The amount of base fees recognized may vary. The weighted average fee rate for Pzena funds was 69.5 basis points for the quarter, decreasing from 71.7 basis points last quarter, and increasing from 68.1 basis points for the first quarter of last year. The decrease from the fourth quarter of 2021, primarily reflects a shift in assets to certain strategies that typically carry lower fee rates. The increase from the fourth quarter of 2021 primarily reflects an increase in performance fees recognized in the first quarter of 2022. Our operating margin was 50.5% this quarter, decreasing from 52.0 last quarter, and increasing from 50.2% in the first quarter of last year.
Looking at operating expenses, our compensation and benefits expense was 21.2 million for the quarter, increasing from $20 million first quarter and from $19.1 million for the first quarter of last year. The increase from the fourth quarter of 2021 reflects compensation expenses recognized in the first quarter associated with tax payments and the company’s employee profit sharing and savings plan, which generally not recur during the rest of the year. The increase in compensation and benefits expense from the first quarter of 2021 reflects an increase in employee headcount and compensation. G&A expenses were $4.9 million for the first quarter of 2022, compared to $4.5 million last quarter, and $3.7 million for the first quarter of last year.
The increase from last year and first — from last quarter and the first quarter of last year primarily reflects an increase in professional fees and travel and occupancy costs. Other income was $0.1 million for the quarter reflecting the performance of our investments. Turning to taxes, the effective tax rate for our unincorporated and other business taxes was 27.5% this quarter, compared to 4.3% last quarter, and 3.2% in the first quarter of last year. The increase in the effective tax rate this quarter reflects the aforementioned $5.9 million expense associated with a change in estimate of uncertain tax positions due to a change in interpretation of administrative rulings.
We expect the effective tax associated with the unincorporated and other business taxes of our operating company to be between 4% and 6% on an ongoing basis. Our effective tax rate for our corporate income taxes, excluding UBT and other business taxes, was 28.3% this quarter compared to 24.6% last quarter, and 26.4% for the first quarter of last year we expect this rate to be between 25 and 27% on an ongoing basis. The allocation to the non-public members of our operating company was approximately 77.3% of the operating company’s net income for the first quarter of 2022 compared to 78% last quarter and 78.4% for the first quarter of last year.
The variance in these percentages is the result of changes in our ownership interest in the operating company. During the quarter through our stock buyback program, we repurchased and retired approximately 273,000 shares of Class A common stock and Class B units for $2.4 million. At March 31st, there was approximately $38.9 million remaining in the repurchase program. At quarter end, our financial position remains strong with $35.6 million in cash and cash equivalents. We declared a 3% quarterly dividend last night. Thank you for joining us, and we’d now be happy to take your questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first question for today comes from Mike Sykes of Pzena. Mike. Your line is now open.
Mike Sykes
Good morning, Rich, and congratulations to Jessica. I have two questions. The first was just maybe you could provide a little more color on the tax expenses quarter, and whether this is likely to come up in the future, maybe a benefit to you guys. I just want to get a little more understanding about what may have happened there. Thanks.
Richard Pzena
Actually, we we’re not changing any tax positions. We increased the reserve due to an adverse tax ruling or tax court case, and a company that has similar but not identical characteristics to lots on the UBT unincorporated business tax. So we don’t anticipate any change in filing position and we expect if things go our way that we will reverse this reserves. But we thought that development was prudent to have a bigger reserve, and that’s why we took that.
Mike Sykes
Understood. Okay. And then just in terms of the value investing universe today, it seems like we’ve had some pretty significant volatility. I mean, one of the stocks was traditional growth stock is now compressed quite a bit today. And I guess my question would be, in light of some of the out-performance in some stocks in the value universe. And obviously some fallen angels or whatever you want to call it from the growth aspect, do you feel like there’s an opportunity to expand some of your core competencies in the industries that you follow. Just given some of the dynamics today, or do you just see a path where you’re focusing on what you’ve done traditionally? Thanks
Richard Pzena
If you mean by expanding our core competencies as moving into more growth for opening or starting up growth type strategies, I would say no, we don’t see any change in that. If you’re asking the question to say, are there companies that have historically been viewed as growth stocks that come into the value universe, of course, we’re open to that. We don’t think we’re anywhere near that being a dominant situation, given how wide the spreads were and even though they’ve narrowed. When you look at it on a fully — on a cap-weighted basis, the narrowing hasn’t been tremendous. And when you look at it on the company-specific basis,
Richard Pzena
Most I’m not going to say all, but most climbs in valuation in the growth stock universe have come from companies where the valuations were highly speculative, relative earnings which have not yet materialized. As opposed to the big, successful franchises that have operating earnings, really getting into. I would say they are just not in our range, broadly speaking. So we certainly have owned in the past companies that are today considered growth stocks and that are fairly expensive. Companies like Microsoft and Google have been in our portfolios in the past 10 years but I wouldn’t say that there is a broad opportunity for us to be looking at those yet. So I don’t know if I exactly answered your question. Hopefully I did.
Mike Sykes
That was that was terrific. Thanks, Richard and congratulations on the quarter.
Richard Pzena
Thank you.
Operator
Thank you. Our next question comes from Tom Brownell, from Rock Point Advisors. Tom your line is now open.
Tom Brownell
Great. Thanks. Good morning, Richard. Good morning everybody. Just following up on that last question, I was wondering if you could talk a little bit about the performance in the first quarter investment performance that is perhaps focusing on your large cap domestic strategy. And then secondly, just real quickly, last quarter, I think we talked a little bit about and this also fallen out of that last question, we’ve talked about, I don’t know if launching is the right word, but at least contemplating moving into high yield, less distressed as perhaps an area that you might explore and I was wondering if that still live or not? Thanks.
Richard Pzena
Sure. Across the board, we outperformed our benchmarks in the first quarter. The first quarter looked like it was a continuation of this great value cycle recovery up until the Russian invasion of Ukraine where things turned back a little bit. So I would say the first half of the quarter, we had very wide leaves against and against the broad market industries and they narrowed a bit in the second half of the quarter. But the quarter still wound up being being a good quarter for us. Not just in U.S. large cap value, but broadly speaking, across all of our strategies. And I would say the issues were never typically associated with value cycles, what are not only the Ukrainian situation, they are also years that have reemerged in the marketplace around recession, mostly tied to what appears to be consensus views that interest rates will go up dramatically to help ward off the inflation.
And so obviously, we always take a long-term approach and generally are not reacting to macro events, so we’ve stayed the course, but that broadly describes how our investment performance looked. As far as our move into high yield and leverage loans, no worse where we made the decision that this is a potential area of opportunity for us, primarily because we think that our industry research and our company specific research can provide us with a pretty nice competitive position in the marketplace for investing in high yield. This is a long-term investment, so we don’t expect to be able — to even be thinking about offering any of these products or services to our clients for the foreseeable future. We have been building up our knowledge and expertise and systems and administrative capability And plan to fund an incubation strategy sometime before the end of the second quarter. But I don’t think it’s reasonable to think that there’s any significant revenues for us for the next couple of years.
Operator
Thank you. [Operator Instructions] We have no further questions, so that concludes today’s conference call. Thank you for joining. You may now disconnect.
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