Pzena Investment Management Inc. (NYSE: PZN) Q4 2020 earnings call dated Feb. 03, 2021
Corporate Participants:
Jessica R. Doran — Chief Financial Officer and Treasurer
Richard S. Pzena — Chairman, Chief Executive Officer and Co-Chief Investment Officer
Analysts:
Sam Sheldon — Punch & Associates — Analyst
Presentation:
Operator
Good morning and welcome to the Pzena Investment Management Inc. Announces Fourth Quarter and Full Year 2020 Earnings Conference Call. (Operator Instructions) Please note this event is being recorded.
I would now like to turn the conference over to Jessica Doran. Please go ahead.
Jessica R. Doran — Chief Financial Officer and Treasurer
Thank you, operator. Good morning and thank you for joining us on the Pzena Investment Management fourth quarter and full year 2020 earnings call. I am Jessica Doran, Chief Financial Officer. With me today is our Chief Executive Officer and Co-Chief Investment Officer, Rich Pzena. 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 filings with the SEC 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, to disclose material that is not public information on our conference call.
Now let me turn the call over to Rich, who will discuss our current view of the investing environment.
Richard S. Pzena — Chairman, Chief Executive Officer and Co-Chief Investment Officer
Thanks, Jessica. Everyone asks me the same question these days. So it seems I should start my remarks by trying to address that question. Was the fourth quarter the start of the long-awaited value cycle or was it just another head fake? The outcome was pretty fantastic for the value style, but so much more for deep value. Most of our strategies outperformed their benchmarks by 10 to 20 percentage points in one quarter. It was the highest alpha generating quarter in our 25-year history. The truth is, though, I really don’t know the answer to that question. And having lived through several cycles, I know that I won’t really know until it’s all become history.
Let’s consider what we actually know so far. First, value cycles and recessions are highly correlated. We have written extensively about this relationship and the data is compelling. Value rallies generally start shortly after recession start, because once the recession starts, investors start looking forward for signals of the further recovery. This relationship has held in the U.S. for nine of the last nine recessions and the data outside the U.S. is similarly well bossed.
Again value stocks actually become momentum stocks when value cycles begin, as the recovery translates into strong earnings growth for these beaten down stocks. Consider the choice investors are being offered today via portfolio of deep value stocks with two-year forward expected earnings growth rates by the consensus of 23% a year, and you can buy that for 11 times earnings or by a portfolio of the Russell 1000 Growth stocks with two-year forward earnings expected growth up 17% a year and that sells for 27 times earnings. The deep value stocks have sharp expected earnings growth as they rebound from recession lows, while the growth stocks are having difficulty growing at rates fast enough to keep up with their high flying multiples. And as investors embrace these truths, value stocks gain the moment.
Even though the fourth quarter resulted in the highest alpha generation in our 25-year history, the spread between expensive and cheap stocks have barely moved. In the U.S., the spread reduction in the quarter was a small fraction of the previously abnormally widespread and the story is similar everywhere in the world. And still, I know as I’m speaking, there are many out there who are saying no, that quarter was just an aberration, the future is tech, the future is disruption via tech, the future is carbon-less, the future is, well, you can go ahead and fill in the blank with any of the commonly repeated themes. But our research keeps us pointed at the long-term truth, buying good businesses at low prices is a winning investment strategy.
Let me share a few words about our business as we closed 2020. We finished with our fourth consecutive calendar year with positive net flows, and that makes it seven out of the past nine calendar years. I have to say on behalf of my partners and in honor of our clients, we are very proud of that record coming in an environment that has been anti-active and anti-deep value. Our AUM closed the year at all-time high of $43.3 billion and we are encouraged about the pipeline as we look forward into 2021.
I look forward to answering your questions.
Jessica R. Doran — Chief Financial Officer and Treasurer
Thank you, Rich. To review our financial results for the period, I’ll share some of our quarterly result details. We periodically present both GAAP and as-adjusted financial results. We did not adjust results for the fourth quarter or full year of 2020, however, our results for the fourth quarter and full year of 2019 were adjusted to exclude $22.7 million in nonrecurring compensation and benefits expenses. For the purpose of this discussion, I will reference the 2019 as-adjusted information.
We reported diluted earnings of $0.22 per share for the fourth quarter compared to $0.16 last quarter and as-adjusted diluted earnings of $0.20 per share for the fourth quarter of last year. Revenues were $39.9 million for the quarter and operating income was $18.2 million. Our operating margin was 45.7% this quarter compared to 44.1% last quarter and the as-adjusted operating margin of 45.5% in the fourth quarter of last year.
We reported diluted earnings of $0.52 per share for the full year of 2020 compared to as-adjusted diluted earnings of $0.73 per share for the full year of 2019. Revenues were $138.6 million for the year and operating income was $55.3 million. This compares to revenue of $150.7 million and as-adjusted operating income of $68.4 million for the full year of 2019. Our operating margin was 39.9% for the full year of 2020, decreasing from the as-adjusted operating margin of 45.4% for the full year of 2019.
Taking a closer look at our quarterly results, we ended the quarter with assets under management, as Rich mentioned, of $43.3 billion, up 30% from last quarter which ended at $33.3 billion and up 5.1% from the fourth quarter of last year which ended at $41.2 billion. The increase in assets under management from last quarter was driven by market appreciation, including the impact of foreign exchange of $10.3 billion, partially offset by net outflows of $0.3 billion. The increase from the fourth quarter of last year reflects $1.6 billion in market appreciation, including the impact of foreign exchange and net inflows of $0.5 billion.
At December 31, 2020, our assets under management consisted of $17.3 billion in separately managed accounts, $23.3 billion in sub-advised accounts and $2.7 billion in our Pzena funds. Compared to last quarter, separately managed account assets increased reflecting $4.1 billion in market appreciation and foreign exchange impact partially offset by $0.1 billion in net outflows, sub-advised account assets increased reflecting $5.5 billion in market appreciation and foreign exchange impact, partially offset by net outflows of $0.2 billion and assets in Pzena funds increased due to $0.7 billion in market appreciation and foreign exchange impact. Average assets under management for the fourth quarter of 2020 were $37.7 billion, an increase of 13.9% from last quarter and a decrease of 1% in the fourth quarter of last year.
Revenues increased 17.7% from last quarter and increased 3.9% from the fourth quarter of last year. The fluctuation in revenue primarily reflects the variance in average assets under management over the periods as well as performance fees and fulcrum fees recognized during the period.
During the quarter, we recognized $1.1 million in performance fees compared to no-performance fees being recognized during last quarter or in the fourth quarter of last year. The fourth quarter also reflects the reduction in base fees of certain accounts related to the fulcrum fee arrangements of one client relationship. These fee arrangements require a reduction in the base fee if the investment strategy underperforms its relevant benchmark or allow for our performance fee if the strategy outperforms its benchmark.
During the fourth and third quarters of 2020, we’ve recognized a $1 million reduction in base fees related to these accounts compared to $8.8 million reduction in base fees during the fourth quarter of 2019. These fees are calculated quarterly and compare relative performance over a three-year measurement period. To the extent, the three-year performance record of these accounts fluctuate relative to their relevant benchmarks, the amount of base fees recognized may vary. Our weighted average fee rate was 42.3 basis points for the quarter compared to 41 basis points last quarter and 40.4 basis points for the fourth quarter of last year. Asset mix and the impact of swings and performance fees and fulcrum fees are all contributors to changes in our overall weighted average fee rate.
Looking at operating expenses, our compensation and benefits expense was $18 million for the quarter, increasing from $15.8 million last quarter and from the as-adjusted amount of $16.2 million for the fourth quarter of last year. The increase from last quarter is driven by an increase in the bonus accrual and in the market performance of strategies tied to our deferred compensation obligations. The increase in the fourth quarter of 2019 reflects increases in compensation.
G&A expenses were $3.7 million for the fourth quarter of 2020 compared to $3.2 million last quarter and $4.8 million for the fourth quarter of last year. The increase from last quarter, primarily reflects an increase in professional fees and data and systems expense, and the decrease from the fourth quarter of last year primarily reflects the reduction in travel costs and professional fees. Other income was $6.1 million for the quarter, driven primarily by the performance of our investments.
The effective rate for our unincorporated and other business taxes was 2.9% this quarter compared to negative 6.8% last quarter and 3.3% in the fourth quarter of last year. The negative effective tax rate last quarter reflects the benefit associated with the reversal of uncertain tax position liabilities and interest due to the expiration of the statute of limitations. We expect the effective rate associated with the unincorporated and other business taxes of our operating company to be between 3% and 5% on an ongoing basis.
Our effective tax rate for our corporate income taxes, ex-UBT and other business taxes, was 24.5% this quarter compared to our effective tax rate of 26.5% last quarter and our as-adjusted tax rate of 27.6% for the fourth quarter of last year. The fluctuation in these effective rates reflect certain permanently non-deductible expenses. We expect this rate, excluding these items, to be between 24% and 26% on an ongoing basis.
The allocation to the non-public members of our operating company was approximately 77.3% of the operating companies net income for the fourth quarter of 2020 compared to 78% last quarter and 74.6% in the fourth 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’ve repurchased and retired approximately 31,09,000 shares of Class A common stock and Class B units for $0.2 million. At December 31st, there was approximately $10.5 million remaining in the repurchase program. At quarter end, our financial position remained strong with $65.5 million in cash and cash equivalents as well as $7.3 million in short-term investments. We declared a $0.25 per share year-end dividends last night.
Thank you for joining us. We’d now be happy to take any questions.
Questions and Answers:
Operator
(Operator Instructions) Our first question today will come from Sam Sheldon with Punch & Associates. Please go ahead.
Sam Sheldon — Punch & Associates — Analyst
Good morning, Rich and Jessica. Rich, you spoke about the strong investment performance in the fourth quarter with plenty of opportunities in the deep value corner of the market. Can you flush out these opportunities a little bit more, I guess what sectors are you spending the most time researching and investing in today?
Richard S. Pzena — Chairman, Chief Executive Officer and Co-Chief Investment Officer
Yeah. I mean for the most part, our portfolios are pretty well stable and not changing very dramatically. Remember a lot of this performance in the fourth quarter came from the fact that these same stocks all had been killed in the previous 12 months leading into the pandemic and through the pandemic. So our exposure continues to be skewed towards financial services, energy, consumer cyclicals and industrial cyclicals with fairly light exposures in consumer staples, real estate and mostly and electric utilities.
Sam Sheldon — Punch & Associates — Analyst
Okay. How would you characterize the current environment for value managers searches and has there been any noticeable changes to RFP activity with values broad performance and your record alpha in the fourth quarter?
Richard S. Pzena — Chairman, Chief Executive Officer and Co-Chief Investment Officer
I would say there is a big increase very, very noticeable in the, I’ll call it, pre-search activity phase. So for example we did a webcast to potential clients and prospects and existing clients in a week or two ago, and those are getting five to 10 times the volume of attendees than we had been getting for the past few years. So while — I would tell you that our pipeline is fine and it’s stable and fine is — and I don’t mean to sound bad by the word fine, there is — the search activity continues to be kind of around the pace that it’s been at maybe a little uptick is, all I can say, but the pre-search activity volume is pretty strong.
Sam Sheldon — Punch & Associates — Analyst
Got it, okay. Can you give us an update…
Richard S. Pzena — Chairman, Chief Executive Officer and Co-Chief Investment Officer
I’m sorry, I was just going to add to that, that if you look at prior cycles, it takes probably a good year for you to get into the positive side of the value cycle before you see strong movements in cash flows. At least that’s been the observation I would make from history. So we’ll see if that’s the same this time and obviously we’re very early in this.
Sam Sheldon — Punch & Associates — Analyst
Sure. That makes sense. Okay, maybe you could update us specifically on the sub-advisory business, I guess what is the sentiment there and is there any large relationships up for renewal on the horizon?
Richard S. Pzena — Chairman, Chief Executive Officer and Co-Chief Investment Officer
As you may be aware, the sub-advisory businesses are always up for renewal. As we have a — generally have an initial term and then it’s just reviewable at will by our partners. So I would tell you that the cycle of renewing is not something that we are concerned about. There has been some increased inactivity in sub-advisory from the standpoint that — it’s hard to characterize it as trends, but I would tell you, we had some very positive rebalancing that happened during the pandemic. And now, we had a big account win during the year where we established a very new sub-advisory relationship and we’re involved in discussions about incremental sub-advisory relationships going forward. But I would say renewal isn’t the issue, the issue for us is will any of this — these existing relationships start allocating more towards us as the value cycle — as they recognize their lack of or too low of a level of exposure to value. So that I think will happen. The sum of the conversations are going on. And then there is the — looking for new sub-advisory relationships, I think you know that we like this business a lot and the partners that we’ve had in sub-advisory have tended to be very, very long lived and mostly because we do what we say we’re going to do, and from everything I can tell, the relationships continue to be strong. So I think there is upside going forward, but I hope that gives you a flavor.
Sam Sheldon — Punch & Associates — Analyst
Sure, that’s helpful. Maybe you could walk us through your philosophy around the special year-end dividend and buybacks and how that possibly might have changed over time?
Richard S. Pzena — Chairman, Chief Executive Officer and Co-Chief Investment Officer
The philosophy really hasn’t changed at all. We’ve tried to use — to pay out between 60% and 70% of our earnings as a dividend and then kind of reserved the rest for stock buyback, and this year is no different than that. Obviously, we had a down year, and as you know, we pay our dividend since the vagaries of the market are very difficult to predict, we’ve operated for over a decade, I guess probably over a decade, with a modest quarterly dividend followed by year-end dividend, that’s pretty much just a calculation based on historical profitability, which was down last year because, as you know, we went through a big dip even though our assets under management ended the year at their high. We were — at the bottom, it was substantially lower, so our revenues were lower this year and our earnings were lower and that’s what led to the dividend, but philosophically that’s no different.
We’ve tended to try to be smart about timing, the stock repurchases by buying when there’s softness in our share price. And for the most part, we’ve accomplished that, we have acquired shares at reasonably attractive prices. Over time, we hope to continue doing that and we hope to deploy the excess cash that we have to buy back stock. We do it in a fashion that is cognizant of the volume of our trading activity, so you can’t turn it on and off in rapid strokes as you might imagine. But given those constraints, we want to take advantage of softness and try to redeploy as much of our capital as possible to offset dilution that comes from our share issuances under our employee compensation programs.
Sam Sheldon — Punch & Associates — Analyst
Okay. Maybe last from me, your cash and investment balance continues to grow, could you update us on capital allocation priorities and maybe what your growth initiatives are that you have in place at the business today?
Richard S. Pzena — Chairman, Chief Executive Officer and Co-Chief Investment Officer
Yeah, you have to remember about the seasonality of our cash. I mean, our cash is sort of at its high at the end of the year. And then there are substantial cash requirements in the first quarter, because we pay our bonuses and we pay our year-end distribution. So mostly, we manage to the minimum cash balance, which occurs in March or April every year and we try to have a modest cushion. So when you see where we are at the low, where there is not — you wouldn’t think of there being a whole lot of excess cash. So the cash that we have on our balance sheet is mostly temporary, and so it’s mostly focused on in short-term investments that are not risky. The only money that we put at risk — some of it is seeding new products and strategies and that we will continue to do and some of it is to fund our employees deferred compensation program, which allows our employees to allocate their deferred comp to our own investment strategies and then we take those funds and actually invest it in those investment strategies. So it has some impact on our quarterly earnings performance, it had a favorable one this quarter. The strategy continues to be primarily to increase the distribution of our existing products, to incubate new products that we think might have interest in the future. And that’s pretty much what we’re doing.
Sam Sheldon — Punch & Associates — Analyst
Okay. Thank you for taking my questions.
Richard S. Pzena — Chairman, Chief Executive Officer and Co-Chief Investment Officer
Of course.
Operator
Our next question will come from (inaudible) with Rocket Point Advisors (sic) [ Rock Point Advisors ]. Please go ahead. (inaudible) you might be muted on your end.
Unidentified Participant — — Analyst
Hi, good morning. I apologize. You are correct, I was muted. Just to be clear, it’s (inaudible) with Rock Point Advisors. Rocket Point might sound better and actually might be a great name for us at some point, first time seeing us as Rock Point Advisors. Thanks for taking the question, if I could ask you to circle back to the sales and marketing initiatives. I was — so this might be slightly repetitive but encouraged by your comment that you were encouraged by your pipeline and I was curious to hear you say that it usually takes about a year for the interest in value mandates to sort of gain traction, I’d be curious to know what you think of this being the start date in this cycle of when that might have started?
Secondly, interested to hear about the participation in your webcast, I guess my question is, is that primarily coming from the consultant space or are those actual members of investment management community that are participating in those webcast? And if depending on the answer to that question, what are you hearing from a consultant space in terms of interest in deep value strategies?
And then lastly, could you just comment quickly on whether there is any change in the sort of geographically where the interest might be coming from and whether you’re seeing greater and/or less interest in deep value strategies domestically or is that coming from abroad, as I think I’m aware you have built out something for your sales and marketing efforts internationally? So thanks.
Richard S. Pzena — Chairman, Chief Executive Officer and Co-Chief Investment Officer
Okay. I hope, well I’ll hit all these, if I didn’t you’ll remind me. Most people are dating the start of the value cycle to October 1st. You can be queued them at [ph] if you want, and we can date it back to the actual bottom of the market in March of last year. But I would, say that there was — from March 23rd, which would have been our bottom October 1st, there was a little bit of — we kept up with the market, we were a little ahead, I wouldn’t call that of dramatic value cycle. So the fourth quarter is a dramatic value cycle or at least a dramatic value performance, we hope it turns into a cycle. So I think October 1st would be my guess of where that starting point would be. The increase in interest is actually in a number of areas, but the one webcast I was specifically referring too, had a lot of financial intermediaries on, these are people that are advising clients, they’re not consultants in the institutional consulting community, but they were on as well. The — but the big bulk were on intermediaries, these are brokers that are probably answering their own clients questions about value and are trying to be educated on that.
We do see consultants and institutions working more closely, we see it in conversations, I’m going to use that same word I used before pre-search activity, conference calls, the consultants were doing educational conference calls for broad swaths of consultants, who are engaged in the same kind of questions with their clients, about should I change my investment allocation given how well growth has done and given maybe that this is the beginning.
So — and I’d say it’s kind of across the board. And you’re right to say that most of the people that we’re talking to are intermediaries rather than the ultimate investment decision-maker. But my sense is that this is getting communicated on, onward, and there is enough of those direct investors that is encouraging. They’re also asking or existing clients are asking for more engagement with their boards and committees than we’ve had lately. So all of those things are the things that give me — may have made we made the statement that pre-search activity is getting pretty, pretty interesting.
Now where is it coming from? It’s everywhere. I don’t think that there is a geographic bias. I probably can look at data and see if that’s the case, but you’re right. This is my gut instinct from the conversations I’ve had over the last few months that it’s pretty much across the board.
Unidentified Participant — — Analyst
Great. Thank you.
Richard S. Pzena — Chairman, Chief Executive Officer and Co-Chief Investment Officer
Did I get every one of your questions.
Unidentified Participant — — Analyst
You nailed it. Thank you.
Operator
(Operator Instructions). There being no further questions at this time, I would like to turn it back to Jessica Doran, who has an emailed question.
Jessica R. Doran — Chief Financial Officer and Treasurer
Thank you, operator. I will read a question from an investor that we received an email this morning. This is a question for, Rich who is operator trying to get back on the line right now. So if you could keep an eye out for that, as I read the question. We’ll just give Rich a moment to get on and respond. So the question that came in, is that — is as follows, the markets are very worrying lately, I’m observing large scale runaway valuations like Tesla, Bitcoin and GamesDot, it makes me think of stories that I read from the late ’20s on Dotcom Bubble. While I understand it’s impossible to predict when or what might happen, I’m wondering your assessment of the greater risks that might affect Pzena’s assets under management, i.e., in your view, is there a large scale that finance speculation or other risks that could cause significant and permanent capital loss in the markets? Further, how do you assess the potential impact of these risks on the assets you manage and what are your clients’ hesitation on how Pzena’s assets are positioned to weather the coming years?
Richard S. Pzena — Chairman, Chief Executive Officer and Co-Chief Investment Officer
Okay, thanks. I apologize that I got disconnected for a quick second. But look the — I’ll use the word the craziness in the market has very little impact on us because we just don’t have any exposure to any of these kinds of companies and we don’t have exposure to the high flying growth stocks that are traditional things that people have invested in, and certainly the items that have caused the market to have these giant dislocations where you stare in amazement that you could have — of the size and magnitude that you’ve had.
We’re not in those. I wish I could tell you that we own some in advance and we benefited from (Technical Difficulty) what happens is when the market is wild like this and volatility gets introduced to the marketplace, it actually creates opportunity for us. And by having a very, very disciplined approach to thinking about valuation and to assessing valuation, we can exploit when the market goes crazy in one way or another by buying things that get punitively priced and lightening up if and when we have something that would run.
Now does this cause our clients to worry about their investment overall inequities? I’m sure it does. Do I think that it’s likely to have much impact on us? I really don’t. Because one thing that we’ve succeeded at over 25 years of being in business is making sure that our clients understand exactly what it is that we do. So there are (Technical Difficulty) they understand and we’ve been repetitive over and over and (Technical Difficulty) because most of our clients particularly (Technical Difficulty) where your money which aspect of equities do you want to put your money in. And given that (Technical Difficulty) has this kind of stable, steady, operator executing the same strategy year-over-year, I think we instil some of the (Technical Difficulty) would exempt us from this kind of fear that it would impact our business. And the only thing I can point to is what happened during (Technical Difficulty), well because we were having a lot of the same discussions at the end of 1999 and early 2000 when we would stare at amazements, I can’t believe that’s going on in the marketplace. And when it unwound, we actually had the five best years of flows into our business and good investment performance, because the stocks that we owned attracted capital as people withdrew capital in companies with market values, many, many, many times the size as ours and people just buy and sell at the wrong time and we try to take advantage of that, and I know it was a red question and I don’t know, if I addressed it well enough but hopefully you can hear my sentiment.
Operator
This will conclude our question and answer session. And at this point, the conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.