Oct 25, 2007
Executives
Philip Talamo - Director of IR Gerald M. Lieberman - President and COO Lewis A.
Sanders - Chairman and CEO Robert H. Joseph, Jr.
- Sr. VP and CFO
Analysts
William Katz - Buckingham Research Group Cynthia Mayer - Merrill Lynch Marc Irizarry - Goldman Sachs Craig Siegenthaler - Credit Suisse Robert Lee - Keefe, Bruyette & Woods
Operator
Thank you for standing by and welcome to the AllianceBernstein Third Quarter 2007 Earnings Review. At this time, all participants are in a listen-only mode.
After the formal remarks, there will be a question-and-answer session and I will give you instructions on how to ask questions at that time. As a reminder, this conference is being recorded and will be replayed for one week.
I would now like to turn the conference over to the host for this call, the Director of Investor Relations for AllianceBernstein, Mr. Philip Talamo.
Please go ahead.
Philip Talamo - Director of Investor Relations
Thank you, Henry. Good afternoon everyone and welcome to our third quarter 2007 earning review.
As a reminder, this conference call is being webcast in the support of a slide presentation that could be found in the investor relation section of our website at www.alliancebernstein.com\Investor Relations. Presenting our results today is our President and Chief Operating Officer, Gerry Lieberman; Lewis Sanders, our Chairman and Chief Executive Officer; and Bob Joseph, our CFO who will also be available to answer questions at the end of our formal remarks.
I would like to take this opportunity to note that some of the information we present today is forward-looking in nature and is such, is subject to certain SEC rules and regulations regarding discloser. Our discloser regarding forward-looking statements can be found on page 2 of our presentation as well as in the risk factor section of our 2006 10-K.
In light of the SEC's regulation update, management has limited to responding to increase from investors and analysts in a non-public form. Therefore, we encourage you ask all questions of a material nature on this call.
At this time, I'd like to turn the call over to Gerry Lieberman.
Gerald M. Lieberman - President and Chief Operating Officer
Thank you, Phil, and good afternoon to everyone on the call. Let's begin with a brief recap, our capital market performance for our third quarter of 2007.
Display 3 shows despite a significant market turbulence throughout most of the quarter, a strong September enabled the S&P 500 and Russell 1000 Growth indices to post solid or better returns. Also, as you can see, the Russell 1000 Growth index outperformed both the S&P 500 and the Russell 1000 Value index for the second consecutive quarter with the Russell 1000 Value index posting a negative return for the first time since the first quarter of 2003.
In fact, 12 months trailing returns for the Russell 1000 Growth were better than its Value counterpart for the first time in four years. Finally, despite the crises that rolled much of the fix income markets during July and August, the Lehman Aggregate index reflects the strong return of 2.8% for the quarter.
Turning to non-U.S. capital markets on display 4, you can see that all three equity indices also posted weaker returns in the third quarter than in the second quarter.
While the MSCI World and MSCI EAFE indices once again performed roughly in line with the S&P 500, the MSCI Emerging Markets index far outpaced all other indices shown on these two slides posting 14.4% return. Highlights of our relative investor returns are summarized on display 5.
As I have mentioned before, relative performance of our growth services have typically been very strong during periods where growth equities outperformed value equities, and this quarter was certainly no exception. More specifically, all but one of the growth services that we track in the appendix exceeded its benchmark in the third quarter.
There are many cases. Relative out performance was quite significant ranging from 200 to 400 basis points.
We see potential for continuous success in these services. On the other hand, our value equity services underperformed relative to benchmarks and our fixed income services posted slightly negatively relative returns.
Overall, returns of our hedge fund services were disappointing, especially in our diversified services where absolute returns were negative. Our blend strategies services performance was respectable with strength in international and U.S.
services, the weakness in emerging markets. Additional detail on the relative performance of many of our services can be found in the appendix on slides 27 to 36.
I'll begin my discussion of changes through our assets under management with display 6. Driven almost entirely by market appreciation, total AUM grew by 3% sequentially.
While gross sales were quite robust at $34.4 billion, net flows were tapping totaling just $390 million. This weakness was especially concentrated on our intuitional investments shown and is largely the result of the loss of $6 billion in low fee price index managed.
Retail net flows were essentially zero as continued strength in U.S. mutual funds was offset by non-U.S.
fund net redemptions an apparent reaction to the uncertainty caused by the subprime crises. Retail flows were also adversely affected by previously announced increased investor minimums on certain separately managed account service that were implemented early in the quarter.
In contrast, our private client channel had another solid quarter with more than $2.4 billion in that influence. Changes in assets that are managed by channel for the trailing 12-month period as show on display 7, total AUM increased by 23% or $153.5 billion with market appreciation accounting for more than three quarters of the increase.
Net inflows of $33.8 billion translate to an organic growth rate of just over 5% as a weak third quarter negatively impacted this metric. However, adjusted net inflows for the $6 billion in index terminations would have resulted in organic growth rate of 6%.
Institutional investments accounted for 40% of total inflows while both retail and private client each contributed just under 30%. Notably, our private client channel delivered the highest organic growth rate for this time at nearly 11%.
Display 8 summarizes the changes in AUM by investment service for the three months ended September 2007. Our value equity services continue to generate the lion share of net inflows, at $7.5 billion for the quarter while fixed income had inflows of $1.1 billion.
Growth equity services had net outflows of $1.8 billion but recent strong performance added $11.4 billion to AUM. The story is quite similar when starting with changes in AUM by investment service over the previous 12 months, as you can see on display 9.
Again, value equity services led the way with $35.3 billion in net inflows followed by fixed income services was $11.8 million. I will start my discussion of distribution channel highlights referred to the third quarter with display 10.
Institutional assets rose 2% sequentially, a strong market appreciation was particularly offset by the net inflows I discussed... net outflows that I discussed earlier.
Despite these net outflows, over 100 institutional mandates were funded during the quarter. This channel generated more than $18 billion of AUM from new accounts with value and blend services accounting for 80% of that total.
From a geographic perspective, global and international services comprised approximately 86% of these new assets, a continuing trend. Lastly, while our pipeline of one but unfunded institutional mandates fell somewhat we expect our pipeline to improve in 2008 in part to our growing momentum to the defined contribution market.
Turning to display 11, you will see that our retail channel had a relatively quiet quarter, with assets under management up $4 billion or just 2% as net flows were inconsequential. This quarter, we are introducing a new face to you of this display; Investments Strategies for Life captures the three most important services that we provide to retail clients and represent the best thinking of the firm for these clients.
These services are wealth strategies, CollegeBoundfund, and retirement strategies, which are our target deep solution for smaller defined contribution players. This suite of services continues to build momentum from an asset gathering and recognition perspective during the quarter.
Wealth strategies added $1 billion in assets and retirement strategies reached the $1 billion milestone. As for recognition and they just recently completed a survey by PlanAdviser magazine, AllianceBernstein's retirement strategies, suite of target day funds, you see more citations as best in class that any other firm in the industry.
Also, our CollegeBoundfund 529 offering was once again ranked number one in the nation by savingforcollege.com, an $8.5 billion in AUM this is the second largest state sponsored plan in the nation. Highlights of our private client show are shown on display 12.
Strong net inflows and market appreciation contributed equally to the 3% sequential growth in assets for the quarter. For the trailing 12-month period, both gross and net inflows set firm records of $18.3 billion and $19.5 billion respectively, contributing to an outstanding 26% year-over-year growth rate, and we anticipate continued robust growth in this show.
We added 24 financial advisors to our staff this quarter to support these growing assets and now employ 341 financial advisors in the U.S. and U.K, a 17 % increase towards the end of September 2006.
Highlights for institutional research services are shown on display 13. Year-over-year revenue growth of 18% driven by double digit growth on our European office resulted in a record quarter for our sell-side business.
We continue to expand our research platform having large coverage of the Southern European banking sector during the quarter, and maintain a robust global pipeline of future coverage launches. As I am sure many of you are aware, Institutional Investor released their latest U.S.
poll just this past week, and I'm proud to say that our firm had another excellent year. In fact, this year's number 7 ranking was the highest in the history of the firm.
For the fourth consecutive year, we placed in the top 10 in II's league table. Also, 95% of our analysts publishing at the start of the year were recognized, including 6 analysts voted number 1 in their sector.
The next 3 slides offer detail on some very important characteristics of our assets under management. Display 14 looks at two aspects of our AUM from a geographic perspective.
A pie chart to the left shows 39% of our AUM was currently managed on behalf of clients who reside outside the United States compared to 34%, a year ago. During the last 12 months, assets from these clients grew by 39% to $315 billion.
You'll note, this growth far outpaces the 23% growth in total AUM for the firm, and accounted for nearly 58% of total AUM growth. Year-over-year growth in global and international investor sources tells me even a more compelling story.
As shown by the pie charts that are right of the display, growth in these services was 46%, double the firm's total AUM growth rate. Assets in these services accounted for 60% of our total at the end of September, up from 51% at the end of third quarter '06.
Said another way, U.S. centric services grew by just $1 billion last year, so global and international investment services represented more than 99% of the firm's growth in total assets under management over the last 12 months.
We have been discussing the trend towards global and international investing for sometime now. We believe that the piece of this trend will not be abating any time soon, and anticipate continuous success to this arena.
Furthermore, this mix added 400 basis points to our revenue growth during the last 12 months. Details of our successful blend strategy services are provided on display 15.
Our blend strategy services totaled $173 billion at quarter end and increased 48% year-over-year. These services accounted from the 21% of our total assets under management at September 30, 2007, up from just under 18% last year.
Evidence of the disappointing hedge fund performance, we referenced in today's press release, is shown on display 16. For the first time in several years, our hedge fund assets fell sequentially, down 5% to $10 billion at the end of the third quarter.
The drop in AUM was a result of disappointing performance in our diversified services, which more than offset single-digit organic growth during the quarter. As indicated by their name, our diversified hedge fund services seek to generate returns from multiple uncorrelated sources.
As such, you should not compare their performance with any single investment strategy. Despite disappointing performance during the third quarter, our hedge fund assets have increased by 38% year-to-date.
Disappointing performance aside, I would like to point out that we have not established materially high watermark issues in our diversified services, as our year-to-date absolute performance is in the mid single-digit loss range or better in virtually all of these services. Now, I'll begin my discussion of our financial results, beginning with revenues on display 17.
Net revenues for the quarter were approximately $1.2 billion, a 23% increase versus the third quarter of 2006 and our fourth consecutive quarter in which revenues exceeded $1 billion. Advisory fees grew by 28% and accounted for 88% of this growth.
Record revenues with institutional research services were driven by the exceptional strength in Europe, while other revenues fell 15% to the lower market... mark-to-market gains on deferred compensation investments including hedge funds.
On display 18, you can see that the 28% growth in advisory fees was attributable to 28% increase in base fees. Base fees grew as a result of higher AUM with all three channels posting greater than 20% year-over-year increases in revenues.
In addition, the growth of global and international investment services in our institutional investment channel generated greater... higher average fee utilization rates.
The firm's AUM growth rate of 24% translated into 28% increase in free revenue owing to the aforementioned mix improvement. Turning to operating expenses, slide 19 shows that total expenses grew by 16% or 700 basis points less than the increase in their revenue.
I'll come back to employee comp and benefits in a moment. But for now, let's drop down to promotion and servicing expenses, which increased by 17% primarily due to the higher distribution plan payments as retail AUM grew by 23% year-over-year.
Higher traveling expenses also contributed to this increase as our client base and operational footprint continue to become increasingly global. Moving down this display, you can see that general and administrative expenses increased by only 9% to $145 million in the third quarter.
It marks the second consecutive quarter where G&A expenses grew by less than 10% versus the prior year quarter. The increase in this expense item continues to derive from our ongoing investment in office space and technology to support the growth of our global operations.
Now, let's turn to display 20 for a granular look to employee compensation and benefits. Here you can say that employee comp and benefit expenses rose 19% to $447 million.
Base compensation is up 15% versus last year driven primarily by 15% increase in headcount and in our annual merit increases. At the end of September 2007, our firm employed more than 5,400 people across 25 countries.
Incentive compensation increased 19% year-over-year, primarily due to higher accruals for estimated year-end bonuses and higher deferred compensation expense in deferred compensation list. On display 21, you'll see that net income for the operating partnership grew by 38% versus the third quarter of 2006.
Importantly, operating margin expanded at 32.9% more than 400 basis points higher than 3Q '06 and 190 basis points higher than the second quarter in 2007. I would also like to point out a continuing trend that's evidenced on this display, so quick math will tell you that we had an effective tax rate north of 9% in the third quarter of 2007 versus 7% in the third quarter of 2006.
As I mentioned previously, our effective income tax rate increases when our non-U.S. business grows faster than our U.S.-based business.
On display 22, you can see that holding companies share of AllianceBernstein's $348 million third quarter, $270 earnings was $115 million versus $82 million in the same quarter last year, resulting in net income after taxes of $105 million or 42% greater than the third quarter of 2006. Diluted net income and distributions per unit of $1.20 represents 38% increase versus the prior quarter, which was slightly lower than the growth of net income, which would increase in fully diluted units outstanding relating to employee option exercises.
I'll wrap up my comments by highlighting the more important 3Q '07 developments listed on display 23. Our growth services performed exceptionally well against their respective benchmarks, while our value services generally underperformed.
Hedge funds declined for the first time in several years, as disappointing performance in our diversified services more than offset net inflows into hedge funds. Organic growth slowed as a quite strong private client net inflows were offset by institutional net outflows.
Our global reach, both in terms of the client domicile and geographic scope of our investment services, continued to increase as assets associated with global and international services and non-U.S. clients once again grew faster rates than total AUM.
Third quarter financial results were outstanding with 23% growth in revenues, 38% growth in net income and operating margin expansion of 400 basis points to 32.9%. Finally, due to a significant decrease in previously forecasted hedge fund and performance fees for the fourth quarter of 2007, we are lowering previous earnings guidance for the full year of 2007 from a range of $4.90 per unit to $5.25 per unit to $4.50 to $4.80.
This testament is based on net asset inflows continuing at levels similar to the third quarter of 2007, adjusting for the $6 billion index mandate losses and assumes that equity and fixed income market returns at annual rates and up 8% and 5% respectively for the fourth quarter. Let me remind you that earnings are subject to considerable uncertainty including, but not limited to capital market volatility, which can be amplified by the increase in assets under management, subject to performance fee arrangements.
As we near the end of 2007, a year that's shaping up to be another successful one, I want to stress that our success as a firm derives from our ability to provide world class service and generate superior investment returns to our clients. Our staff's continued focus on the best interest of all of our clients is the means to this continued success, which in turn of course translates into success for all of our stakeholders.
And now, Lou and I are available for your questions. Question And Answer
Operator
Thank you. [Operator Instructions].
Thank you. Our first question is coming from Bill Katz from Buckingham Research.
Please go ahead.
William Katz - Buckingham Research Group
Okay. Thank you and good afternoon.
I was just wondering if you could talk a little bit about flows and sort of the question... first question is on the institutional side.
If you look more broadly than just this one quarter, it seems like the organic growth rate in the absolute level of flows continues to decelerate. And I'm sort of curious, how much of that reflects to sort of the macro backdrop verses perhaps starting to reach an upper limit under the client benefit business?
That's my first question.
Lewis A. Sanders - Chairman and Chief Executive Officer
Hi, Bill. It's Lou Sanders.
William Katz - Buckingham Research Group
Hello.
Lewis A. Sanders - Chairman and Chief Executive Officer
I think both are contributed. It's very difficult to do an accurate attribution when you try to decompose flows.
The changes that you cite are evident, but they're fairly subtle, and I think if there was any noteworthy feature of the marketplace certainly in the U.S., it is... the shift in assets is from DB to DC and as you know we have a comprehensive effort to build our presence in the DC arena and we are enthusiastic about our prospects.
And noted in Gerry's remarks as well as mine in the press release that we are gaining traction and we do anticipate that it will begin to reflect itself more meaningfully inflows in 2008.
William Katz - Buckingham Research Group
Okay. And the other question also said as outflows for now and then I'll hop back in the queue perhaps.
On the private client's side, it has been... one area where there's been tremendous growth has been in the alternative product line.
Just sort of curious if the recent volatility and performance here dense that growth on a go-forward basis?
Gerald M. Lieberman - President and Chief Operating Officer
Bill, you know, possibly but I think that you need to understand, I think you do, but let me reiterate that. Our private client offering is rarely a point product relationship with the client.
It can take that form but that would be unusual. Instead, the alternatives are part of many services that clients engage with us for as part of a broad plan, the alternatives tend not to be a major part of that plan just because of their very character, and as a result, I wouldn't anticipate a very significant reduction in flows related to a one quarter of motivation and return.
There'll be some slowing is certainly possible, but I think if you see it in this broader context, you will find it appropriate.
William Katz - Buckingham Research Group
Okay, thanks. I'll hop back in the queue.
Operator
Thank you. Our next question is coming from Cynthia Mayer of Merrill Lynch.
Please go ahead.
Cynthia Mayer - Merrill Lynch
Hi, good afternoon. I was interested in the retail dynamics.
It sounded like the non-U.S. clients took out money and I am wondering if you have seen that dynamic before or if you are seeing it come back at all?
Robert H. Joseph, Jr. - Senior Vice President and Chief Financial Officer
Cynthia, we are particularly strong outside the U.S. in our fixed income services and with all those turmoil that took place in the quarter, the gross flows were impacted by that as well as in that flows.
We don't expect that to be a long time... a long time at all.
We expect that to come back as soon as it will, a little less uncertainty overseas in this arena.
Lewis A. Sanders - Chairman and Chief Executive Officer
Although the timing of course of that recovery is unpredictable, Cynthia. What gives us some confidence is that our global fixed income services are actually performing quite well.
Cynthia Mayer - Merrill Lynch
And I guess can you give us any sense of what you are seeing in this quarter because it sounds like in terms of you are guiding, it sounds like you are assuming basically no flows in 4Q?
Lewis A. Sanders - Chairman and Chief Executive Officer
That is the assumption. We will see how the quarter unfolds.
Operator
Thank you. Our next question is coming from Marc Irizarry of Goldman Sachs.
Please go ahead.
Marc Irizarry - Goldman Sachs
Oh, great. Thanks.
Lewis, this is a question for you on hedge funds just in terms of having multiple uncorrelated strategies. It obviously looks like the diverse fund strategy may be proved to be less so during the quarter.
Now when you are going... I guess it's a twofold question.
One, can you just dig into a little more what happened and then also your plans to market that performance to institutions, where do those stand? Thanks.
Lewis A. Sanders - Chairman and Chief Executive Officer
Well, I think you are aware by the way you posed the question that alpha sources that have a history of low and no correlation actually were in many cases highly correlated in the third quarter. And there was some of that in our return profile as well.
On part b, we are indeed active in building presence institutionally with the services and the main optimistic about our potential third quarter results not withstanding by comparison to the fund community more broadly and within the context of the history of these services, third quarter is in our judgment unlikely to pose a very serious impediment to our success institutional.
Operator
Thank you. Moving on to the next question.
It's coming from Craig Siegenthaler of Credit Suisse. Please go ahead.
Craig Siegenthaler - Credit Suisse
Hi, thanks. Just a question here on target date funds, wondering when you pointed that out on slide 11, how this business is directing in a benefit from the recently rolling from the department of labor.
How you think this could trend in the next few years?
Lewis A. Sanders - Chairman and Chief Executive Officer
Yes, it's a tremendous benefit. It creates a safe haven for companies to do what's right for, for their employees, and we think it's going to create real opportunities for us.
The one that here to four [ph] was hard for us to take advantage of, so the time is right for us. We came up with what we think are great target date services.
I think we have a great story to tell in regards to how the help funds improve quite frankly, therefore our 1-K programs and we think this is of a great benefit for our clients, for their employees and for us.
Craig Siegenthaler - Credit Suisse
Got it. And then on the 40, the roughly $0.40 revision to guidance all that coming from hedge funds performance fees, I am just wondering can you give us a target of how much EPS in '07 is roughly coming from performance fees, so we can kind of estimate how that should trend in '08 and kind of see what a core number is on that basis?
Robert H. Joseph, Jr. - Senior Vice President and Chief Financial Officer
We don't have that number on our fingertips, but it's easy for you to compute.
Craig Siegenthaler - Credit Suisse
How's that?
Robert H. Joseph, Jr. - Senior Vice President and Chief Financial Officer
Well, the numbers are completely disclosed for last year and we've given you enough color about this year for you to judge what our expectations actually are. As uncertain as they remain, I must empathize given that the year is not yet over and as Gerry noted and as the press release stresses, the earnings still remain sensitive to capital market returns and our performance relative to there too.
Craig Siegenthaler - Credit Suisse
Got it. Thanks a lot.
Operator
Thank you. Our next question is coming from Robert Lee of KBW.
Please go ahead.
Robert Lee - Keefe, Bruyette & Woods
Thank you. Good afternoon.
First question is on the margin. As you noted, you know, a pretty substantial margin improvement.
Is there any reason that we shouldn't expect this a sustainable rate going forward, and how do you feel about your ability to even improve margins assuming you have some descent top-line growth going into 2008?
Lewis A. Sanders - Chairman and Chief Executive Officer
Well, we work hard to manage the margins in a thoughtful way, Bob, as you know. We certainly aren't anticipating an increase in margin going forward like we are showing right now.
But we worked hard on the G&A line. That helps a little bit.
Growing the revenue obviously helps a little bit. So I think we can sustain where we are in improvement.
I think I've mentioned on this call before, we don't look for our firm to end up with a ford [ph] bigger than these margins numbers. We are not heading in that direction, and we don't manage to get there.
Robert Lee - Keefe, Bruyette & Woods
Okay.
Lewis A. Sanders - Chairman and Chief Executive Officer
Does that help.
Robert Lee - Keefe, Bruyette & Woods
Yes, it does. And second question is on the fixed income business.
You noted that, I guess, year-to-date that business seems to have picked up and I think you mentioned you had some pretty good numbers in your global fixed income strategies. Can you give us some more color on how you see that business progressing?
Inflows, they were a little below where they had been running. Do you see...
are you pretty optimistic about that heading into 2008?
Lewis A. Sanders - Chairman and Chief Executive Officer
Yes, we remain optimistic for the reasons that you cited.
Gerald M. Lieberman - President and Chief Operating Officer
Bob, the third quarter had the negative numbers in our retail channel for fixed income, all right. And we liked the performance numbers.
We liked what we have done in these investment services. We liked the reception that we've seen in clients in this space.
So we are optimistic about our fixed income services.
Lewis A. Sanders - Chairman and Chief Executive Officer
And you have to see the institutional fixed income businesses as having evolved from performance against the benchmark to relationships that are fabricated on meeting unique client objectives, often in using cash as well as emphatics and mandate designs that aren't standardized. And so our success in this domain rest as well on our capabilities to actually compete well for mandates of that character was increasingly characterized the comparative settings especially outside the United States.
Robert Lee - Keefe, Bruyette & Woods
Okay. Thank you.
Operator
Thank you. Our next question is a follow-up from Bill Katz from Buckingham Research.
Please go ahead.
William Katz - Buckingham Research Group
Thanks again. Gerry just go back where you were you talking about higher watermark issue.
I just want to make sure I understand that. As you look out to next year, is it a reset to the calendar date or is it based on rolling terms, trying to get a better hand on sort of the leverage into next year?
Lewis A. Sanders - Chairman and Chief Executive Officer
Gerry's point was to stress that as things now stand, they are not material high watermarks to have to overcome, before the diversified services would be in a position to earn performance fees. There are some but they are not really material, and it's not calendar date base.
It's a rolling schema. You should also understand that there are hedge funds in the line that are fairly strong like positive returns here to-date, and are earning meaningful performances.
William Katz - Buckingham Research Group
And the other question, in terms of the operating leverage, if I recall correctly, you were accruing [ph] compensation against a certain level of, I guess, anticipate performance fees. How much if any of the operating leverage this quarter reflected any kind of reversal of those compensation accruals?
Robert H. Joseph, Jr. - Senior Vice President and Chief Financial Officer
There some in there Bill, and you can figure this out yourself by looking at the, what we've now put into comp for the nine months versus the compensation versus where we were before, and there was indeed a year-to-date update on that number in the quarter. So that's a good catch.
William Katz - Buckingham Research Group
And then if I can ask just one more since I have here, just sort of curious. Given the robust growth in value and what seems to be a more decisive shift to growth in the industry, I'm so surprised you are not seeing a more robust shift into growth as some of your competitors are?
And do you think that the ultimate outcome here is a flattening of flows given a slowdown in value offset by increasing growth?
Lewis A. Sanders - Chairman and Chief Executive Officer
Look. This is actually a fairly immature phenomenon Bill that is growth outperformed value.
It's really less than two quarters. And so if one were to extrapolate these conditions, I think you could make a prediction that value flows would slow some, growth flows would accelerate.
And we would anticipate participating on both parts of that equation. Remember too however that it would be muted in our case because of style blend, which is a growing part of the mix and where this has moved indeed that's its principle attribute.
William Katz - Buckingham Research Group
Okay. Thank you.
Operator
Thank you.
Gerald M. Lieberman - President and Chief Operating Officer
Just to explain a little bit on the last comment, it's principle attribute. This will further sell show client, why that is a great solution and the coming year of the firms and the coming year of our...
of these services represents a great solution for our clients.
Operator
Thank you. Our next question is a follow-up from Cynthia Mayer of Merrill Lynch.
Please go ahead.
Cynthia Mayer - Merrill Lynch
Hi, just a follow-up on the high watermark issue. Can you give us a sense of this historic return of the diversified services, so we can get a sense of how easy it would be to overcome a mid-single digit deficit?
Lewis A. Sanders - Chairman and Chief Executive Officer
Well, Cynthia naturally, we can't do that easily by a telephone call, but let me summarizes by saying that the return profile for those services in the third quarter was not statistically provocative, which is to say that within the range of predications one would make given the character of those services and outcome like the third quarter, which was negative, would not have been highly unusual. It wouldn't have great frequency, but it would not be highly unusual.
There is a rough cemetery to the distribution of returns. So that quarters that proved as hostile as third quarter have corresponding quarters that are highly favorable but unpredictable in their appearance.
So therefore, when during the forecast as to... when they might be recovery and will it have similar magnitude isn't really possible.
The message I am trying to leave is there isn't anything about the third quarter return that will make you feel their expectations for returns in the services need to be adjusted.
Cynthia Mayer - Merrill Lynch
Okay. And since it sounds like the hedge funds a lot of them reside in private client and some of the hedge funds are doing well, would you expect rather than outflows across the hedge funds as a group to see money transfer from one to the other?
Lewis A. Sanders - Chairman and Chief Executive Officer
No, I wouldn't anticipate that at all. I mean you know again, I want to stress that the hedge funds and private client for the most part, there are exceptions to this, but for the most part...
a part of a well-crafted investment plan, which employs multiple strategies, not just hedge funds. The ones that are selected are selected because they sit well given the other asset exposure those clients have with us and perhaps even outside of us.
And disturbing those allocations because of three months period of disappointing returns would be inappropriate to say the least. So I don't think you should anticipate anything like that.
You just have to see this in the context in which it resides. It's different than hedge funds that are standalones and point product solutions from the perspective of their client.
Cynthia Mayer - Merrill Lynch
Okay.
Gerald M. Lieberman - President and Chief Operating Officer
Cynthia, so thinking about our flows going forward and the assumption that we made, there's nothing in there for significant outflows and hedge funds.
Lewis A. Sanders - Chairman and Chief Executive Officer
We don't anticipate that. It's conceivable that as I mentioned earlier that the flows could slow somewhat in the immediate period, it's possible.
It's also possible that our progress institutionally, we've restrained a bit. It wouldn't be surprising.
But I don't think that you should judge that our interest in success in this area is going to be substantially changed as a function of this one quarter result. I want to stress again these funds, the weakest of them is down mid single-digits.
And many... a number of us actually to pretty substantially, so you have to keep this in context.
Cynthia Mayer - Merrill Lynch
Okay. Can I ask one more question?
Gerald M. Lieberman - President and Chief Operating Officer
Sure.
Cynthia Mayer - Merrill Lynch
It sounds like you're a little bit cautious on DB for next year and hopeful on DC, and I'm just wondering if you're thinking in terms of the dimensions of those two as one being a large enough as DC making up for a slow down in DB in terms of either dollars of AUM or the earnings they bring to the firm. You expect it to be enough to replace a slowdown in DB?
Lewis A. Sanders - Chairman and Chief Executive Officer
Well, first of all, I don't want to leave you with a forecast that we're anticipating a slowdown in DB. We actually didn't provide any such forecast.
We simply noted that in response I think was to Bill's question that the slowdown that's occurred could be explained by the setting in the DB marketplace in the U.S., and the emerging vibrancy of the DC arena, which is actually a new phenomenon for this firm. But I don't want to leave you with the impression that we think our global DB business in '08 is going to slow.
We are not offering that forecast one way or the other.
Cynthia Mayer - Merrill Lynch
Okay.
Gerald M. Lieberman - President and Chief Operating Officer
All right. So slowing of the DB in the U.S.
offsetting increasing performance in regards to us collecting funds on the DC in the U.S. and nothing, if anything surprises were made up in all this [ph] outside the U.S.
Cynthia Mayer - Merrill Lynch
Okay.
Robert H. Joseph, Jr. - Senior Vice President and Chief Financial Officer
So actually, when you think about institutional flows, remember that we are talking about many kinds of relationships that are outside of the pension arena. You have the emerging Simon [ph] wealth funds, you have any number of government sponsored funds, some of retirement based actually many are.
The DC encroachment isn't initial at all. If you look at our institutional business, you will note that 50% of the excess of clients' domicile is outside the United States, which is why I don't think you should...
it's simple to draw conclusion about slows as you say, well, gee the DB U.S. marketplace is migrating rapidly to DC and doesn't that therefore mean your gross rate will slow.
Cynthia Mayer - Merrill Lynch
Right. I understand.
DB is a pocket within a large institutional channel.
Robert H. Joseph, Jr. - Senior Vice President and Chief Financial Officer
Well put. More succinct than I.
Operator
Thank you. There appears to be no further questions at this time.
And I'll turn the floor back over to Phil Talamo for any closing remarks.
Philip Talamo - Director of Investor Relations
I want to thank everyone for participating on our call. As always feel free to call the Investor Relations team with any further questions.
Enjoy the rest of your evening.
Operator
Thank you. This concludes today's conference.
You may now disconnect.